<PAGE> 1
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 30, 1997 Commission file number:0-16641
RAINBOW TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 95-3745398
(State of incorporation) (I.R.S. Employer Identification No.)
50 Technology Drive, Irvine, California 92618
(Address of principal executive offices) (Zip Code)
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 [ ]
The number of shares of common stock, $.001 par value, outstanding as of
September 30, 1997 was 7,738,368.
<PAGE> 2
RAINBOW TECHNOLOGIES, INC.
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Balance Sheets at
September 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income
for the three and nine months ended September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 1997 and 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II - OTHER INFORMATION
Item 1 to 6 - Not applicable
SIGNATURES 12
</TABLE>
2
<PAGE> 3
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
A S S E T S
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................ $ 34,739,000 $ 31,735,000
Marketable securities available-for-sale ................................. 4,956,000 11,437,000
Accounts receivable, net of allowance for doubtful accounts
of $410,000 and $330,000 in 1997 and 1996, respectively ................. 12,755,000 15,297,000
Inventories .............................................................. 9,508,000 7,853,000
Unbilled costs and fees .................................................. 2,401,000 2,249,000
Prepaid expenses and other current assets ................................ 4,390,000 2,106,000
------------ ------------
Total current assets ................................................ 68,749,000 70,677,000
Property, plant and equipment, at cost:
Buildings ................................................................ 8,154,000 9,122,000
Furniture ................................................................ 1,180,000 1,200,000
Equipment ................................................................ 12,079,000 6,026,000
Leasehold improvements ................................................... 570,000 347,000
------------ ------------
21,983,000 16,695,000
Less accumulated depreciation and amortization ........................... 5,774,000 4,615,000
------------ ------------
Net property, plant and equipment ................................... 16,209,000 12,080,000
Goodwill, net of accumulated amortization of $8,348,000 and
$7,936,000 in 1997 and 1996, respectively ............................... 4,385,000 4,064,000
Other assets, net of accumulated amortization of $2,939,000
and $2,199,000 in 1997 and 1996, respectively ............................ 6,048,000 6,543,000
------------ ------------
$ 95,391,000 $ 93,364,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 4,136,000 $ 4,109,000
Accrued payroll and related expenses ..................................... 3,493,000 3,339,000
Other accrued liabilities ................................................ 1,427,000 1,500,000
Income taxes payable ..................................................... -- 948,000
Billings in excess of costs and fees ..................................... 87,000 314,000
Long-term debt, due within one year ...................................... 263,000 301,000
------------ ------------
Total current liabilities ........................................... 9,406,000 10,511,000
Long-term debt, net of current portion ........................................ 1,708,000 2,145,000
Deferred income taxes ......................................................... -- 1,515,000
Minority interest ............................................................. 861,000 80,000
Other liabilities ............................................................. 61,000 37,000
Shareholders' equity:
Common stock, $.001 par value, 20,000,000 shares authorized, 7,738,368 and
7,775,389 shares issued and outstanding
in 1997 and 1996, respectively ......................................... 8,000 8,000
Additional paid-in capital ............................................... 29,339,000 30,686,000
Cumulative translation adjustment ........................................ (1,648,000) (251,000)
Cumulative difference between cost and
market value of marketable securities .................................. (42,000) 154,000
Retained earnings ........................................................ 56,512,000 48,479,000
------------ ------------
84,169,000 79,076,000
Less cost of treasury shares (34,490 shares) ............................. 814,000 --
------------ ------------
Total shareholders' equity .......................................... 83,355,000 79,076,000
------------ ------------
$ 95,391,000 $ 93,364,000
============ ============
</TABLE>
See accompanying notes.
3
<PAGE> 4
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
---------------------------- ----------------------------
September 30, September 30, September 30, September 30,
1997 1996 1997 1996
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Software protection products ........ $ 14,741,000 $ 13,981,000 $ 44,688,000 $ 43,288,000
Information security products ....... 7,314,000 5,101,000 20,983,000 17,225,000
Ion beam surface treatment .......... 201,000 -- 212,000 --
------------ ------------ ------------ ------------
Total revenues ................. 22,256,000 19,082,000 65,883,000 60,513,000
Operating expenses:
Cost of software protection products 4,128,000 4,026,000 12,902,000 12,868,000
Cost of information security products 5,975,000 4,145,000 16,930,000 14,410,000
Cost of ion beam surface treatment .. 2,000 -- 419,000 --
Selling, general and administrative . 5,305,000 5,216,000 16,021,000 14,781,000
Research and development ............ 2,010,000 1,442,000 5,985,000 4,710,000
Goodwill amortization ............... 429,000 449,000 1,289,000 1,344,000
------------ ------------ ------------ ------------
Total operating expenses ....... 17,849,000 15,278,000 53,546,000 48,113,000
------------ ------------ ------------ ------------
Operating income ........................ 4,407,000 3,804,000 12,337,000 12,400,000
Interest income ......................... 442,000 354,000 1,287,000 1,234,000
Interest expense ........................ (52,000) (80,000) (192,000) (248,000)
Other income (expense) .................. (73,000) (197,000) 276,000 (220,000)
------------ ------------ ------------ ------------
Income before provision for income taxes 4,724,000 3,881,000 13,708,000 13,166,000
Provision for income taxes .............. 1,937,000 1,832,000 5,675,000 5,610,000
============ ============ ============ ============
Net income .............................. $ 2,787,000 $ 2,049,000 $ 8,033,000 $ 7,556,000
============ ============ ============ ============
Net income per common and common
equivalent share .................... $ 0.35 $ 0.26 $ 1.01 $ 0.94
============ ============ ============ ============
Weighted average common and common
equivalent shares outstanding ....... 8,033,000 8,030,000 7,976,000 8,068,000
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE> 5
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine months ending Nine months ending
September 30, 1997 September 30, 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income ................................................ $ 8,033,000 $ 7,556,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization ......................................... 2,041,000 2,251,000
Depreciation ......................................... 1,504,000 1,104,000
Change in deferred income taxes ...................... (1,153,000) (361,000)
Provision for loss on contract ....................... 400,000 --
Allowance for doubtful accounts ...................... 90,000 (62,000)
Loss from retirement of property, plant, and equipment 34,000 88,000
Write-down of long-term investment ................... -- 205,000
Share in investee's loss ............................. 45,000 266,000
Minority interest in subsidiary's earnings ........... (392,000) --
Write-off of capitalized software .................... -- 273,000
Changes in operating assets and liabilities:
Accounts receivable .............................. 2,073,000 357,000
Inventories ...................................... (1,733,000) (3,766,000)
Unbilled costs and fees .......................... (152,000) 2,282,000
Prepaid expenses and other current assets ........ (232,000) (17,000)
Accounts payable ................................. (455,000) 532,000
Accrued liabilities .............................. (80,000) 152,000
Billings in excess of costs and fees ............. (227,000) 312,000
Income taxes payable ............................. (2,765,000) (1,622,000)
------------ ------------
Net cash provided by operating activities .... 7,031,000 9,550,000
Cash flows from investing activities:
Purchase of marketable securities ......................... (9,930,000) (7,099,000)
Sale of marketable securities ............................. 16,211,000 8,282,000
Purchases of property, plant, and equipment ............... (5,732,000) (2,023,000)
Acquired cash from QMT .................................... 556,000 (1,000,000)
Other long-term assets .................................... (775,000) (2,170,000)
Capitalized software development costs .................... (1,150,000) --
------------ ------------
Net cash used in investing activities ........ (820,000) (4,010,000)
Cash flows from financing activities:
Exercise of Rainbow common stock options .................. 936,000 731,000
Payment of long-term debt ................................. (214,000) (229,000)
Purchase of treasury stock ................................ (814,000) --
Purchase and retirement of common stock ................... (2,767,000) (706,000)
------------ ------------
Net cash used by financing activities ........ (2,859,000) (204,000)
Effect of exchange rate changes on cash ........................ (348,000) (119,000)
------------ ------------
Net increase in cash and cash equivalents ...................... 3,004,000 5,217,000
Cash and cash equivalents at beginning of period ............... 31,735,000 25,330,000
============ ============
Cash and cash equivalents at end of period ..................... $ 34,739,000 $ 30,547,000
============ ============
Supplemental disclosure of cash flow information:
Income taxes paid ......................................... $ 8,748,000 $ 6,825,000
Interest paid ............................................. 199,000 247,000
</TABLE>
See accompanying notes.
5
<PAGE> 6
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(Unaudited)
1. Basis of presentation
The accompanying financial statements consolidate the accounts of Rainbow
Technologies, Inc. (the Company) and its wholly-owned subsidiaries. Amounts for
the three and nine month periods ended September 30, 1996 have been restated to
reflect the acquisition of Software Security, Inc. (SSI) which has been
accounted for using the pooling-of-interests method (Note 5). All significant
inter-company balances and transactions have been eliminated.
In the opinion of the Company's management, the accompanying condensed
consoldiated financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the financial
position at September 30, 1997 and results of operations for the three and nine
months ended September 30, 1997 and 1996. The condensed consolidated financial
statements do not include footnotes and certain financial information normally
presented annually under generally accepted accounting principles and,
therefore, should be read in conjunction with the Company's December 31, 1996
Annual Report on Form 10-K. Results of operations for the three and nine months
ended September 30, 1997 are not necessarily indicative of results to be
expected for the full year.
The Company has subsidiaries in the United Kingdom, Germany, France and Belarus.
The Company utilizes the currencies of the countries where its foreign
subsidiaries operate as the functional currency. In accordance with Statement of
Financial Accounting Standards No. 52, the balance sheets of the Company's
foreign subsidiaries are translated into U.S. dollars at the exchange rates at
the respective dates. The income statements of those subsidiaries are translated
into U.S. dollars at the weighted average exchange rates for the respective
periods presented.
2. 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 stock options.
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128).
SFAS No. 128 redefines the standards for computing earnings per share and is
effective for the Company on December 31, 1997. The Company believes adoption of
SFAS No. 128 will not have a material impact on future earnings per share
calculations.
3. Government Contracts
The Company is both a prime contractor and subcontractor under fixed-price and
cost-plus-fixed-fee 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 amounts in these financial
statements. 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 at September 30, 1997 of $2,401,000.
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.
6
<PAGE> 7
4. Inventories
Inventoried costs relating to long-term contracts are stated at the actual
production costs, 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. Inventories
consist of the following:
<TABLE>
<CAPTION>
September 30, 1997 December 31, 1996
--------- ---------
<S> <C> <C>
Raw materials $ 839,000 $ 908,000
Work in process 1,113,000 819,000
Finished goods 2,866,000 3,211,000
Inventoried costs related
to long-term contracts 4,690,000 2,915,000
--------- ---------
$9,508,000 $7,853,000
========== ==========
</TABLE>
5. 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, headquartered 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. QMT
has obtained the 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". IBEST technology benefits and
enhances the durability and utility of a large number of industrial and consumer
products at relatively low cost and without creating any impact on the
environment. As of September 30, 1997, the Company owns 58% of QMT, although it
is not a significant subsidiary of the Company.
On June 1, 1995, the Company acquired Mykotronx in a merger transaction
resulting in Mykotronx becoming a wholly-owned subsidiary of Rainbow. Mykotronx,
headquartered 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 Company 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 options. The merger was accounted for as a pooling-of-interests.
7
<PAGE> 8
6. Other assets
Included in other assets are certain investments in early-stage companies. The
Company closely monitors the operations and cash flows of these companies to
evaluate their status and ensure that amounts reported for these investments do
not exceed net realizable value. If the Company determines that impairment in
the investment of any such company exists, an adjustment would be made to reduce
the investment amount to net realizable value.
8
<PAGE> 9
RAINBOW TECHNOLOGIES, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant
factors which have affected the consolidated results of operations and the
consolidated financial position of the Company during the periods included in
the accompanying condensed consolidated financial statements. This discussion
should be read in conjunction with the related condensed consolidated financial
statements and associated notes. Prior period financial statements have been
restated to reflect the acquisition of SSI, which has been accounted for using
the pooling-of-interest method.
RESULTS OF OPERATIONS
(dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended September 30,
1997 1996
-------- --------
<S> <C> <C>
Revenues
Software Protection Products $ 14,741 $ 13,981
Information Security Products 7,314 5,101
IBEST 201 --
-------- --------
Consolidated $ 22,256 $ 19,082
======== ========
Operating Income
Software Protection Products $ 4,176 $ 2,872
Information Security Products 303 932
IBEST (72) --
-------- --------
Consolidated $ 4,407 $ 3,804
======== ========
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1997 1996
-------- --------
<S> <C> <C>
Revenues
Software Protection Products $ 44,688 $ 43,288
Information Security Products 20,983 17,225
IBEST
212 --
-------- --------
Consolidated $ 65,883 $ 60,513
======== ========
Operating Income
Software Protection Products $ 11,616 $ 9,666
Information Security Products 1,718 2,734
IBEST (997)
-------- --------
Consolidated $ 12,337 $ 12,400
======== ========
</TABLE>
REVENUES
Revenues from software protection products for the three and nine months ended
September 30, 1997 increased by 5% and 3%, respectively, when compared to the
same periods in 1996. The average selling price per product in the three and
nine months ended September 30, 1997 decreased approximately 9% and 4% when
compared to the same periods in 1996. Unit volume for the three and nine months
ended September 30, 1997 increased by 18% and 4%, respectively, when compared to
the corresponding 1996 periods. The Asia Pacific region grew at 33% while
revenues in other international markets were impacted by the strong dollar.
9
<PAGE> 10
Revenues from information security products for the three and nine months ended
September 30, 1997 increased by 43% and by 22%, respectively, when compared to
the same periods in 1996. The revenue growth was primarily due to the increase
in sales of network security products to the government and the delivery of new
satellite communication products to commercial customers.
Revenues from IBEST are contract earnings from an equipment development contract
and from validation test services.
GROSS PROFIT
Gross profit from software protection products for the three and nine months
ended September 30, 1997 was at 72% and 71% of revenues, respectively, when
compared with 71 and 70%, respectively, for the corresponding periods in 1996.
The increase in gross margin was primarily due to improvements in manufacturing
efficiencies.
Gross profit from information security products for the three and nine months
ended September 30, 1997 was 18% and 19% of revenues, respectively, when
compared with 19% and 16% of revenues, respectively, for the corresponding 1996
periods. These changes were primarily due to the change in the revenue mix from
less profitable research and development contracts to more profitable contracts
based on deliverables.
SELLING, GENERAL AND ADMINISTRATIVE
Sellling, general and administrative expenses for the three and nine months
ended September 30, 1997 increased by 2% and 8%, respectively, when compared to
the corresponding 1996 periods. The increases were due to additional staffing,
increased amortization of other assets and higher marketing expenses for the
license management and internet security products.
RESEARCH AND DEVELOPMENT
Total research and development expenses for the three and nine months ended
September 30, 1997 increased by 39% and 27%, respectively, when compared to the
corresponding 1996 period. The increases were due to the research and
development expenses on the Cryptoswift program and the research and development
efforts of QMT.
INTEREST INCOME
Interest income for the three and nine months ended September 30, 1997 increased
by 25% and 4%, respectively, compared to the corresponding periods in 1996. The
increase is due to higher interest rates and higher balances.
PROVISION FOR INCOME TAXES
The effective tax rate was 41% for the three months and nine ended September 30,
1997. The effective tax rates for the corresponding periods in 1996 were 47% and
43%, respectively. The decrease in the effective tax rate was due to expenses
related to the SSI acquisition incurred in the three month period ended
September 30, 1996.
10
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 1997, the Company's principal sources of
operating funds have been from operations and the sale of marketable securities.
The Company's cash flow from operations for the nine months ended September 30,
1997 and 1996 were $7,031,000 and $9,550,000, respectively.
The Company intends to use its capital resources to expand its product lines and
for the acquisition of additional products and technologies. In October 1997,
the Company announced its acquisition of the KIV-7 family of communication
encrytion products from Allied Signal Inc. Under the agreement, the Company's
subsidiary, Mykotronx, Inc., will acquire all intellectual property and
marketing rights to the KIV-7 product line
The Company's use of cash includes purchases of property, plant and equipment,
repayment of long-term debt and the purchase and retirement of common stock.
Management believes the Company's current working capital of $59,343,000 and
anticipated working capital to be generated by future operations will be
sufficient to support the Company's requirements for at least the next twelve
months.
11
<PAGE> 12
PART II OTHER INFORMATION
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Dated: November 12, 1997
RAINBOW TECHNOLOGIES, INC.
By: /s/ PATRICK E. FEVERY
Patrick E. Fevery
Chief Financial Officer
12
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 34,739
<SECURITIES> 4,956
<RECEIVABLES> 13,165
<ALLOWANCES> (410)
<INVENTORY> 9,508
<CURRENT-ASSETS> 66,749
<PP&E> 21,983
<DEPRECIATION> 5,774
<TOTAL-ASSETS> 95,391
<CURRENT-LIABILITIES> 9,406
<BONDS> 0
0
0
<COMMON> 8
<OTHER-SE> 84,169
<TOTAL-LIABILITY-AND-EQUITY> 95,391
<SALES> 65,883
<TOTAL-REVENUES> 65,883
<CGS> 30,251
<TOTAL-COSTS> 53,546
<OTHER-EXPENSES> 276
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (192)
<INCOME-PRETAX> 13,708
<INCOME-TAX> 5,675
<INCOME-CONTINUING> 8,033
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,033
<EPS-PRIMARY> 1.01
<EPS-DILUTED> 1.01
</TABLE>
