<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, 1998 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
November 10, 1998 was 11,721,975.
<PAGE> 2
RAINBOW TECHNOLOGIES, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
<TABLE>
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 1998 (unaudited) and December 31, 1997 3
Condensed Consolidated Statements of Income
for the Three and Nine months ended September 30, 1998 and 1997 (unaudited) 4
Condensed Consolidated Statements of Comprehensive Income for the
Three and Nine months ended September 30, 1998 and 1997 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the Nine
months ended September 30, 1998 and 1997 (unaudited) 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
PART II - OTHER INFORMATION
Item 1 to 5 - Not applicable
Item 6. Exhibits and reports on Form 8-K 15
SIGNATURES 15
</TABLE>
2
<PAGE> 3
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
A S S E T S
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................. $ 29,519,000 $ 29,556,000
Marketable securities available-for-sale ................... 7,969,000 6,841,000
Accounts receivable, net of allowance for doubtful accounts
of $340,000 and $500,000 in 1998 and 1997, respectively ... 17,502,000 16,343,000
Inventories ................................................ 11,655,000 9,780,000
Unbilled costs and fees .................................... -- 1,782,000
Prepaid expenses and other current assets .................. 3,036,000 4,803,000
------------- -------------
Total current assets .................................. 69,681,000 69,105,000
Property, plant and equipment, at cost:
Buildings .................................................. 8,610,000 8,058,000
Furniture .................................................. 1,323,000 1,191,000
Equipment .................................................. 15,522,000 12,963,000
Leasehold improvements ..................................... 907,000 636,000
------------- -------------
26,362,000 22,848,000
Less accumulated depreciation and amortization ............. 8,298,000 6,315,000
------------- -------------
Net property, plant and equipment ..................... 18,064,000 16,533,000
Goodwill, net of accumulated amortization of $11,304,000 and
$8,736,000 in 1998 and 1997, respectively ................. 7,035,000 5,543,000
Product licenses, net of accumulated amortization of $879,000
and $469,000 in 1998 and 1997, respectively ................ 6,163,000 6,481,000
Other assets, net of accumulated amortization of $3,441,000
and $2,763,000 in 1998 and 1997, respectively .............. 7,644,000 5,389,000
------------- -------------
$ 108,587,000 $ 103,051,000
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................... $ 5,090,000 $ 4,937,000
Accrued payroll and related expenses ....................... 3,790,000 4,199,000
Other accrued liabilities .................................. 3,515,000 2,986,000
Income taxes payable ....................................... 706,000 861,000
Billings in excess of costs and fees ....................... 417,000 87,000
Long-term debt, due within one year ........................ 278,000 259,000
------------- -------------
Total current liabilities ............................. 13,796,000 13,329,000
Long-term debt, net of current portion ...................... 1,524,000 1,616,000
Minority interest ........................................... 1,638,000 1,723,000
Other liabilities ........................................... 12,000 24,000
Shareholders' equity:
Common stock, $.001 par value, 20,000,000 shares authorized,
11,715,093 and 11,726,754 shares issued and outstanding
in 1998 and 1997, respectively ........................... 8,000 8,000
Additional paid-in capital ................................. 29,661,000 30,633,000
Accumulated other comprehensive loss ....................... (388,000) (1,906,000)
Retained earnings .......................................... 62,336,000 59,811,000
------------- -------------
91,617,000 88,546,000
Less cost of treasury shares (133,302 shares in 1997) ...... -- (2,187,000)
------------- -------------
Total shareholders' equity ............................ 91,617,000 86,359,000
------------- -------------
$ 108,587,000 $ 103,051,000
============= =============
</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,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Software protection products ................ $ 14,250,000 $ 14,741,000 $ 42,871,000 $ 44,688,000
Information security products ............... 12,498,000 7,314,000 35,650,000 20,983,000
Ion beam surface treatment .................. 9,000 201,000 27,000 212,000
------------ ------------ ------------ ------------
Total revenues ......................... 26,757,000 22,256,000 78,548,000 65,883,000
Operating expenses:
Cost of software protection products ........ 4,354,000 4,128,000 11,711,000 12,902,000
Cost of information security products ....... 9,620,000 5,975,000 27,639,000 16,930,000
Cost of ion beam surface treatment .......... 1,000 2,000 21,000 419,000
Selling, general and administrative ......... 6,551,000 5,305,000 18,526,000 16,021,000
Research and development .................... 1,924,000 2,010,000 6,708,000 5,985,000
Goodwill amortization ....................... 651,000 429,000 1,869,000 1,289,000
Provision for restructured operations ....... (222,000) -- 98,000 --
Acquired research and development ........... -- -- 4,000,000 --
------------ ------------ ------------ ------------
Total operating expenses ............... 22,879,000 17,849,000 70,572,000 53,546,000
------------ ------------ ------------ ------------
Operating income ............................. 3,878,000 4,407,000 7,976,000 12,337,000
Interest income .............................. 338,000 442,000 922,000 1,287,000
Interest expense ............................. (53,000) (52,000) (162,000) (192,000)
Other income (expense) ....................... 138,000 (73,000) (852,000) 276,000
------------ ------------ ------------ ------------
Income before provision for taxes ............ 4,301,000 4,724,000 7,884,000 13,708,000
Provision for income taxes ................... 1,626,000 1,937,000 5,359,000 5,675,000
------------ ------------ ------------ ------------
Net income ................................... $ 2,675,000 $ 2,787,000 $ 2,525,000 $ 8,033,000
============ ============ ============ ============
Net income per share:
Basic ....................................... $ 0.23 $ 0.24 $ 0.22 $ 0.69
============ ============ ============ ============
Diluted ..................................... $ 0.22 $ 0.24 $ 0.21 $ 0.68
============ ============ ============ ============
Shares used in computing net income per share:
Basic ....................................... 11,715,000 11,553,000 11,686,000 11,635,000
============ ============ ============ ============
Diluted ..................................... 12,136,000 11,823,000 12,051,000 11,840,000
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE> 5
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
<TABLE>
<CAPTION>
Three months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net income ...................................... $ 2,675,000 $ 2,787,000 $ 2,525,000 $ 8,033,000
Other comprehensive income (loss):
Foreign currency translation adjustment ....... 1,323,000 1,567,000 2,448,000 (2,328,000)
Unrealized gain (loss) on securities .......... 2,000 (112,000) (2,000) (327,000)
Reclassification adjustment ................... -- -- (6,000) --
----------- ----------- ----------- -----------
Other comprehensive income (loss),
before income taxes ......................... 1,325,000 1,455,000 2,440,000 (2,655,000)
Provision for income taxes related to other
comprehensive income (loss) ................. (501,000) (582,000) (922,000) 1,062,000
----------- ----------- ----------- -----------
Other comprehensive income (loss), net of taxes 824,000 873,000 1,518,000 (1,593,000)
----------- ----------- ----------- -----------
Comprehensive income ........................... $ 3,499,000 $ 3,660,000 $ 4,043,000 $ 6,440,000
=========== =========== =========== ===========
</TABLE>
See accompanying notes.
5
<PAGE> 6
RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30, September 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................... $ 2,525,000 $ 8,033,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization ............................................ 2,841,000 2,041,000
Depreciation ............................................ 2,177,000 1,504,000
Provision for loss in contract .......................... -- 400,000
Change in deferred income taxes ......................... (78,000) (1,153,000)
Allowance for doubtful accounts ......................... (165,000) 90,000
Loss from retirement of property, plant, and equipment .. 47,000 34,000
Write-down of long-term investment ...................... 1,320,000 --
Share in investee's loss ................................ -- 45,000
Minority interest in subsidiary's earnings .............. (241,000) (392,000)
Write-off of capitalized software ....................... 784,000 --
Provision for restructured operations ................... 98,000 --
Write-off of in-process research and development ........ 4,000,000 --
Changes in operating assets and liabilities:
Accounts receivable ................................... (1,080,000) 2,073,000
Inventories ........................................... (951,000) (1,733,000)
Unbilled costs and fees ............................... 1,782,000 (152,000)
Prepaid expenses and other current assets ............. 23,000 (232,000)
Accounts payable ...................................... 121,000 (455,000)
Accrued liabilities ................................... (1,887,000) (80,000)
Billings in excess of costs and fees .................. 330,000 (227,000)
Income taxes payable .................................. 591,000 (2,765,000)
------------ ------------
Net cash provided by operating activities ............ 12,237,000 7,031,000
Cash flows from investing activities:
Purchase of marketable securities ........................ (5,336,000) (9,930,000)
Sale of marketable securities ............................ 4,216,000 16,211,000
Purchases of property, plant, and equipment .............. (3,280,000) (5,732,000)
Net cash paid for acquisition of Wyatt River
Software, Inc .......................................... (7,871,000) --
Other non-current assets ................................. (1,597,000) (775,000)
Acquired cash from QM Technologies, Inc. ................. -- 556,000
Capitalized software development costs ................... (872,000) (1,150,000)
------------ ------------
Net cash used in investing activities ................ (14,740,000) (820,000)
Cash flows from financing activities:
Exercise of Rainbow common stock options ................. 1,439,000 936,000
Investment by new partners in QM Technologies, Inc.
and Rainbow Technologies, Russia ....................... 998,000 --
Payment of long-term debt ................................ (205,000) (214,000)
Purchase of treasury stock ............................... (662,000) (814,000)
Purchase and retirement of common stock .................. -- (2,767,000)
------------ ------------
Net cash provided by (used in) financing activities .. 1,570,000 (2,859,000)
Effect of exchange rate changes on cash ................... 896,000 (348,000)
------------ ------------
Net (decrease) increase in cash and cash equivalents ...... (37,000) 3,004,000
Cash and cash equivalents at beginning of period .......... 29,556,000 31,735,000
------------ ------------
Cash and cash equivalents at end of period ................ $ 29,519,000 $ 34,739,000
============ ============
Supplemental disclosure of cash flow information:
Income taxes paid ........................................ $ 4,679,000 $ 8,748,000
Interest paid ............................................ 159,000 199,000
</TABLE>
See accompanying notes.
6
<PAGE> 7
RAINBOW TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
1. Basis of presentation
The accompanying financial statements consolidate the accounts of Rainbow
Technologies, Inc. (the Company) and its wholly-owned subsidiaries. All
significant inter-company balances and transactions have been eliminated.
Certain amounts previously reported have been reclassified to conform with the
1998 presentation.
In the opinion of the Company's management, the accompanying condensed
consolidated financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the financial
position at September 30, 1998 and results of operations for the three and nine
months ended September 30, 1998 and 1997. 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, 1997
Annual Report on Form 10-K. Results of operations for the three and nine months
ended September 30, 1998 are not necessarily indicative of results to be
expected for the full year.
The Company has subsidiaries in the United Kingdom, Germany, France, Belarus,
the Netherlands, India and Russia. 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 statements of operations of
those subsidiaries are translated into U.S. dollars at the weighted average
exchange rates for the respective periods presented.
As of January 1, 1998, the Company adopted Statement 130, "Reporting
Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes new rules for the
reporting and display of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net income or
shareholders' equity. SFAS 130 requires unrealized gains or losses on the
Company's available-for-sale securities and foreign currency translation
adjustments, which prior to adoption were reported separately in shareholders'
equity to be included in other comprehensive income. Prior year financial
statements have been reclassified to conform to the requirements of SFAS 130.
During the three and nine months ended September 30, 1998 total comprehensive
income amounted to $3,499,000 and $4,043,000 respectively. The total
comprehensive income for the three and nine months ended September 30, 1997
amounted to $3,660,000 and $6,440,000, respectively.
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
(SFAS No. 131), which requires publicly-held companies to report financial and
descriptive information about its operating segments in financial statements
issued to shareholders for interim and annual periods. The statement also
requires additional disclosures with respect to products and services,
geographical areas of operations, and major customers. The company will adopt
SFAS No. 131 effective December 31, 1998 and will restate all periods presented.
7
<PAGE> 8
2. Earnings per share
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share" (SFAS No. 128) effective December 31, 1997. SFAS No. 128
replaced the calculation of primary and fully diluted earnings per share with
basic and diluted earnings per share. Basic earnings per share is computed by
dividing income available to common shareholders by the weighted-average number
of common shares outstanding for the period. Diluted earnings per share reflects
the assumed conversion of all diluted securities. Earnings per share amounts for
all periods presented have been calculated in accordance with the requirements
of SFAS No. 128.
3. Government Contracts
The Company is both a prime contractor and a 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.
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, December 31,
1998 1997
------------ --------------
<S> <C> <C>
Raw materials $ 722,000 $ 271,000
Work in process 500,000 761,000
Finished goods 4,306,000 4,257,000
Inventoried costs related
to long-term contracts 6,127,000 4,491,000
------------ --------------
$ 11,655,000 $ 9,780,000
============ ===========
</TABLE>
8
<PAGE> 9
5. Acquisitions
In March 1998, the Company purchased certain assets from Elan Computer Group,
Inc. ("Elan") in a cash transaction. The assets included Elan's license manager
software technology, which the Company had previously licensed from Elan, and
Elan's end-user maintenance and support relationships.
In February 1998, the Company acquired Wyatt River Software, Inc. ("Wyatt
River"), including its "LicenseServe" and "LicenseTrack" technology in a cash
transaction. The Company will also pay the Wyatt River shareholders an
additional sum based upon sales of Wyatt River technology through June 30, 1999.
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.
Also included in other assets are capitalized software development costs. Based
on the Company's product development process, technological feasibility is
established upon completion of a working model. Amortization of capitalized
software development costs commence when the products are available for general
release to customers and are determined using the straight line method over the
expected useful lives of the respective products. These amounts are written off
if it is determined that the projects can not be brought to market.
7. Stock split
On March 17, 1998 the Company announced that its Board of Directors approved a
3-for-2 split of its common stock. The effective date was July 1, 1998 and the
payout date was July 15, 1998. These financial statements have been adjusted to
reflect the impact of the stock split.
8. Subsequent Event
Globetrotter Software, Inc. filed suit against Rainbow Technologies, Inc and
Rainbow Technologies North America, Inc. on or about September 1, 1998, alleging
that Rainbow Technologies' Sentinel LM product infringes US Patent No. 5,390,297
which Globetrotter Software, Inc. purchased from another company. Rainbow
Technologies, Inc. believes that the Sentinel LM product does not infringe on
this patent and intends to vigorously defend the suit. The Company does not
believe the outcome will have a material adverse effect on the financial
position of the company.
9
<PAGE> 10
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.
RESULTS OF OPERATIONS
(dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended September 30,
--------------------------------
1998 1997
-------- --------
<S> <C> <C>
Revenues
Software Protection Products $ 14,250 $ 14,741
Information Security Products 12,498 7,314
IBEST 9 201
-------- --------
Consolidated $ 26,757 $ 22,256
======== ========
Operating Income
Software Protection Products $ 2,406 $ 4,176
Information Security Products 1,697 303
IBEST (225) (72)
-------- --------
Consolidated $ 3,878 $ 4,407
======== ========
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1997
-------- --------
<S> <C> <C>
Revenues
Software Protection Products $ 42,871 $ 44,688
Information Security Products 35,650 20,983
IBEST 27 212
-------- --------
Consolidated $ 78,548 $ 65,883
======== ========
Operating Income
Software Protection Products $ 4,424 $ 11,616
Information Security Products 4,251 1,718
IBEST (699) (997)
-------- --------
Consolidated $ 7,976 $ 12,337
======== ========
</TABLE>
REVENUES
Revenues from software protection products for the three and nine months ended
September 30, 1998 decreased by 3% and 4%, respectively, when compared to the
same period in 1997. The overall business has been impacted by the economic
problems in Asia and other emerging markets as well as by the erosion of average
selling prices. Revenues from Europe increased by 5% while revenues from the US
decreased by 9% for the nine months ended September 30, 1998 compared with the
same period in 1997. The decrease in US revenues is due to slower sales to US
customers who export their products to Asia as well as lower direct sales to
Asian distributors. The average selling price per product in the quarter ended
September 30, 1998 decreased approximately 3% when compared to the same period
in 1997. Unit volume for the three months ended September 30, 1998 decreased by
6% while unit volume for the nine months ended September 30, 1998 increased by
4% when compared to the corresponding 1997 periods. The decrease in average
selling prices and the increase in unit volume is primarily due to a change in
customer mix.
10
<PAGE> 11
Revenues from information security products for the three and nine months ended
September 30, 1998 increased by 71% and 70%, respectively, when compared to the
same period in 1997. The revenue growth was primarily due to strong demand for
network security products.
GROSS PROFIT
Gross profit from software protection products for the three months ended
September 30, 1998 decreased to 69% of revenues compared to 72% of revenues for
the corresponding period in 1997. For the nine months ended September 30, 1998
gross profit increased to 73% of revenues compared to 71% of revenues for the
same period in 1997. The decrease in the gross profit was due to several
inventory adjustments.
Gross profit from information security products for the three months ended
September 30, 1998 increased to 23% of revenues compared to 18% for the three
months ended September 30, 1997. Gross profit from information security products
for the nine months ended September 30, 1998 decreased to 22% of revenues
compared to 19% for the nine months ended September 30, 1997. The decrease for
the nine month period is due to the change in mix from predominantly contract
revenues to predominantly product revenues.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses for the three and nine months ended
September 30, 1998 increased by 23% and 16%, respectively, when compared to the
corresponding 1997 period. The increase was due to increased staffing and
professional expenses, new product introductions in software protection and
information security products, and higher marketing expenses.
RESEARCH AND DEVELOPMENT
Total research and development expenses for the three months ended September 30,
1998 decreased by 4% when compared to the corresponding 1997 period. The
decrease in research and development expenses was due primarily to the deferral
of non-recurring engineering expenses related to several projects. Total
research and development expenses for the nine months ended September 30, 1998
increased by 12% when compared to the corresponding 1997 period. The increase
was primarily due to the write-off of previously capitalized computer software
development expenses of $784,000 in the first quarter of 1998.
PROVISION FOR RESTRUCTURED OPERATIONS
The sum of $98,000 for the nine months ended September 30, 1998 represents the
Company's estimate of the costs of restructuring certain operations.
Approximately $222,000 previously reserved for cancellation of the lease on a
building was reversed in the current quarter when the Company was successful in
securing a third party to assume the lease.
ACQUIRED RESEARCH AND DEVELOPMENT
Based on the results of third-party appraisals, the Company recorded charges of
$4,000,000 in the three months ended March 31, 1998 to expense in-process
research and development costs related to the acquisition of Wyatt River. In the
opinion of management and the appraiser, the acquired in-process research and
development had not yet reached technological feasibility and had no alternative
future use.
11
<PAGE> 12
OTHER INCOME (EXPENSE)
Interest income for the quarter ended September 30, 1998 decreased by 24%
compared to $442,000 for the quarter ended September 30, 1997 because of lower
balances of cash and cash equivalents.
The Company recorded $65,000 in other income related to the minority interest in
QMT for the three months ended September 30, 1998 compared to a loss of $36,000
in the corresponding period in 1997. The income of $65,000 is a result of
adjustments to prior quarters' losses. QMT received additional investment of
$962,000 from a third party during the three months ended September 30, 1998.
PROVISION FOR INCOME TAXES
The effective tax rate was 38% for the three months ended September 30, 1998
compared to 41% for the corresponding period in 1997. The effective tax rate for
the first nine months of 1998 was negatively affected due to non-deductibility
of the charges related to acquired in-process research and development, and a
timing difference related to the write-off of the original investment in Elan.
Excluding the effect of these charges, the effective tax rate was 41% for the
nine months ended September 30, 1998 and 1997. The lower tax rate is due to the
benefits of restructuring foreign operations.
12
<PAGE> 13
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 for the nine months ended September 30, 1998 and 1997 were
$12,237,000 and $7,031,000, respectively. The increase in cash flow from
operations is attributable to benefits from overall operating efficiencies of
its information security product line.
The Company intends to use its capital resources to expand its product lines and
for the acquisition of additional products and technologies. The Company has no
significant capital commitments or requirements at this time.
The Company's use of cash includes purchases of property, plant and equipment,
repayment of long-term debt and investment in long-term assets.
Management believes the Company's current working capital of $55,885,000 and
anticipated working capital to be generated by future operations will be
sufficient to support the Company's requirement for at least the next twelve
months.
IMPACT OF YEAR 2000
Year 2000 Compliance. Many existing computer systems and applications, and other
control devices, use only two digits to identify a year in the date field,
without considering the impact of the upcoming change in the century. Others do
not correctly process "leap year" dates. As a result, such systems and
applications could fail or create erroneous results unless corrected to process
data related to the year 2000 and beyond. The problems are expected to increase
in frequency and severity as the year 2000 approaches, and are commonly referred
to as the "Year 2000 Problem." The Company relies on its systems, applications
and devices in operating and monitoring all major aspects of its business,
including systems (such as general ledger, accounts payable, and payroll
modules), customer services, infrastructure, embedded computer chips, networks
and telecommunications equipment. The Company also relies, directly and
indirectly, on external systems of business enterprises such as customers,
suppliers, creditors, financial organizations and governmental entities, both
domestic and international, for accurate exchange of data.
The Company is continuing to assess the impact that the Year 2000 Problem may
have on its operations and has identified the following four key areas of its
business that may be affected:
Products: The Company has completed Year 2000 compliance testing on its
currently supported products. The products were classified into two categories:
category I having no date related processing and category II having internal
date clocks which will properly handle and roll-over calendar data. Based upon
the evaluation and testing completed, the Company believes that its currently
supported products are Year 2000 compliant. The Company's testing did not assess
compliance of products modified by customers or third parties nor did it assess
compliance of products connected to individual customer work environments. The
Company has listed its currently supported products and test data on its
Internet site.
Internal Business Systems. The Year 2000 Problem could affect the systems,
transaction processing computer applications and devices used by the Company to
operate and monitor all major aspects of its business, including financial
systems (such as general ledger, accounts payable and payroll), customer
services, infrastructure, materials requirement planning, master production
scheduling, networks and telecommunications systems. The Company has completed
its assessment phase and believes that it has identified substantially all of
the major systems, software applications and related equipment used in
connection with its internal operations that must be modified or upgraded in
order to minimize the possibility of a material disruption to its business. The
Company is currently in its remediation phase of modifying and upgrading all
affected systems and expects to complete this phase by the end of the first
quarter of 1999. The Company estimates that it will be Year 2000 compliant by
the end of the fourth quarter of 1999. However, any unforeseen problems which
occur during the testing phase may adversely effect the Company's Year 2000
readiness.
13
<PAGE> 14
Third-Party Suppliers. The Company relies, directly and indirectly, on external
systems utilized by its suppliers for products used in the manufacture of its
products. The Company will request confirmation from its suppliers of their Year
2000 compliance; however, there can be no assurance that these suppliers will
resolve any or all Year 2000 Problems with their systems in a timely manner. Any
failure of these third parties to resolve their Year 2000 Problems in a timely
manner could result in the material disruption of the business of the Company.
Any such disruption could have a material adverse effect on the Company's
business, financial condition and results of operations.
Facility Systems. Systems such as heating, sprinklers, elevators, test equipment
and security systems at the Company's facilities may also be affected by Year
2000 Problem. The Company has contacted the Irvine facility owners seeking
assurances of Year 2000 compliance. The Company has not yet assessed its
facilities at other locations.
The Company has incurred approximately $150,000 as of the nine-month period
ended September 30, 1998, to address its Year 2000 issues. The Company presently
estimates that the total cost of addressing its Year 2000 issues will be
approximately $250,000. This estimate was derived utilizing numerous
assumptions. First, the current staff is adequate to finish the project. Second,
the product is already Year 2000 compliant. Next, to the best of its knowledge,
the Company estimates that approximately half of the work is already done and
that no system changes are anticipated. However, there can be no guarantee that
these assumptions are accurate, and actual results could differ materially from
those anticipated.
The Company recognizes the need for developing contingency plans to address the
Year 2000 issues that may pose a significant risk to its on-going operations.
Such plans could include the implementation of manual procedures to compensate
for system deficiencies. During the remediation phase of the internal business
systems, the Company will be evaluating potential failures and attempt to
develop responses in a timely manner. However, there can be no assurance that
any contingency plans evaluated and potentially implemented by the Company would
be adequate to meet the Company's needs without materially impacting its
operations, that any such plan would be successful or that the Company's results
of operations would not be materially and adversely affected by the delays and
inefficiencies inherent in conducting operations in an alternative manner.
14
<PAGE> 15
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 11, 1998
RAINBOW TECHNOLOGIES, INC.
By: /s/ Patrick Fevery
---------------------------------
Chief Financial Officer
15
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