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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 (FEE REQUIRED)
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission file number: 0-16641
RAINBOW TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 953745398
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
50 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92618
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (714) 450-7300
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
Indicate by check mark whether the Registrant (i) 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 (ii) has been subject to
such filing requirements for the past 90 days. Yes X No .
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K (X).
As at March 21, 1997, the aggregate market value of the voting stock of the
Registrant (based upon the closing sales price of the shares on the NASDAQ
National Market System) held by non-affiliates was approximately $130,852,641.
As at March 21, 1997, there were outstanding 7,812,098 shares of Common Stock
of the Registrant, par value $.001 per share.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Proxy Statement to be submitted to the
Commission on or before April 30, 1997, are incorporated by reference into
Part III.
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INTRODUCTORY NOTE
The Annual Report on Form 10-K contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 and the Company intends that
such forward-looking statements be subject to the safe harbors created thereby.
These forward-looking statements include (i) the existence and development of
the Company's technical and manufacturing capabilities, (ii) anticipated
competition, (iii) potential future growth in revenues and income, (iv)
potential future decreases in costs, and (v) the need for, and availability of
additional financing.
The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties. These
forward-looking statements are based on the assumption that the Company will not
lose a significant customer or customers or experience increased fluctuations of
demand or rescheduling of purchase orders, that the Company's markets will
continue to grow, that the Company's products will remain accepted within their
respective markets and will not be replaced by new technology, that competitive
conditions within the Company's markets will not change materially or adversely,
that the Company will retain key technical and management personnel, that the
Company's forecasts will accurately anticipate market demand, that there will be
no material adverse change in the Company's operations or business and that the
Company will not experience significant supply shortages with respect to
purchased components, sub-systems or raw materials. Assumptions relating to the
foregoing involve judgments with respect to, among other things, future
economic, competitive and market conditions, and future business decisions, all
of which are difficult or impossible to predict accurately and many of which are
beyond the control of the Company. In addition, the business and operations of
the Company are subject to substantial risks which increase the uncertainty
inherent in the forward-looking statements. In light of the significant
uncertainties inherent in the forward-looking information included herein, the
inclusion of such information should not be regarded as a representation by the
Company or any other person that the objectives or plans of the Company will be
achieved.
ITEM 1. BUSINESS
General
Rainbow Technologies, Inc., a Delaware corporation, and its subsidiaries
(the "Company") design, develop and manufacture (i) anti-piracy products (the
"Software Protection Products"), which the Company markets to software
developers and information publishers worldwide, and (ii) products that secure
satellite and network communications using encryption technology (the
"Information Security Products") which the Company markets to the United States
Government and to contractors and manufacturers in aerospace and related
industries.
In October 1996, the Company acquired Software Security Inc., a
Connecticut corporation, and its subsidiaries ("SSI") in a transaction accounted
for as a pooling-of-interests. Located in Darien, Connecticut, SSI designs,
manufactures, sells and distributes software protection products.
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In May 1995, the Company acquired Mykotronx, Inc. ("Mykotronx") in a
transaction accounted for as a pooling-of-interests. Located in Torrance,
California, Mykotronx is a leading supplier of information security products.
The Company's principal subsidiaries are located in California,
Connecticut, United Kingdom, Germany, France and Belarus. Unless the context
otherwise requires, the term "Company" refers to Rainbow Technologies, Inc. and
its subsidiaries.
The Company's Software Protection Products strategy focuses on
improvements to its technology and products to enhance product performance and
maintain the Company's competitive advantage in the software protection market.
The Company intends to expand its marketing and distribution efforts for its
Software Protection Products both domestically and internationally. The Company
also plans to focus on areas where there is high incidence of software piracy,
such as eastern Europe and the Far East. The Company believes that the software
protection market will experience a unit growth rate of 20% per year over the
next several years, based on estimates by the Software Publisher's Association.
The Company's Information Security Products strategy is to concentrate on
technology supporting new telecommunications and hardware cryptographic
applications. Currently, the Company's Information Security Products are
primarily sold to the U.S. Government, aerospace and related industry
contractors. The Company believes that this market is greater than $500 million
and is one of the fastest growth segments of the U.S. Government budget. The
Company intends to actively pursue new opportunities in the commercial
marketplace with its Internet Security Group, a business unit focusing on high
performance cryptographic Internet security products. The Company believes that
these emerging markets for security will experience significant growth over the
next five years.
In addition, the Company intends to acquire and/or invest in technologies
and companies that support the Company's core business or have market leadership
and long term value potential.
The Company markets its Software Protection Products worldwide to
software developers and information providers. In 1996, 45% of the Company's
sales of Software Protection Products were made internationally. The Company
markets its Information Security Products to various organizations of the U.S.
Government, including the Department of Defense, NASA and the United States Air
Force, and to contractors and manufacturers in aerospace and related industries.
Approximately 70% of the Company's revenues are derived from Software Protection
Products and approximately 30% of the Company's revenues are derived from
Information Security Products.
Software Protection Products
The Company's Software Protection Products contain hardware and software
components. The hardware component is a "key" which the software publisher
includes with each copy of a protected software program sold to an end-user. The
software component is the software licensed to the software developer which
enables the software developer to direct their programs to "look for and
communicate with" the key. The keys incorporate either the Company's proprietary
algorithms programmed into Company designed Application Specific Integrated
Circuits ("ASIC") computer chips, or customer specific information programmed
into a standard computer memory chip. The key is attached by the end-user to the
parallel printer port of a stand alone personal computer or a local area network
file server. In "looking for and communicating with" the key, the protected
software program interacts with the key. The interaction consists of a
continuous challenge-and-response procedure requiring the key to be attached to
the computer for the protected
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software program to operate. In operation, the interactions of the protected
software and the key are transparent to the end-user. In addition, other
software programs may operate concurrently with the protected software program
and corresponding key, without interference. Printer operation is not affected
and protected software programs can be copied and backed up to a hard disk if
required by the end-user.
The Company's Software Protection Products include:
SENTINELSUPERPRO. Features the Company's next generation ASIC technology.
This is the industry's first key to combine multiple algorithms with
programmable memory for increased security and flexibility. This product
is compatible with DOS, Windows, Windows 95 and Windows NT based
applications.
SENTINELPRO. An algorithm-based key utilizing the Company's proprietary
ASIC technology for the protection of DOS, Windows, Windows 95, Windows
NT, OS/2, UNIX or XENIX based applications.
SENTINELSCRIBE. A field writable memory key with full read/write
capabilities for simple field upgrades or where sophisticated software
metering is required for DOS, Windows, Windows NT or OS/2 software.
SENTINELC-PLUS. A memory-based key designed for DOS, Windows, Windows NT,
OS/2, UNIX or XENIX applications where custom security protection for
special or multiple/modular applications is required.
SENTINELEVE3. Software protection for Apple Macintosh-based software.
Attaches to the ADB port making it compatible with Apple PowerMac and
PowerBook computers. Protects stand-alone and/or multiple modular
applications.
NETSENTINEL. For sophisticated network license management to control
concurrent users over LANs running DOS, OS/2, Windows, Windows 95 and
Windows NT based applications. This product is compatible with Novell,
NetBIOS, TCP/IP and IPX/SPX.
MICROSENTINELUX. Specifically designed for UNIX and open systems
applications, this key features an intelligent microprocessor for
sophisticated operation control. It can serve many marketing functions
including execution control, software leasing, site license management
and can be used as a portable host-ID.
SENTINELLM LICENSE MANAGER. A software based license management product
for Windows, Netware and UNIX environments. The product allows developers
to control network usage of software with remote upgrade capabilities.
End-users are offered a wide variety of licensing models for them to try,
buy and use software. Product features include the capability to securely
distribute software on CD-ROM or via the Internet.
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Information Security Products
The Company believes the importance of protecting the privacy and
security of satellite and network communications has increased in direct
proportion with the technological advances, capabilities and overall growth in
the telecommunications field. Information security remains critical to military
and government applications and is increasingly valued by private sector
businesses to protect communications. The Company's Information Security
Products are integrated circuits and electronic assemblies which encrypt and
decrypt (scramble and unscramble) electronic communications and are designed and
developed by the Company for use in government applications and for private
industry purposes.
The Company, through its subsidiary Mykotronx, enters into development
contracts with the U.S. Government, aerospace and related industry contractors.
In such contracts, the Company generally agrees to develop an integrated circuit
or other electronic assembly for the customer's particular application. As to
U.S. Government contracts, the Company usually serves as the prime contractor or
as a subcontractor, under fixed-price or cost-plus-fixed-fee contracts.
Contracts with the U.S. Government account for a majority of the revenues
received by the Company from sales of its Information Security Products. The
Company has recently begun to market its Information Security Products to wider
commercial applications that require the transmission of secure data such as
banking and financial transaction information, telecommunications networks and
company-wide intranets.
The Company's Information Security Products are currently categorized
into two general areas of customer applications:
A.) SATELLITE AND NETWORK COMMUNICATIONS PRODUCTS.
U.S. Government Space. Products for use in connection with satellite
systems launched by the U.S Government or its agencies.
U.S. Government Ground Based Communications Networks. Products to support
a variety of intra and inter-agency ground-based communications networks
such as Department of Defense, Department of State, Department of the
Treasury and other agencies transmitting classified and sensitive
information.
Commercial Space. Products for use in commercial space applications in
connection with direct broadcast satellite (DBS) and other commercial
space based communication satellite systems.
Commercial Ground Based Communications Networks. Products to secure
communications through cellular voice systems, fax machines, computer
networks, portable and standard phone systems.
B.) INTERNET SECURITY PRODUCTS
CRYPTOSWIFT. An accelerator board which features a high performance
cryptographic co-processor that significantly accelerates the security
calculations associated with public key cryptography.
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Research and Development
Because of the rapid technological advances and other changes affecting
our markets, the Company's competitive position hinges upon the adaptation of
its current products, to such changes in the market. Introduction of new
products that gain market acceptance are crucial to sustainable growth.
Accordingly, the Company directs research and development activity toward
applying its ASIC and software technology in lowering the cost of existing
products, the design and development of new hardware and software products and
the enhancement of existing products.
Expenditures for research and development for the years ended December
31, 1996, 1995 and 1994 were $6,247,000 $6,073,000 and $5,307,000, respectively,
or as a percentage of Software Protection Product sales, 11%, 12%, and 12%,
respectively. The Company believes that its research and development efforts are
greater than any of its competitors and that the Company's technological
leadership could broaden in the future.
Also, the Company performs research and development with regard to its
Information Security Products in connection with U.S. Government contracts. The
costs incurred by the Company in connection with such research and development
activities are substantially recoverable by the Company pursuant to the terms of
these contracts. The Company believes that some of the research and development
performed under such contracts can be applied to the emerging issues of
information security.
Sales and Marketing
Software Protection Products
The Company markets its Software Protection Products to software
publishers throughout the world for use with their software programs selling at
retail for $500 or more in the United States, and for use with lower priced
software programs sold internationally. For 1996, 1995 and 1994, 55%, 51% and
48%, respectively, of the Company's Software Protection Product sales were made
in the United States and 45%, 49% and 52%, respectively, were made
internationally. Since its formation, the Company has shipped more than
11,500,000 keys to more than 28,000 customers. Among the Company's major
customers are Autodesk, Inc., Corel Corp., Macromedia, Viewlogic Systems Inc.,
SPSS, Inc., Adobe Systems, Inc., Wonderware Software Development Corp., Quark
Systems, Inc. and Orcad.
The Company has its own direct sales and marketing personnel in the
United States, the United Kingdom, Germany and France. In addition, the Company
has 45 distributors worldwide. During 1996, 1995 and 1994 the Company had no
single customer which accounted for ten percent or more of the Company's
revenues.
The Company's direct sales force calls on targeted software publishers in
order to increase usage of the Company's products. The direct sales force
pursues a global marketing plan which focuses on multinational software
publishers.
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The Company exhibits at trade shows and advertises in trade publications
in order to attract new customers. The Company's technical support personnel
also assist in the Company's marketing effort through pre-sale and post-sale
activity.
Information Security Products
The Company markets its Information Security Products directly to the
U.S. Government and maintains close relationships with government related
agencies and the aerospace industry. Through these relationships, the Company
receives contracts for services and products on a selected source basis. In
addition, contracts are awarded to the Company in response to requests for
proposal from U.S. Government agencies and aerospace companies.
Manufacturing
Software Protection Products
The Company's hardware keys are manufactured by subcontractors in the
United States, Asia and Europe from components specified and approved by the
Company. The components include ASIC chips, standard computer memory chips and
standard computer hardware parts. The Company maintains control over the
purchasing of materials and the planning and scheduling of the manufacturing and
assembly process. After assembly of the components, the keys are delivered to
the Company's facilities in the United States and Europe where the products are
inspected, tested and configured. The Company believes that it is the lowest
cost producer of software protection products and believes that will continue to
be a competitive advantage.
The Company currently has one supplier of the ASIC chips used in the
Company's largest selling product, SentinelSuperPro. In the event that such
supplier is unable to fulfill the Company's requirements, the Company may
experience an interruption in the production of SentinelSuperPro until an
alternative source of supply is developed. The Company maintains a six month
inventory of ASIC chips in order to limit the potential for such an
interruption. The Company believes that there are a number of companies capable
of commencing the manufacture of its ASIC chips within approximately six months
of such an interruption.
Information Security Products
For its Information Security Products, the Company's manufacturing
operations include the testing of ASICs and the final assembly and testing of
its satellite and network communications products.
The Company has specific cryptographic technology embedded into ASIC
integrated circuits which are fabricated to the Company's specifications by
integrated circuit manufacturers. The Company currently has relationships with
two such integrated circuit manufacturers, VLSI Technologies and United
Technologies Microelectronics Center. These ASIC integrated circuits are
processed to the specifications of the U.S. Government and the Company. Any
interruption in the availability of these integrated circuits could have a
material adverse effect on the operations of the Company.
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Backlog
The Company manufactures its Software Protection Products on the basis of
its forecast of near-term demand and maintains inventory in advance of receipt
of firm customer orders. Orders from software publishers are generally placed on
an "as needed" basis and are usually shipped by the Company within one week
after receipt of the order. For these reasons, the Company's backlog of Software
Protection Product orders at any particular time is generally not large and not
indicative of future sales levels.
As of December 31, 1996, the backlog for the Company's Information
Security Products represented in excess of five months of revenues. Actual
revenue recognition of the backlog mix of contracts can vary from three months
to two years.
Trade Secrets
The Company believes that the value of its Software Protection Products
is dependent upon its proprietary algorithms and encryption techniques remaining
"trade secrets." The Company has obtained copyright protection on certain of its
products and trademark protection for certain of its trade names. Through its
recent acquisition of SSI, the Company has obtained patents on certain of its
designs used in certain of its products. There can be no assurance that the
Company's proprietary technology will remain a secret or that others will not
develop similar technology and use such technology to compete with the Company.
There can be no assurance that if the Company decides to apply for additional
patents in the future for any of its products, or on any new technology or
products derived therefrom, that patents will be granted.
Competition
Software Protection Products
The worldwide software protection industry is highly competitive and
characterized by rapid technological advances in both computer hardware and
software development. The Company believes it is the industry leader with an
estimated 55% worldwide market share. The Company's principal competitor in the
software protection industry is Aladdin Knowledge Systems, Ltd. The Company also
competes with smaller companies. The Company believes that it offers the most
cost effective Software Protection Products available to software publishers.
Although certain of the Company's competitors offer lower prices, the Company
believes that its technical support services and the ease of implementation of
its products favorably distinguish the Company from its competitors.
The Company's principal competitors for its Information Security Products
are Group Technologies, Inc., Motorola, Inc., VLSI Technology, Inc., Cylink
Corporation and Atalla Corporation.
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Employees
The Company presently employs 336 full-time employees divided among sales
and marketing, manufacturing, research and development and administration. The
Company believes that its employee relations are excellent. The employees and
the Company are not parties to collective bargaining agreements.
Recent Events
On October 4, 1996, the Company acquired Software Security, Inc. and its
subsidiaries in a transaction accounted for as a pooling-of-interests.
Accordingly, the Company issued 336,511 shares of its Common Stock in exchange
for all of the outstanding shares of SSI which resulted in SSI becoming a
wholly-owned subsidiary of the Company. The Company also assumed all the
outstanding SSI options and reserved 4,366 shares of its Common Stock for
issuance upon the exercise of the SSI options. On December 19, 1996, the Company
filed a registration statement with the United States Securities and Exchange
Commission (the "Commission") to register the 336,511 shares of its Common
Stock. The registration statement was declared effective by the Commission on
January 31, 1997. SSI designs, develops and manufactures software security
products to prevent the unauthorized use of intellectual property. The software
security products are sold throughout the U.S. and Europe.
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ITEM 2. PROPERTIES
The Company's executive offices and principal facility are located in a
55,800 square foot building in Irvine, California. The Company leases the
facility pursuant to a lease expiring June, 2000.
The Company owns a 5,000 square foot facility in the United Kingdom which
is used primarily for northern European sales and administration. The Company
also owns an 8,000 square foot facility in Paris, France which is used primarily
for southern European sales and administration.
The Company leases a facility in Torrance, California, at which Mykotronx
maintains its principal offices, design and production facilities. The lease is
for 27,000 square feet, and expires in 2000.
The Company leases a facility in Darien, Connecticut, at which SSI
maintains its principal offices, design and production facilities. The lease is
for 12,000 square feet, and expires in 2004.
The Company leases an office in Maryland, at which Mykotronx houses its
direct sales and development. The lease is for 3,000 square feet, and expires in
1998.
ITEM 3. LEGAL PROCEEDINGS
The Company believes that there are no legal proceedings, pending or
contemplated, to which the Company, or any of its subsidiaries, is the subject
or to which the Company or any of its subsidiaries is a party. The Company also
knows of no material legal proceeding pending or threatened, or judgments
entered against any director or executive officer of the Company or any of its
subsidiaries in his/her capacity as such where the position of any such director
or executive officer is adverse to the Company or any of its subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Neither the Board of Directors nor any security holder submitted any
matter during the fourth quarter of the fiscal year covered by this Report to a
vote of the security holders through solicitation of proxies or otherwise.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Common Stock of the Company is traded on the NASDAQ National Market
System under the symbol "RNBO". The following table sets forth high and low
"sales" prices of the shares of Common Stock of the Company for the periods
indicated (as reported by the National Quotation Bureau).
<TABLE>
<CAPTION>
SALES PRICE
--------------------
HIGH LOW
------- -------
<S> <C> <C>
1997 First Quarter $20 3/4 $16 1/2
(through February 28, 1997)
1996 First Quarter 24 1/4 17 1/4
1996 Second Quarter 24 16 7/8
1996 Third Quarter 20 14 5/8
1996 Fourth Quarter 22 1/8 17
1995 First Quarter 18 1/8 13 7/8
1995 Second Quarter 24 1/2 15 1/4
1995 Third Quarter 26 1/4 17 1/2
1995 Fourth Quarter 24 11/16 17 1/2
</TABLE>
As of February 28, 1997, there were approximately 3,600 holders of record of
the Company's Common Stock including those shares held in "street name".
The Company has never paid cash dividends on its Common Stock and the Board
of Directors intends to retain all of its earnings, if any, to finance the
development and expansion of its business. However, there can be no assurance
that the Company can successfully expand its operations, or that such expansion
will prove profitable. Future dividend policy will depend upon the Company's
earnings, capital requirements, financial condition and other factors considered
relevant by the Company's Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been derived from
the consolidated financial statements of the Company for the five years ended
December 31, 1996. Data for the years ended December 31, 1995, 1994, 1993 and
1992 have been restated to include the financial information of SSI, which was
acquired in October 1996 and accounted for as a pooling-of-interests.
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<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------------------------
1996 1995 1994 1993 1992(a)
-------- ------- ------- ------- -------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Selected Consolidated Income Statement Data:
Total revenues $81,710 $72,584 $60,814 $50,182 $40,339
Income before taxes 17,936 16,790 12,478 11,027 10,587
Net income 10,517 9,814 7,182 6,882 6,423
Net income per share $1.30 $1.23 $0.94 $0.92 $0.88
Proforma net income
(unaudited) 10,517 9,814 7,182 6,589(b) 6,137(b)
Proforma net income
per share (unaudited) $1.30 $1.23 $0.94 $0.88(b) $0.84(b)
Shares used in calculating
net income per share 8,072,000 7,958,000 7,673,000 7,509,000 7,281,000
Selected Consolidated Balance Sheet Data:
Total assets $93,364 $82,274 $67,259 $57,315 $48,501
Working capital 60,166 50,690 39,110 30,563 20,733
Long-term debt 2,145 2,616 2,695 2,730 3,275
Shareholders' equity 79,076 68,251 56,231 46,867 37,453
</TABLE>
(a) Reflects the operations, assets and liabilities of Microphar S.A. which was
acquired effective June 1, 1992 and accounted for as a purchase.
(b) Pro forma net income and net income per share reflects unaudited
provisions for income taxes which would have been recorded had Mykotronx
been subject to federal and state income taxes as a C Corporation. Prior
to January 1, 1994, Mykotronx was an S Corporation.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
The following is management's discussion and analysis of certain
significant factors that have affected the profitability of the Company's
business segments (Software Protection and Information Security Products) and
its consolidated results of operations and financial condition during the
periods included in the accompanying consolidated financial statements. The
discussion reflects the impact of the acquisition of SSI and Mykotronx, which
were both accounted for using the pooling-of-interests method as described more
fully in Note 2 to the consolidated financial statements. The following should
be read in conjunction with the consolidated financial statements and related
notes.
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1996 COMPARED WITH 1995
Global Software Protection Products revenue for the year ended December
31, 1996 increased 13% to $57,440,000 as compared with 1995. The revenue growth
was primarily due to increased unit sales in European and Asian markets.
Software Protection Products revenue for the year ended December 31, 1996 in
Europe increased by 18% as compared with 1995. The average selling price per
product in the year ended December 31, 1996 decreased approximately 7% from
the year ended December 31, 1995.
During the year ended December 31, 1996, approximately 22% of the
Company's Software Protection Products revenue was subject to currency
fluctuations, up from 21% in 1995. Software Protection Products revenue in the
future is expected to continue to be affected by foreign currency rate
fluctuations.
Information Security Products revenue for the year ended December 31,
1996 increased 11% to $24,270,000, as compared with 1995. The revenue growth was
primarily due to increases in satellite communications revenues.
Software Protection Products gross profit for the year ended December 31,
1996 was 70% of revenue compared with 71% for the year ended December 31, 1995.
The decrease in gross margin was due to lower average selling prices in Europe
and Asia Pacific. There can be no assurance that the Company will improve or
maintain the level of gross profit percentage it experienced during the year
ended December 31, 1996.
Gross profit from Information Security Products for the year ended
December 31, 1996 was 18% of revenues compared with 23% of revenues for the year
ended December 31, 1995. The decrease in gross profit was due to the change of
mix from predominately product contracts to mainly less profitable research and
development contracts.
Consolidated selling, general and administrative expenses for the years
ended December 31, 1996 and 1995 were 24% of revenues for each year. Selling,
general and administrative expenses for the year ended December 31, 1996
increased by $1,949,000 as compared with 1995. This increase was primarily due
to additional staff and increased compensation expenses.
Total research and development expenses were 8% of revenues for each of
the years ended December 31, 1996 and 1995. Current research and development
activities are focused on additional ASIC development for future software
protection, and the adaptation of the Company's existing products to additional
software operating environments and computer platforms, and on the cryptographic
security products to improve the performance of electronic commerce servers on
the Internet.
Interest income for the year ended December 31, 1996 decreased by 12% to
$1,520,000, as compared with 1995, primarily due to a shift from taxable
instruments to non-taxable interest bearing instruments and lower worldwide
interest rates.
During the year ended December 31, 1996, the Company incurred foreign
currency gains of $270,000, primarily due to dollar denominated deposit accounts
maintained in Europe. During the year ended December 31, 1995, the Company
recognized foreign currency losses of $268,000,
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also primarily due to dollar denominated deposit accounts maintained in Europe.
Such foreign currency gains and losses result from the movement in the value of
the U.S. dollar against the functional currencies used by the Company's foreign
subsidiaries.
During the year ended December 31, 1996, the Company recognized its share
of operating losses in Quantum Manufacturing Technologies, of Albuquerque, New
Mexico, in which the Company holds a minority investment. The Company's share of
the losses amounted to approximately $524,000.
The effective tax rate was 41.4% for the year ended December 31, 1996
compared with 41.6% for the year ended December 31, 1995.
1995 COMPARED WITH 1994
Global Software Protection Products revenue for the year ended December
31, 1995 increased 14% to $50,622,000 as compared with 1994. The revenue growth
was primarily due to increased unit sales in European markets. Software
Protection Products revenue for the year ended December 31, 1995 in Europe
increased by 37%. The average selling price per product in the year ended
December 31, 1995 decreased 5% from the year ended December 31, 1994.
During the year ended December 31, 1995, approximately 21% of the
Company's Software Protection Products revenue was subject to currency
fluctuations, up from 20% in 1994.
Information Security Products revenue for the year ended December 31,
1995 increased 33% to $21,962,000, as compared with 1994. The revenue growth was
due to higher performance on software and service contracts across various
products lines. Additionally, the space communication security business
experienced strong growth, particularly in the high grade security products for
government network security.
Software Protection Products gross profit for the year ended December 31,
1995 was 71% of revenue compared with 70% for the year ended December 31, 1994.
The increase in gross margin was due to increased sales in Europe with
corresponding higher margins.
Gross profit from Information Security Products for the year ended
December 31, 1995 was 23% of revenues compared with 18% of revenues for the year
ended December 31, 1994. The increase in gross profit was due to the increased
volume of space communications products that benefited from continued economies
of scale. Gross profit was highly dependent on the mix of contracts with higher
margin percentages versus contracts with lower margin percentages.
Consolidated selling, general and administrative expenses for the years
ended December 31, 1995 and 1994 were 24% of revenues for both years. Selling,
general and administrative expenses for the year ended December 31, 1995
increased by $3,273,000 as compared with 1994. This increase was primarily due
to additional staff, increased compensation expenses and expenses incurred in
connection with the Mykotronx acquisition.
Total research and development expenses were 8% and 9% of revenue for the
years ended December 31, 1995 and 1994, respectively. In 1994, the Company
capitalized $735,000 of software development costs. There were no software
development costs capitalized during 1995.
13
<PAGE> 15
Research and development activities were focused on additional ASIC development
for future software protection and the adaptation of the Company's existing
products to additional software operating environments and computer platforms.
Interest income for the year ended December 31, 1995 increased by 133% to
$1,726,000, as compared with 1994, primarily because of higher investment
balances.
During the year ended December 31, 1995, the Company incurred foreign
currency losses of $268,000, primarily due to dollar denominated deposit
accounts maintained in Europe. During the year ended December 31, 1994, the
Company recognized foreign currency losses of $588,000, also primarily due to
dollar denominated deposit accounts maintained in Europe. Such foreign currency
gains and losses result from the movement in the value of the U.S. dollar
against the functional currencies used by the Company's foreign subsidiaries.
During the year ended December 31, 1994, the Company wrote off a $252,000
investment it held in a company that subsequently filed for bankruptcy
protection in January 1995.
The effective tax rate decreased to 41.6% for the year ended December 31,
1995 from 42.4% for the year ended December 31, 1994. The decrease in the tax
rate was due to the expansion of business unit profits in European countries
with lower effective tax rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of operating funds have been from operations
and proceeds from sales of the Company's equity securities. The Company's cash
flow from operations during 1996, 1995 and 1994 was $12,262,000, $13,049,000,
and $8,738,000, respectively.
The Company intends to use its capital resources to expand its product lines
and for possible acquisitions of additional products and technologies. The
Company has no significant capital commitments or requirements at this time.
The Company's subsidiaries in France carry $2.1 million in interest earning
deposits which may result in foreign exchange gains or losses due to the fact
that the functional currency in those subsidiaries is not the U.S. dollar.
Management believes that the effect of inflation on the business of the
Company for the past three years has been minimal.
The Company believes that its current working capital of $60,166,000 and
anticipated working capital to be generated by future operations will be
sufficient to support the Company's working capital requirements through at
least December 31, 1997.
14
<PAGE> 16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and Schedule of the Company are
listed in Item 14 (a) and included herein on pages F-1 through F-25.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
The Company has not had any disagreement with its independent auditors on
any matter of accounting principles or practices or financial statement
disclosure.
PART III
ITEM 10. ALL DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information appearing under the caption
"Election of Directors" in the Company's Proxy Statement to be submitted to the
Commission on or before April 30, 1997.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to the information appearing under the caption
"Executive Compensation" in the Company's Proxy Statement to be submitted to the
Commission on or before April 30, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the information appearing under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement to be submitted to the Commission on or before April
30, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the information appearing under the caption "Certain
Relationships and Related Transactions" in the Company's Proxy Statement to be
submitted to the Commission on or before April 30, 1997.
15
<PAGE> 17
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Consolidated Financial Statements
Reports of Independent Auditors.
Consolidated Balance Sheets at December 31, 1996 and 1995.
Consolidated Statements of Income for the years ended December 31, 1996, 1995
and 1994.
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1995 and 1994.
Consolidated Statements of Shareholders' Equity for the years ended December 31,
1996, 1995 and 1994.
Notes to Consolidated Financial Statements.
2. Consolidated Financial Statement Schedule
II. Consolidated Valuation and Qualifying Accounts for the years ended
December 31, 1996, 1995 and 1994.
All other schedules are omitted because they are not applicable or the
required information is shown in the consolidated financial statements or notes
thereto.
3. Exhibits
2.(i) Agreement and Plan of Reorganization, dated as of January 26, 1995
among the Company, Rainbow Acquisition Inc., a California corporation and a
wholly owned subsidiary of Rainbow, and Mykotronx, Inc., a California
corporation ("Mykotronx") (incorporated by reference to the Company's
Registration Statement on Form S-4 under the Securities Act of 1933, as amended,
effective on April 20,1995, Registration No.33-89918).
2.(ii) Agreement and Plan of Merger, dated September 30, 1996, by and
among the Company, RNBO Acquisition Corporation, a Nevada corporation and a
wholly-owned subsidiary of the Company, and Software Security, Inc., a
Connecticut corporation.
3.(i) Articles of Incorporation of Rainbow, as amended (incorporated by
reference to Exhibit 3(a) to Rainbow's Registration Statement on Form S-18 under
the Securities Act of 1933, as amended, filed on July 20, 1987-File No.
33-15956-LA (the "S-18 Registration Statement")).
3.(ii) By-Laws of Rainbow (incorporated by reference to Exhibit 3(b) to
the S-18 Registration Statement).
16
<PAGE> 18
4(a) See Exhibit 3(i).
4(b) See Exhibit 3(ii).
10(a) Lease for premises at 50 Technology Drive, Irvine, California, dated June
1, 1995, between the Company and Birtcher Medical Systems, Inc., a California
corporation (filed as an exhibit to the Company's 1995 Form 10-K).
10(b) Agreement, dated May 26, 1989, between the Company and Catalyst
Semiconductor, Inc. (incorporated by reference to Exhibit 10(h) of the Company's
1989 Annual Report on Form 10-K under the Securities Exchange Act of 1934 filed
in March 1990 (the "1989 10-K")).
10(c) Agreement, dated August 17, 1989, between the Company and Catalyst
Semiconductor, Inc. (incorporated by reference to Exhibit 10(i) of the 1989
10-K).
10(d) 1990 Incentive Stock Option Plan as amended (incorporated by reference to
Exhibit 10(j) of the 1991 10-K)).
10(e) Asset Purchase Agreement, dated January 20,1994, between the Company and
the AND Group, Inc. (incorporated by reference to Exhibit 10(s) to the Company's
1993 Annual Report on Form 10-K under the Securities Exchange Act of 1934 filed
in March 1994 (the "1993 10-K")).
10(f) Employment Agreement, dated February 16, 1990, between the Company and
Walter W. Straub (incorporated by reference to Exhibit 10(j) of the 1989 10-K).
10(g) Change of Control Agreement, dated February 16, 1990, between the Company
and Walter W. Straub (incorporated by reference to Exhibit 10(k) of the 1989
10-K).
10(h) Employment Agreement, dated January 15, 1992, between the Company and
Peter M. Craig (incorporated by reference to Exhibit 10(m) of the 1991 10-K).
10(i) Change of Control Agreement, dated January 15, 1992, between the Company
and Peter M. Craig (incorporated by reference to Exhibit 10(n) of the 1991
10-K).
10(j) Employment Agreement, dated January 5, 1995, between the Company and
Norman L. Denton, III (incorporated by reference to Exhibit 10(j) of the
Company's 1994 Annual Report on Form 10-K under the Securities Exchange Act of
1934, filed in March 1995 (the "1994 10-K")).
10(k) Change of Control Agreement, dated January 5, 1995, between the Company
and Norman L. Denton, III (incorporated by reference to Exhibit 10(k) to the
1994 10-K).
10(l) Employment Agreement, dated January 5, 1995, between the Company and
Patrick E. Fevery (incorporated by reference to Exhibit 10(l) of the 1994 10-K).
10(m) Change of Control Agreement, dated January 5, 1995, between the Company
and Patrick E. Fevery (incorporated by reference to Exhibit 10(m) of the 1994
10-K).
10(n) Employment Agreement, dated January 5, 1995, between the Company and Paul
A. Bock (incorporated by reference to Exhibit 10(n) of the 1994 10-K).
10(o) Change of Control Agreement, dated January 5, 1995, between the Company
and Paul A. Bock (incorporated by reference to Exhibit 10(o) of the 1994 10-K).
17
<PAGE> 19
10(p) Employment Agreement, dated May 31, 1995, among Mykotronx, the Company and
Theodore S. Bettwy (filed as an exhibit to the Company's 1995 Form 10-K).
10(q) Employment Agreement dated May 31, 1995, among Mykotronx, the Company and
John C. Droge (filed as an exhibit to the Company's 1995 Form 10-K).
21(a) List of Rainbow's wholly-owned subsidiaries.
23 Consents of Independent Auditors.
(1) Ernst & Young LLP.
(2) KMPG Peat Marwick LLP.
27 FINANCIAL DATA SCHEDULE
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the three months ended
December 31, 1996.
18
<PAGE> 20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
RAINBOW TECHNOLOGIES, INC.
By: /s/ WALTER M. STRAUB
-------------------------------
Walter W. Straub, President
Chief Executive Officer,
and Chairman of the Board
Date: March 31, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ WALTER M. STRAUB President, Chief Executive March 31, 1997
- --------------------------- Officer, and
Walter M. Straub Chairman of the Board
/s/ PETER M. CRAIG Vice Chairman, March 31, 1997
- --------------------------- Executive Vice President,
Peter M. Craig Secretary and Director
/s/ PATRICK E. FEVERY Vice President and March 31, 1997
- --------------------------- Chief Financial Officer
Patrick E. Fevery
/s/ ALAN K. JENNINGS Director March 31, 1997
- ---------------------------
Alan K. Jennings
/s/ RICHARD P. ABRAHAM Director March 31, 1997
- ---------------------------
Richard P. Abraham
/s/ MARVIN HOFFMAN Director March 31, 1997
- ---------------------------
Marvin Hoffman
/s/ FREDERICK M. HANEY Director March 31, 1997
- ---------------------------
Frederick M. Haney
19
<PAGE> 21
RAINBOW TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
FOR THE YEAR ENDED DECEMBER 31, 1996
Page
----
Reports of Independent Auditors F-2
Consolidated Balance Sheets F-4
Consolidated Statements of Income F-5
Consolidated Statements of Shareholders' Equity F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8
Schedule II - Consolidated Valuation and Qualifying Accounts F-25
F-1
<PAGE> 22
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Rainbow Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Rainbow
Technologies, Inc. as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and the schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the schedule based on our audits.
We did not audit the financial statements of Mykotronx, Inc., a
wholly-owned subsidiary acquired on June 1, 1995 and accounted for as a
pooling-of-interests, which statements reflect total revenues of $16,571,000
for the year ended December 31, 1994. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the data included for Mykotronx, Inc., is based solely on the report
of the other auditors.
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, based upon our audits and the report of other auditors,
the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Rainbow Technologies, Inc. at
December 31, 1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1996, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
ERNST & YOUNG LLP
Orange County, California
February 25, 1997
F-2
<PAGE> 23
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Mykotronx, Inc.
We have audited the balance sheet of Mykotronx, Inc. as of December 31, 1994
and the related statements of earnings, shareholders' equity and cash flows
(not presented herein) for the year then ended. 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mykotronx, Inc., as of
December 31, 1994 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 16, 1995
F-3
<PAGE> 24
RAINBOW TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1996 1995
------------ ------------
A S S E T S
Current assets:
<S> <C> <C>
Cash and cash equivalents ......................................... $31,735,000 $25,330,000
Marketable securities available-for-sale .......................... 11,437,000 11,799,000
Accounts receivable, net of allowance for doubtful accounts
of $330,000 and $453,000 in 1996 and 1995, respectively .......... 15,297,000 13,732,000
Inventories ....................................................... 7,853,000 3,559,000
Unbilled costs and fees ........................................... 2,249,000 3,962,000
Prepaid expenses and other current assets ......................... 2,106,000 1,873,000
----------- -----------
Total current assets ......................................... 70,677,000 60,255,000
Property, plant and equipment, at cost:
Buildings ......................................................... 9,122,000 9,572,000
Furniture ......................................................... 1,200,000 892,000
Equipment ......................................................... 6,026,000 4,921,000
Leasehold improvements ............................................ 347,000 230,000
----------- -----------
16,695,000 15,615,000
Less accumulated depreciation and amortization .................... 4,615,000 4,280,000
----------- -----------
Net property, plant and equipment ............................ 12,080,000 11,335,000
Goodwill, net of accumulated amortization of $7,936,000 and
$6,602,000 in 1996 and 1995, respectively ........................ 4,064,000 6,186,000
Other assets, net of accumulated amortization of $2,199,000
and $1,193,000 in 1996 and 1995, respectively ..................... 6,543,000 4,498,000
----------- -----------
$93,364,000 $82,274,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................. $ 4,109,000 $ 3,848,000
Accrued payroll and related expenses .............................. 3,339,000 2,084,000
Other accrued liabilities ......................................... 1,500,000 1,428,000
Income taxes payable .............................................. 948,000 1,887,000
Billings in excess of costs and fees .............................. 314,000 2,000
Long-term debt, due within one year ............................... 301,000 316,000
----------- -----------
Total current liabilities .................................... 10,511,000 9,565,000
Long-term debt, net of current portion ................................ 2,145,000 2,616,000
Deferred income taxes ................................................. 1,515,000 1,780,000
Other liabilities ..................................................... 117,000 62,000
Shareholders' equity:
Common stock, $.001 par value, 20,000,000 shares authorized,
7,775,389 and 7,569,178 shares issued and outstanding
in 1996 and 1995, respectively .................................. 8,000 8,000
Additional paid-in capital ........................................ 30,686,000 29,825,000
Cumulative translation adjustment ................................. (251,000) 404,000
Cumulative difference between cost and
market value of marketable securities ........................... 154,000 52,000
Retained earnings ................................................. 48,479,000 37,962,000
----------- -----------
Total shareholders' equity ................................... 79,076,000 68,251,000
----------- -----------
$93,364,000 $82,274,000
=========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE> 25
<TABLE>
<CAPTION>
RAINBOW TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1996, 1995 and 1994
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Software protection products .................. $57,440,000 $50,622,000 $44,243,000
Information security products ................. 24,270,000 21,962,000 16,571,000
----------- ----------- -----------
Total revenues ........................... 81,710,000 72,584,000 60,814,000
Operating expenses:
Cost of software protection products .......... 17,051,000 14,534,000 13,103,000
Cost of information security products.......... 19,851,000 16,865,000 13,521,000
Selling, general and administrative ........... 19,512,000 17,563,000 14,290,000
Research and development ...................... 6,247,000 6,073,000 5,307,000
Goodwill amortization ......................... 1,784,000 1,830,000 1,676,000
----------- ----------- -----------
Total operating expenses.................. 64,445,000 56,865,000 47,897,000
----------- ----------- -----------
Operating income................................... 17,265,000 15,719,000 12,917,000
Interest income.................................... 1,520,000 1,726,000 742,000
Interest expense................................... (325,000) (387,000) (383,000)
Other expense...................................... (524,000) (268,000) (798,000)
----------- ----------- -----------
Income before provision for income taxes........... 17,936,000 16,790,000 12,478,000
Provision for income taxes......................... 7,419,000 6,976,000 5,296,000
----------- ----------- -----------
Net income......................................... $10,517,000 $ 9,814,000 $ 7,182,000
=========== =========== ===========
Net income per common and common
equivalent share............................... $ 1.30 $ 1.23 $ 0.94
=========== =========== ===========
Weighted average common and common
equivalent shares outstanding.................. 8,072,000 7,958,000 7,673,000
=========== =========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE> 26
RAINBOW TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Cumulative
difference
between
cost and
Additional Cumulative market value
Common Stock paid-in translation of marketable Retained
Shares Amount capital adjustment securities earnings Total
----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993 .... 7,364,759 $ 7,000 $25,984,000 $(1,966,000) $ -- $22,842,000 $46,867,000
Exercise of common stock
options .................... 138,117 -- 593,000 -- -- -- 593,000
Tax benefit of employee stock
options .................... -- -- 173,000 -- -- -- 173,000
Repurchase of shares of former
Mykotronx shareholders ...... (79,860) -- (5,000) -- -- (101,000) (106,000)
Distribution to former
Mykotronx shareholders ...... -- -- -- -- -- (295,000) (295,000)
Transfer of retained earnings
to additional paid-in capital
upon termination of Mykotronx
S Corporation election ...... -- -- 1,480,000 -- -- (1,480,000) --
Translation adjustment, net ... -- -- -- 1,501,000 -- -- 1,501,000
Net income .................... -- -- -- -- -- 7,182,000 7,182,000
----------------------------------------------------------------------------------------------
Balance, December 31, 1994 .... 7,423,016 7,000 28,225,000 (465,000) -- 28,148,000 55,915,000
Exercise of common stock
options .................... 146,162 1,000 1,191,000 -- -- -- 1,192,000
Tax benefit of employee stock
options .................... -- -- 409,000 -- -- -- 409,000
Unrealized gain on
marketable securities ....... -- -- -- -- 52,000 -- 52,000
Translation adjustment, net ... -- -- -- 869,000 -- -- 869,000
Net income .................... -- -- -- -- -- 9,814,000 9,814,000
----------------------------------------------------------------------------------------------
Balance, December 31, 1995 .... 7,569,178 8,000 29,825,000 404,000 52,000 37,962,000 68,251,000
Exercise of common stock
options ..................... 241,211 -- 1,184,000 -- -- -- 1,184,000
Purchase and retirement of
common stock ................ (35,000) -- (706,000) -- -- -- (706,000)
Tax benefit of employee stock
options .................... -- -- 383,000 -- -- -- 383,000
Unrealized gain on
marketable securities ....... -- -- -- -- 102,000 -- 102,000
Translation adjustment, net ... -- -- -- (655,000) -- -- (655,000)
Net income .................... -- -- -- -- -- 10,517,000 10,517,000
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 .... 7,775,389 $8,000 $30,686,000 $(251,000) $154,000 $48,479,000 $79,076,000
==================================================================================================================================
</TABLE>
See accompanying notes.
F-6
<PAGE> 27
RAINBOW TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .............................................. $10,517,000 $ 9,814,000 $ 7,182,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization ......................................... 2,821,000 2,352,000 2,034,000
Depreciation ......................................... 1,453,000 1,290,000 1,160,000
Change in deferred income taxes ...................... (666,000) 493,000 (11,000)
Allowance for doubtful accounts ...................... 33,000 76,000 20,000
Loss from retirement of property, plant, and equipment 87,000 7,000 28,000
Write-down of long-term investment ................... 203,000 -- 252,000
Share in investee's loss ............................. 524,000 -- --
Write-off of previously capitalized software ......... 273,000 -- --
Changes in operating assets and liabilities:
Accounts receivable ................................ (1,539,000) (2,540,000) (1,511,000)
Inventories ........................................ (4,273,000) (65,000) 638,000
Unbilled costs and fees ............................ 1,713,000 (1,067,000) (1,460,000)
Prepaid expenses and other current assets .......... 157,000 89,000 206,000
Accounts payable ................................... 281,000 1,168,000 261,000
Accrued liabilities ................................ 1,341,000 289,000 314,000
Billings in excess of costs and fees ............... 312,000 (420,000) 417,000
Income taxes payable ............................... (975,000) 1,563,000 (792,000)
-----------------------------------------
Net cash provided by operating activities ....... 12,262,000 13,049,000 8,738,000
Cash flows from investing activities:
Purchase of marketable securities ....................... (8,960,000) (12,271,000) (12,376,000)
Sale of marketable securities ........................... 9,424,000 4,115,000 16,990,000
Purchases of property, plant, and equipment ............. (2,719,000) (1,780,000) (645,000)
Other long-term assets .................................. (3,703,000) (1,731,000) (456,000)
Notes receivable ........................................ -- 3,000,000 (3,000,000)
Capitalized software development costs .................. (348,000) -- (735,000)
Acquisition of AND Group, Inc ........................... -- -- (1,498,000)
-----------------------------------------
Net cash used in investing activities ........... (6,306,000) (8,667,000) (1,720,000)
Cash flows from financing activities:
Exercise of common stock options ........................ 1,184,000 1,191,000 593,000
Payment of long-term debt ............................... (303,000) (357,000) (496,000)
Purchase and retirement of common stock ................. (706,000) -- --
Repayment of capital lease .............................. -- (31,000) (25,000)
Repurchase of shares of former Mykotronx
shareholders ......................................... -- -- (106,000)
Distribution to former Mykotronx S Corporation
shareholders ......................................... -- -- (295,000)
-----------------------------------------
Net cash provided by (used in) financing
activities .................................... 175,000 803,000 (329,000)
Effect of exchange rate changes on cash ..................... 274,000 (146,000) 482,000
-----------------------------------------
Net increase in cash and cash equivalents ................... 6,405,000 5,039,000 7,171,000
Cash and cash equivalents at beginning of period ............ 25,330,000 20,291,000 13,120,000
-----------------------------------------
Cash and cash equivalents at end of period .................. $31,735,000 $ 25,330,000 $ 20,291,000
=========================================
Supplemental disclosure of cash flow information:
Income taxes paid ....................................... $ 8,105,000 $ 6,005,000 $ 6,059,000
Interest paid............................................ 247,000 302,000 381,000
</TABLE>
See accompanying notes.
F-7
<PAGE> 28
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Rainbow Technologies, Inc. (the Company) develops, manufactures, programs
and markets products which prevent the unauthorized use of intellectual
property, including software programs, and also develops and manufactures
information security products to provide privacy and security for satellite and
network communications. The accompanying financial statements consolidate the
accounts of the Company and its wholly-owned subsidiaries and have been restated
for all prior periods presented to reflect the acquisition of Software Security,
Inc. (SSI), which has been accounted for using the pooling-of-interest method
(Note 2). All significant intercompany balances and transactions have been
eliminated. Certain amounts previously reported have been reclassified to
conform with the 1996 presentation.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the accompanying financial
statements. Actual results could differ from those estimates. Significant
estimates made in preparing these financial statements include the allowance for
doubtful accounts, the allowance for inventory obsolescence, accrued warranty
costs, the allowance for deferred tax assets and total estimated contract costs
associated with billed and unbilled contract revenues.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
MARKETABLE SECURITIES
All investment securities are considered to be available-for-sale and are
carried at fair value. Management determines classification at the time of
purchase and reevaluates its appropriateness at each balance sheet date. The
Company's marketable securities consist of tax-exempt and other debt instruments
that bear interest at variable rates. As of December 31, 1996 and 1995 gross
unrealized gains were $154,000 and $52,000, respectively. There were no
material realized gains or losses recognized for the years ending December 31,
1996 and 1995. The cost of securities sold is based on the specific
identification method. The Company's portfolio of marketable debt securities at
December 31, 1996 matures as follows: 27% in 1997, 52% in 1998-2001, 9% in
2002-2005 and 12% thereafter.
F-8
<PAGE> 29
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
SOFTWARE DEVELOPMENT COSTS
Statement of Financial Accounting Standards No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed," requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based on the Company's product
development process, technological feasibility is established upon completion of
a working model. Amortization of capitalized software development costs
commences when the products are available for general release to customers and
is determined using the straight line method over the expected useful lives of
the respective products.
At December 31, 1996 and 1995, the Company had capitalized computer
software development costs of $766,000 and $735,000, respectively. Amortization
of computer software development costs for the year ended December 31, 1996
amounted to $44,000. There was no such amortization for the years ended December
31, 1995 and 1994. During 1996, the Company wrote-off $273,000 of previously
capitalized computer software development costs.
INVENTORIES
Inventoried costs relating to long-term contracts are stated at the actual
production cost, including pro-rata allocations of factory overhead and general
and administrative costs incurred to date reduced by amounts identified with
revenue recognized on units delivered. The costs attributed to units delivered
under such long-term contracts are based on the estimated average cost of all
units expected to be produced.
Inventories other than inventoried costs relating to long-term contracts
are stated at the lower of cost (first-in, first-out basis) or market.
PROPERTY, PLANT AND EQUIPMENT
Additions to property, plant, equipment and leasehold improvements are
recorded at cost and depreciated on the straight-line method over their
estimated useful lives as follows:
Buildings....................................... 31 years
Furniture....................................... 5 to 7 years
Equipment....................................... 3 to 7 years
Leasehold improvements.......................... Term of lease
INTANGIBLE ASSETS
Intangible assets consisting of goodwill and patents are amortized using
the straight-line method over seven years. Goodwill represents the excess of
purchase price over the estimated fair value of assets acquired.
F-9
<PAGE> 30
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
LONG-LIVED ASSETS
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121 (SFAS No. 121), "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." In accordance
with SFAS No. 121, the Company records impairment losses on long-lived assets
used in operations when events and circumstances indicate that the assets might
be impaired and the undiscounted cash flows estimated to be generated by those
assets are less than the carrying amounts of those assets. The adoption of SFAS
No. 121 had no impact on the Company's financial condition or results of
operations.
REVENUE RECOGNITION
Software Protection Products
The Company recognizes revenues from Software Protection Product sales at
the time of shipment. Provision is currently made for estimated product returns
which may occur under programs the Company has with certain of its distributors.
Information Security Products
Catalog product revenues and revenues under certain fixed-price contracts
calling for delivery of a specified number of units are recognized as deliveries
are made. Revenues under cost-reimbursement contracts are recognized as costs
are incurred and include estimated earned fees in the proportion that costs
incurred to date bear to total estimated costs. Certain contracts are awarded on
a fixed-price incentive fee basis. Incentive fees on such contracts are
considered when estimating revenues and profit rates and are recognized when the
amounts can reasonably be determined. The costs attributed to units delivered
under fixed-price contracts are based on the estimated average cost per unit at
contract completion. Profits expected to be realized on long-term contracts are
based on total revenues and estimated costs at completion. Revisions to contract
profits are recorded in the accounting period in which the revisions are made.
Estimated losses on contracts are recorded when identified. For research and
development and other cost-plus-fee type contracts, the Company recognizes
contract earnings using the percentage-of-completion method. The estimated
contract revenues are recognized based on percentage-of-completion as determined
by the cost-to-cost basis whereby revenues are recognized ratably as contract
costs are incurred.
WARRANTY
The Company generally warrants its products for one year. An estimate of
the amount required to cover warranty expense on products sold is charged
against income at the time of sale.
ADVERTISING
The Company expenses the costs of advertising as incurred. Advertising
expense was $2,221,000, $1,212,000 and $1,123,000 for 1996, 1995, and 1994,
respectively.
F-10
<PAGE> 31
RESEARCH AND DEVELOPMENT
Expenditures for research and development are expensed as incurred.
INCOME TAXES
Deferred taxes are provided for items recognized in different periods for
financial and tax reporting purposes in accordance with Financial Accounting
Standards Board Statement No. 109, "Accounting For Income Taxes."
F-11
<PAGE> 32
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
FOREIGN CURRENCY
Balance sheet accounts denominated in foreign currencies are translated at
exchange rates as of the date of the balance sheet and income statement accounts
are translated at average exchange rates for the period. Translation gains and
losses are accumulated as a separate component of Shareholders' Equity. The
Company has adopted local currencies as the functional currencies for its
subsidiaries because their principal economic activities are most closely tied
to the respective local currencies.
The Company may enter into foreign exchange contracts as a hedge against
foreign currency denominated receivables. It does not engage in currency
speculation. Foreign currency transaction gains and losses are included in
current earnings. There were no foreign exchange contracts at December 31, 1996.
STOCK OPTION PLANS
Effective January 1, 1996, the Company has adopted the disclosure-only
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" (SFAS No. 123) and accordingly, is continuing to
account for its stock-based compensation plans under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. The adoption of SFAS No. 123 had no impact on the Company's
consolidated results of operations or financial position.
F-12
<PAGE> 33
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
EARNINGS PER SHARE
Earnings per share are based on the weighted average number of common and
common equivalent shares outstanding during each period. Common equivalent
shares include the potential dilution from the exercise of common stock options
determined using the treasury stock method when the effect of such options is
dilutive.
CONCENTRATIONS OF BUSINESS AND CREDIT RISK
Financial instruments which potentially subject the Company to credit risk
consist principally of trade receivables and interest bearing investments. The
Company performs on-going credit evaluations of its customers and generally does
not require collateral. The Company maintains adequate reserves for potential
losses and such losses, which have historically been minimal, have been included
in management's estimates. The Company places substantially all its interest
bearing investments with major financial institutions and, by policy, limits the
amount of credit exposure to any one financial institution.
The Company sells the majority of its Software Protection Products to
software developers and wholesale distributors throughout North America, Europe
and Asia Pacific. The majority of the Company's Information Security Products
are sold to the U.S. Government (Note 3). The U.S. Government accounted for over
65%, 81%, and 95% of contract revenues in 1996, 1995, and 1994, respectively. In
addition, approximately 81% and 90% of contract accounts receivable and
approximately 78% and 90% of unbilled costs and fees at December 31, 1996 and
1995, respectively, were related to the U.S. Government.
F-13
<PAGE> 34
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
2. ACQUISITIONS
On October 4, 1996, the Company acquired Software Security, Inc. (SSI) in
a merger transaction resulting in SSI becoming a wholly-owned subsidiary of
Rainbow. SSI, a Connecticut corporation with headquarters in Darien,
Connecticut, designs, develops and manufactures software security products to
prevent the unauthorized use of intellectual property. These products are sold
in the U.S. and Europe. Shareholders of SSI received 0.35 shares of Company
common stock for each share of issued and outstanding SSI common stock.
Accordingly, the Company issued 336,511 shares of its common stock to SSI
shareholders in exchange for all outstanding SSI shares. In addition, 4,366
shares of Rainbow common stock were reserved for issuance upon the exercise of
assumed SSI options. The merger was accounted for as a pooling-of-interests.
Expenses associated with the merger of approximately $191,000 were included
in the consolidated results of operations for the year ended December 31, 1996.
There were no significant intercompany transactions between Rainbow and SSI
during any period presented.
On March 6, 1996, the Company entered into an agreement to acquire up to
58% of Quantum Manufacturing Technologies, Inc. (QMT) of Albuquerque, New
Mexico, in exchange for $4.2 million, subject to certain technology and business
milestones. The Company has invested $2.7 million for 48.5% of the common stock
of QMT and is accounting for this investment under the equity method. The
Company's share in QMT losses for the year ended December 31, 1996 amounted to
approximately $524,000. QMT, a development stage company formed in 1995, has an
exclusive worldwide license from Sandia National Laboratories for the commercial
use and exploitation of patented pulsed power ion beam surface treatment
technology known as "IBEST".
On June 1, 1995, the Company acquired Mykotronx, Inc. (Mykotronx) in a
merger transaction resulting in Mykotronx becoming a wholly-owned subsidiary of
Rainbow. The merger was accounted for as a pooling-of-interests. Mykotronx, a
California corporation with headquarters in Torrance, California, designs,
develops and manufactures information security products to provide privacy and
security for voice communication and data transmission. These products are sold
to the U.S. Government and customers in the aerospace and telecommunications
industries. Shareholders of Mykotronx received 2.64 shares of the Company's
common stock for each share of issued and outstanding Mykotronx common stock.
Accordingly, the Company issued 1,620,564 shares of its common stock to
Mykotronx shareholders in exchange for all outstanding Mykotronx shares. In
addition, 195,096 shares of Rainbow common stock were reserved for issuance
upon the exercise of assumed Mykotronx stock options. Expenses associated with
the merger of approximately $552,000 were included in the consolidated results
of operations for the year ended December 31, 1995.
Revenue and net income from the combining companies included in the
accompanying consolidated results of operations were as follows (the Rainbow
amounts have been restated to reflect the acquisition of SSI):
<TABLE>
<CAPTION>
Rainbow Mykotronx Consolidated
------- --------- ------------
<S> <C> <C> <C>
For the five months ended May 31, 1995
(prior to the effective date of the
Mykotronx merger):
Revenue.................................. $19,314,000 $9,663,000 $28,977,000
Net income............................... 2,489,000 1,278,000 3,767,000
</TABLE>
F-14
<PAGE> 35
<TABLE>
<S> <C> <C> <C>
For the year ended December 31, 1994:
Revenue ........................................ 44,243,000 16,571,000 60,814,000
Net income ..................................... 5,738,000 1,444,000 7,182,000
</TABLE>
There were no significant intercompany transactions between Rainbow and
Mykotronx during any period presented.
In January 1994, the Company purchased the assets of the AND Group Inc., a
Canadian corporation, in exchange for the sum of $1.5 million. As a result, the
Company acquired all of the intellectual property rights to a software product,
and extinguished all previously existing obligations to pay royalties to the AND
Group, Inc.
In exchange for a minority interest, the Company contributed the assets
acquired from the AND Group, Inc. and other assets to Vendor Systems
International, Inc. (VSI). VSI is a company located in Minneapolis, Minnesota.
F-15
<PAGE> 36
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
3. GOVERNMENT CONTRACTS
The Company is both a prime contractor and subcontractor under fixed-price
and cost reimbursement contracts with the U.S. Government (Government). At the
commencement of each contract or contract modification, the Company submits
pricing proposals to the Government to establish indirect cost rates applicable
to such contracts. These rates, after audit and approval by the Government, are
used to settle costs on contracts completed during the previous fiscal year.
To facilitate interim billings during the performance of its contracts, the
Company establishes provisional billing rates, which are used in recognizing
contract revenue and contract accounts receivable. These provisional billing
rates are adjusted to actual at year-end and are subject to adjustment after
Government audit.
The Company has unbilled costs and fees of $2,249,000 and $3,962,000 at
December 31, 1996 and 1995, respectively . Based on the Company's experience
with similar contracts in recent years, the unbilled costs and fees are expected
to be collected within one year.
4. INVENTORIES
Inventories consist of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Raw materials $ 908,000 $1,365,000
Work in process 819,000 621,000
Finished goods 3,211,000 1,476,000
Inventoried costs relating to long-term
contracts, net of amounts attributed
to revenues recognized to date 2,915,000 97,000
---------- ----------
$7,853,000 $3,559,000
========== ==========
</TABLE>
The amount of general and administrative expenses remaining in inventories
at December 31, 1996 and December 31, 1995 was $124,000 and $11,000,
respectively.
5. LONG-TERM DEBT
Long-term debt consists of a note payable to a bank with principal and interest
at 11.98% payable quarterly, in French Francs. The note matures in January 2005
and is secured by a building with a net book value of $6,677,000 at December
31, 1996.
Annual principal payments are as follows:
<TABLE>
<S> <C>
1997 ................................ $ 301,000
1998 ................................ 297,000
1999 ................................ 296,000
2000 ................................ 296,000
2001 ................................ 296,000
Thereafter ................................ 960,000
----------
$2,446,000
==========
</TABLE>
F-16
<PAGE> 37
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
6. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values presented are estimates of the fair value of the financial
instruments at a specific point in time using available market information and
appropriate valuation methodologies. These estimates are subjective in nature
and involve uncertainties and significant judgment in the interpretation of
current market data. Therefore, the fair values presented are not necessarily
indicative of amounts the Company could realize or settle currently. The Company
does not intend to dispose of or liquidate such instruments prior to maturity.
The carrying values and estimated fair values of the Company's financial
instruments are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995
-------------------------- -----------------------------
Carrying Estimated Carrying Estimated Fair
Value Fair Value Value Value
----- ---------- ----- -----
<S> <C> <C> <C> <C>
Marketable securities ...... $11,437,000 $11,437,000 $11,799,000 $11,799,000
Long-term debt ............. 2,446,000 2,714,000 2,932,000 3,363,000
</TABLE>
7. COMMITMENTS AND CONTINGENCIES
The Company has purchase commitments with various vendors for approximately
$4,038,000 as of December 31, 1996. These purchase commitments are payable in
less than a year.
Annual obligations under non-cancelable operating leases are as follows:
<TABLE>
<S> <C>
1997 ................................. $1,442,000
1998 ................................. 1,431,000
1999 ................................. 1,371,000
2000 ................................. 1,187,000
2001 ................................. 866,000
Thereafter.............................. 695,000
----------
$6,992,000
==========
</TABLE>
Rent expense charged to operations for the years ended December 31, 1996,
1995 and 1994 was $1,410,000, $1,331,000 and $912,000, respectively.
8. STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123 requires use of option valuation models that were not developed for use
in valuing employee stock options. Under APB 25, because the exercise price of
the Company's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
F-17
<PAGE> 38
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
In August 1987, the Board of Directors adopted an incentive stock option
plan and a non-qualified stock option plan under which options could be granted
to purchase up to an aggregate of 700,000 shares of the Company's common stock.
The exercise price for options granted under these plans could not be less than
100% of the fair market value of the common stock on the date of grant. Options
become exercisable and expire at the discretion of the Board of Directors,
although the plans specify that no options shall be exercisable prior to 12
months from the date of grant and all options expire five years from the date
of grant.
On April 12, 1990, the Board of Directors of the Company terminated the
1987 plans and approved the Company's 1990 Stock Option Plan under which
non-statutory or incentive stock options may be granted to key employees and
individuals who provide services to the Company. Up to an aggregate of 450,000
shares of the Company's common stock were originally authorized for issuance.
Options become exercisable and expire at the discretion of the Board of
Directors, although the plans specify that no options shall be exercisable
prior to 12 months from the date of grant and all options expire ten years from
the date of grant. On June 29, 1993, the Board of Directors of the Company
amended the Company's Restated 1990 Stock Option Plan to authorize the issuance
of an additional 450,000 shares of common stock. At the May 31, 1995 shareholder
meeting, an increase of 750,000 was approved. As of December 31, 1996 the total
number of shares reserved for issuance under the existing stock option plan and
agreements total 141,196.
The following is a summary of changes in options outstanding pursuant to
the plans for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------- -------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding -
beginning of year 1,286,034 $12.80 1,095,486 $10.25 874,659 $10.84
Granted 341,879 15.82 351,300 18.74 530,996 10.40
Exercised (241,211) 5.74 (146,162) 8.97 (138,117) 6.74
Cancelled (44,980) 16.14 (14,590) 13.88 (172,052) 17.37
--------- ------ --------- ------ --------- ------
Outstanding - end
of year 1,341,722 $14.32 1,286,034 $12.80 1,095,486 $10.25
========= ====== ========= ====== ========= ======
Exercisable at end
of year 597,277 $12.97 430,961 $ 9.93 267,360 $ 9.69
Weighted-average
fair value of
options granted
during the year $6.18 $7.25 $7.34
</TABLE>
F-18
<PAGE> 39
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
Outstanding Exercisable
--------------------------------------- ---------------------------
Weighted
Average
Remaining Weighted Weighted
Range of Number Contractual Average Number Average
Exercise Prices Outstanding Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 3.020 to 3.290 61,514 0.41 $ 3.22 49,117 $ 3.20
5.379 to 6.600 57,385 2.71 6.14 57,125 6.14
8.730 to 12.000 405,482 7.40 11.43 235,005 11.49
13.500 to 18.750 791,591 8.62 17.04 253,630 17.69
20.750 to 21.125 25,750 8.84 20.86 2,400 20.75
</TABLE>
The weighted-average remaining contractual life of stock options
outstanding at December 31, 1996 and 1995 was 7.6 years and 7.4 years,
respectively.
Pro forma information regarding net income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company has accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions for 1996
and 1995: risk free interest rate of 6.3%; no dividend yield; a volatility
factor of the expected market price of the Company's common stock of 0.38; and a
weighted-average life of each option of 4 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Pro forma net income $9,840,000 $9,417,000
Pro forma earnings per share $ 1.22 $ 1.18
</TABLE>
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.
The results above are not likely to be representative of the effects of
applying SFAS 123 on reported net income or loss for future years as these
amounts reflect the expense for only one or two years vesting.
F-19
<PAGE> 40
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
9. INCOME TAXES
The provision (benefit) for income taxes consists of the following for the
years ended December 31:
1996 1995 1994
----------------------------------------------
Current:
Federal ............ $4,775,000 $3,496,000 $3,624,000
State ............ 1,387,000 1,202,000 871,000
Foreign ............ 1,923,000 1,785,000 812,000
---------- ---------- ----------
8,085,000 6,483,000 5,307,000
Deferred:
Federal ............ (567,000) 329,000 (308,000)
State ............ (96,000) 34,000 99,000
Foreign ............ (3,000) 130,000 198,000
---------- ---------- ----------
(666,000) 493,000 (11,000)
---------- ---------- ----------
$7,419,000 $6,976,000 $5,296,000
========== ========== ==========
A reconciliation of the statutory federal income tax provision to the actual
provision follows for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
Statutory federal income tax expense................. $6,278,000 $5,777,000 $4,267,000
Non-deductible amortization of goodwill.............. 624,000 610,000 587,000
State taxes, net of federal benefit.................. 839,000 804,000 649,000
Non-deductible merger related costs.................. 116,000 185,000 123,000
Effect of foreign operations, net ................... (242,000) (116,000) 183,000
Research and experimentation credit ................. - (30,000) (185,000)
Municipal interest................................... (223,000) (156,000) (166,000)
Other................................................ 27,000 (98,000) (162,000)
---------- ---------- ----------
$7,419,000 $6,976,000 $5,296,000
========== ========== ==========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
F-20
<PAGE> 41
Significant components of the Company's deferred tax assets and liabilities are
as follows for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995
-----------------------------------
<S> <C> <C>
Deferred tax assets:
Foreign tax loss carryforwards......................... $ 554,000 $ 493,000
Contract revenue recognized for tax reporting purposes 50,000 184,000
State taxes not currently deductible................... 423,000 380,000
Accruals and reserves not currently tax deductible..... 1,309,000 341,000
Tax credit carryforwards............................... 132,000 25,000
----------- -----------
Total deferred tax assets.......................... 2,468,000 1,423,000
Valuation allowance for deferred tax assets............ (554,000) (493,000)
----------- -----------
1,914,000 930,000
Deferred tax liabilities:
Cumulative translation adjustment...................... (14,000) (298,000)
Accruals without tax effect............................ (620,000) (37,000)
Tax depreciation....................................... (1,501,000) (1,482,000)
----------- -----------
Total deferred tax liabilities..................... (2,135,000) (1,817,000)
----------- -----------
Net deferred tax liabilities ............................... $ (221,000) $ (887,000)
=========== ===========
</TABLE>
United States and foreign earnings before income taxes are as follows for the
years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------------------------------------
<S> <C> <C> <C>
United States.......... $14,281,000 $12,875,000 $10,360,000
Foreign................ 3,655,000 3,915,000 2,118,000
----------- ----------- -----------
$17,936,000 $16,790,000 $12,478,000
=========== =========== ===========
</TABLE>
F-21
<PAGE> 42
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
The Company realized tax benefits of $383,000, $409,000, and $173,000 in 1996,
1995 and 1994, respectively, from the exercise of non-qualified stock options
and disqualifying disposition of incentive stock options.
10. BENEFIT PLANS
At December 31, 1996, the Company sponsored two tax deferred defined
contribution plans for all eligible US employees, each of which was sponsored by
the predecessor companies prior to the merger of SSI into Rainbow. The Rainbow
and Mykotronx plans were merged effective January 1, 1996. Under both plans, the
employer matches certain employee contributions. During the years ended December
31, 1996, 1995 and 1994, Company contributions under both Plans totaled
approximately $307,000, $183,000, and $156,000, respectively.
11. RELATED PARTY TRANSACTIONS
During the years ended December 31, 1996, 1995 and 1994 the Company made
purchases of services from a company controlled by a director of the Company
and royalty payments to a partnership controlled by certain corporate officers
totaling $152,000, $197,000, and $288,000, respectively.
12. INDUSTRY SEGMENTS
The Company operates in two industry segments. The first segment is the
development and sale of devices which protect data and software from
unauthorized use (Software Protection Products segment). The second segment is
the development and sale of information security products to provide privacy and
security for voice communication and data transmission (Information Security
Products segment). Summaries of the Company's operations by industry and
geographic area are as follows:
A summary of the Company's operations by industry segment follows:
<TABLE>
<CAPTION>
For the year ended December 31, 1996
-------------------------------------------------------
Software Information
Protection Security Elimination Consolidated
---------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues $57,440,000 $24,270,000 $ - $81,710,000
Operating income 13,736,000 3,529,000 - 17,265,000
Identifiable assets 78,562,000 15,052,000 (250,000) 93,364,000
Depreciation and amortization 4,055,000 219,000 - 4,274,000
Capital expenditures 1,298,000 1,421,000 - 2,719,000
</TABLE>
<TABLE>
<CAPTION>
For the year ended December 31, 1995
-------------------------------------------------------
Software Information
Protection Security Elimination Consolidated
---------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Revenues $50,622,000 $21,962,000 $ - $72,584,000
Operating income 10,757,000 4,962,000 - 15,719,000
Identifiable assets 73,411,000 8,863,000 - 82,274,000
Depreciation and amortization 3,490,000 152,000 - 3,642,000
Capital expenditures 1,418,000 362,000 - 1,780,000
</TABLE>
F-22
<PAGE> 43
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
<TABLE>
<CAPTION>
For the year ended December 31, 1994
------------------------------------------------------------
Software Information
Protection Security Elimination Consolidated
---------- -------- ----------- -------------
<S> <C> <C> <C> <C>
Revenues $44,243,000 $16,571,000 $ - $60,814,000
Operating income 10,251,000 2,666,000 - 12,917,000
Identifiable assets 60,919,000 6,340,000 - 67,259,000
Depreciation and amortization 3,123,000 71,000 - 3,194,000
Capital expenditures 504,000 141,000 - 645,000
</TABLE>
A summary of the Company's operations by geographic area follows:
<TABLE>
<CAPTION>
For the year ended December 31, 1996
-----------------------------------------------------------------
United States Europe Elimination Consolidated
------------- ------ ----------- ------------
<S> <C> <C> <C> <C>
Sales to unaffiliated
customers............. $61,976,000 $19,734,000 $ - $81,710,000
Transfers between
geographic areas...... 1,042,000 3,160,000 (4,202,000) -
----------- ----------- ----------- -----------
Revenues.............. $63,018,000 $22,894,000 $(4,202,000) $81,710,000
=========== =========== =========== ===========
Operating income.......... $13,664,000 $ 3,819,000 $ (218,000) $17,265,000
Identifiable assets....... 61,280,000 32,414,000 (330,000) 93,364,000
</TABLE>
<TABLE>
<CAPTION>
For the year ended December 31, 1995
-----------------------------------------------------------------
United States Europe Elimination Consolidated
------------- ------ ----------- ------------
<S> <C> <C> <C> <C>
Sales to unaffiliated
customers............. $54,953,000 $17,631,000 $ - $72,584,000
Transfers between
geographic areas.......... 1,223,000 3,249,000 (4,472,000) -
----------- ----------- ----------- -----------
Revenues............. $56,176,000 $20,880,000 $(4,472,000) $72,584,000
=========== =========== =========== ===========
Operating income.......... $12,058,000 $ 5,310,000 $(1,649,000) $15,719,000
Identifiable assets....... 45,442,000 36,952,000 (120,000) 82,274,000
</TABLE>
<TABLE>
<CAPTION>
For the year ended December 31, 1994
----------------------------------------------------------------
United States Europe Elimination Consolidated
------------- ------ ----------- ------------
<S> <C> <C> <C> <C>
Sales to unaffiliated
customers............. $48,614,000 $12,200,000 $ - $60,814,000
Transfers between
geographic areas...... 751,000 2,531,000 (3,282,000) -
----------- ----------- ----------- -----------
Revenues.............. $49,365,000 $14,731,000 $(3,282,000) $60,814,000
=========== =========== =========== ===========
Operating income.......... $12,183,000 $ 2,733,000 $(1,999,000) $12,917,000
Identifiable assets....... 37,812,000 29,607,000 (160,000) 67,259,000
</TABLE>
F-23
<PAGE> 44
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
Geographic information for Europe encompasses the Company's operations in
France, the United Kingdom, Germany and Belarus. In determining operating
income for each geographic area, sales and purchases between geographic areas
have been accounted for on the basis of internal transfer prices set by the
Company. Identifiable assets are those tangible and intangible assets used in
operations in each geographic area.
13. SUPPLEMENTARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
March 31, 1996 June 30, 1996 September 30, 1996 December 31, 1996
-------------- ------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Revenues :
Software Protection........ $14,454,000 $14,853,000 $13,981,000 $14,152,000
Information Security....... 6,127,000 5,997,000 5,101,000 7,045,000
----------- ----------- ----------- -----------
Total Revenues............... $20,581,000 $20,850,000 $19,082,000 $21,197,000
=========== =========== =========== ===========
Cost of revenues:
Software Protection........ $ 4,375,000 $ 4,467,000 $ 4,026,000 $ 4,183,000
Information Security....... 5,168,000 5,097,000 4,145,000 5,441,000
----------- ----------- ----------- -----------
Total cost of revenues....... $ 9,543,000 $ 9,564,000 $ 8,171,000 $ 9,624,000
=========== =========== =========== ===========
Operating income............. $ 4,321,000 $ 4,275,000 $ 3,804,000 $ 4,865,000
Net income................... 2,833,000 2,674,000 2,049,000 2,961,000
Net income per share......... $ 0.35 $ 0.33 $ 0.26 $ 0.37
</TABLE>
<TABLE>
<CAPTION>
March 31, 1995 June 30, 1995 September 30, 1995 December 31, 1995
-------------- ------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Revenues:
Software Protection......... $12,368,000 $12,080,000 $12,238,000 $13,936,000
Information Security........ 5,091,000 6,091,000 5,090,000 5,690,000
----------- ----------- ----------- -----------
Total revenues............... $17,459,000 $18,171,000 $17,328,000 $19,626,000
============ =========== =========== ===========
Cost of revenues:
Software Protection......... $ 3,420,000 $ 3,555,000 $ 3,394,000 $ 4,165,000
Information Security........ 3,870,000 4,650,000 4,007,000 4,338,000
----------- ----------- ----------- -----------
Total cost of revenues....... $ 7,290,000 $ 8,205,000 $ 7,401,000 $ 8,503,000
=========== =========== =========== ===========
Operating income............. $ 3,734,000 $ 3,528,000 $ 3,697,000 $ 4,760,000
Net income................... 2,263,000 2,226,000 2,498,000 2,827,000
Net income per share......... $ 0.29 $ 0.28 $ 0.31 $ 0.35
</TABLE>
Net income per share is computed independently for each of the quarters
presented and the summation of quarterly amounts may not equal the total net
income per share reported for the year.(C)
F-24
<PAGE> 45
RAINBOW TECHNOLOGIES, INC.
SCHEDULE II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Balance Deductions/
At Recoveries Balance At
Beginning and End of
Description Of Year Additions Write-Offs Year
----------- ------- --------- ---------- ----
<S> <C> <C> <C> <C>
For the year ended December 31:
1996
Allowance for doubtful accounts receivable....... $453,000 $33,000 $(156,000) $330,000
1995
Allowance for doubtful accounts receivable....... $391,000 $76,000 $ (14,000) $453,000
1994
Allowance for doubtful accounts receivable....... $505,000 $20,000 $(134,000) $391,000
</TABLE>
F-25
<PAGE> 46
INDEX EXHIBIT
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
<S> <C> <C>
2.(i) Agreement and Plan of Reorganization, dated as of January 26,
1995 among the Company, Rainbow Acquisition Inc., a California
corporation and a wholly owned subsidiary of Rainbow, and
Mykotronx, Inc., a California corporation ("Mykotronx")
(incorporated by reference to the Company's Registration
Statement on Form S-4 under the Securities Act of 1933, as
amended, effective on April 20,1995, Registration No.33-89918)...
2.(ii) Agreement and Plan of Merger, dated September 30, 1996, by and
among the Company, RNBO Acquisition Corporation, a Nevada
corporation and a wholly-owned subsidiary of the Company, and
Software Security, Inc., a Connecticut corporation...............
3.(i) Articles of Incorporation of Rainbow, as amended (incorporated by
reference to Exhibit 3(a) to Rainbow's Registration Statement on
Form S-18 under the Securities Act of 1933, as amended, filed on
July 20, 1987-File No. 33-15956-LA (the "S-18 Registration
Statement")).....................................................
3.(ii) By-Laws of Rainbow (incorporated by reference to Exhibit 3(b) to
the S-18 Registration Statement).................................
4(a) See Exhibit 3(i).................................................
4(b) See Exhibit 3(ii)................................................
10(a) Lease for premises at 50 Technology Drive, Irvine, California,
dated June 1, 1995, between the Company and Birtcher Medical
Systems, Inc., a California corporation (filed as an exhibit to
the Company's 1995 Form 10-K)....................................
10(b) Agreement, dated May 26, 1989, between the Company and Catalyst
Semiconductor, Inc. (incorporated by reference to Exhibit 10(h)
of the Company's 1989 Annual Report on Form 10-K under the
Securities Exchange Act of 1934 filed in March 1990
(the "1989 10-K"))...............................................
10(c) Agreement, dated August 17, 1989, between the Company and
Catalyst Semiconductor, Inc. (incorporated by reference to
Exhibit 10(i) of the 1989 10-K)..................................
10(d) 1990 Incentive Stock Option Plan as amended (incorporated by
reference to Exhibit 10(j) of the 1991 10-K))....................
10(e) Asset Purchase Agreement, dated January 20,1994, between the
Company and the AND Group, Inc. (incorporated by reference to
Exhibit 10(s) to the Company's 1993 Annual Report on Form 10-K
under the Securities Exchange Act of 1934 filed in March 1994
(the "1993 10-K"))...............................................
10(f) Employment Agreement, dated February 16, 1990, between the
Company and Walter W. Straub (incorporated by reference to
Exhibit 10(j) of the 1989 10-K)..................................
10(g) Change of Control Agreement, dated February 16, 1990, between
the Company and Walter W. Straub (incorporated by reference to
Exhibit 10(k) of the 1989 10-K)..................................
10(h) Employment Agreement, dated January 15, 1992, between the
Company and Peter M. Craig (incorporated by reference to Exhibit
10(m) of the 1991 10-K)..........................................
10(i) Change of Control Agreement, dated January 15, 1992, between
the Company and Peter M. Craig (incorporated by reference to
Exhibit 10(n) of the 1991 10-K)..................................
10(j) Employment Agreement, dated January 5, 1995, between the
Company and Norman L. Denton, III (incorporated by reference to
Exhibit 10(j) of the Company's 1994 Annual Report on Form 10-K
under the Securities Exchange Act of 1934, filed in March 1995
(the "1994 10-K"))...............................................
</TABLE>
<PAGE> 47
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
- ------- ----------- ------------
<S> <C> <C>
10(k) Change of Control Agreement, dated January 5, 1995, between
the Company and Norman L. Denton, III (incorporated by reference
to Exhibit 10(k) to the 1994 10-K)...............................
10(l) Employment Agreement, dated January 5, 1995, between the
Company and Patrick E. Fevery (incorporated by reference to
Exhibit 10(l) of the 1994 10-K)..................................
10(m) Change of Control Agreement, dated January 5, 1995, between
the Company and Patrick E. Fevery (incorporated by reference to
Exhibit 10(m) of the 1994 10-K)..................................
10(n) Employment Agreement, dated January 5, 1995, between the Company
and Paul A. Bock (incorporated by reference to Exhibit 10(n) of
the 1994 10-K)...................................................
10(o) Change of Control Agreement, dated January 5, 1995, between
the Company and Paul A. Bock (incorporated by reference to
Exhibit 10(o) of the 1994 10-K)..................................
10(p) Employment Agreement, dated May 31, 1995, among Mykotronx,
the Company and Theodore S. Bettwy (filed as an exhibit to
the Company's 1995 Form 10-K)....................................
10(q) Employment Agreement dated May 31, 1995, among Mykotronx,
the Company and John C. Droge (filed as an exhibit to the
Company's 1995 Form 10-K)........................................
21(a) List of Rainbow's wholly-owned subsidiaries......................
23 Consents of Independent Auditors.................................
(1) Ernst & Young LLP............................................
(2) KMPG Peat Marwick LLP........................................
27 FINANCIAL DATA SCHEDULE............................................
</TABLE>
<PAGE> 1
EXHIBIT 2(ii)
AGREEMENT AND PLAN OF MERGER, entered into on September 30, 1996 by and
among Rainbow Technologies, Inc., a Delaware corporation with a principal place
of business located at 50 Technology Drive, Irvine, California 92718
("Rainbow"), RNBO Acquisition Corporation., a Nevada corporation and a
wholly-owned subsidiary of Rainbow with a principal place of business located at
50 Technology Drive, Irvine, California 92718 ("Sub"), and Software Security,
Inc., a Connecticut corporation with a principal place of business located at 6
Thorndal Circle, Darien, Connecticut 06820 ("SSI"). Rainbow, Sub and SSI are
referred to collectively herein as the "Parties."
W I T N E S S E T H
WHEREAS, the Parties desire to effect a tax-free merger of SSI with and
into Sub in a reorganization pursuant to Code Section 368(a)(1)(A) (the
"Merger") in order to further certain of their business objectives; and
WHEREAS, in furtherance of the Merger, SSI Stockholders will receive
capital stock in Rainbow in exchange for their capital stock in SSI.
NOW, THEREFORE, in consideration of the premises and the mutual promises
herein made, and in consideration of the representations, warranties, and
covenants herein contained, the Parties agree as follows.
1 DEFINITIONS. Certain terms used in this Agreement are defined below.
Additional terms are defined in the text of the Agreement.
1.1 AGREEMENT means this Agreement and Plan of Merger.
1.2 AFFILIATE has the meaning set forth in Rule 12b-2 of the regulations
promulgated under the Securities Exchange Act.
1.3 AFFILIATE'S AGREEMENT means the affiliate's agreement annexed hereto as
Exhibit A.
1.4 BELARUS SUBSIDIARY means Software Security Belarus, a joint venture
formed under the laws of Belarus of which SSI owns 85% of the outstanding
equity.
1.5 CERTIFICATES OF MERGER has the meaning set forth in Section 2.3 below.
1.6 CODE means the Internal Revenue Code of 1986, as amended.
1.7 CLOSING has the meaning set forth in Section 2.2 below.
1.8 CLOSING DATE has the meaning set forth in Section 2.2 below.
1.9 CONFIDENTIAL INFORMATION means any information concerning the businesses
and affairs of SSI and its UK Subsidiary that is not already generally available
to the public.
1.10 CONSENT SOLICITATION OFFERING MEMORANDUM has the meaning set forth in
Section 2.6.
1.11 CONVERSION RATIO means the ratio established at the close of business on
the last business day immediately preceding the Closing Date by dividing the
difference between 341,000 Rainbow Shares and the Option Exchange Shares by the
total number of issued and outstanding SSI Shares as of such date.
1.12 DISCLOSURE SCHEDULE has the meaning set forth in Section 3 below.
<PAGE> 2
1.13 DISSENTING SHARE means any SSI Share for which any SSI Stockholder has
exercised his appraisal rights under the Connecticut Stock Corporation Act.
1.14 EFFECTIVE TIME has the meaning set forth in Section 2.4.1 below.
1.15 EXCHANGE AGENT has the meaning set forth in Section 2.5 below.
1.16 GAAP means United States generally accepted accounting principles as in
effect from time to time.
1.17 IRS means the Internal Revenue Service.
1.18 KNOWLEDGE means actual knowledge after reasonable investigation.
1.19 MOST RECENT FISCAL QUARTER END has the meaning set forth in Section 3.5
below.
1.20 MOST RECENT FISCAL YEAR END has the meaning set forth in Section 3.5
below.
1.21 MERGER means the merger of SSI with and into Sub as contemplated by the
provisions of this Agreement.
1.22 NEVADA GENERAL CORPORATION LAW means the General Corporation Law of the
State of Nevada, as amended.
1.23 OPTION EXCHANGE SHARES has the meaning set forth in Section 2.4.8.
1.24 OPTION REGISTRATION STATEMENT has the meaning set forth in Section
2.4.8.2.
1.25 ORDINARY COURSE OF BUSINESS means the ordinary course of business
consistent with past custom and practice (including with respect to quantity and
frequency).
1.26 PARTY OR PARTIES has the meaning set forth in the preface above.
1.27 PATENTS means those patents identified in exhibits 3.19 (I), (II) and
(III) to the Disclosure Schedule.
1.28 PERSON means an individual, a partnership, a corporation, an
association, a joint stock company, a trust, a joint venture, an unincorporated
organization, or a governmental entity (or any department, agency, or political
subdivision thereof).
1.29 RAINBOW has the meaning set forth in the preface above.
1.30 RAINBOW SHARE means any share of the Common Stock, $0.001 par value per
share, of Rainbow, issued or to be issued in connection with the transactions
contemplated by this Agreement.
1.31 REGISTRATION STATEMENT has the meaning set forth in Section 2.4.5.1
below.
1.32 REQUISITE SSI STOCKHOLDER APPROVAL means the appropriate SSI Stockholder
approval of this Agreement and the Merger.
1.33 SEC means the Securities and Exchange Commission.
1.34 SECURITIES ACT means the Securities Act of 1933, as amended.
1.35 SECURITIES EXCHANGE ACT means the Securities Exchange Act of 1934, as
amended.
1.36 SECURITY INTEREST means any mortgage, pledge, lien, encumbrance, charge,
or other security interest, other than (a) mechanic's, materialmen's, and
similar liens, (b) liens for taxes not yet due and payable or for taxes that the
taxpayer is contesting in good faith through appropriate proceedings, (c)
purchase money liens and liens securing rental payments under capital lease
arrangements, and (d) other liens arising in the Ordinary Course of Business and
not incurred in connection with the borrowing of money.
<PAGE> 3
1.37 SHARE EXCHANGE AND REGISTRATION RIGHTS AGREEMENT means the share
exchange and registration rights agreement annexed hereto as Exhibit B.
1.38 SSI has the meaning set forth in the preface above.
1.39 SSI INTELLECTUAL PROPERTY RIGHTS has the meaning set forth in Section
3.19.1 below.
1.40 SSI OPTIONS has the meaning set forth in Section 2.4.8 below.
1.41 SSI SHARE means any share of the Common Stock, no par value per share,
of SSI.
1.42 TAX has the meaning set forth in Section 3.14.2 below.
1.43 TAXING AUTHORITY has the meaning set forth in Section 3.14.2 below.
1.44 TRANSACTION EXPENSES has the meaning set forth in Section 3.6 below.
1.45 SSI STOCKHOLDER means any Person who or which holds any SSI Share.
1.46 SUB has the meaning set forth in the preface above.
1.47 SUBSIDIARY means any corporation with respect to which a specified
Person (or a Subsidiary thereof) owns a majority of the common stock or has the
power to vote or direct the voting of sufficient securities to elect a majority
of the directors.
1.48 UK SUBSIDIARY means Software Security International Ltd., a wholly-owned
subsidiary of SSI.
1.49 SURVIVING CORPORATION has the meaning set forth in Section 2.1 below.
2 BASIC TRANSACTION.
2.1 THE MERGER. On and subject to the terms and conditions of this
Agreement, SSI will merge with and into Sub at the Effective Time. Sub shall be
the corporation surviving the Merger (the "Surviving Corporation").
2.2 THE CLOSING. The closing of the transactions contemplated by this
Agreement (the "Closing") shall take place at a place mutually agreed upon by
the parties on the date that is two business days following the date upon which
all of the conditions to the obligations of the Parties to close set forth in
Section 6.1 and Section 6.3 shall have been satisfied or waived in accordance
with the terms hereof, or upon such other date as shall have been mutually
agreed upon by the Parties (the "Closing Date"); provided, however, that the
Closing Date shall be no later than October 31, 1996.
2.3 ACTIONS AT THE CLOSING. At the Closing, (i) SSI will deliver to
Sub the various certificates, instruments, and documents referred to in Section
6.1 below, (ii) Sub and Rainbow will deliver to SSI the various certificates,
instruments, and documents referred to in Section 6.4 below, (iii) Sub and SSI
will file with the Secretary of State of the States of Nevada and Connecticut
the Certificates of Merger in the forms attached hereto as Exhibits C and D
(collectively, the "Certificates of Merger"), and (iv) Rainbow will deliver to
the Exchange Agent in the manner provided below in this Section 2 the
certificate evidencing Rainbow Shares issued in the Merger.
<PAGE> 4
1.1 EFFECT OF MERGER.
1.1.1 GENERAL. The Merger shall become effective at the time (the
"Effective Time") Sub and SSI file the Certificates of Merger with the Secretary
of State of the States of Nevada and Connecticut. The Merger shall have the
effect set forth in the Nevada General Corporation Law and the Connecticut Stock
Corporation Act. The Surviving Corporation may, at any time after the Effective
Time, take any action (including executing and delivering any document) in the
name and on behalf of either Sub or SSI in order to carry out and effectuate the
transactions contemplated by this Agreement.
1.1.2 CERTIFICATE OF INCORPORATION. The Certificate of
Incorporation of Sub in effect at and as of the Effective Time will remain the
Certificate of Incorporation of the Surviving Corporation without any
modification or amendment in the Merger. A copy of such Certificate of
Incorporation has been provided to SSI.
1.1.3 BYLAWS. The Bylaws of Sub in effect at and as of the
Effective Time will remain the Bylaws of the Surviving Corporation without any
modification or amendment in the Merger. A copy of such Bylaws has been provided
to SSI.
1.1.4 DIRECTORS AND OFFICERS. The directors and officers of Sub in
office at and as of the Effective Time will remain the directors and officers of
the Surviving Corporation (retaining their respective positions and terms of
office).
1.1.5 CONVERSION OF SSI SHARES. At and as of the Effective Time,
(i) each SSI Share (other than any Dissenting Share) shall automatically convert
into the right to receive a number of Rainbow Share(s) determined by dividing
the Conversion Ratio by one, and (ii) each Dissenting Share shall be converted
into the right to receive payment from the Surviving Corporation with respect
thereto in accordance with the provisions of the Connecticut Stock Corporation
Act; provided, however, that the Conversion Ratio shall be subject to equitable
adjustment in the event of any stock split or other recapitalization effecting
the Rainbow Shares prior to the Closing Date.
1.1.5.1 REGISTRATION OF RAINBOW SHARES. Rainbow will cause a
registration statement on Form S-3 (the "Registration Statement") to become
effective under the Securities Act covering the Rainbow Shares issued in
exchange for the SSI Shares in connection with the Merger, as set forth in the
Share Exchange and Registration Rights Agreement.
1.1.6 FRACTIONAL SHARES. No fraction of a Rainbow Share shall be
issued, but in lieu of any such fraction each holder of an SSI Share who would
otherwise be entitled to receive a fraction of a Rainbow Share shall receive
from Rainbow an amount of cash equal to the per share market value of Rainbow
Shares (based on the closing price of Rainbow Common Stock as reported on the
NASDAQ National Market System ("NASDAQ") on the last trading day prior to the
Effective Time of the Merger) multiplied by the fraction of a Rainbow Share to
which such a holder would otherwise be entitled.
1.1.7 SUB SHARES. Each share of common stock of Sub issued and
outstanding at and as of the Effective Time will remain issued and outstanding.
1.1.8 CONVERSION OF SSI OPTIONS. At the Effective Time of the
Merger, each 4.41 options to purchase SSI Shares, whether vested or unvested,
(including all outstanding options granted under SSI's 1993 Employee Stock
Option Plan, SSI's 1993 Director Stock Option Plan, and the option agreement
between SSI and Frederick Engel, dated January 1, 1993) (collectively, the "SSI
Options") will, by virtue of the Merger and at the Effective Time of the Merger,
and without any further action on the part of any holder thereof, be converted
into an option to purchase a single Rainbow Share. The exercise price of each
Rainbow Share issuable upon exercise of an SSI Option shall be the amount
(rounded up to the nearest cent) obtained by
<PAGE> 5
multiplying the exercise price per share of
<PAGE> 6
SSI Shares at which such SSI Option is exercisable immediately prior to the
Effective Time by 4.41. If the foregoing calculation results in an assumed SSI
Option being exercisable for a fraction of a Rainbow Share, then the number of
Rainbow Shares subject to such SSI Option will be rounded up to the nearest
whole number of Rainbow Shares with no cash being payable for such fractional
share. The term, exercisability, vesting schedule, and all other terms and
conditions of the SSI Options will otherwise be unchanged. For purposes of this
Agreement, Rainbow agrees to reserve for issuance that number of Rainbow Shares
for which SSI Options may be exercised (the "Option Exchange Shares").
1.1.8.1 STOCK OPTION AGREEMENT. Promptly after the Effective
Time of the Merger, Rainbow shall issue to each holder of an SSI Option a stock
option agreement evidencing the foregoing assumption of such SSI Options by
Rainbow on terms no less favorable to the holder of such SSI Options than as set
forth in the option agreement existing with respect to such SSI Options
immediately prior to the Effective Time.
1.1.8.2 REGISTRATION ON FORM S-8. Rainbow will cause the Option
Exchange Shares issuable upon exercise of the assumed SSI Options to be included
in a registration statement under the Securities Act, on Form S-8 promulgated by
the SEC (the "Option Registration Statement") and to be registered or qualified
(or to have established that an exemption from such registration or
qualification is available) such Option Exchange Shares under the blue sky laws
of all states in which holders of SSI Options reside within 45 days after the
Effective Time of the Merger. Rainbow will use its best efforts to maintain the
effectiveness of such registration statement or registration statements for so
long as any such SSI Options assumed by Rainbow remain outstanding.
1.2 EXCHANGE PROCEDURE. Immediately after the Effective Time, (i)
Rainbow will furnish to Rainbow's Transfer Agent, U.S. Stock Transfer Co. (the
"Exchange Agent"), a letter of direction authorizing the issuance of that number
of Rainbow Shares equal to the product of (a) the Conversion Ratio times (b) the
number of outstanding SSI Shares (other than any Dissenting Shares) and (ii)
Rainbow will cause the Exchange Agent to mail a letter of transmittal (with
instructions for its use), in a form reasonably acceptable to counsel to SSI, to
each record holder of outstanding SSI Shares for the holder to use in
surrendering the certificates which represented his SSI Shares in exchange for a
certificate representing the number of Rainbow Shares (or the fair value for his
Dissenting Shares) to which he is entitled.
1.2.1 Rainbow will not pay any dividend or make any distribution on
Rainbow Shares (with a record date at or after the Effective Time) to any record
holder of outstanding SSI Shares until the holder surrenders for exchange his or
its certificates which represented SSI Shares. Rainbow instead will pay the
dividend or make the distribution to the Exchange Agent in trust for the benefit
of the holder pending surrender and exchange.
1.2.2 Rainbow may cause the Exchange Agent to return any Rainbow
Shares and dividends and distributions thereon remaining unclaimed 180 days
after the Effective Time, and thereafter each remaining record holder of
outstanding SSI Shares shall be entitled to look to Rainbow (subject to
abandoned property, escheat, and other similar laws) as a general creditor
thereof with respect to Rainbow Shares and dividends and distributions thereon
to which he is entitled upon surrender of his certificates.
1.2.3 Rainbow shall pay all charges and expenses of the Exchange
Agent.
1.3 CONSENT SOLICITATION OFFERING MEMORANDUM. The Rainbow Shares
to be issued on the Closing Date in exchange for the SSI Shares will not be
registered under the Securities Act until the Registration Statement filed with
the SEC becomes effective. Accordingly, the Rainbow Shares will be issued
pursuant to an exemption from the Securities Act in a private placement to the
SSI Stockholders. As promptly as practicable after the date of this
<PAGE> 7
Agreement, Rainbow and SSI will prepare and issue to the SSI Stockholders a
Consent Solicitation Offering Memorandum (the "Consent Solicitation Offering
Memorandum"). Rainbow will also take any action required to be taken under any
applicable state securities or "blue sky" laws in connection with the issuance
of the Rainbow Shares. The Parties will furnish each other with all information
reasonably required in connection with any action contemplated by this Section
2.6.
2. REPRESENTATIONS AND WARRANTIES OF SSI. SSI represents and warrants
to Rainbow and Sub that the statements contained in this Section 3 are correct
and complete as of the date of this Agreement and will be correct and complete
in all material respects as of the Closing Date (as though made then and as
though the Closing Date were substituted for the date of this Agreement
throughout this Section 3), except as set forth in the disclosure schedule
accompanying this Agreement and initialed by the Parties (the "Disclosure
Schedule"). The Disclosure Schedule will be arranged in paragraphs corresponding
to the lettered and numbered paragraphs contained in this Section 3. With regard
to the Belarus Subsidiary, SSI represents and warrants only that SSI has not
been subject to any claim of any third party, named as a party in any litigation
or received notice of any claim or threatened litigation relating to Belarus
Subsidiary or its business or operations, and SSI makes no other representations
or warranties of any nature whatsoever with respect to Belarus Subsidiary.
2.1 ORGANIZATION, QUALIFICATION, AND CORPORATE POWER. Each of SSI and
its UK Subsidiary is a corporation duly organized, validly existing, and in good
standing under the laws of the jurisdiction of its incorporation. Each of SSI
and its UK Subsidiary is duly authorized to conduct business and is in good
standing under the laws of each jurisdiction where such qualification is
required. Each of SSI and its UK Subsidiary has full corporate power and
authority to carry on the businesses in which it is engaged and to own and use
the properties owned and used by it.
2.2 CAPITALIZATION. The entire authorized capital stock of SSI
consists of 1,200,000 SSI Shares (consisting of 800,000 voting shares and
400,000 non-voting shares). The number of issued and outstanding voting shares,
non-voting shares and SSI Options are as set forth on the Disclosure Schedule.
All of the issued and outstanding SSI Shares have been duly authorized and are
validly issued, fully paid, and nonassessable. Except as described above, there
are no outstanding or authorized options, warrants, purchase rights,
subscription rights, conversion rights, exchange rights, or other contracts or
commitments that could require SSI to issue, sell, or otherwise cause to become
outstanding any of its capital stock. There are no outstanding or authorized
stock appreciation, phantom stock, profit participation, or similar rights with
respect to SSI.
2.3 AUTHORIZATION OF TRANSACTION. SSI has full power and authority
(including full corporate power and authority) to execute and deliver this
Agreement and to perform its obligations hereunder; provided, however, that SSI
cannot consummate the Merger unless and until it receives the Requisite SSI
Stockholder Approval. This Agreement constitutes the valid and legally binding
obligation of SSI, enforceable against it in accordance with its terms and
conditions.
2.4 NONCONTRAVENTION. Neither the execution and the delivery of this
Agreement, nor the consummation of the transactions contemplated hereby, will
(i) violate any constitution, statute, regulation, rule, injunction, judgment,
order, decree, ruling, charge, or other restriction of any government,
governmental agency, or court to which any of SSI and its UK Subsidiary is
subject or any provision of the charter or bylaws of any of SSI and its UK
Subsidiary or (ii) conflict with, result in a breach of, constitute a default
under, result in the acceleration of, create in any party the right to
accelerate, terminate, modify, or cancel, or require any notice under any
agreement, contract, lease, license, instrument or other arrangement to which
any of SSI and its UK Subsidiary is a party or by which it is bound or to which
any of its assets is subject
<PAGE> 8
(or result in the imposition of any Security Interest upon any of its assets)
except where the violation, conflict, breach, default, acceleration,
termination, modification, cancellation, or failure to give notice would not
have a material adverse effect on the ability of the Parties to consummate the
transactions contemplated by this Agreement.
2.5 FINANCIAL STATEMENTS. Attached hereto as Exhibit E are the
following financial statements (collectively the "SSI Financial Statements"):
(i) preliminary consolidated balance sheets of SSI and its UK Subsidiary, and
the related statements of income, shareholders' equity, and cash flows as of and
for the fiscal years ended March 31, 1996 and 1995 (the "Most Recent Fiscal Year
End"); and (ii) preliminary unaudited consolidated balance sheets of SSI and Its
UK Subsidiary, and the related statements of income, shareholders' equity, and
cash flows as of and for the three months ended June 30, 1996 and 1995 (the
"Most Recent Fiscal Quarter End"). The SSI Financial Statements (including the
notes thereto) have been prepared in accordance with GAAP applied on a
consistent basis throughout the periods covered thereby , present fairly the
financial condition of SSI and its UK Subsidiary as of such dates and the
results of operations of the SSI and its UK Subsidiary for the periods then
ended; provided, however, that the Most Recent Fiscal Quarter End is subject to
normal year-end adjustments.
2.6 UNDISCLOSED LIABILITIES. None of SSI and its UK Subsidiary has any
material liability (and, to the knowledge of SSI, there is no reasonable basis
for any action, suit, proceeding, hearing, investigation, charge, complaint,
claim, or demand against any of them giving rise to any material liability),
including liability for taxes, except for (i) liabilities, obligations or
contingencies not required to be disclosed on a balance sheet prepared in
accordance with GAAP, (ii) liabilities which have arisen after the Most Recent
Fiscal Quarter End in the Ordinary Course of Business none of which results
from, arises out of, relates to, is in the nature of, or was caused by any
breach of contract, breach of warranty, tort, infringement, or violation of law,
(iii) liabilities and obligations disclosed in the Disclosure Schedule, and (iv)
costs and expenses incurred and to be incurred by SSI in connection with the
negotiation, documentation and closing of the transactions contemplated by this
Agreement (the "Transaction Expenses").
2.7 BROKERS' FEES. None of SSI and its UK Subsidiary has any liability
or obligation to pay any fees or commissions to any broker, finder, or agent
with respect to the transactions contemplated by this Agreement.
2.8 CONTINUITY OF BUSINESS ENTERPRISE. SSI operates at least one
significant historic business line, or owns at least a significant portion of
its historic business assets, in each case within the meaning of Treas. Reg.
Section 1.368-1(d).
2.9 INVENTORIES AND ACCOUNTS RECEIVABLE. The inventories of SSI,
whether finished goods, work in process or raw materials, shown on the SSI
Financial Statements, are all items of a quality usable or salable in the
ordinary and usual course of SSI's business, except for inventory items that
have been written down to an amount not in excess of realizable market value or
for which adequate reserves or allowances have been provided. The values at
which inventories are carried reflect an inventory valuation policy of SSI which
is consistent with SSI's past practice and which is in accordance with GAAP
applied on a consistent basis. The accounts receivable of SSI shown on the SSI
Financial Statements arose from valid transactions. To SSI's knowledge, the
reserve for doubtful accounts and product returns is adequate, and the values at
which accounts receivable are carried reflect the policies of SSI consistent
with SSI's past practice and are in accordance with GAAP applied on a consistent
basis.
2.10 NO VIOLATIONS. The business of SSI is not being conducted in
violation of any applicable law, rule or regulation, judgment, decree or order
of any governmental entity except for any violations which, individually or in
the aggregate, have not had and will not have a material adverse effect on the
business condition of SSI. There are no judgments or outstanding orders,
injunctions, decrees, stipulations or awards (whether rendered by a court or
<PAGE> 9
administrative agency or by arbitration) against SSI or any of its properties
or businesses which will, individually or in the aggregate, have a material
adverse effect on the business condition of SSI.
2.11 NO DEFAULTS. SSI is not aware of and has not received written
notice that it would be with the passage of time, in default or violation of any
term, condition or provision of (i) the Certificate of Incorporation or Bylaws
of SSI; (ii) any judgment, decree or order applicable to SSI; or (iii) any
material mortgage, note, indenture, contract, agreement, lease or other
instrument or commitment to which SSI is now a party or by which SSI or any of
its properties or assets may be bound, except for any defaults or violations
which would not have a material adverse effect on the business condition of SSI.
2.12 LITIGATION. There is no action, suit or proceeding pending, or to
the knowledge of SSI, threatened, which would, individually or in the aggregate,
have a material adverse effect on the business condition of SSI. There is no
investigation pending or, to the knowledge of SSI, threatened against SSI or any
of its officers or directors, before any federal, state, municipal or other
governmental department, commission, board, bureau, agency, instrumentality or
other governmental entity. To SSI's knowledge, no governmental entity is
currently challenging or questioning the legal right of SSI to manufacture,
offer or sell any of their products in the present manner or style thereof and
any prior matters of such nature have been settled and properly reflected in the
SSI Financial Statements.
2.13 ABSENCE OF CERTAIN CHANGES. Since the Most Recent Fiscal Year End,
except for the Transaction Expenses, there has not been any material adverse
change in the business, financial condition, operations, results of operations,
or, to SSI's knowledge, future prospects of either SSI or its UK Subsidiary.
Without limiting the generality of the foregoing, except as contemplated by this
Agreement, since that date: (i) neither SSI nor its UK Subsidiary has sold,
leased, transferred, or assigned any of its assets, tangible or intangible,
other than in the Ordinary Course of Business; (ii) neither SSI nor its UK
Subsidiary has entered into any agreement, contract, lease, or license (or
series of related agreements, contracts, leases, and licenses) either involving
more than $10,000 or outside the Ordinary Course of Business; (iii) no party
(including SSI and its UK Subsidiary) has accelerated, terminated, modified, or
canceled any agreement, contract, lease, or license (or series of related
agreements, contracts, leases, and licenses) involving more than $10,000 to
which either SSI or its UK Subsidiary is a party or by which either of them is
bound; (iv) neither SSI nor its UK Subsidiary has imposed any Security Interest
upon any of its assets, tangible or intangible; (v) neither SSI nor its UK
Subsidiary has made any capital expenditure (or series of related capital
expenditures) either involving more than $10,000 or outside the Ordinary Course
of Business; (vi) neither SSI nor its UK Subsidiary has made any capital
investment in, any loan to, or any acquisition of the securities or assets of,
any other Person (or series of related capital investments, loans, and
acquisitions) either involving more than $10,000 or outside the Ordinary Course
of Business; (vii) neither SSI nor its UK Subsidiary has issued any note, bond,
or other debt security or created, incurred, assumed, or guaranteed any
indebtedness for borrowed money or capitalized lease obligation either involving
more than $10,000 or outside the Ordinary Course of Business; (viii) neither SSI
nor its UK Subsidiary has delayed or postponed the payment of accounts payable
and other liabilities outside the Ordinary Course of Business; (ix) neither SSI
nor its UK Subsidiary has canceled, compromised, waived, or released any right
or claim (or series of related rights and claims) involving more than $10,000 or
outside the Ordinary Course of Business; (x) neither SSI nor its UK Subsidiary
has granted any license or sublicense of any rights under or with respect to any
intellectual property outside the Ordinary Course of Business; (xi) there has
been no change made or authorized in the charter or bylaws of any of SSI and its
UK Subsidiary; (xii) neither SSI nor its UK Subsidiary has issued, sold, or
otherwise disposed of any of its capital stock, or granted any options,
warrants, or other rights to purchase or obtain (including upon conversion,
exchange, or exercise) any of its capital stock; (xiii) neither SSI nor its UK
Subsidiary has declared, set aside, or paid any dividend or made any
distribution with respect to its capital stock
<PAGE> 10
(whether in cash or in kind) or redeemed, purchased, or otherwise acquired any
of its capital stock; (xiv) neither SSI nor its UK Subsidiary has experienced
any material damage, destruction, or loss (whether or not covered by insurance)
to its property, except for property not material to its business; (xv) neither
SSI nor its UK Subsidiary has made any loan to, or entered into any other
transaction with, any of its directors, officers, and employees outside the
Ordinary Course of Business; (xvi) neither SSI nor its UK Subsidiary has entered
into any employment contract or collective bargaining agreement, written or
oral, or modified the terms of any existing such contract or agreement; (xvii)
neither SSI nor its UK Subsidiary has granted any increase in the base
compensation of any of its directors, officers, and employees outside the
Ordinary Course of Business; (xviii) neither SSI nor its UK Subsidiary has
adopted, amended, modified, or terminated any bonus, profit-sharing, incentive,
severance, or other plan, contract, or commitment for the benefit of any of its
directors, officers, and employees (or taken any such action with respect to any
other Employee Benefit Plan); (xix) neither SSI nor its UK Subsidiary has made
any other change in employment terms for any of its directors, officers, and
employees outside the Ordinary Course of Business; (xx) neither SSI nor its UK
Subsidiary has made or pledged to make any charitable or other capital
contribution outside the Ordinary Course of Business; and (xxi) neither SSI nor
its UK Subsidiary has committed to any of the foregoing.
2.14 TAXES.
2.14.1 All Tax returns, statements, reports and forms
(including estimated tax returns and reports and information returns and
reports) required to be filed with any Taxing Authority with respect to any
Taxable period ending on or before the Effective Time of the Merger by or on
behalf of SSI, (collectively, the "SSI Returns") have been or will be filed when
due in accordance with all applicable laws (including any extensions of such due
date); (ii) SSI has timely paid or withheld all Taxes reasonably estimated as
payable by SSI Returns that have been filed; (iii) SSI has made provision for
all Taxes reasonably estimated as payable by SSI for any Taxable period
(including any portion thereof) ending on or before June 30, 1996 for which no
SSI Return has yet been filed; (iv) the charges, accruals and reserves for taxes
with respect to SSI for any Taxable period (including any portion thereof)
ending on or before the Effective Time of the Merger reflected on the SSI
Financial Statements are adequate to cover such Taxes; (v) SSI has withheld and
paid to the applicable financial institutions or Taxing Authority all amounts
required to be withheld; (vi) since June 30, 1996, no Tax liability has been or
will be incurred by SSI other than in the Ordinary Course of Business; (vii)
there is no material claim, audit, action, suit, proceeding or investigation now
pending or (to the knowledge of SSI) threatened against or with respect to SSI
in respect of any Tax or assessment; and (viii) there are no liens for Taxes
upon the assets of SSI except liens for current Taxes not yet due.
2.14.2 For purposes of this Agreement, "Tax" (and, with
correlative meaning, "Taxes" and "Taxable") means (i) any net income,
alternative or add-on minimum tax, gross income, gross receipts, sales, use, ad
valorem, transfer, franchise, profits, license, withholding, payroll,
employment, excise, severance, stamp, occupation, premium, property,
environmental or windfall profit tax, custom, duty or other tax, governmental
fee or other like assessment or charge of any kind whatsoever, together with any
interest or any penalty, addition to tax or additional amount imposed by any
governmental authority (a "Taxing Authority") responsible for the imposition of
any such tax (domestic or foreign), (ii) any liability for the payment of any
amounts of the type described (i) as a result of being a member of an
affiliated, consolidated, combined or unitary group for any Taxable period and
(iii) any liability for the payment of any amounts of the type described in (i)
or (ii) as a result of any express or implied obligation to indemnify any other
person.
2.14.3 SSI has provided Sub or its designated representatives
true and correct copies of all material Tax returns, information statements,
reports, work papers, Tax opinions and memoranda and other Tax data and
documents requested by Sub.
<PAGE> 11
2.15 EMPLOYEE BENEFIT PLANS. All material employee benefit plans,
policies, programs or arrangements covering active, former or retired employees
(collectively, the "Plans") of SSI, to the extent applicable, (i) comply, in all
material respects, with the requirements of the Employee Retirement Income
Security Act of 1974, as amended (ERISA) and the Code, and any such Plan
intended to be qualified under Section 401(a) of the Code has been determined by
the IRS to be so qualified; (ii) no such plan is covered by Title IV of ERISA or
Section 412 of the Code; (iii) have not incurred any liability or penalty under
Section 4975 of the Code or Section 502(i) of ERISA; and (iv) have been
maintained and administered in all material respects in compliance with its
terms and with the requirements prescribed by any and all statutes, orders,
rules and regulations, including but not limited to ERISA and the Code, which
are applicable to such Plans. To the knowledge of SSI there are no pending or
threatened material claims against or otherwise involving any such plans and no
suit, action or other litigation (excluding claims for benefits incurred in the
ordinary course of such Plan activities) has been brought against or with
respect to any such Plan, and all material contributions, reserves or premium
payments required to be made as of the date hereof to such Plans have been made
or provided for.
2.16 MAJOR CONTRACTS. SSI is not a party to any written or oral,
formal or informal:
(i) union contract, employment contract or arrangement providing for
future compensation with any officer, consultant, director or employee which is
not terminable by it on 30 days' notice or less without penalty or obligation to
make payments related to such termination;
(ii) plan, contract or arrangement exceeding $5000, providing for
bonuses, pensions, deferred compensation, retirement payments, profit-sharing or
the like;
(iii) OEM agreement, distribution agreement, dealer agreement, volume
purchase agreement or manufacturing agreement in which SSI has granted or
received manufacturing rights, most favored customer pricing provisions or
exclusive marketing rights related to any product, group of products or
territory;
(iv) agreement, license, franchise, permit, indenture or
authorization, in each case, which is material to the business condition of SSI,
which has not been terminated, or performed in its entirety and not renewed
which may be, by its terms, terminated, materially impaired or materially
adversely affected by reason of the execution of this Agreement, the Merger
Agreement, the closing of the Merger, or the transactions contemplated hereby or
thereby;
(v) except with respect to trade indebtedness incurred in the Ordinary
Course of Business, instruments evidencing or related in any way to indebtedness
incurred in the acquisition of products, or companies or other entities, or
indebtedness for borrowed money by way of direct loan, sale of debt securities,
purchase money obligation, conditional sale, guarantee or otherwise which
individually is in the amount of $5000 or more; or
(vi) contract containing covenants purporting to limit the freedom of
SSI or, to SSI's knowledge, any key employee of SSI to compete in any line of
business in any geographic area, other than agreements related to
confidentiality and assignment of inventions between SSI and its employees in
the form heretofore furnished to Sub.
1.1 All agreements, contracts, plans, leases, instruments,
arrangements, licenses and commitments heretofore furnished to Sub are valid and
in full force and effect and SSI has not, nor to the knowledge of SSI has any
other party thereto, breached any provision of, or is in default under the terms
of, any such contract, agreement, instrument, arrangement, commitment, plan,
lease or license, except for such breaches or defaults as would not have a
material adverse effect on the business condition of SSI.
<PAGE> 12
1.2 INTERESTS OF CERTAIN PERSONS. To the best knowledge of SSI,
neither SSI's officers, directors, or key employees or consultants has any
direct or indirect interest material to SSI in any property, real or personal,
tangible or intangible, including inventions, patents, copyrights, trademarks or
trade names, used in or pertaining to SSI's business, except for such agreements
that are not material to the business condition of SSI and except for rights of
a shareholder and except for rights under existing employee benefit plans. To
the best knowledge of SSI, no officer of SSI has any financial interest in any
corporation, partnership, joint venture or other entity that is a party to any
agreement with SSI, except rights of a shareholder and rights under existing
employee benefit plans. For this purpose, an ownership interest of less than 5%
of the voting stock of a publicly held company shall be deemed to be not
material.
1.3 INTELLECTUAL PROPERTY.
1.3.1 The Patents, trademarks and copyrights listed in the
Disclosure Schedule are either owned by or licensed to SSI, as indicated in the
Disclosure Schedule, and together with all of the know-how used by SSI in the
conduct of its business all of which is owned by SSI (such know-how together
with such Patents, trademarks and copyrights, collectively, the "SSI
Intellectual Property Rights") constitute all the know-how, Patents, trademarks
and copyrights necessary to conduct the business of SSI as currently conducted
by it.
1.3.2 To the best of SSI's knowledge, neither the manufacture,
marketing, license, sale or use of any product currently licensed or sold by SSI
violates in any material respect any license or agreement between SSI and any
third party or infringes any valid intellectual property right of any other
party; there is no pending or, to the knowledge of SSI, threatened claim or
litigation contesting the validity, ownership or right to use, any SSI
Intellectual Property Rights nor, to the knowledge of SSI, is there any
reasonable basis for any such claim, nor has SSI received any written notice
asserting that any SSI Intellectual Property Rights or the use thereof by SSI
conflicts with the rights of any other party.
1.4 EMPLOYEES. No officer or key employee of SSI has given notice to
SSI of his or her intention to terminate his or her employment with SSI. To
SSI's knowledge, no employee of SSI is subject to any secrecy or noncompetition
agreement or any agreement or restriction of any kind that would impede in any
material way the ability of such employee to carry out fully all activities of
such employee in furtherance of the business of SSI now or upon consummation of
the transactions contemplated hereby.
1.5 INSURANCE. SSI has insurance policies in the type and amounts
customarily carried by persons conducting businesses similar to those of SSI.
1.6 ENVIRONMENTAL MATTERS. At all times prior to the date hereof, SSI
has complied with, and, to SSI's knowledge, SSI's facilities are in all material
respects in compliance with, all applicable environmental laws, orders,
regulations, rules and ordinances adopted , imposed or promulgated by any
governmental entity relating to the properties owned or leased by SSI (the "SSI
Properties"), the violation of which could have a material adverse effect on the
business condition of SSI. The environmental licenses, permits, clearances,
consents and authorizations material to the operations of SSI are in full force
and effect. SSI has not released or caused to be released on or about any of SSI
properties any pollutants, contaminations, "hazardous substances" (as that term
is defined in Section 101(14) of the Comprehensive Environmental Response,
Compensation and Liability Act, as amended) or "regulated substances" (as that
term is defined in Section 9001 or the Resource Conservation and Recovery Act,
42 U.S.C. Section 6901, et seq, as amended) required to be remedied by any
governmental agency with jurisdiction over SSI Properties under the authority of
laws, regulations and ordinances as in effect and currently interpreted, which
would have a material adverse effect on the business condition of SSI. No
action, proceeding, liability or claim exists, or to SSI's knowledge is
threatened, against SSI or to the knowledge of SSI, any landfills, disposal
sites, agents and recycles used by SSI. To the knowledge of SSI, there is no
fact or circumstance
<PAGE> 13
which could involve SSI in any environmental litigation or impose any
environmental liability upon SSI which would have a materially adverse effect on
the business condition of SSI.
1.7 DISCLOSURE. None of the information that SSI will supply
specifically for use in the Consent Solicitation Offering Memorandum will
contain any untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements made therein not misleading. No
representation or warranty of SSI set forth in this Section 3 or any of the
documents delivered pursuant to this Agreement contains an untrue statement of a
material fact or omits to state a material fact necessary in order to make the
statements made herein or therein not misleading.
2. REPRESENTATIONS AND WARRANTIES OF SUB AND RAINBOW. Each of Sub and
Rainbow represent and warrant to SSI that the statements contained in this
Section 4 are correct and complete as of the date of this Agreement and will, on
the Closing Date, continue to be correct and complete (as though made then and
as though the Closing Date were substituted for the date of this Agreement
throughout this Section 4).
2.1 ORGANIZATION. Rainbow is a corporation duly organized, validly
existing, and in good standing under the laws of Delaware, and Sub is a
corporation duly organized, validly existing and in good standing under the laws
of Nevada. Sub is qualified to do business as a foreign corporation under the
laws of the State of Connecticut.
2.2 CAPITALIZATION. As of September 26, 1996, the entire authorized
capital stock of Rainbow consists of 20,000,000 Rainbow Shares, of which
7,412,327 Rainbow Shares are issued and outstanding and 1,098,700 Rainbow Shares
are reserved for issuance under outstanding options to purchase Rainbow Shares.
All of Rainbow Shares to be issued in the Merger, including the Option Exchange
Shares to be issued upon the exercise of SSI Options have been duly authorized
and, upon consummation of the Merger, will be validly issued, fully paid, and
nonassessable. Rainbow has reserved for issuance upon exercise of the SSI
Options that number of Rainbow Shares for which the SSI Options may be
exercised.
2.3 AUTHORIZATION OF TRANSACTION. Sub and Rainbow have full power and
authority (including full corporate power and authority) to execute and deliver
this Agreement and to perform its obligations hereunder. This Agreement
constitutes the valid and legally binding obligation of Sub and Rainbow,
enforceable against each of them in accordance with its terms and conditions.
2.4 NONCONTRAVENTION. Neither the execution and the delivery of this
Agreement, nor the consummation of the transactions contemplated hereby, will
(i) violate any constitution, statute, regulation, rule, injunction, judgment,
order, decree, ruling, charge, or other restriction of any government,
governmental agency, or court to which Sub and Rainbow are subject or any
provision of the charter or bylaws of Sub or Rainbow or (ii) conflict with,
result in a breach of, constitute a default under, result in the acceleration
of, create in any party the right to accelerate, terminate, modify, or cancel,
or require any notice under any agreement, contract, lease, license, instrument
or other arrangement to which Sub or Rainbow is a party or by which it is bound
or to which any of its assets is subject except where the violation, conflict,
breach, default, acceleration, termination, modification, cancellation, or
failure to give notice would not have a material adverse effect on the ability
of the Parties to consummate the transactions contemplated by this Agreement.
Other than in connection with the provisions of the Nevada General Corporation
Law, the Securities Exchange Act, the Securities Act, and the state securities
laws, Sub and Rainbow do not need to give any notice to, make any filing with,
or obtain any authorization, consent, or approval of any government or
governmental agency in order for the Parties to consummate the transactions
contemplated by this Agreement, except where the failure to give notice, to
file, or to obtain any authorization, consent, or approval would
<PAGE> 14
not have a material adverse effect on the ability of the Parties to consummate
the transactions contemplated by this Agreement.
2.5 BROKERS' FEES. Neither Sub nor Rainbow has any liability or
obligation to pay any fees or commissions to any broker, finder, or agent with
respect to the transactions contemplated by this Agreement for which any of SSI
and its UK Subsidiary could become liable or obligated.
2.6 CONTINUITY OF BUSINESS ENTERPRISE. It is the present intention of
Sub to continue at least one significant historic business line of SSI, or to
use at least a significant portion of SSI's historic business assets in a
business, in each case within the meaning of Treas. Reg. Section 1.368-1(d).
2.7 DISCLOSURE. The Registration Statement and the Option Registration
Statement will comply with the Securities Act and all applicable state
securities law in all material respects. The Registration Statement and the
Option Registration Statement will not contain any untrue statement of a
material fact or omit to state a material fact necessary in order to make the
statements therein not misleading; provided, however, Rainbow and Sub make no
representation or warranty with respect to any information that SSI will supply
for use in the Registration Statement and the Option Registration Statement.
None of the information about Rainbow contained in the Consent Solicitation
Offering Memorandum will contain any untrue statement of a material fact or omit
to state a material fact necessary in order to make the statements made therein
not misleading.
3 . COVENANTS. The Parties agree as follows with respect to the
period from and after the execution of this Agreement.
3.1 GENERAL. Each of the Parties will cooperate to take all action and
to do all things necessary in order to consummate and make effective the
transactions contemplated by this Agreement including satisfaction of their
respective conditions to closing set forth in Section 6 below.
3.2 NOTICES AND CONSENTS. SSI will give any notices (and will cause
its UK Subsidiary to give any notices) to third parties, and will use its best
efforts to obtain (and will cause its UK Subsidiary to use its best efforts to
obtain) any third party consents, that Sub may reasonably request in connection
with the matters referred to in Section 3.4 above.
3.3 REGULATORY MATTERS AND APPROVALS. Sub and Rainbow will give any
notices to, make any filings with, and use its best efforts to obtain any
authorizations, consents, and approvals of governments and governmental agencies
in connection with the matters referred to in Section 4.4 above. Without
limiting the generality of the foregoing:
3.3.1 SECURITIES ACT, SECURITIES EXCHANGE ACT, AND STATE SECURITIES
LAWS. Rainbow covenants that, at the Closing, Rainbow shall execute a Share
Exchange and Registration Rights Agreement with each SSI Stockholder and shall
cause the Rainbow Shares to be covered by an effective registration statement as
described in Section 2.4.5.1.
3.4 GENERAL CORPORATION LAWS. Promptly following execution of this
Agreement by the Parties, SSI, in conjunction with Rainbow as the issuer of the
Consent Solicitation Offering Memorandum, will cause to be delivered to each SSI
Stockholder the Consent Solicitation Offering Memorandum and will cause to be
delivered to each holder of SSI Options a letter describing the treatment of SSI
Options in the Merger.
3.5 AFFILIATES AGREEMENTS.
3.5.1 At least one day prior to the Closing, SSI and Rainbow shall
deliver to each other a list of names and addresses of those persons who were in
their reasonable judgement, as of such date, "affiliates" of the respective
companies within the
<PAGE> 15
meaning of Rule 145 (each such person, together with the persons identified
below and "Affiliate") of the rules and regulations under the Securities Act
("Rule 145").
3.5.2 SSI and Rainbow shall provide such information and documents
reasonably requested for purposes of reviewing such list. SSI and Rainbow shall
use all reasonable efforts to deliver or cause to be delivered to the other
party, prior to the Effective Time, from each of the Affiliates identified in
the foregoing lists (as the same may be supplemented as aforesaid), an
Affiliate's Agreement.
3.5.3 Rainbow shall be entitled to place legends as specified in
the Affiliates Agreement on the certificate evidencing any Rainbow Shares to be
received by SSI Affiliates pursuant to the terms of this Agreement, and to issue
appropriate stop transfer instructions to the transfer agent for Rainbow Shares,
consistent with the terms of such Agreements whether or not such letter is
actually delivered to Rainbow.
3.6 OPERATION OF BUSINESS. SSI will not (and will not cause or permit
its UK Subsidiary to) engage in any practice, take any action, or enter into any
transaction outside the Ordinary Course of Business except for the payment of
the Transaction Expenses. Without limiting the generality of the foregoing:
3.6.1 Neither SSI nor its UK Subsidiary will authorize or effect
any change in its charter or bylaws;
3.6.2 Neither SSI nor its UK Subsidiary will grant any options,
warrants, or other rights to purchase or obtain any of its capital stock or
issue, sell, or otherwise dispose of any of its capital stock (except upon the
conversion or exercise of options, warrants, and other rights currently
outstanding);
3.6.3 Neither SSI nor its UK Subsidiary will declare, set aside, or
pay any dividend or distribution with respect to its capital stock (whether in
cash or in kind), or redeem, repurchase, or otherwise acquire any of its capital
stock, in either case outside the Ordinary Course of Business;
3.6.4 Neither SSI nor its UK Subsidiary will issue any note, bond,
or other debt security or create, incur, assume, or guarantee any indebtedness
for borrowed money or capitalized lease obligation outside the Ordinary Course
of Business;
3.6.5 Neither SSI nor its UK Subsidiary will impose any Security
Interest upon any of its assets outside the Ordinary Course of Business;
3.6.6 Neither SSI nor its UK Subsidiary will make any capital
investment in, make any loan to, or acquire the securities or assets of any
other Person outside the Ordinary Course of Business;
3.6.7 Neither SSI nor its UK Subsidiary will make any change in
employment terms for any of its directors, officers, and employees outside the
Ordinary Course of Business; and
3.6.8 Neither SSI nor its UK Subsidiary will commit to any of the
foregoing.
3.7 FULL ACCESS. SSI will (and will cause its UK Subsidiary to) permit
representatives of Rainbow and/or Sub to have full access at all reasonable
times with prior notice, and in a manner so as not to interfere with the normal
business operations of SSI and its UK Subsidiary, to information related to all
premises, properties, personnel, books, records (including tax records),
contracts, and documents of or pertaining to each of SSI and its UK Subsidiary.
Sub will treat and hold as such any Confidential Information it receives from
any of SSI and its UK Subsidiary in the course of the reviews contemplated by
this Section 5.7, will not use any of the Confidential Information except in
connection with this Agreement, and, if this Agreement is
<PAGE> 16
terminated for any reason whatsoever, agrees to return to SSI all tangible
embodiments (and all copies) thereof which are in its possession. In furtherance
of the foregoing, SSI acknowledges that it has been informed that six
representatives of Rainbow will be at the offices of SSI from October 1, 1996
through October 3, 1996 for purposes of collecting available information and
planning to assume control of the operation of the business of SSI following the
Closing. SSI agrees to provide such access to such Rainbow representatives and
to provide its diligent best efforts to cooperate and aide the Rainbow
representatives so as to enable them to obtain such information they request,
and to otherwise comply with the provisions of this Section 5.7.
3.8 NOTICE OF DEVELOPMENTS. Each Party will give prompt written notice
to the other of any material adverse development known to it to cause a breach
of any of its own representations and warranties in Section 3 and Section 4
above.
3.9 EXCLUSIVITY. SSI will not (and will not cause or permit its UK
Subsidiary to) solicit, initiate, or encourage the submission of any proposal or
offer from any Person relating to the acquisition of all or substantially all of
the capital stock or assets of any of SSI and its UK Subsidiary (including any
acquisition structured as a merger, consolidation, or share exchange); provided,
however, that SSI, its UK Subsidiary, and their directors and officers will
remain free to participate in any discussions or negotiations regarding, furnish
any information with respect to, assist or participate in, or facilitate in any
other manner any effort or attempt by any Person to do or seek any of the
foregoing to the extent their fiduciary duties may require. SSI shall notify Sub
immediately if any Person makes any proposal, offer, inquiry, or contact with
respect to any of the foregoing.
3.10 INDEMNIFICATION. Rainbow agrees to indemnify all individuals who
served as a director or officer of SSI at any time prior to the Effective Time
in accordance with the indemnification provisions existing in the certificate of
incorporation and/or bylaws of SSI on the date of the Agreement, and further
agrees to observe the limitations of director liability set forth in the
certificate of incorporation of SSI.
3.11 CONTINUITY OF BUSINESS ENTERPRISE. Sub will continue at least one
significant historic business line of SSI, or use at least a significant portion
of SSI's historic business assets in a business, in each case within the meaning
of Treas. Reg. Section 1.368-1(d).
3.12 CONFIDENTIALITY AGREEMENTS. SSI will use its reasonable best
efforts to cause each of its employees to enter into a confidentiality agreement
with SSI prior to the Closing.
4. CONDITIONS TO OBLIGATION TO CLOSE.
4.1 CONDITIONS TO OBLIGATION OF SUB AND RAINBOW. The obligation of Sub
and Rainbow to consummate the transactions to be performed by each of them in
connection with the Closing is subject to satisfaction of the following
conditions:
4.1.1 this Agreement and the Merger shall have received the
Requisite SSI Stockholder Approval;
4.1.2 SSI shall have procured the consent of The Nielsen Company to
the assignment by SSI to Sub of the Darien Lease (as such term is defined in the
Disclosure Schedule);
4.1.3 the representations and warranties set forth in Section 3
above shall be true and correct in all material respects as of the Closing Date
(subject to changes in Section 3.2 regarding the number of SSI Shares and SSI
Options outstanding resulting from the exercise of SSI Options);
<PAGE> 17
4.1.4 SSI shall have performed and complied with all of its
covenants hereunder in all material respects through the Closing;
4.1.5 SSI will have received an audit opinion, without
qualification, from Deloitte & Touche for the SSI Financial Statement for the
Most Recent Fiscal Year End, without any adjustment to such statement.
4.1.6 Wayne W. Chou will have entered into a consulting agreement
with Rainbow in a form satisfactory to counsel to Rainbow and Wayne W. Chou.
4.1.7 all technology owned, licensed or otherwise controlled by SSI
will be available for use by Sub following the Effective Time in the same manner
as that used by SSI and all of the Patents shall be unencumbered and owned by
SSI;
4.1.8 SSI will have obtained a "pooling letter" from Deloitte &
Touche LLP, its independent auditors, to the effect that no conditions exist
concerning SSI that would preclude accounting for the Merger as a pooling of
interests.
4.1.9 SSI will have delivered to Ernst & Young LLP, independent
auditors to Rainbow, and to Deloitte & Touche LLP, independent auditors for SSI,
"pooling representation letters," in forms reasonably satisfactory to such
auditors, regarding the Merger.
4.1.10 Rainbow shall have received a letter from Ernst & Young LLP,
its independent auditors, in form reasonably satisfactory to Rainbow to the
effect that Ernst & Young LLP concurs with the conclusion of the management of
Rainbow that, as of the date of such letter, no conditions exist that would
preclude Rainbow from accounting for the Merger as a pooling of interests.
4.1.11 no action, suit, or proceeding shall be pending or threatened
before any court or quasi judicial or administrative agency of any federal,
state, local, or foreign jurisdiction or before any arbitrator wherein an
unfavorable injunction, judgment, order, decree, ruling, or charge would (A)
prevent consummation of any of the transactions contemplated by this Agreement,
(B) cause any of the transactions contemplated by this Agreement to be rescinded
following consummation, (C) materially affect adversely the right of the
Surviving Corporation to own the former assets, to operate the former
businesses, and to control the former UK Subsidiary of SSI, or (D) materially
affect adversely the right of any of the former UK Subsidiary of SSI to own its
assets and to operate its businesses (and no such injunction, judgment, order,
decree, ruling, or charge shall be in effect);
4.1.12 SSI shall have delivered to Sub a certificate to the effect
that each of the conditions specified in this Section 6.1 is satisfied in all
respects;
4.1.13 Sub shall have received from counsel to SSI an opinion in
form and substance reasonably satisfactory to counsel to Rainbow, addressed to
Sub, and dated as of the Closing Date;
4.1.14 Sub shall have received the resignations, effective as of the
Closing, of each director and officer of SSI and its UK Subsidiary other than
those whom Sub shall have specified in writing prior to the Closing; and
4.1.15 all actions to be taken by SSI in connection with
consummation of the transactions contemplated hereby and all certificates,
opinions, instruments, and other documents required to effect the transactions
contemplated hereby will be reasonably satisfactory in form and substance to
Sub.
4.2 Sub may waive any condition specified in Section 6.1 if it
executes a writing so stating at or prior to the Closing.
4.3 CONDITIONS TO OBLIGATION OF SSI. The obligation of SSI to
consummate the transactions to be performed by it in connection with the Closing
is subject to satisfaction of the following conditions:
<PAGE> 18
4.3.1 the representations and warranties set forth in Section 4
above shall be true and correct in all material respects at and as of the
Closing Date;
4.3.2 Sub and Rainbow shall have performed and complied with all of
its covenants hereunder in all material respects through the Closing;
4.3.3 no action, suit, or proceeding shall be pending or threatened
before any court or quasi judicial or administrative agency of any federal,
state, local, or foreign jurisdiction or before any arbitrator wherein an
unfavorable injunction, judgment, order, decree, ruling, or charge would (A)
prevent consummation of any of the transactions contemplated by this Agreement,
(B) cause any of the transactions contemplated by this Agreement to be rescinded
following consummation, (C) materially affect adversely the right of the
Surviving Corporation to own the former assets, to operate the former
businesses, and to control the former UK Subsidiary of SSI, or (D) materially
affect adversely the right of any of the former UK Subsidiary of SSI to own its
assets and to operate its businesses (and no such injunction, judgment, order,
decree, ruling, or charge shall be in effect);
4.3.4 Sub and Rainbow shall have delivered to SSI a certificate to
the effect that each of the conditions specified in this Section 6.3 is
satisfied in all respects;
4.3.5 this Agreement and the Merger shall have received the
Requisite SSI Stockholder Approval;
4.3.6 Rainbow shall have entered into the Share Exchange and
Registration Rights Agreement with each SSI Stockholder;
4.3.7 SSI shall have received from counsel to Sub an opinion in
form and substance reasonably satisfactory to counsel to SSI, addressed to SSI,
and dated as of the Closing Date; and
4.3.8 all actions to be taken by Sub and Rainbow in connection with
consummation of the transactions contemplated hereby and all certificates,
opinions, instruments, and other documents required to effect the transactions
contemplated hereby will be reasonably satisfactory in form and substance to
SSI.
4.3.9 SSI may waive any condition specified in this Section 6.3 if
it executes a writing so stating at or prior to the Closing.
5. TERMINATION.
5.1 TERMINATION OF AGREEMENT. This Agreement may be terminated as
provided below:
5.1.1 the Parties may terminate this Agreement by mutual written
consent at any time prior to the Effective Time;
5.1.2 Either party may terminate this Agreement by giving written
notice to the other party at any time prior to the Effective Time (A) in the
event the other party has breached any material representation, warranty, or
covenant contained in this Agreement in any material respect, the terminating
party has notified the other party of this breach, and the breach has continued
without cure for a period of 30 days after the notice of breach or (B) if the
Closing shall not have occurred on or before October 31, 1996, by reason of the
failure to satisfy any condition precedent under Section 6 hereof (unless the
failure results primarily from a breach of any representation, warranty, or
covenant contained in this Agreement by the party seeking termination);or
5.1.3 Sub or SSI may terminate this Agreement by giving written
notice to the other party at any time in the event this Agreement and the Merger
fail to receive the
<PAGE> 19
Requisite SSI Stockholder Approval following the holding of a special meeting of
SSI Stockholders for such purpose.
5.2 EFFECT OF TERMINATION. If any Party terminates this Agreement
pursuant to Section 7.1 above, all rights and obligations of the Parties
hereunder shall terminate without any liability of any Party to any other Party
(except for any liability of any Party then in breach); provided, however, that
(i) the terms of the confidentiality provisions contained in Section 5.7 of this
Agreement and the terms of the Confidentiality Agreement, dated April 29, 1996,
shall survive any such termination; and (ii) in the event either party
terminates this Agreement for reasons of convenience and not as a result of a
failure of the other party to satisfy the terms of this Agreement, the
terminating party will pay to the other party the sum of $250,000 as liquidated
damages within 30 days of the date of such termination.
6. MISCELLANEOUS.
6.1 SURVIVAL. None of the representations and warranties of the
Parties contained in this Agreement will survive the Closing. All covenants of
the parties which by their terms include obligations to be performed subsequent
to the Closing shall survive the Closing until such obligations are performed in
full.
6.2 PRESS RELEASES AND PUBLIC ANNOUNCEMENTS. Prior to the Closing, SSI
shall not issue any press release or make any public announcement relating to
the subject matter of this Agreement without the prior written approval of
Rainbow. Rainbow shall give SSI advance notice of any such press release or
public announcement to be made by it and agrees to consult with SSI regarding
the timing and content of such press release and public announcement.
6.3 NO THIRD PARTY BENEFICIARIES. This Agreement shall not confer any
rights or remedies upon any Person other than the Parties and their respective
successors and permitted assigns; provided, however, that the provisions in
Section 2.4.5, 2.4.5.1, 2.4.6, 2.4.8, 2.4.8.1, 2.4.8.2, 2.5. 2.5.3, 5.3.1 and
5.10 are intended for the benefit of the individuals specified therein and their
respective legal representatives.
6.4 ENTIRE AGREEMENT. This Agreement (including the documents referred
to herein and the documents to be delivered at Closing) constitutes the entire
agreement between the Parties and supersedes any prior understandings,
agreements, or representations by or between the Parties, written or oral, to
the extent they related in any way to the subject matter hereof.
6.5 SUCCESSION AND ASSIGNMENT. This Agreement shall be binding upon
and inure to the benefit of the Parties named herein and their respective
successors and permitted assigns. No Party may assign either this Agreement or
any of its rights, interests, or obligations hereunder without the prior written
approval of the other Party.
6.6 COUNTERPARTS. This Agreement may be executed in one or more
counterparts, each of which shall be deemed an original but all of which
together will constitute one and the same instrument.
6.7 HEADINGS. The section headings contained in this Agreement are
inserted for convenience only and shall not affect in any way the meaning or
interpretation of this Agreement.
6.8 NOTICES. All notices, requests, demands, claims, and other
communications hereunder will be in writing. Any notice, request, demand, claim,
or other communication hereunder shall be deemed duly given if (and then two
business days after) it is sent by registered or certified mail, return receipt
requested, postage prepaid, and addressed to the intended recipient as set forth
below, or one day after if it is sent via overnight courier:
<PAGE> 20
IF TO SSI:
Software Security, Inc.
6 Thorndal Circle
Darien, Connecticut 06820-5421
Att: Wayne W. Chou, Executive Vice President
WITH A COPY TO:
Cummings & Lockwood
Attorneys at Law
Four Stamford Plaza
P.O. Box 120
Stamford, CT 06904
Att: Stephen Marcovich, Esq.
IF TO RAINBOW:
Rainbow Technologies, Inc.
50 Technology Drive
Irvine, California 92718
Att: Paul Bock, Senior Vice President
WITH A COPY TO:
Moskowitz Altman & Hughes LLP
11 East 44th Street, Suite 504
New York, New York 10017
Att: John J. Hughes, Esq.
IF TO SUB:
RNBO Acquisition Corporation
50 Technology Drive
Irvine, California 92718
Att: Paul Bock, Senior Vice President
WITH A COPY TO:
Moskowitz Altman & Hughes LLP
11 East 44th Street, Suite 504
New York, New York 10017
Att: John J. Hughes, Esq.
Any Party may send any notice, request, demand, claim, or other communication
hereunder to the intended recipient at the address set forth above using any
other means (including personal delivery, expedited courier, messenger service,
telecopy, telex, ordinary mail, or electronic mail), but no such notice,
request, demand, claim, or other communication shall be deemed to have been duly
given unless and until it actually is received by the intended recipient. Any
Party may change the address to which notices, requests, demands, claims, and
other communications hereunder are to be delivered by giving the other Party
notice in the manner herein set forth.
1.1 GOVERNING LAW. This Agreement shall be governed by and construed
in accordance with the domestic laws of the State of Delaware without giving
effect to any choice or conflict of law provision or rule (whether of the State
of Delaware or any other jurisdiction) that would cause the application of the
laws of any jurisdiction other than the State of Delaware.
1.2 AMENDMENTS AND WAIVERS. The Parties may mutually amend any
provision of this Agreement at any time prior to the Effective Time with the
prior authorization of their respective boards of directors; provided, however,
that any amendment effected subsequent
<PAGE> 21
to stockholder approval will be subject to the restrictions contained in the
Delaware General Corporation Law. No amendment of any provision of this
Agreement shall be valid unless the same shall be in writing and signed by both
of the Parties. No waiver by any Party of any default, misrepresentation, or
breach of warranty or covenant hereunder, whether intentional or not, shall be
deemed to extend to any prior or subsequent default, misrepresentation, or
breach of warranty or covenant hereunder or affect in any way any rights arising
by virtue of any prior or subsequent such occurrence.
1.3 SEVERABILITY. Any term or provision of this Agreement that is
invalid or unenforceable in any situation in any jurisdiction shall not affect
the validity or enforceability of the remaining terms and provisions hereof or
the validity or enforceability of the offending term or provision in any other
situation or in any other jurisdiction.
1.4 EXPENSES. Each of the Parties will bear its own costs and expenses
(including legal fees and expenses) incurred in connection with this Agreement
and the transactions contemplated hereby.
1.5 CONSTRUCTION. The Parties have participated jointly in the
negotiation and drafting of this Agreement. In the event an ambiguity or
question of intent or interpretation arises, this Agreement shall be construed
as if drafted jointly by the Parties and no presumption or burden of proof shall
arise favoring or disfavoring any Party by virtue of the authorship of any of
the provisions of this Agreement. Any reference to any federal, state, local, or
foreign statute or law shall be deemed also to refer to all rules and
regulations promulgated thereunder, unless the context otherwise requires. The
word "including" shall mean including without limitation.
1.6 INCORPORATION OF EXHIBITS AND SCHEDULES. The Exhibits and
Schedules identified in this Agreement are incorporated herein by reference and
made a part hereof.
<PAGE> 22
IN WITNESS WHEREOF, the Parties hereto have executed this Agreement as
of the date first above written.
RAINBOW TECHNOLOGIES, INC. SOFTWARE SECURITY, INC.
By: __________________________ By: __________________________
Title: _________________________ Title: _________________________
RNBO ACQUISITION CORPORATION
By: __________________________
Title: _________________________
<PAGE> 23
EXHIBIT A
FORM OF RAINBOW AFFILIATE'S AGREEMENT
September , 1996
Rainbow Technologies, Inc.
50 Technology Drive
Irvine, CA 92718
Ladies and Gentlemen:
Reference is made to the Agreement and Plan of Merger (the "Merger
Agreement") dated as of September , 1996, by and among Rainbow Technologies,
Inc., a Delaware corporation ("Rainbow"), RNBO Acquisition Corporation, a Nevada
corporation and a wholly-owned subsidiary of Rainbow ("Sub"), and Software
Security, Inc., a Connecticut corporation ("SSI"). The Merger Agreement provides
for the merger of SSI with and into Sub (the "Merger") pursuant to which, among
other things, SSI Shares (as defined in the Merger Agreement) will be converted
into the right to receive such number of Rainbow Shares (as defined in the
Merger Agreement) as determined in accordance with the provisions of the Merger
Agreement.
The undersigned has been informed that the undersigned may be deemed to
be an "affiliate" of Rainbow within the meaning of Rule 144 and that the Merger
is intended to be a "pooling of interest" for financial accounting purposes.
The undersigned understands that the Merger will not be accounted for as
a pooling of interests unless, among other requirements, following the Merger,
affiliates of Rainbow comply with requirements of Section 1.3 below. The
undersigned further understands that the representations, warranties and
agreements set forth herein will be relied upon by the auditors for Rainbow and
by counsel for Rainbow and SSI in rendering opinions to Rainbow, SSI and their
stockholders regarding accounting and other legal consequences of the Merger.
The capitalized terms used and not defined herein shall have the
meanings set forth in the Merger Agreement.
<PAGE> 24
1. The undersigned represents, warrants and agrees as follows:
1.1 The undersigned has full power to execute this Affiliate's Agreement
and to make the representations, warranties and agreements herein and to perform
the undersigned's obligations hereunder.
1.2 Appendix A attached hereto sets forth all shares of Rainbow Common
Stock and other equity securities of Rainbow owned by the undersigned, including
all rights to acquire Rainbow Common Stock and all equity securities of Rainbow
as to which the undersigned has sole or shares voting or investment power
(collectively, the "Rainbow Shares").
1.3 The undersigned will not sell, transfer or dispose of any of the
Rainbow Shares and the undersigned will not in any other way reduce the
undersigned's risk of ownership or investment in any of such Rainbow Shares
until the financial report including the combined revenues and net income of
Rainbow and SSI covering a period of at least 30 days of combined operations
following the Effective Time of the Merger has been published by Rainbow
(provided that the undersigned may make bona fide gifts or charitable
contributions or distributions of such Rainbow Shares without consideration).
2. The undersigned also understands that stop transfer instructions concerning
the provisions of Section 1.3 above will be given to Rainbow's transfer agent
with respect to certificates evidencing the Rainbow Shares. Rainbow agrees that
such stop transfer instructions will be promptly rescinded upon publication of
the financial report referred to in Section 1.3 above.
3. The undersigned understands that the certificates representing the Rainbow
Shares will bear restrictive legend substantially in the following form:
THE SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO A
CONTRACTUAL HOLDING PERIOD EXPIRING ON THE DATE ON WHICH CERTAIN
FINANCIAL STATEMENTS ARE ISSUED AS SET FORTH IN THAT CERTAIN
AFFILIATES AGREEMENT BETWEEN THE ISSUER AND THE HOLDER HEREOF. PRIOR
TO THE EXPIRATION OF SUCH HOLDING PERIOD, SUCH SHARES MAY NOT BE SOLD,
TRANSFERRED OR ASSIGNED (EXCEPT FOR BONA FIDE GIFTS OR CHARITABLE
CONTRIBUTIONS OR DISTRIBUTIONS OF SUCH SHARES WITHOUT CONSIDERATION).
UPON THE WRITTEN REQUEST OF THE HOLDER OF THIS CERTIFICATE, THE ISSUER
AGREES TO REMOVE THIS RESTRICTIVE LEGEND ( AND ANY STOP ORDER PLACED
WITH THE TRANSFER AGENT) WHEN THE HOLDING PERIOD HAS EXPIRED.
4. The undersigned has carefully read this Affiliate's Agreement and discussed
its requirements and other applicable limitations upon the sale, transfer or
other disposition of the Rainbow Shares and other Rainbow securities owned by
the undersigned, to the extent the undersigned felt necessary, with the
undersigned's counsel or with counsel for Rainbow.
Very truly yours,
By:_________________________
Title:________________________
(if applicable)
<PAGE> 25
Agreed to and accepted:
Rainbow Technologies, Inc.
By:____________________________
Title:___________________________
<PAGE> 1
EXHIBIT 21.a
List of Subsidiaries
Mykotronx, Inc.
357 Van Ness Way, Suite 200
Torrance, CA 90501
Tel: (310) 533-8100
Fax: (310) 533-0527
Rainbow Technologies SA
122, Avenue Charles de Gaulle
92522 Neuilly sur Seine Cedex
Tel: (33) 1 41 43 29 00
Fax: (33) 1 46 24 76 91
Rainbow Technologies GmbH
Lise Meitner Strasse 1
85716 Unterschleissheim
Tel: (49) 89 32 17 98 0
Fax: (49) 89 32 17 98 50
Rainbow Technologies Ltd
4 The Forum, Hanworth Lane
Chertsey, Surrey
KT16 9JX
Tel: (44) 1932 579200
Fax: (44) 1932 570743
Software Security Ltd
Partizansky Prospect, Bld. B3
Room 52
220026 Minsk, Belarus CIS POB 12
Software Security, Inc.
6 Thorndal Circle
Darien, Connecticut
06820
<PAGE> 1
EXHIBIT 23(1)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statements (Form S-8 No. 33-60267 and Form S-8 No. 33-60265) pertaining to the
Assumed Options of Mykotronx, Inc., 1987 Non-Qualified Stock Option Plan, 1987
Incentive Stock Option Plan and 1990 Stock Option Plan of Rainbow Technologies,
Inc., of our report dated February 25, 1997, with respect to the consolidated
financial statements and schedule of Rainbow Technologies, Inc. included in
this Annual Report (Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
Orange County, California
March 29, 1997
<PAGE> 1
EXHIBIT 23(2)
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(No. 33-60267) on Form S-8 of Rainbow Technologies, Inc., of our report dated
February 16, 1995, with respect to the balance sheet of Mykotronx, Inc., as of
December 31, 1994, and the related statements of earnings, shareholders' equity
and cash flows for the year then ended, insofar as it relates to the data
included in the consolidated financial statements and schedule of Rainbow
Technologies, Inc., included in the 1996 Annual Report on Form 10-K.
KPMG PEAT MARWICK LLP
Los Angeles, California
March 31, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 31,735,000
<SECURITIES> 11,437,000
<RECEIVABLES> 15,627,000
<ALLOWANCES> 330,000
<INVENTORY> 7,853,000
<CURRENT-ASSETS> 70,677,000
<PP&E> 16,695,000
<DEPRECIATION> 4,615,000
<TOTAL-ASSETS> 93,364,000
<CURRENT-LIABILITIES> 10,511,000
<BONDS> 0
0
0
<COMMON> 8,000
<OTHER-SE> 79,068
<TOTAL-LIABILITY-AND-EQUITY> 93,364,000
<SALES> 0
<TOTAL-REVENUES> 81,710,000
<CGS> 0
<TOTAL-COSTS> 64,445,000
<OTHER-EXPENSES> 524,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 325,000
<INCOME-PRETAX> 17,936,000
<INCOME-TAX> 7,419,000
<INCOME-CONTINUING> 10,517,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,517,000
<EPS-PRIMARY> 1.30
<EPS-DILUTED> 0
</TABLE>
