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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the fiscal year ended December 31, 1997
Or
[ ] Transition Report Pursuant to Section 13 OR 15 (d) Of the Securities
Exchange Act of 1934
Commission File Number 0-20634
INFORMATION RESOURCE ENGINEERING, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 52-1287752
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
8029 Corporate Drive
BALTIMORE, MARYLAND 21236
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(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code (410) 931-7500
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Securities registered under Section 12 (b) of the Exchange Act: NONE
Securities registered under Section 12 (g) of the Exchange Act:
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Name of each exchange on
Title of each class which registered
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Common Stock, $.01 par value Nasdaq National Market
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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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]
Revenues for the most recent fiscal year were $16.0 million.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 20, 1998, based upon the closing price on that date, on
the Nasdaq National Market, was approximately $30.0 million.
The number of shares of the registrant's Common Stock outstanding as of March
20, 1998 was 5,463,727.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the registrant's proxy
statement for the Annual Meeting of Shareholders, which proxy statement in
definitive form will be filed no later than 120 days after the close of the
registrant's fiscal year ended December 31, 1997.
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PART I
ITEM 1 - BUSINESS
Except for historical information contained herein, the statements in this Item
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others, risks
associated with the receipt and timing of future customer orders, price
pressures, other competitive factors leading to a decrease in anticipated
revenues, achieving technical and product development milestones, the ability to
manufacture product in a timely manner to meet market demand, market acceptance
of products, the ability to negotiate favorable purchase and sale agreements,
and sufficient cash flow for future liquidity and capital resource needs. Gross
margins can vary from quarter to quarter based on product and channel mix, and
current gross margin levels may not be indicative of future results.
The Company's historical and prospective operating results have been and
are expected to continue to be dependent on a variety of factors including, but
not limited to, the length of the sales cycle, the timing of orders from and
shipments to clients, product development expenses and the timing of development
and introduction of new products. The Company's expense levels are based, in
part, on expectations of future revenues. The size and timing of the Company's
historical revenues have varied substantially from quarter to quarter and year
to year. Accordingly, the results of a particular period, or period to period
comparisons of recorded sales and profits may not be indicative of future
operating results.
These factors, among others, could cause results to differ materially from those
in the forward looking statements.
See "Glossary of Technical Terms" on page 12 for explanation of certain
technical terms used herein.
GENERAL
Information Resource Engineering, Inc. (the "Company") designs,
manufactures and markets enterprise network communications systems secured by
encryption technology. The Company's products are used in Virtual Private
Network ("VPN") applications, and electronic commerce applications by financial
institutions, government agencies and large corporations to secure data
transmissions on private and public computer networks, such as the Internet.
GRETACODER Data Systems AG ("Gretacoder"), a subsidiary of the Company,
manufactures and markets cryptographic equipment primarily in Switzerland and
Europe.
Encryption technologies are utilized by the Company to provide selective
access to computer networks, prevent electronic eavesdropping or alteration
during electronic data transmission; to provide message authentication
confirming that messages are received in unaltered form; and to enable user
authentication and digital signatures verifying the identity of the message
sender and limiting computer access to authorized users. The Company offers a
choice of encryption algorithms to provide the level of network security
appropriate for each client application.
The Company's clients include seven of the largest banks in the U.S., Union
Bank of Switzerland, the Society for Worldwide Interbank Financial
Telecommunications ("SWIFT") an international financial clearing house, The
Euroclear System ("Euroclear"), TRW Inc., major federal, state and international
law enforcement agencies and the U.S. Department of Treasury. While the network
security market has traditionally been limited to financial institutions and
government agencies, the Company believes that emerging electronic commerce
applications, particularly business-to-bank and business-to-business, provide
new market opportunities.
In the second half of 1996, the Company introduced
"SafeNet/Enterprise(TM)", a comprehensive, centrally managed VPN security system
that enables secure use of public networks, such as the Internet, for private
business transactions. In 1997 software and smartcard based product members were
added to the SafeNet product family.
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This product introduction substantially increased unit sales and expanded the
market for SafeNet products by lowering significantly the cost per client
device.
The Company was originally incorporated in Maryland on April 7, 1983 under
the name "Industrial Resource Engineering, Inc." The Company reincorporated
under its present name in Delaware by merging with its subsidiary in March 1989.
The Company's executive offices are located at 8029 Corporate Drive, Baltimore,
Maryland 21236, and its telephone number is (410) 931-7500.
The Market for Enterprise Network Security Solutions
Virtual Private Networks allow corporations to use public networks for
their communications backbone. This is achieved by protecting the data traffic
with data communications security technology such as: encryption, message
authentication, user authentication, and firewall technology. Since public
networks are much cheaper than private leased lines and Frame Relay networks
corporations can generally achieve substantial cost savings by using VPNs.
Management believes that the market for security systems and products
providing VPN solutions has grown over the last several years due to an increase
in the use of the Internet for business communications. Remote access to
computers has increased substantially due to the use of remote databases,
work-at-home arrangements or telecommuting, electronic mail, satellite offices
connected to a central computer, electronic funds transfer, electronic data
interchange with clients, suppliers and business partners and numerous other
arrangements. With the increasing use of public and private communications
networks and the ability of different types of computers to communicate with
each other, data integrity and security have gained increased importance.
Unsecured data transmitted over public networks, such as the Internet, is
subject to interception, electronic vandalism or terrorism, and alteration. The
increased use of networked computers also increases risk, both by multiplying
the number of access points to valuable data and the number of personal
computers which can be utilized to obtain unauthorized information. The Company
believes that the use of computer networks such as the Internet, will continue
to expand and that, as the reliance on these networks grows, organizations will
become more dependent on the integrity and security of the network.
BUSINESS STRATEGY
The Company's objective is to be a leading provider of secure network
systems, services and products to the growing market for Virtual Private
Networks. The key elements of the Company's strategy are as follows:
Provide Clients with a Broad Range of Enterprise Network Security Solutions
The Company has historically grown by applying its technological competence
to the development of network security systems and products for use in the
complex computer networks of financial, corporate and government clients. The
Company's focus on technology has led to a family of products which have reduced
the complexity and cost associated with applying encryption technology to
computer networks. The SafeNet/Enterprise(TM) product line includes firewalls,
encryption and user identification tokens in a comprehensive, centrally managed
system. The Company believes that this focus on technology is vital for its
future growth and will continue to invest its resources accordingly.
Develop an Original Equipment Manufacturer Business
The Company believes that, due to the fact that security is a major concern
among network users, manufacturers of computer and communications products are
seeking to add security capabilities to their products. Consequently, the
Company is developing a family of products which can be incorporated into
computers and communications products manufactured by others. Such products
include smart card readers, a secure communications chip and a line of products
designed around the chip.
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Develop a Transaction Services Business
The Company is leveraging its network security expertise to develop a
transaction services business since it believes that the recurring revenue
stream and strategic relationships generated from such business will be
instrumental to its future growth. In the second half of 1996, the Company
established the SafeNet/Trusted Services facility at Company headquarters to
provide security management services such as subscriber enrollment, product
configuration, digital certificates, and key management services to Internet
access providers and directly to end users. The Company expects to receive both
monthly fixed and fee per transaction revenue for providing such services.
Establish Key Strategic Relationships
The Company seeks to establish domestic and international relationships
with organizations that have the ability to expand the use of encryption
technology. Relationships currently exist with the following:
Analog Devices Inc. ("ADI"), a leading manufacturer of high-performance
integrated circuits, is assisting the Company in the design, manufacture and
marketing of the Company's new secure communications chip. The new chip will
provide organizations with a highly secure, inexpensive solution to conducting
business over computer networks.
CyberGuard Corporation, a leading provider of network security
solutions, has entered into a joint product development and marketing agreement
aimed at providing a comprehensive security solution for Internet business
communications.
Financial Services Technology Consortium is a group of leading
financial institutions whose goal is to utilize emerging technologies to enhance
the competitiveness of the financial services industry. The Company is a member
of a multiple industry team formed to design and implement an electronic check
for use on the Internet by consumers and businesses.
PRODUCT DESIGN STANDARDS
Encryption technologies are utilized by the Company to provide selective
access to computer networks, prevent electronic eavesdropping or alteration
during electronic data transmission; to provide message authentication
confirming that messages are received in unaltered form; and to enable user
authentication and digital signatures verifying the identity of the message
sender and limiting computer access to authorized users. The Company offers a
choice of encryption algorithms to provide the level of network security
appropriate for each client application.
All of the Company's network security systems and products comply with the
following general product design standards:
Standards Compliance
The Company's policy is to offer products based upon encryption algorithms
that have been approved as industry and government standards. This provides the
Company's clients assurance that they are using interoperable products which
meet commercial reasonability tests as applied by both government regulation and
courts of law.
Network Compatibility
The Company's systems and products contain sufficient intelligence to
accommodate the specific communication protocols employed by complex computer
networks. Appropriate models of each product type are provided to support Frame
Relay, Dial Asynchronous, leased line, X.25, Bisync and Internet protocol-based
networks. This network compatibility results in security systems that are
completely independent of the computer
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hardware systems and software application programs used by clients. No
modifications to hardware or application software are required to implement the
Company's systems and products.
Ease of Use
The Company believes that users of its products, while concerned that their
data is secure, do not wish to be required to take specific actions to achieve
secure status. Therefore, the Company's products are designed to function
without user involvement, thus offering an extremely high level of ease of use.
Ease of Administration
The Company has extended its ease of use concept to the central management
of a secure network with a product known as the SafeNet/Security Center(TM)
("SSC"). The SSC provides central management and tracking capability for the
entire encrypted network thus reducing the cost of implementing security for
client organizations. For organizations aiming to defer capital and personnel
investment, the Company's SafeNet/Trusted Services facility provides
comprehensive security management as an optional service performed at the
Company's headquarters.
Price Performance Criteria
The Company believes that in order for clients to invest in encryption
technology, its products must be implemented cost effectively. As such, the
Company's development staff follows a design approach similar to that used with
consumer electronics products that are designed for low manufacturing cost.
ENCRYPTION ALGORITHMS
At present, the Company's products employ a variety of encryption
algorithms including the U.S. Government Data Encryption Standard, ("DES"), RSA
Data Security Inc. Encryption Standard, ("RSA") and Gretacoder Data Systems
Encryption Standard, ("GDS"). DES, as described in American National Standards
Institute ("ANSI") Standard X3.92, has been certified by the National Institute
of Standards and Technology ("NIST") and is the accepted encryption algorithm
for commercial and non-classified government applications in the U.S. as well as
financial applications worldwide. The Company has received export approval from
the U.S. Commerce Department to export its products with the DES algorithm.
The Company holds a license to use RSA; a leading public key based
encryption algorithm. RSA is used in Company products to generate and verify
digital signatures as well as for key management purposes.
GDS is a strong algorithm employing encryption keys which are much
longer than keys in algorithms that are exportable from the United States. GDS
is used by security conscious European organizations including banks and
governments.
New encryption algorithms are periodically proposed as industry
standards. The Company's policy is to adopt and offer its clients new algorithms
for various applications as they become certified by standards organizations
such as ANSI, NIST and the Internet Engineering Task Force. The Company is
currently developing products which include Triple DES, a longer key length
version of DES.
CURRENT NETWORK SECURITY PRODUCTS AND SYSTEMS
The Company's principal network security systems and products secure
information transmissions on public and private networks.
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Public Network/Internet Products
SAFENET/ENTERPRISE(TM). In the second half of 1996, the Company introduced
SafeNet/Enterprise(TM), a comprehensive, centrally managed security system that
enables secure use of public networks, such as the Internet, for private
business transactions. By providing a high level of security,
SafeNet/Enterprise(TM) will allow organizations to reduce their networking costs
by using the Internet instead of costly private networks.
The product line includes:
- SafeNet/Smartcard(TM) is a credit card user token that stores user
identification and encryption keys in an advanced computer chip,
- SafeNet/Soft(TM) is a Windows compatible software package that
provides continuous user authentication, one-time password
generation and data encryption,
- SafeNet/LAN(TM) Encrypting Firewall which provides security for
LAN connections to the Internet, as well as packet filtering,
- SafeNet/Firewall(TM) is a highly secure proxy firewall based on
the CyberGuard Firewall,
- SafeNet/Dial(TM), a secure pocket modem operating at 28.8 bps for
secure dial access to the Internet by remote users such as
traveling professionals and telecommuters,
- SafeNet/Dial-R(TM) provides security identical to the
SafeNet/Dial(TM), without the integral modem,
- SafeNet/Security Center(TM), a high performance workstation which
automatically manages the entire suite of SafeNet/Enterprise(TM)
products,
- SafeNet/Trusted Services(TM) provides central management of VPN
security as a service 24 hours a day, 365 days a year.
Private Network Products
SECURE MODEMS. In 1994, the Company introduced its AX400 Secure Modem. The
AX400 is a portable device that fits in the palm of a user's hand, weighs just a
few ounces and uses power from the remote computer. It contains an internal
modem that delivers a 14.4K bps data rate while in secure operation using
standards compliant encryption technology. The AX400 also generates a random
password for each communications session when a user enters the appropriate
personal identification number. Due to its small size, user authentication and
data protection capabilities, the AX400 is convenient for mobile or remote
users.
SECURE DIAL ACCESS SYSTEMS. These products are designed to protect data
communications when remote users access host computers via the voice telephone
network and are most commonly employed when personal computers are communicating
with central computer sites, such as company headquarters. Since computer
communications are taking place over normal, unsecured telephone lines, some
type of security is frequently required in these applications.
GRETACODER FRAME RELAY ENCRYPTORS. The GDS Frame Relay encryptor combines
the advantages of circuit and packet switched services: small delays over the
network and lower transmission cost. The properties of Frame Relay make it
especially suitable for LAN interconnections where bursty traffic has to be
transmitted.
X.25 SECURITY SYSTEMS. Complex computer networks such as X.25 networks
break down the data stream sent from computers into smaller, more manageable
pieces called, "packets" which contain address and routing information as well
as user data. The X.25 Security System selectively applies encryption technology
only to the users data while leaving address and routing information intact,
thus assuring proper delivery of user data in secure form at minimal expense.
The Company markets X.25 Security Systems under both the IRE and GDS names.
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LINK SECURITY SYSTEMS. While dedicated links are inherently more secure
than dial networks, the nature of the data that is frequently transmitted over
dedicated lines (the connections to bank branch offices, for instance) often
requires a high level of security. IRE's products are designed to protect
synchronous or asynchronous communications at speeds up to 64K bps over
dedicated telephone lines. GDS products are designed to protect synchronous or
asynchronous communications at speeds up to 2M bps over dedicated telephone
lines. The Link Security Systems are protocol transparent and supports
asynchronous, bisynchronous, SDLC and HDLC communications protocols.
NEW PRODUCT DEVELOPMENT
The Company conducts product development activities to increase the size of
its available market through broader product offerings and to reduce the cost of
its products resulting in more competitive pricing and/or better operating
margins.
New products, capable of a high level of security on the Internet, were
introduced under the SafeNet/Enterprise(TM) brand name in the second half of
1996. The Company intends to continue to develop new versions of the
SafeNet/Enterprise(TM) products to support growth of both its product and
service businesses.
New encryption algorithms such as the digital signature standard, escrowed
encryption and RSA utilize a technology generally known as public key
encryption. The Company believes that this new technology has potential
widespread demand, and is therefore developing products that utilize this new
technology to manage the security of large computer networks.
In January 1997, the Company announced that it is developing a low-cost
secure communications chip with ADI. The new chip can combine encryption and
communications functions, such as modems and LAN adapters, on a single
integrated circuit. The chip supports current and future security standards and
can be software personalized for communications applications such as LAN, ADSL,
ISDN and cable modems. The initial secure communications chip will be aimed at
environments which require encrypted communications at high speed.
Gretacoder is also developing a high performance encryption chip which will
employ the Triple DES Encryption algorithm. Since this chip was entirely
developed and manufactured outside the United States, the Company believes that
it is not subject to U.S. Government export controls.
The Company is currently devoting significant resources toward the
foregoing product development activities. There can be no assurance that the
Company will successfully complete the development of these products in a timely
fashion or that the Company's current or planned products will satisfy the needs
of the computer and network security market.
PRINCIPAL CLIENTS
The Company focuses its marketing efforts on both commercial and U.S.
government sales.
The Company's largest clients vary from year to year and the Company has
experienced shifts in sales patterns with large clients in the past.
Accordingly, the complete loss of any large client or substantial reduction of
sales to such clients could have a material adverse effect on the Company.
Principal commercial clients of the Company, which accounted for more than 10%
of total revenues, by year and percentage of revenue were Lockheed Martin with
15%, in 1997, and MCI with 27% and 13% of revenues in 1996 and 1995,
respectively. For the year ended December 31, 1995, the percentage of revenues
from sales to agencies of the U.S. government was 26%.
Commercial Clients
Sales to financial institutions are a central part of the Company's
business. Banks use the Company's network security systems and products to
protect corporate cash management applications. In these systems, financial
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officers located at corporations use personal computers to dial into the bank's
computing facility in order to transfer funds electronically.
In the past year the Company received orders from TRW Inc., the prime
contractor for the development and maintenance of the Treasury Communications
System (TCS) of the U.S. Department of Treasury. The Company's AX Family and
SafeNet/Enterprise(TM) products are being used to protect communications between
Treasury departments and offices nationwide. The Company's automated key
management center was also purchased by TRW for user identification and
authentication, real-time security monitoring, audit services and electronic key
delivery. In addition to TRW Inc., several other customers placed orders for the
Company's SafeNet/Enterprise(TM) products including Credit Management Solutions,
Inc. ("CMSI"), a provider of consumer credit applications on the Internet; State
of Maryland Motor Vehicle Administration, a provider of on-line applications
including electronic vehicle registration; and Interbanking S.A., a financial
institution providing Internet protocol based communications with 3,000
corporate customers in Argentina.
Euroclear is the world's largest provider of security clearinghouse
services to over 1,400 large international banks and brokerage firms. Euroclear
is owned by a consortium of 120 international financial institutions. The
Company's network security systems and products are used to protect the money
transfer service available to Euroclear participants. When the participant
authorizes a wire transfer for payment, the transfer is protected by the
Company's network security systems and products. Participants who wish to use
the wire transfer service are required to purchase the Company's remote security
devices which provide message authentication, user authentication and data
encryption for the participant's funds transfers communications.
GDS has also recognized the emerging information security needs of
commercial clients, primarily transactions between banks. GDS products are
utilized commercially in several countries to protect financial transactions
from wiretapping and fraudulent data manipulation. Several Swiss banks and other
financial institutions use GDS units to protect their electronically transmitted
transactions, including Union Bank of Switzerland, Swiss Interbank Clearing,
SWIFT, European Payment Systems Services, Societa Interbancaria per
l'Automazione S.p.A., and Swiss Securities Clearing Operation.
Government Clients
The U.S. Department of Treasury uses the Company's network security systems
and products to protect the electronic payment of the government's bills for
civilian agencies, securing approximately 750 million payment requests each
year, with an annual value of more than $700 billion. In the electronic
certification system provided to the U.S. Department of Treasury, the Company's
products verify the integrity of electronic payment orders using message and
user authentication.
The U.S. Department of Energy uses a large installation of the Company's
Link Security System in a communications network that is part of a premises
security system at a highly classified location. The Department of Energy has
deployed the Company's Link Security System at an additional installation.
Other government agencies deploying the Company's systems and products
include the Federal Bureau of Investigation, National Crime Information Network,
U.S. Drug Enforcement Agency and U.S. Customs Service. The Company's security
systems and products are utilized by these law enforcement agencies to protect
sensitive information traveling across telephone and computer networks.
CLIENT SUPPORT AND PRODUCT WARRANTIES
The Company provides support for clients through a staff of support
engineers knowledgeable in both the Company's network security systems and
products and complex computer networks. In addition to supporting clients, this
group of engineers performs system level quality assurance testing of new
products and product enhancements.
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The Company provides client telephone support, including 24 hour a day "hot
line" support. In addition, the Company offers on-site training, installation
and trouble-shooting services, generally on a fee basis.
The Company provides limited warranties on its products for one year from
acceptance of a product. After warranty expiration, clients may purchase an
extended warranty support contract. This contract extends warranty service for
an additional one year period, providing repair or replacement of defective
products, telephone support, software and firmware support, regular maintenance
releases for products and early access to major product enhancements. The
Company also offers support on a time and materials basis.
SALES AND MARKETING
Sales
In 1997, the Company continued to transition to indirect distribution
channels in order to expand worldwide sales coverage. In North America, IRE
sells its products through a direct sales force and selected distributors which
include Value Added Resellers and Internet Service Providers. In Switzerland,
GDS sells its products through a direct sales force reporting to a sales manager
at GDS. Outside of such territories, the Company and GDS sell their products
through distributors of communication or information security products. Support
for these distributors is provided by a sales force headed by a Vice President
of International Sales.
Marketing
In 1997, the Company's marketing program emphasized continued trade show
participation to generate sales leads resulting in increased coverage of the
Company's products in leading trade publications. In addition, the Company has
upgraded the quality of its sales materials, equipping each sales employee with
the capability to make live demonstrations illustrating the value and efficacy
of secure communications to prospective clients.
INVENTORY, SUPPLIES AND MANUFACTURING
Components for the Company's products are purchased from a limited number
of electronic parts manufacturers and distributors. Electronic assembly firms
are used to mount components onto printed circuit boards according to designs
and instructions provided by the Company's engineers. Since the components are
readily available from other suppliers and since there are several electronic
assembly firms available, a change in suppliers would not have a material effect
on the Company's operations. However, while the Company has not experienced any
significant supply problems in the past, it is possible that in the future the
Company may encounter shortages in parts, components, or other elements vital to
the manufacture, production and sale of its products.
GDS operations are quality certified according to ISO 9001 and EN 29001.
This is meant to ensure that quality control procedures satisfying the
requirements of these standards are maintained in all processes performed by
GDS. Actual compliance and control are checked by semi-annual third party
audits. In addition to manufacturing, such certifications also extend to
marketing, sales and administration.
The Company anticipates that it will continue to utilize qualified
suppliers and electronic assembly firms to produce sub-assemblies. The Company
presently performs system integration, final assembly and testing which consists
of assembling the cases containing the product components; attaching integrated
circuits, which contain the specific computer instructions and algorithms, to
printed circuit boards; labeling; adding serial numbers; testing; packaging and
shipping. The Company has and will continue to utilize contract manufacturers
for products requiring high volume production.
COMPETITION
The network security market is relatively new, highly competitive and
subject to rapid technological changes. The Company believes that competition in
this market is likely to intensify as a result of increasing demand for network
security products. There are several companies in this field that have been
established longer than the
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Company, and have greater financial, research, service support and marketing
resources than those of the Company. There are also a number of other data
encryption methods on the market, both hardware and software, which compete with
the Company's products.
Management believes that the principal competitive factors affecting the
network security market include standards compliance, quality/reliability,
technical features, network compatibility, ease of use, client service and
support, distribution and price. Although the Company believes its products
currently compete favorably with respect to such factors, there can be no
assurance that the Company can maintain its competitive position against current
and potential competitors.
If the network security market continues to develop, it will likely be
characterized by rapid advances in technology and the continuing introduction of
new products which could render the existing technology upon which the Company's
products are based obsolete or non-competitive. This risk will increase to the
extent that the Company's competitors include manufacturers of computer
equipment and modems to which the Company's products relate, since such
manufacturers may be in a better position than the Company to develop security
products in anticipation of developments in their computer equipment.
INTELLECTUAL PROPERTY
In September 1996, the Company was awarded a United States Patent covering
portable encrypting and authenticating network interface devices such as modems.
The new patent provides the Company with ownership rights to a technology that
the Company believes will be applicable to the growth of computer networks, such
as the Internet. The patent covers various forms of pocket-sized devices
including PCMCIA and Smartcard-based secure tokens and is adaptable to modems
and newer network technologies including ISDN, ADSL and cable modems. The
Company's products covered by the patent include the SafeNet/Dial(TM) and the
AX400. Two additional U.S. patent applications and an international (PCT) patent
application, which cover the same products and technology, are pending.
The Company has acquired a worldwide license under a United States Patent
for a self authenticating fingerprint identification card for certain computer
security and financial applications from CardGuard International, Inc.
The Company has filed ten (10) provisional applications related to its
chip development activities.
The computer software source codes, which are essential elements of the
Company's products, are the proprietary trade secrets of and are copyrighted by
the Company. The protection of proprietary technology and information developed
by the Company will be limited to such protection as the Company may be able to
secure pursuant to trade secret or copyright laws or under any confidentiality
agreements which it may enter. The Company owns federally registered trademarks
for the Company name and for certain of its products; however, there is no
assurance as to the validity, enforceability or lack of infringement of such
trademarks.
At present, the Company is a party to confidentiality agreements with its
officers, directors and employees. There can be no assurance that the scope of
any such protection the Company is able to secure will be adequate to protect
its proprietary information, or that the Company will have the financial
resources to engage in litigation against parties who may infringe such
proprietary technology or copyrights. In addition, there can be no assurance
that others will not develop similar technology independently of the Company.
The Company believes that its products do not infringe the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not assert infringement claims in the future.
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EMPLOYEES
As of March 20, 1998, the Company had approximately 129 full time employees,
of whom 17 are engaged in assembly and quality control, 15 in administration and
financial control, 53 in engineering, development and client support, and 44 in
marketing and sales. The Company employs 99 full time employees in the U.S. and
30 persons are in Switzerland.
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GLOSSARY OF TECHNICAL TERMS
ALGORITHM A process or procedure, generally expressed as a set of instructions
for carrying out a particular task.
ASYNCHRONOUS Data transmission that takes place one character (of 5 to 8 bits)
at a time, with each character preceded by a start code and followed by a stop
code of set duration.
BISYNCHRONOUS (BISYNC) A type of synchronous communication protocol
characterized by bi-directional transmission of character-oriented data.
DEDICATED LINK A type of network wherein telecommunications lines are dedicated
to particular clients along predetermined routes.
DIAL ASYNCHRONOUS A type of network wherein remote computers access a host
computer through dial telephone lines and the clocks need not be synchronous.
DIGITAL SIGNATURE A mechanism that allows the recipient of information stored in
digital form to prove that the information originated from the claimed source.
DIGITAL SIGNATURE STANDARD A U.S. Government standard for digital signatures
using the Digital Signature Algorithm, proposed by NIST.
ENCRYPT, ENCRYPTION TECHNOLOGY The protection of data employing cryptographic
procedures to convert it to a form that is unintelligible until it is converted
back to its original form.
FIREWALL Hardware or software devices which screen data traffic at Internet
access points in order to assure that only authorized data and users can reach
computers that are connected to the network.
FRAME RELAY A data communication technology that is used to provide higher speed
for Internet connections. Its usual application is in connecting work groups
rather than individuals.
HDLC High Level Data Link Control. A well-known family of data link layer
protocols defined by the International Standards Organization.
INTERNET A global collection of interconnected computer networks which use
TCP/IP, a common communications protocol.
INTRANET A network within an organization which provides similar services to the
Internet but is not necessarily connected to it.
ISDN A collection of telecommunications protocols and standards for high-speed,
error-minimized, digital data and voice transmission at speeds up to 128 Kbps
worldwide.
KEY, CRYPTOGRAPHIC KEY A sequence of letters/numbers/bits which is used by a
cryptographic algorithm to transform data from plaintext to ciphertext or vice
versa. DES uses a key which is 56 bits long.
KEY MANAGEMENT SYSTEM OR CENTER The physical place or workstation running
specialized programs that are responsible for generating, disseminating,
distributing, changing, replacing, storing, checking, and destroying
cryptographic keys.
12
<PAGE> 13
LAN Local-Area Network. An interconnected set of systems and devices--such as
PCs, mainframes, workstations, minicomputers, file servers, terminals,
printers, and other communications and computing devices--within a localized
environment.
LINK ENCRYPTION The use of encryption at the beginning, and decryption at the
end, of each link in a communications chain.
MESSAGE AUTHENTICATION A system in which a cryptographic checksum/checkfunction
is created for a message, and the result added to the message. The recipient
performs the same procedure on the message and compares the computed result to
that appended to the original message to verify that it is complete and has not
been modified in any way.
PACKET A collection of data and control characters in a specified format that
are transferred as a whole.
PRIVATE KEY One of the two keys in a public-key cryptographic system--normally
the key used for decryption--which is kept secret.
PROTOCOL A set of rules and conventions for communications, especially those in
a network, that include specifications of syntax, semantics, and timing.
PUBLIC KEY One of the two keys in a public-key cryptographic system, normally
made public or distributed to others for their use in encrypting messages to a
particular recipient.
PUBLIC-KEY CRYPTOGRAPHY A cryptographic system employing separate keys for
encryption and decryption. One of the keys can be made public, thus enabling a
message to be encrypted for transmission to a particular recipient, preserving
its confidentiality because no one without the private key can decipher the
message.
SDLC Synchronous Data Link Control. A bit-oriented IBM version of HDLC protocol,
as used in IBM's Systems Network Architecture.
SMARTCARD A plastic card resembling a credit card containing one or more
computer chips and logic for identification, special-purpose processing, and
data storage and distribution.
SYNCHRONOUS DATA Transmission that takes place with predictable, exact departure
or arrival times regulated by clocking data.
TCP/IP Transmission Control Protocol/Internet Protocol. A suite of network
protocols that allow computers with different architectures and operating
system software to communicate with other computers on the Internet.
USER AUTHENTICATION Generally, a means of verifying the claimed identity of an
individual computer user or terminal so as to properly determine what access
rights are to be given.
VPN Virtual Private Network. A virtual network created by using encryption to
create a secure "tunnel" through a public network, thereby allowing companies
to use the lowest cost network infrastructure for their business
communications.
X.25 A widely used protocol standard for telecommunications between a computer
and a packet-switched data network; it encompasses layers 2 and 3 of the OSI
model.
13
<PAGE> 14
ITEM 2 - PROPERTIES
The Company maintains its corporate and administrative facilities at 8029
Corporate Drive, Baltimore, Maryland. The building, constructed in 1988, has
approximately 25,000 square feet and is also used for the Company's executive
headquarters, United States production and SafeNet Trusted Services facilities.
The lease, which expires in June 2003, requires the Company to pay real estate
taxes, insurance and maintenance. The lease, which provides for annual increases
in rentals during each year of the lease, requires the Company to pay
approximately $170,000 in 1998.
GDS leases approximately 20,000 square feet for its administrative and
production facilities in Regensdorf, Switzerland. The lease, which expires on
December 31, 2002, calls for an annual rental of approximately $268,000.
The Company also leases office space in Danvers, Massachusetts, Bethesda,
Maryland, Princeton, New Jersey, and Dallas, Texas.
ITEM 3 - LEGAL PROCEEDINGS
The Company knows of no litigation or proceeding, pending or threatened, to
which the Company is or may become a party.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to the vote of Security Holders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year covered by this report.
PART II
ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED MATTERS
The following table sets forth the range of high and low sales prices for
the Company's Common Stock, as reported by the Nasdaq National Market under the
symbol IREG.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1998:
First Quarter (through March 20, 1998) $7.38 $5.88
1997:
Fourth Quarter 11.38 6.00
Third Quarter 15.75 10.63
Second Quarter 14.50 6.25
First Quarter 10.75 6.88
1996:
Fourth Quarter 20.25 8.75
Third Quarter 24.75 10.50
Second Quarter 29.50 17.75
First Quarter 25.50 16.00
</TABLE>
14
<PAGE> 15
On March 20, 1998, the last reported sale price of the Company's Common
Stock was $7.25, as reported by the Nasdaq National Market. As of that date,
there were approximately 198 holders of record of the Common Stock and 4,000
beneficial holders of the Common Stock. The Company has not paid dividends on
its Common Stock and intends for the foreseeable future to retain earnings, if
any, to finance the expansion and development of its business.
ITEM 6 - SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for each of the five-years
ended December 31, 1997 are derived from the Consolidated Financial Statements
of the Company, which financial statements have been audited by KPMG Peat
Marwick LLP. The Consolidated Financial Statements as of December 31, 1996 and
1997 and for each of the years in the three year period ended December 31,
1997 are included elsewhere herein. The selected financial data is qualified by
and should be read in conjunction with the Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein.
<TABLE>
<CAPTION>
Year ended December 31,
------------- ------------- ------------- ------------ ------------
1993 1994 1995 1996 1997
------------- ------------- ------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues $ 2,631 $ 3,424 $ 8,149 $ 14,317 $ 16,007
Cost of Revenues 871 1,233 3,318 7,672 6,971
------------- ------------- ------------- ------------ ------------
Gross Profit 1,760 2,191 4,831 6,645 9,036
Operating expenses
Research and development expenses 627 906 1,299 3,840 3,756
Sales and marketing expenses 665 1,083 1,979 4,692 6,720
General and administrative expenses 541 705 1,331 2,976 2,570
Amortization of acquired intangible assets - 410 631 733 122
Write-off of unamortized acquired intangible
assets from the Connective Strategies,
Inc. acquisition - - - 2,216 -
------------- ------------- ------------- ------------ ------------
Operating loss (73) (913) (409) (7,812) (4,132)
Interest income (expense), net 117 24 (96) 728 494
------------- ------------- ------------- ------------ ------------
Earnings (loss) before income taxes 44 (889) (505) (7,084) (3,638)
Income tax expense (benefit) (15) (173) 190 - -
------------- ------------- ------------- ------------ ------------
Net earnings (loss) 59 (716) (695) (7,084) (3,638)
Preferred stock dividends 128 85 82 - -
------------- ------------- ------------- ------------ ------------
Net loss attributable to
common stock $ (69) $ (801) $ (777) $ (7,084) $ (3,638)
============= ============= ============= ============ ============
Loss per common share-basic and diluted $ (0.02) $ (0.25) $ (0.20) $ (1.34) $ (0.67)
============= ============= ============= ============ ============
</TABLE>
15
<PAGE> 16
<TABLE>
<CAPTION>
Year ended December 31,
------------ ------------ ------------ ------------ ------------
1993 1994 1995 1996 1997
------------ ------------ ------------ ------------ ------------
<C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working Capital $ 3,536 $ 671 $ 2,186 $16,664 $12,499
Intangible Assets 384 3,974 4,927 3,223 3,503
Total Assets 4,812 7,724 15,472 24,653 21,531
Long-term debt - 116 47 17 -
Stockholders' equity 4,236 5,405 8,216 21,861 17,980
</TABLE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information contained herein, the statements in this
Item are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others, risks
associated with the receipt and timing of future customer orders, price
pressures, other competitive factors leading to a decrease in anticipated
revenues, achieving technical and product development milestones, the ability to
manufacture product in a timely manner to meet market demand, market acceptance
of products, the ability to negotiate favorable purchase and sale agreements,
and sufficient cash flow for future liquidity and capital resource needs. Gross
margins can vary from quarter to quarter based on product and channel mix, and
current gross margin levels may not be indicative of future results.
The Company's historical and prospective operating results have been and
are expected to continue to be dependent on a variety of factors including, but
not limited to, the length of the sales cycle, the timing of orders from and
shipments to clients, product development expenses and the timing of development
and introduction of new products. The Company's expense levels are based, in
part, on expectations of future revenues. The size and timing of the Company's
historical revenues have varied substantially from quarter to quarter and year
to year. Accordingly, the results of a particular period, or period to period
comparisons of recorded sales and profits may not be indicative of future
operating results.
These factors, among others, could cause results to differ materially from
those in the forward looking statements.
OVERVIEW
The Company designs, manufactures and markets enterprise network security
solutions using encryption technology. The Company's products are used in
electronic commerce applications by financial institutions, government agencies
and large corporations to secure data transmissions on private and public
computer networks, such as the Internet. In order to expand its product
offerings, the Company acquired GDS in October 1995. GDS designs, manufactures
and markets cryptographic equipment primarily in Switzerland and Europe.
While Management is committed to the long-term profitability of the
Company, the recent growth of the computer security industry has made it
important that market share be obtained. The Company has undertaken various
strategies in order to increase its revenues and improve its future operating
results, including the GDS
16
<PAGE> 17
acquisition and new product offerings such as its SafeNet/Enterprise(TM)
products for the Internet and the SafeNet/Security Center(TM), a high
performance workstation which automatically manages SafeNet/Enterprise(TM)
products. Management believes that growth in the market for products that
provide secure remote access to computer networks requires the Company to
increase its investment in development, sales and marketing activities to allow
the Company to take advantage of this market opportunity and to achieve
long-term profitability thereby maximizing shareholder value. However, there can
be no assurance that these strategies will be successful.
RESULTS OF OPERATIONS OF THE COMPANY
The following table sets forth certain Consolidated Statement of Operations data
of the Company as a percentage of revenues for the years ended December 31:
<TABLE>
<CAPTION>
1995 1996 1997
------------ ------------- -------------
<S> <C> <C> <C>
Revenues ................................................ 100 % 100 % 100 %
Cost of Revenues ........................................ 41 54 44
------------ ------------- -------------
Gross profit ..................................... 59 46 56
Operating Expenses
Research and development expenses ....................... 16 27 23
Sales and marketing expenses ............................ 25 32 43
General and administrative expenses ..................... 16 21 16
Amortization of acquired intangible assets .............. 7 5 1
Write-off of unamortized acquired intangible assets .....
from the CSI acquisition ......................... - 15 -
------------ ------------- -------------
Operating loss ................................... (5) (54) (27)
Interest income (expense), net .......................... (1) 5 3
------------ ------------- -------------
Loss before income tax expense ................... (6) (49) (24)
Income tax expense ...................................... 2 - -
============ ============= =============
Net loss ................................................ (8) % (49) % (24)%
============ ============= =============
</TABLE>
Year ended December 31, 1997, Compared to Year ended December 31, 1996
Revenues increased 12%, or $1.7 million, to $16.0 million for the year
ended December 31, 1997, from $14.3 million in 1996. During 1997, the Company
was able to generate revenues from new and existing clients that more than
offset the loss of revenue due to the termination of the product agreement with
MCI Telecommunications Corporation ("MCI"), and lower revenues from GDS. The
revenue increase in 1997 was primarily a result of the increased level of
product development services provided by the engineering group in Danvers, MA.
Gross margin increased to 56% for the year ended December 31, 1997, from
46% for 1996. During 1996, the Company realized a lower gross margin on the
SafeNet dial access products sold to MCI. In 1997, the shift towards sales of
higher gross margin products, the decrease in sales of low margin products to
MCI, and the shift in the product mix towards software-based products,
contributed to the increased margin.
Sales and marketing expenses accounted for more than the entire increase in
expenses, with a total of $6.7 million in 1997 compared to $4.7 million in 1996,
an increase of $2.0 million, or 43%. The increase in sales and marketing expense
was primarily a result of increased spending on personnel, mostly in the North
American territory, and increased focus on marketing efforts.
17
<PAGE> 18
Research and development expenses were at the same level in 1997 compared
to 1996, with expenses totaling approximately $3.8 million.
General and administrative expense decreased by 14% to $2.6 million in
1997, compared to $3.0 million in 1996 which included start up expenses
associated with SafeNet Trusted Services facility.
The Company had a net operating loss of $4.1 million for the year ended
December 31, 1997, compared to $7.8 million in 1996. The 1996 operating loss
includes charges for amortization of acquired intangible assets from the
acquisitions of CSI and GDS of approximately $0.7 million. The 1996 loss also
includes a one-time charge of $2.2 million for the write-off of unamortized
acquired intangible assets from the Connective Strategies, Inc. acquisition.
Net interest income totaled $0.5 million in 1997, compared to $0.7 million
in 1996, due to the lower level of investable funds.
The Company had a net loss of $3.6 million for the year ended December 31,
1997, compared to a net loss of $7.1 million in 1996. The loss per common share
- - basic and diluted, was $0.67 for the year ended December 31, 1997, compared to
a loss of $1.34 per share in 1996.
Year ended December 31, 1996, Compared to Year ended December 31, 1995
Revenues increased 76%, or $6.2 million, to $14.3 million for the year
ended December 31, 1996, from $8.1 million in 1995. Of the increase, $2.2
million is attributable to network security systems and products, mainly the
SafeNet/Dial(TM) products. The remainder of the increase, $3.9 million, is
attributable to the inclusion of GDS revenues for twelve months in 1996 but only
for two months in 1995. Revenues for 1995 on a pro forma basis, which includes
GDS, were $13.2 million.
The Company concluded discussions with MCI in the fourth quarter of
1996 to terminate a previous product agreement under which MCI was obligated to
purchase $7.0 million of SafeNet/ Enterprise(TM) products during the twelve
month period ending September 30, 1997. As a result, the Company experienced
only a nominal increase in network security systems and products when the
revenues for the last six months of 1996 are compared to revenues for the same
period in 1995 and revenues from MCI are removed from both periods.
Gross margin decreased to 46% for the year ended December 31, 1996,
from 59% in 1995. On a pro forma basis, which includes GDS, the gross margin was
61% in 1995. The decrease was caused by higher costs associated with the
production of SafeNet/Dial(TM) products, changes in the GDS product mix and a
favorable profit margin on a large purchase order in 1995. The Company realized
a lower gross profit on the SafeNet/Dial(TM) products sold to MCI in 1996 in
order to obtain market share.
Research and development expenses increased 196%, or $2.5 million, to
$3.8 million for the year ended December 31, 1996, from $1.3 million for 1995.
The inclusion of GDS for the entire year in 1996 accounted for $1.4 million of
the increase. The remainder of the increase was primarily due to higher
personnel related costs associated with the expansion of the engineering staff.
Sales and marketing expenses increased by 138%, or $2.7 million, to
$4.7 million for the year ended December 31, 1996, from $2.0 million in 1995.
The inclusion of GDS for the entire year accounted for $1.1 million of the
increase. The remainder of the increase was primarily due to higher personnel
related costs associated with the expansion of the sales and marketing staffs
and from increased sales and marketing activities.
General and administrative expenses increased by 124%, or $1.6 million,
to $3.0 million for the year ended December 31, 1996, from $1.3 million in 1995.
The inclusion of GDS for the entire year accounted for $0.5 million of the
increase. The remainder of the increase was primarily due to start-up costs
associated with the Safe/Net Trusted Services facility and the establishment of
a management information function.
18
<PAGE> 19
The Company had an operating loss of $7.8 million for the year ended
December 31, 1996, compared to $0.4 in 1995. The 1996 operating loss includes
charges for amortization of acquired intangible assets from the acquisitions of
Connective Strategies, Inc. ("CSI") and GDS of $0.7 million, compared to $0.6
million in 1995. The 1996 loss also includes a one-time charge of $2.2 million
for the write-off of unamortized acquired intangible from the CSI acquisition.
Net interest income for the year ended December 31, 1996 was $0.7
million compared to net interest expense of $0.1 million for 1995. The increase
resulted from the temporary investment of surplus cash that resulted mainly from
the Company's public offering of common stock in 1996.
The Company had no income tax expense for the year ended December 31,
1996, compared to $0.2 million for 1995. A valuation allowance has been
established since the Company's ability to fully use the net operating loss is
dependent upon future taxable income.
The Company had a net loss of $7.1 million for the year ended December
31, 1996 compared to a net loss of $0.7 million in 1995. The loss per common
share was $1.34 for the year ended December 31, 1996, of which $0.42 is due to
the one-time charge, compared to a net loss of $0.20 per common share in 1995.
On a pro forma basis, which includes GDS, the net loss per common share was
$0.30 in 1995
LIQUIDITY AND FINANCIAL POSITION OF THE COMPANY
The Company believes that its current cash resources, together with the
cash flows from operations, will be sufficient to meet its needs for its 1998
fiscal year. As of December 31, 1997, the Company had cash and short-term
investments of $9.6 million, and working capital of $12.5 million.
Significant uses of the Company's financial resources in 1997 include $3.5
million in operating activities, and $1.0 million in investing activities.
Accounts receivable increased $1.7 million in the year, primarily a result of a
large volume of shipments at the end of the fourth quarter. Inventories
decreased by approximately $629,000.
In August 1996, the Company signed a two year Joint Development and
Marketing Agreement with CyberGuard. The companies have developed and intend to
market a product that combines the Company's SafeNet/Enterprise(TM) products and
CyberGuard's Firewall product. In connection therewith, the Company has prepaid
a refundable $1.0 million license fee to CyberGuard. As of December 31, 1997,
the Company has utilized $27,500 in credits against the prepaid license fee. The
agreement provides that in the event that it is terminated prior to such credit
aggregating $1.0 million, then Cyberguard shall repay to the Company the balance
of the $1.0 million prepaid license fee within one year of the termination with
interest at the prime rate.
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. It does not, however, specify when to
recognize or how to measure items that make up comprehensive income.
SFAS No. 130 is effective for both interim and annual periods beginning
December 15, 1997. Earlier application is permitted. Comparative financial
statements provided for earlier periods are required to be reclassified to
reflect the provisions of this statement.
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to report
selected information about operating segments in interim financial statements
issued to shareholders.
SFAS No. 131 is effective for financial statements for periods beginning
after December 15, 1997. Management intends to adopt its provisions during 1998.
19
<PAGE> 20
Management has initiated a program to prepare the Company's computer
systems and applications for the year 2000. The Company expects to incur
internal staff costs as well as other expenses related to infrastructure and
facilities enhancements necessary to prepare the systems for the year 2000. A
significant proportion of these costs are not likely to be incremental costs to
the Company, but rather will represent the redeployment of existing information
technology resourses. The costs incurred to date and future costs are not
expected to be material to the financial statements.
INFLATION AND SEASONALITY
The Company does not anticipate that inflation will significantly impact
its business. The Company does not believe its business is seasonal, however,
because the Company recognizes revenues upon shipment of finished products, such
recognition may be irregular and uneven, thereby disparately impacting quarterly
operating results and balance sheet comparisons.
20
<PAGE> 21
ITEM 8 - FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report 22
Consolidated Balance Sheets as of December 31, 1996 and 1997 23
Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 24
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 25
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 26
Notes to Consolidated Financial Statements 28
</TABLE>
21
<PAGE> 22
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Information Resource Engineering, Inc.:
We have audited the accompanying consolidated balance sheets of Information
Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Information
Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1997 in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Baltimore, Maryland
March 13, 1998
22
<PAGE> 23
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1996 and 1997
<TABLE>
<CAPTION>
=======================================================================================================================
1996 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11,916,991 7,222,069
Short-term investments 2,311,980 2,339,408
Accounts receivable, net of allowance for doubtful
accounts of $60,276 for 1997 (note 4) 1,564,381 3,216,542
Inventories (note 5) 3,543,995 2,915,331
Prepaid expenses 101,843 356,735
- -----------------------------------------------------------------------------------------------------------------------
Total current assets 19,439,190 16,050,085
Equipment and leasehold improvements, net (notes 6 and 8) 1,842,725 1,575,777
Computer software development costs, net of accumulated
amortization of $336,525 and $498,430 1,142,352 1,407,076
Goodwill, net of accumulated amortization of $142,662 and $264,986 1,080,568 958,244
Prepaid license fees (note 14) 1,000,000 1,137,500
Other assets 148,406 402,337
- -----------------------------------------------------------------------------------------------------------------------
$ 24,653,241 21,531,019
=======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 8) $ 18,480 16,710
Accounts payable 1,288,929 1,034,667
Accrued expenses (note 7) 1,317,389 1,736,963
Deferred revenue 150,498 762,579
- -----------------------------------------------------------------------------------------------------------------------
Total current liabilities 2,775,296 3,550,919
Long-term debt, less current maturities (note 8) 16,710 -
- -----------------------------------------------------------------------------------------------------------------------
Total liabilities 2,792,006 3,550,919
- -----------------------------------------------------------------------------------------------------------------------
Stockholders' equity (notes 9 and 13):
Preferred stock, $.01 par value per share. Authorized 500,000 shares - -
Common stock, $.01 par value per share. Authorized 15,000,000 shares, issued
and outstanding 5,458,127 shares in 1996 and 5,462,727 shares in 1997 54,581 54,627
Additional paid-in capital 30,917,584 30,929,277
Deficit (8,597,003) (12,234,705)
Cumulative foreign currency translation adjustment (513,927) (769,099)
- -----------------------------------------------------------------------------------------------------------------------
Net stockholders' equity 21,861,235 17,980,100
Commitments (notes 11 and 14) -
- -----------------------------------------------------------------------------------------------------------------------
$ 24,653,241 21,531,019
=======================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE> 24
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
=============================================================================================================
1995 1996 1997
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues (note 4) $ 8,149,224 14,317,423 16,006,998
Cost of revenues 3,318,605 7,671,957 6,971,144
- -------------------------------------------------------------------------------------------------------------
Gross profit 4,830,619 6,645,466 9,035,854
Research and development expenses 1,298,808 3,840,475 3,755,766
Sales and marketing expenses 1,979,356 4,692,556 6,720,075
General and administrative expenses 1,331,194 2,976,273 2,570,200
Amortization of acquired intangible assets (note 3) 630,658 732,644 122,324
Write-off of unamortized acquired intangible assets from
the Connective Strategies, Inc. acquisition - 2,216,200 -
- -------------------------------------------------------------------------------------------------------------
Operating loss (409,397) (7,812,682) (4,132,511)
Interest income (expense), net (95,854) 728,132 494,809
- -------------------------------------------------------------------------------------------------------------
Loss before income tax expense (505,251) (7,084,550) (3,637,702)
Income tax expense (note 10) 190,000 - -
- -------------------------------------------------------------------------------------------------------------
Net loss (695,251) (7,084,550) (3,637,702)
Preferred stock dividends (82,270) - -
- -------------------------------------------------------------------------------------------------------------
Net loss attributable to common stockholders $ (777,521) (7,084,550) (3,637,702)
=============================================================================================================
Loss per common share - basic and diluted $ (.20) (1.34) (.67)
=============================================================================================================
Weighted average number of common shares outstanding 3,826,831 5,304,984 5,461,611
=============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE> 25
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
===============================================================================================================================
9% Convertible 9% Convertible
redeemable cumulative redeemable cumulative
preferred stock preferred stock
--------------------------- -------------------------
Shares Amount Shares Amount
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 75,086 $ 751 65 $ 1
Sale of common stock, net of offering expenses - - - -
Stock options exercised - - - -
Conversion of preferred stock (74,586) (746) (65) (1)
Redemption of preferred stock (500) (5) - -
Issuance of common stock upon exercise of warrants,
net of registration expense - - - -
Preferred stock dividends declared - - - -
Net loss for 1995 - - - -
Foreign currency translation adjustment - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 - - - -
Sale of common stock, net of offering expenses - - - -
Stock options exercised - - - -
Net loss for 1996 - - - -
Foreign currency translation adjustment - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 - - - -
Stock options exercised - - - -
Net loss for 1997 - - - -
Foreign currency translation adjustment - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 - $ - - $ -
===============================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
==============================================================================================================================
Common stock Additional
--------------------------- paid-in
Shares Amount capital Deficit
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 3,638,063 $ 36,380 6,103,099 (734,932)
Sale of common stock, net of offering expenses 300,000 3,000 3,331,036 -
Stock options exercised 300 3 1,478 -
Conversion of preferred stock 240,464 2,405 (1,924) -
Redemption of preferred stock - - (5,495) -
Issuance of common stock upon exercise of warrants,
net of registration expense 66,000 660 284,583 -
Preferred stock dividends declared - - - (82,270)
Net loss for 1995 - - - (695,251)
Foreign currency translation adjustment - - - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 4,244,827 42,448 9,712,777 (1,512,453)
Sale of common stock, net of offering expenses 1,172,500 11,725 21,023,046 -
Stock options exercised 40,800 408 181,761 -
Net loss for 1996 - - - (7,084,550)
Foreign currency translation adjustment - - - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 5,458,127 54,581 30,917,584 (8,597,003)
Stock options exercised 4,600 46 11,693 -
Net loss for 1997 - - - (3,637,702)
Foreign currency translation adjustment - - - -
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 5,462,727 $ 54,627 30,929,277 (12,234,705)
===============================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
==================================================================================================
Cumulative
foreign currency Net
translation stockholders'
adjustment equity
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at December 31, 1994 - 5,405,299
Sale of common stock, net of offering expenses - 3,334,036
Stock options exercised - 1,481
Conversion of preferred stock - (266)
Redemption of preferred stock - (5,500)
Issuance of common stock upon exercise of warrants,
net of registration expense - 285,243
Preferred stock dividends declared - (82,270)
Net loss for 1995 - (695,251)
Foreign currency translation adjustment (26,310) (26,310)
- --------------------------------------------------------------------------------------------------
Balance at December 31, 1995 (26,310) 8,216,462
Sale of common stock, net of offering expenses - 21,034,771
Stock options exercised - 182,169
Net loss for 1996 - (7,084,550)
Foreign currency translation adjustment (487,617) (487,617)
- --------------------------------------------------------------------------------------------------
Balance at December 31, 1996 (513,927) 21,861,235
Stock options exercised - 11,739
Net loss for 1997 - (3,637,702)
Foreign currency translation adjustment (255,172) (255,172)
- --------------------------------------------------------------------------------------------------
Balance at December 31, 1997 (769,099) 17,980,100
==================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE> 26
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
===================================================================================================================
1995 1996 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (695,251) (7,084,550) (3,637,702)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization 515,647 659,792 840,499
Amortization of acquired intangible assets 630,658 732,644 122,324
Write-off of unamortized acquired intangible assets
from the Connective Strategies, Inc. acquisition - 2,216,200 -
Deferred income taxes 215,300 - -
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable (2,040,764) 2,608,430 (1,707,438)
Decrease in costs and estimated earnings in
excess of billing on uncompleted contracts 248,700 - -
(Increase) decrease in inventories 677,587 (1,425,750) 511,506
Decrease in recoverable income taxes 184,872 32,369 -
Increase (decrease) in accounts payable 136,106 (53,635) (208,882)
Increase (decrease) in accrued expenses 384,301 (112,880) 468,364
Decrease in billings in excess of costs and
estimated earnings on uncompleted contracts (199,225) - -
Increase (decrease) in deferred revenue 64,759 (41,290) 616,561
Other 45,152 (137,878) (549,383)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 167,842 (2,606,548) (3,544,151)
- -------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Acquisition of GRETACODER Data Systems AG,
net of cash acquired of $131,798 (439,602) - -
Maturities of short-term investments 399,409 - 7,054,000
Purchase of short-term investments (902) (2,311,980) (7,081,428)
Equipment expenditures (154,862) (1,274,770) (307,258)
Additions to computer software development costs (538,200) (440,568) (506,042)
Prepaid license fees - (1,000,000) (137,500)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities $ (734,157) (5,027,318) (978,228)
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
(Continued)
26
<PAGE> 27
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
====================================================================================================
1995 1996 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from notes payable $ 589,000 -
Payments of notes payable (1,081,351) (4,053,416) -
Proceeds from issuance of common stock, net of
offering expense 3,619,279 21,034,771 -
Redemption of preferred stock (5,766) - -
Payment of preferred stock dividends (127,118) - -
Payments of long-term debt (67,345) (80,979) (18,480)
Stock options exercised 1,481 182,169 11,739
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in ) financing activities 2,928,180 17,082,545 (6,741)
- ----------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 3,266 (188,182) (165,802)
- ----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 2,365,131 9,260,497 (4,694,922)
Cash and cash equivalents at beginning of year 291,363 2,656,494 11,916,991
- ----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 2,656,494 11,916,991 7,222,069
====================================================================================================
Cash paid for:
Interest expense $ 66,481 159,509 11,520
====================================================================================================
Income taxes $ 800 - -
====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE> 28
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years ended December 31, 1996 and 1997
================================================================================
(1) BUSINESS
Information Resource Engineering, Inc. (the Company) is engaged in the
business of designing, manufacturing and marketing a line of products
which secure data transmissions on computer networks through the use of
encryption technology.
During 1994, the Company acquired Connective Strategies, Inc. (CSI), which
designs, manufactures and markets communications equipment enabling data
and voice connectivity via the Integrated Services Digital Network (ISDN).
In 1996, the Company invested in the development of a new secure
communications chip. Due to this new superseding technology, which does
not utilize CSI's ISDN product, the Company no longer markets its CSI
products to new customers. Consequently, the Company has taken a one-time
charge in 1996 of $2,216,200 related to the write-off of the unamortized
acquired intangible assets from this acquisition. Future CSI ISDN product
sales are not expected to be significant since the products will only be
sold pursuant to commitments to existing customers.
On October 31, 1995, the Company acquired all of the issued and
outstanding stock of GRETACODER Data Systems AG (formerly Gretag Data
Systems AG) (GDS), a company which designs, manufactures and markets
cryptographic equipment. Results of operations for GDS are included in the
accompanying consolidated statement of operations for the period after
October 31, 1995.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances
have been eliminated in consolidation.
CASH EQUIVALENTS
The Company considers investments purchased with maturities, at date of
purchase, of three months or less to be cash equivalents.
SHORT-TERM INVESTMENTS
Short-term investments, which consist of commercial paper and corporate
bonds which mature within one year, are stated at the lower of cost or
market.
(Continued)
28
<PAGE> 29
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) CONTINUED
REVENUES
Revenue is recognized from sales when the product is shipped. Unearned
income on maintenance contracts is amortized by the straight-line method
over the terms of the contracts. Revenues from engineering services are
recognized as the services are provided. There was no material accounts
receivable related to unbilled engineering services at December 31, 1996
and 1997.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
by the first-in, first-out method.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost less accumulated
depreciation. Depreciation of equipment is determined using the
straight-line method over the estimated useful life of five years.
Leasehold improvements are amortized over the life of the lease.
COMPUTER SOFTWARE DEVELOPMENT COSTS
Computer software development costs are capitalized subsequent to the
establishment of technological feasibility for each software product which
is evidenced by a detailed program design. Capitalization of costs ceases
when the product is available for general release to customers. Such costs
are amortized using the straight-line method over a three to five year
period beginning on product release dates. The Company assesses the
recoverability of this intangible asset by comparing the unamortized
balance to the net realizable value.
GOODWILL
The excess of acquisition costs over the fair value of net assets acquired
is amortized on a straight-line basis over ten years. The Company assesses
the recoverability of this intangible asset by determining whether the
amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows.
(Continued)
29
<PAGE> 30
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) CONTINUED
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996.
This Statement requires that long-lived assets and certain identifiable
intangibles be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of assets exceed the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount
or fair value less costs to sell.
PRODUCT WARRANTIES
The Company warrants to the original purchaser that each of its products
will be free from defects in materials and workmanship generally for a
period of one year from the date of purchase. Expected future product
warranty expense is recorded when the product is sold.
TRANSLATION OF FOREIGN CURRENCIES
Assets and liabilities of the foreign subsidiary are translated at the
exchange rates as of the balance sheet dates; equity accounts are
translated at historical exchange rates. Revenues and expenses are
translated at the average exchange rates for the periods presented.
Translation gains and losses are included in stockholders' equity.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
STOCK OPTIONS
On January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, and has
elected to continue to
(Continued)
30
<PAGE> 31
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) CONTINUED
apply the intrinsic value method under Accounting Principles Board (APB)
No. 25, Accounting for Stock Issued to Employees to account for
stock-based employee compensation. Under this method, compensation cost is
recognized for awards of shares of common stock to employees under
compensatory plans only if the quoted market price of the stock at the
grant date (or other measurement date, if later) is greater than the
amount the employee must pay to acquire the stock. SFAS No. 123 permits
companies to adopt a new fair value based method to account for
stock-based employee compensation plans or to continue using the intrinsic
value method. If the intrinsic value method is used, information
concerning the pro forma effects on net earnings and earnings per share of
adopting the fair value based method for stock-based employee compensation
grants made in 1995 and subsequent years is required to be presented in
the notes to the financial statements. The pro forma disclosures are
presented in note 13 to the consolidated financial statements.
LOSS PER COMMON SHARE
The Company adopted SFAS No. 128, Earnings Per Share, during the year
ended December 31, 1997. Statement 128 establishes revised standards for
computing and presenting earnings per share (EPS) data. It requires dual
presentation of "basic" and "diluted" EPS on the face of the statements of
income and reconciliation of the numerators and denominators used in the
basic and diluted EPS calculations. As required by SFAS No. 128, EPS data
for prior periods presented have been restated to conform to the new
standard.
(Continued)
31
<PAGE> 32
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) CONTINUED
Basic EPS is calculated by dividing net loss by the weighted-average
number of common shares outstanding for the applicable period. Diluted EPS
is calculated after adjusting the numerator and the denominator of the
basic EPS calculation for the effect of all dilutive potential common
shares outstanding during the period. Information related to the
calculation of net loss per share of common stock is summarized as follows
for the years ended December 31:
<TABLE>
<CAPTION>
1995 1996 1997
---------------------- ---------------------- -----------------------
Basic Diluted Basic Diluted Basic Diluted
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net loss $ (695,251) (695,251) (7,084,550) (7,084,550) (3,637,702) (3,637,702)
Accrued dividends
on preferred stock (82,270) (82,270) - - - -
- -------------------------------------------------------------------------------------------------------
Net loss
attributable
to common
stockholders $ (777,521) (777,521) (7,084,550) (7,084,550) (3,637,702) (3,637,702)
- -------------------------------------------------------------------------------------------------------
Weighted-average
shares
outstanding 3,826,831 3,826,831 5,304,984 5,304,984 5,461,611 5,461,611
Dilutive securities
options - - - - - -
- -------------------------------------------------------------------------------------------------------
Adjusted weighted-
average shares
used in EPS
computation 3,826,831 3,826,831 5,304,984 5,304,984 5,461,611 5,461,611
- -------------------------------------------------------------------------------------------------------
</TABLE>
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. It does
not, however, specify when to recognize or how to measure items that make
up comprehensive income.
SFAS No. 130 is effective for both interim and annual periods beginning
after December 15, 1997. Earlier application is permitted. Comparative
financial statements provided for earlier periods are required to be
reclassified to reflect the provisions of this statement.
(Continued)
32
<PAGE> 33
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(2) CONTINUED
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards
for the way public business enterprises are to report information about
operating segments in annual financial statements and requires those
enterprises to report selected information about operating segments in
interim financial reports issued to shareholders.
SFAS No. 131 is effective for financial statements for periods beginning
after December 15, 1997. Management intends to adopt its provision during
1998.
USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
that affect the reported amounts of assets and liabilities as of the date
of the balance sheet and revenues and expenses for the period to prepare
these financial statements in conformity with generally accepted
accounting principles. Actual results could differ significantly from
those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments:
The carrying value of cash and cash equivalents, short-term investments,
accounts receivable, accounts payable and accrued expenses approximates
fair value due to the short maturity of these instruments.
The Company evaluates the fair value of fixed-rate debt based upon rates
currently available for similar types of borrowing arrangements. The book
value approximates fair value of these instruments.
SUPPLEMENTARY STATEMENT OF CASH FLOWS INFORMATION
As described in note 3, during 1995 the Company purchased GDS for cash and
the issuance of two promissory notes aggregating $3,853,416.
RECLASSIFICATIONS
Certain amounts for 1995 and 1996 have been reclassified to conform to the
1997 presentation.
(Continued)
33
<PAGE> 34
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(3) ACQUISITIONS
GRETACODER DATA SYSTEMS AG
On October 31, 1995, the Company acquired all of the issued and
outstanding stock of GDS. The Stock Purchase Agreement provided for an
initial cash payment of $431,850 and two promissory notes aggregating
$3,853,416. Such amount is net of a $400,000 payment discount that the
Company received upon payment of the notes in February 1996. This
transaction effectively transferred all ownership of GDS to the Company
and was accounted for under the purchase accounting method.
The aggregate net purchase price for GDS was determined as follows:
<TABLE>
<S> <C>
Cash purchase price $ 431,850
Notes payable 3,853,416
Transaction costs 139,550
- -----------------------------------------------------------------
Net purchase price $ 4,424,816
=================================================================
</TABLE>
The net purchase price was allocated to the acquired tangible and
intangible net assets based upon the relative fair values as follows:
<TABLE>
<S> <C>
Cash $ 131,798
Inventory 2,346,416
Other current assets 1,484,883
Equipment and leasehold improvements 412,986
Deferred tax assets 194,000
Current liabilities (1,368,497)
Goodwill 1,223,230
- -----------------------------------------------------------------
Net purchase price $ 4,424,816
=================================================================
</TABLE>
The Company allocated $474,000 of the purchase price to inventory in
excess of the carrying cost of GDS. Of this amount, $238,000 and $236,000
was charged to cost of revenues in 1995 and 1996, respectively.
(4) REVENUES AND ACCOUNTS RECEIVABLE
During the three years ended December 31, 1997, revenues from two
commercial clients accounted for greater than 10% of annual revenues as
follows: one client accounted for 13% of 1995 revenues and 27% of 1996
revenues and one client accounted for 15% of 1997 revenues. During the
three years ended December 31, 1997, revenues from non-U.S. clients were
34%, 47% and 44%, respectively. The majority of these revenues were
derived from European distributors and financial institutions.
(Continued)
34
<PAGE> 35
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(4) CONTINUED
The Company grants credit to clients. Sales terms with clients, including
distributors, generally do not provide for right of return privileges for
credit, refund or other products. The Company's clients, which include
both commercial companies and governmental agencies, are in various
industries, including banking, security, communications and distributors
of electronic products.
(5) INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
1996 1997
- -------------------------------------------------------------------------
<S> <C> <C>
Raw materials $ 1,451,142 1,208,439
Finished goods 2,092,853 1,706,892
- -------------------------------------------------------------------------
$ 3,543,995 2,915,331
=========================================================================
</TABLE>
(6) EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET
Equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
1996 1997
- ----------------------------------------------------------------------------
<S> <C> <C>
Equipment $ 1,973,584 2,191,109
Automobiles 87,636 87,180
Leasehold improvements 629,252 630,953
- ----------------------------------------------------------------------------
2,690,472 2,909,242
Less accumulated depreciation and amortization 847,747 1,333,465
- ----------------------------------------------------------------------------
$ 1,842,725 1,575,777
============================================================================
</TABLE>
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
1996 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Accrued salaries and commissions $ 694,412 1,016,970
Other 622,977 719,993
- ----------------------------------------------------------------------
$ 1,317,389 1,736,963
======================================================================
</TABLE>
(Continued)
35
<PAGE> 36
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(8) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
1996 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Note payable to finance company bearing interest at 8.95% and requiring
monthly payments of principal and interest of $1,740 through October 1998 $ 35,190 16,710
- -----------------------------------------------------------------------------------------------------------------
35,190 16,710
Less current maturities 18,480 16,710
- -----------------------------------------------------------------------------------------------------------------
$ 16,710 -
=================================================================================================================
</TABLE>
The notes payable are secured by an automobile having a net carrying value
of $59,558 and $49,126 at December 31, 1996 and 1997, respectively.
(9) STOCKHOLDERS' EQUITY
The 9% convertible redeemable cumulative preferred stock (9% preferred
stock) required cumulative dividends of $.90 per share payable
semiannually. Holders of the 9% preferred stock converted 74,586 shares of
such stock into common stock of the Company during the year ended December
31, 1995. The remaining 500 shares of 9% preferred stock were redeemed for
cash on June 30, 1995.
In connection with the offering of the 9% preferred stock, the Company
issued the underwriter warrants to purchase 66,000 shares of common stock
at $4.675 per share. The warrants were exercised in June 1995. The Company
received proceeds from the exercise of $285,243, net of offering expenses.
In connection with the acquisition of CSI (note 1), the Company issued 65
shares of Series A Convertible Redeemable Cumulative Preferred Stock
(Series A preferred stock) valued at $10,000 per share. The Series A
preferred stock required cumulative dividends payable semiannually at an
annual rate of 8.75%. On December 5, 1995, the 65 shares of the Series A
preferred stock were converted for 65,000 shares of common stock.
In February 1996, the Company completed a public offering of 1,172,500
shares of common stock at a per share price of $20.00. The net proceeds of
the Company from the offering were approximately $21,035,000 after
deducting offering expenses.
(Continued)
36
<PAGE> 37
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(10) INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
1995 1996 1997
- ----------------------------------------------------------------------
Current:
<S> <C> <C> <C>
Federal $ (29,000) - -
State (5,300) - -
Foreign 9,000 - -
- ----------------------------------------------------------------------
(25,300) - -
Deferred:
Federal 19,700 - -
State 1,600 - -
Foreign 194,000 - -
- ----------------------------------------------------------------------
215,300 - -
- ----------------------------------------------------------------------
$ 190,000 - -
======================================================================
</TABLE>
The income tax expense (benefit) differed from the amount computed by
applying the Federal income tax rate of 34% to loss before income tax
expense as a result of the following:
<TABLE>
<CAPTION>
1995 1996 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Computed "expected" tax benefit $ (171,785) (2,408,747) (1,236,819)
Increase (reduction) in income taxes resulting from:
State and local income taxes,
net of Federal income tax benefit (2,442) (190,026) (173,387)
Amortization of acquired intangible assets,
not deductible for tax purposes 214,423 249,099 41,590
Write-off of unamortized acquired intangible assets
from the Connective Strategies, Inc. acquisition
not deductible for tax purposes - 753,508 -
Foreign income taxes at rates less than 34% (72,950) - -
Change in valuation allowance 169,500 1,774,500 1,635,000
Other, net 53,254 (178,334) (266,384)
- ---------------------------------------------------------------------------------------------------------------------------
$ 190,000 - -
===========================================================================================================================
</TABLE>
(Continued)
37
<PAGE> 38
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(10) CONTINUED
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are presented below at December 31:
<TABLE>
<CAPTION>
1996 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Inventories, due to additional costs inventoried for tax
purposes pursuant to the Tax Reform Act of 1986 $ 67,000 241,000
Net operating loss carryforward 1,906,000 3,358,000
Other 18,000 99,000
- ----------------------------------------------------------------------------------------------------
1,991,000 3,698,000
- ----------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Equipment, due to differences in depreciation (22,000) (88,000)
Other (25,000) (31,000)
- ----------------------------------------------------------------------------------------------------
(47,000) (119,000)
- ----------------------------------------------------------------------------------------------------
Net deferred tax asset 1,944,000 3,579,000
Less valuation allowance (1,944,000) (3,579,000)
- ----------------------------------------------------------------------------------------------------
$ - -
====================================================================================================
</TABLE>
The Company has net operating loss carryforwards for United States income
tax purposes of approximately $8,700,000 which are available to reduce
future taxable income through 2012. In addition, the Company has a net
operating loss of $1,754,000 which is attributable to CSI's preacquisition
period and is available to reduce future taxable income of CSI at the rate
of approximately $124,000 per year and expires in various amounts through
2008.
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
the deferred tax assets is dependent on the generation of future taxable
income during the periods in which temporary differences are deductible
and net operating losses are allowable. Based on consideration of the
above factors management established a valuation allowance for which the
balance was $1,944,000 and $3,579,000 at December 31, 1996 and 1997,
respectively.
The Company has not provided any additional U.S. income taxes on the GDS
taxable income since management does not expect to repatriate such
earnings.
(Continued)
38
<PAGE> 39
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(11) LEASES
The Company leases office facilities and equipment under operating leases
expiring at various dates through 2003. The leases require the Company to
pay real estate taxes, insurance and maintenance. The Company recognizes
rent expense on a straight-line basis. The annual minimum rentals under
the leases as of December 31, 1997 are as follows:
<TABLE>
<C> <C>
1998 $ 549,387
1999 549,593
2000 464,478
2001 468,639
2002 481,621
Thereafter 115,296
================================================================
</TABLE>
Rent expense for the years ended December 31, 1995, 1996 and 1997 was
$184,224, $518,177 and $616,465, respectively.
(12) PENSION PLAN
The Company has a defined contribution pension plan for employees who have
completed three months of service with the Company. The Plan permits
pre-tax contributions to the Plan by participants pursuant to Section
401(k) of the Internal Revenue Code (the Code) of 3% to 10% of base
compensation up to the maximum allowable contributions as determined by
the Code. The Company matches participants' contributions on a
discretionary basis. The Company may also make additional discretionary
contributions. The Company made no contributions to the plan during the
three years ended December 31, 1997.
(13) STOCK OPTIONS AND WARRANTS
The Company has an incentive stock option plan which provides for the
granting of stock options to officers, directors, consultants and key
employees of the Company. Options issued pursuant to the plan are
exercisable at the fair market value of the common stock on the date of
the issuance of the option. Either incentive stock options or qualified
stock options may be granted under the plan. The vesting and exercise
periods are determined by the Board of Directors not to exceed ten years.
Options issued to date generally vest 20% per year commencing with dates
of employment or dates of grant and expire seven years from date of grant.
(Continued)
39
<PAGE> 40
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(13) CONTINUED
Option transactions during 1995, 1996 and 1997 were as follows:
<TABLE>
<CAPTION>
Number Range of Weighted average
of shares exercise prices exercise price
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at December 31, 1994 112,600 $ 0.10 to $ 5.25 $ 3.22
Granted 151,000 $ 7.25 to $17.00 14.06
Canceled (9,700) $ 4.50 to $13.50 7.48
Exercised (300) $ 4.94 4.94
- --------------------------------------------------------------------------------------
Outstanding at December 31, 1995 253,600 $ 0.10 to $17.00 9.54
Granted 393,000 $ 9.88 to $28.63 18.45
Canceled (37,200) $ 1.30 to $17.00 12.85
Exercised (40,800) $ 0.10 to $13.50 4.46
- --------------------------------------------------------------------------------------
Outstanding at December 31, 1996 568,600 $ 1.30 to $28.63 15.92
Granted 931,250 $ 6.38 to $20.00 10.39
Canceled (500,867) $ 4.50 to $28.63 16.68
Exercised (4,600) $ 1.30 to $ 4.50 2.55
- --------------------------------------------------------------------------------------
Outstanding at December 31, 1997 994,383 $ 1.30 to $20.00 $ 10.45
======================================================================================
Exercisable at December 31, 1997 151,599 $ 1.30 to $17.00 $ 9.33
======================================================================================
</TABLE>
<TABLE>
<CAPTION>
1996
------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------- ---------------------------------
Weighted average
Range of Number remaining Weighted average Number Weighted average
exercise prices of shares contractual life exercise price of shares exercise price
- -------------------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C>
$1.30 to $9.88 105,300 4.97 years $ 5.90 35,100 $ 3.54
$10.00 to $20.00 285,300 5.88 years 14.55 43,700 14.14
$20.38 to $28.63 178,000 6.32 years 24.02 - -
- -------------------------------------------------------------------------------------------------------------------------
568,600 5.85 years $ 15.92 78,800 $ 9.42
=========================================================================================================================
</TABLE>
(Continued)
40
<PAGE> 41
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(13) CONTINUED
<TABLE>
<CAPTION>
1997
--------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------ ---------------------------------
Weighted average
Range of Number remaining Weighted average Number Weighted average
exercise prices of shares contractual life exercise price of shares exercise price
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$1.30 to $8.88 210,800 4.49 years $ 6.86 64,100 $ 5.24
$9.00 to $9.88 424,083 5.54 years 9.38 34,999 9.58
$10.00 to $20.00 359,500 5.73 years 13.81 52,500 14.15
- ---------------------------------------------------------------------------------------------------------------------
994,383 5.39 years $ 10.45 151,599 $ 9.33
=====================================================================================================================
</TABLE>
The Company applies the intrinsic value method in accounting for its Plan
and, accordingly, no compensation cost has been recognized for its options
in the financial statements. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net loss and per share amounts would have been the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
1995 1996 1997
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Net loss As reported $ (695,251) (7,084,550) (3,637,702)
Pro forma (760,000) (7,578,000) (4,252,000)
Loss per common share -
basic and diluted As reported (.20) (1.34) (.67)
Pro forma (.22) (1.43) (.78)
==================================================================================
</TABLE>
Pursuant to SFAS No. 123, pro forma net loss reflects only options granted
in 1995, 1996 and 1997. Therefore, the full impact of calculating
compensation cost for stock options under SFAS No. 123 is not reflected in
the pro forma net loss amounts presented above because compensation cost
recognized over the option's vesting periods and compensation cost for
options granted prior to January 1, 1995 is not considered.
The weighted average fair values of options granted during 1995, 1996 and
1997 were $806,000, $2,453,000 and $4,128,000, respectively, on the dates
of grant. The fair values of options granted were calculated using the
Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1995, 1996 and 1997, respectively:
risk-free interest rates of 5.83% to 6.76% for 1995, 5.253% to 6.78% for
1996 and 5.71% to 6.78% for 1997; expected volatility of 32% for 1995 and
1996 and 63% for 1997; dividend yield and expected dividend growth rate of
0% in all years; and expected lives of 3 to 5 years and expected
forfeitures of 0% for all years.
(Continued)
41
<PAGE> 42
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(13) CONTINUED
In addition, in November 1995, in connection with the private placement of
300,000 shares of the Company's common stock, the Company issued the
placement agent warrants to purchase 30,000 shares of common stock at
$17.00 per share. The warrants are exercisable at any time during a
four-year period commencing on January 29, 1997. The price and number of
shares is subject to adjustment in certain circumstances to protect
against dilution. Holders of the warrants are not entitled to vote,
receive dividends or exercise any of the rights of holders of shares of
common stock for any purpose until such warrants are exercised.
In connection with a financial consulting agreement in February 1997, the
Company issued warrants to purchase 25,000 shares of common stock at $9.00
per share and 25,000 shares of common stock at $20.00 per share. The
warrants are exercisable at any time during a three-year period commencing
in February 1997.
At December 31, 1997, the Company had reserved 1,529,300 shares of common
stock for the stock option plan and conversion of outstanding warrants.
(14) OTHER COMMITMENTS AND CONTINGENCIES
In August 1996, the Company signed a two year joint development and
marketing agreement (agreement) with CyberGuard Corporation (CyberGuard).
The companies have developed and intend to market a product that combines
the Company's SafeNet/Enterprise products and CyberGuard's Firewall
product. In connection therewith, the Company has prepaid a refundable
$1.0 million license fee to CyberGuard. As of December 31, 1997, the
Company has utilized $27,500 in credits against the prepaid license fee.
The agreement provides that in the event that this agreement is terminated
prior to such credit aggregating $1.0 million, then CyberGuard shall repay
to the Company the balance of the $1.0 million prepaid license fee within
one year of the date of such termination with interest at the prime rate.
(15) OPERATIONS OUTSIDE THE UNITED STATES
Net income (loss) of the Company's non-U.S. subsidiary was $403,769,
$(298,872) and $46,182 for 1995, 1996 and 1997, respectively. Net sales
to unaffiliated customers of the Company's non-U.S. subsidiary were
$2,295,843, $6,235,987 and $5,474,327 for 1995, 1996 and 1997,
respectively.
(Continued)
42
<PAGE> 43
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
================================================================================
(15) CONTINUED
The Company's investment in identifiable assets and liabilities located
outside the United States was as follows at December 31:
<TABLE>
<CAPTION>
1996 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Current assets $ 4,002,221 4,294,819
Property, plant and equipment, net 190,187 73,789
- -----------------------------------------------------------------------------
Total assets 4,192,408 4,368,608
Current liabilities 1,257,190 1,579,718
- -----------------------------------------------------------------------------
Net assets $ 2,935,218 2,788,890
=============================================================================
</TABLE>
================================================================================
(Continued)
43
<PAGE> 44
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------ --- ------------------------------------------
<S> <C> <C>
Anthony A. Caputo 56 Chairman, Chief Executive Officer and President
Michael M. Kaplan 53 Senior Vice President, Technology
Jill Leukhardt 41 Senior Vice President, Director
Richard G. Tennant 52 Vice President of Finance and Administration,
Chief Financial Officer
Dubhe E. Beinhorn 41 Vice President, International Sales
Sean Price 34 Vice President, North American Sales
Gary L. McGreal 45 Vice President, Marketing
John F. Hembrough 48 Vice President, OEM Sales
Steven Turner 39 Vice President, Product Support
Douglas E. Kozlay 58 Principal Engineer, Director
Ira A. Hunt, Jr 73 Director
Bruce R. Thaw 44 Director
</TABLE>
All directors hold office until the next annual meeting of shareholders or
until their respective successors are elected and qualify. Executive officers
hold office until their successors are chosen and qualify, subject to earlier
removal by the Board of Directors. Set forth below is a biographical description
of each director and executive officer of the Company based on information
supplied by each of them.
Anthony A. Caputo, the Chairman, Chief Executive Officer and President of
the Company, invested in the Company in 1986, and became a director in November
1986. In 1982, Mr. Caputo founded another computer security firm, TACT
Technology, as a division of a public company, and after securing outside
funding through a $3.0 million limited partnership in 1984, managed TACT as a
separate company. Mr. Caputo resigned from TACT Technology in November 1986 to
join the Company. Mr. Caputo has over 20 years' experience in the computer
industry, in marketing and management capacities. In June 1993, Mr. Caputo was
named Maryland's High Tech Entrepreneur of the Year, an annual award sponsored
by organizations including Inc. Magazine, Ernst and Young LLP and Merrill Lynch.
He has served as an officer of several publicly traded companies including
International Mobile Machines Inc., and Comshare, Inc., as well as Value
Software, now part of Computer Associates, Inc. Currently, Mr. Caputo is also a
director of CardGuard International, Inc., a privately held company focused on
developing fingerprint identification technology..
Michael M. Kaplan joined the Company in February 1996 as Senior Vice President,
Technology. Formerly the Director of Secure Technologies at AT&T Bell
Laboratories, Mr. Kaplan led the design, development and support of AT&T's
security products for voice, data, fax and video applications. Mr. Kaplan was
employed at AT&T Bell Labs for twenty-seven years and holds a Master of Science
in Mathematics from Adelphi University and a Bachelor of Arts in Mathematics
from Queens College. Mr. Kaplan holds four patents for various aspects of
telephone security devices and associated services and there are two additional
patents pending.
Jill Leukhardt has been a Senior Vice President of the Company since June
1995. She served as the Vice President of Sales and Marketing of the Company
from 1989 to 1995. She was appointed a director of the Company in December,
1990. Ms. Leukhardt possesses a graduate level degree in Electrical Engineering.
From 1980 to 1986,
44
<PAGE> 45
Ms. Leukhardt was a Marketing Manager at Intel Corporation where she managed
several projects including the planning, specification and initial marketing of
the 80386 microprocessor. Prior to joining the Company, from 1986 to 1989, she
served as Vice President-Marketing for Micro Wholesalers, Inc., a microcomputer
distributor. She has also served as a Trustee of Johns Hopkins University since
July 1992.
Richard G. Tennant has been Vice President of Finance and Administration
and Chief Financial Officer since July 1997. Prior to joining the Company, Mr.
Tennant served as Vice President of Finance and Administration and Chief
Financial Officer of Netrix Corporation, a wide-area networking corporation,
since 1987.
Dubhe E. Beinhorn has been Vice President, International Sales since
October 1996. Ms. Beinhorn's principal responsibilities include the
identification and development of distribution channels, partnerships, strategic
alliances and direct customer relationships outside North America. Prior to
joining the Company, Ms. Beinhorn served as Vice President, International Sales
for Netrix Corporation, and National Account Manager, Federal Operations at
Network Equipment Technologies.
Sean Price joined the Company in April 1997 as Vice President, North
America Sales. His primary responsibility is managing and expanding the
Company's domestic distribution channels, more specifically Value Added
Resellers, systems integrators, and network service providers. Prior to joining
IRE, Mr. Price was Vice President of Worldwide Sales for Nuera Communications,
where he managed direct sales to carriers and end users as well as indirect
sales through Value Added Resellers.
Gary L. McGreal joined the Company in October 1994 in connection with the
Company's acquisition of Connective Strategies, Inc., and became Director of
Product Planning. In 1996 he became IRE's Director of Planning, and in 1997 he
was made Vice President, Marketing. From 1985 to 1994 he was Executive Vice
President and Chief Operating Officer of Connective Strategies, Inc.
John F. Hembrough joined the Company in September 1997 as Vice President,
OEM Sales. Mr. Hembrough is responsible for building sales channels and managing
the Company's OEM division through sales of Safenet technology to major
computer, communications, and software manufacturers. Prior to joining IRE, he
was the Vice President/General Manager of European Operations for Raptor
Systems, a software security company.
Steven Turner has been with the Company since March 1988 serving as
Technician, Engineer, Production Manager, and Director, Product Support. Mr.
Turner has been the Vice President of Product Support since July 1994 where he
is the senior manager for the manufacturing, client support, Safenet Trusted
Services, and MIS groups. Prior to joining the Company, he held various
positions at the U.S. Naval Research Lab, E-Systems, and the U.S. Air Force.
Douglas E. Kozlay is the co-founder, and was President, of the Company from
1983 until March 1993. Mr. Kozlay's principal responsibilities include serving
as the Company's chief technical officer providing guidance and advice on
product architecture to the Chief Executive Officer and performing engineering
functions as required. Mr. Kozlay has been a director of the Company since its
inception. From 1979 to 1982 Mr. Kozlay served as President of EMAX, Inc., a
company which designed and marketed data acquisition and control systems.
Previously, Mr. Kozlay has served as a manager of a research and development
laboratory for the U.S. National Security Agency and design engineer for IBM
Corporation. In 1982 Mr. Kozlay was Director of Industrial Automation for EMC
Controls. He currently teaches graduate level courses in robotics at Loyola
College of Baltimore.
Ira A. Hunt, Jr. has been a director of the Company since December 1990.
Mr. Hunt is a graduate of the U.S. Military Academy, West Point, New York. He
served 33 years in various command and staff positions in the U.S. Army,
retiring from active military service as a Major General in 1978. Subsequently
he was President of Pacific Architects and Engineers in Los Angeles, California
and a Vice President of Frank E. Basil, Inc. in Washington, D.C. Mr. Hunt has a
Masters of Science degree in civil engineering from the Massachusetts Institute
of Technology; an MBA from the University of Detroit; a Doctor of the University
degree from the University of Grenoble, France; and a Doctor of Business
Administration degree from George Washington University.
45
<PAGE> 46
Bruce R. Thaw has been a director of the Company since December 1990. From
1987 to the present, Mr. Thaw has served as general counsel to the Company. Mr.
Thaw was admitted to the bar of the State of New York in 1978 and the California
State Bar in 1983. Mr. Thaw is also a director of Amtech Systems, Inc., a
publicly traded company engaged in the semiconductor industry, and Nastech
Pharmaceutical Company, Inc., a publicly traded company engaged in drug delivery
technology.
The Company's By-Laws provide for the election of directors at the annual
meeting of shareholders, such directors to hold office until the next annual
meeting and until their successors are duly elected and qualified. The By-Laws
also provide that the annual meeting of shareholders be held each year at such
time, date and place as the Board of Directors shall determine by resolution.
Directors may be removed at any time for cause by the Board of Directors and
with or without cause by a majority of the votes cast by the shareholders
entitled to vote for the election of directors.
Officers will normally be elected at the annual meeting of the Board of
Directors held immediately following the annual meeting of shareholders, to hold
office for the term for which elected and until their successors are duly
elected and qualified. Officers may be removed by the Board of Directors at any
time with or without cause.
In January 1997, the Company announced the formation of an advisory board
chaired by former United States Treasury Secretary William E. Simon. Developed
to assist in building shareholder value by managing and maintaining Company
expansion, the Company expects to add additional high-caliber executives to its
board. Subsequently, the Company announced the addition of Dr. Vinton G. Cerf,
MCI's Senior Vice President of Internet Architecture and Daniel L. Mosley, a
partner in the law firm of Cravath, Swaine & Moore, to the board.
The Company's Certificate of Incorporation contains provisions indemnifying
its officers, directors, employees and agents against certain liabilities.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.
46
<PAGE> 47
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
<TABLE>
<S> <C>
(a) 1. The financial statements filed as part of this report are listed
separately on the Index To Financial Statements on page 19 of this
Form.
2. Financial Statement Schedules: None
(b) Reports on Form 8-K: None
(c) Exhibits required by Item 601 of Regulation S-K:
3A Articles of Incorporation of Registrant, as filed with the Secretary of State of
Delaware on November 1, 1988, as amended on March 6, 1989, May 19, 1989,
September 22, 1992, June 30, 1995 and October 4, 1995 1/B/R(1)
3B By-laws of Registrant 1/B/R(2)
4 Specimen of Common Stock Certificate of Registrant 1/B/R(2)
10A Sublease dated November 2, 1993 for facility at 8029 Corporate Drive, Baltimore, Md. 1/B/R(3)
10B Stock Option Plan 1/B/R(4)
10C Employment Agreement with Douglas Kozlay 1/B/R(2)
10D Form Employee Non-Disclosure Agreement 1/B/R(2)
10E Award Contract with United States Department of the Treasury 1/B/R(4)
10F Agreement with GTE Government Systems Corporation 1/B/R(5)
10G Agreement and Plan of Merger dated September 30, 1995 with Connective Strategies, Inc. 1/B/R(6)
10H Employment Agreement with Charles D. Brown 1/B/R(7)
10I Agreement between the Registrant and AT&T International, Inc. for the acquisition of
Gretag Data Systems AG 1/B/R(8)
10J Agreement between the Registrant and MCI Telecommunications Corporation 1/B/R(9)
10K Employment Agreement between GDS and Dr. Kurt H. Mueller 1/B/R(1)
10L Placement Agent Warrant 1/B/R(1)
10M Alliance and Joint Marketing Agreement between the Registrant and MCI Telecommunications
Corporation 1/B/R(11)
10N Joint Development and Marketing Agreement between the Registrant and CyberGuard
Corporation 1/B/R(11)
10O Employment Agreement with Anthony Caputo 1/B/R(11)
10P Agreement between the Registrant Lockheed Martin Corporation Information Systems & 1/B/R(11)
Technologies
10Q Agreement between IRE Secure Solutions, Inc. (wholly-owned subsidiary of the Registrant) 1/B/R(10)
and Analog Devices, Inc.
21 Subsidiaries of Registrant
27 Financial Data Schedule
</TABLE>
- --------------
(1) Filed as an exhibit to the Registration Statement on Form SB-2 (File No.
33-80161) of the Registrant and incorporated herein by reference.
(2) Filed as an exhibit to the Registration Statement on Form S-18 (File No.
33-28673) of the Registrant and incorporated herein by reference.
(3) Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
1993 and incorporated herein by reference.
(4) Filed as an exhibit to the Registration Statement on Form S-1 (File No.
33-52066) of the Registrant and incorporated herein by reference.
(5) Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
1995 and incorporated herein by reference.
(6) Filed as an exhibit to Form 8-K, dated October 24, 1995 and incorporated
herein by reference.
(7) Filed as an exhibit to Form 10-QSB for the quarterly period ended June 30,
1995 and incorporated herein by reference.
47
<PAGE> 48
(8) Filed as an exhibit to Form 8-K dated October 31, 1995 and incorporated
herein by reference.
(9) Filed as an exhibit to Form 10-QSB for the quarterly period ended September
30, 1995 and incorporated herein by reference.
(10) Filed as an exhibit to Form 10-Q for the quarterly period ended September
30,1996 and incorporated herein by reference.
(11) Filed as an exhibit to Form 10-K for the fiscal year ended December 31,
1996 and incorporated herein by reference.
48
<PAGE> 49
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
behalf of the undersigned, thereunto duly authorized.
INFORMATION RESOURCE ENGINEERING, INC.
By: /s/ ANTHONY A. CAPUTO
-----------------------------------------------
Anthony A. Caputo
Chairman, Chief Executive Officer and President
Date: March 27, 1998
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ ANTHONY A. CAPUTO Chairman, Chief Executive Officer March 27, 1998
- -------------------------------------------- and President
Anthony A. Caputo
Senior Vice President, Director March 27, 1998
- --------------------------------------------
Jill L. Leukhardt
/s/ RICHARD G. TENNANT Vice President of Finance and March 27, 1998
- -------------------------------------------- Administration, Chief Financial Officer
Richard G. Tennant (Principal Financial and Accounting Officer)
/s/ DOUGLAS E. KOZLAY Director March 27, 1998
- --------------------------------------------
Douglas E. Kozlay
/s/ IRA A. HUNT, JR. Director March 27, 1998
- --------------------------------------------
Ira A. Hunt, Jr.
/s/ BRUCE R. THAW Director March 27, 1998
- --------------------------------------------
Bruce R. Thaw
</TABLE>
49
<PAGE> 1
Exhibit 21
SUBSIDIARIES OF REGISTRANT
The registrant owns 100% of the capital stock of the following subsidiaries:
Connective Strategies, Inc. (A Delaware Corporation)
GRETACODER Data Systems AG (A Switzerland Corporation)
SafeNet/Trusted Services Corporation (A Delaware Corporation)
IRE Secure Solutions, Inc. (A Delaware Corporation)
50
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT
OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 FOR INFORMATION RESOURCE
ENGINEERING.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,222,069
<SECURITIES> 2,339,408
<RECEIVABLES> 3,276,818
<ALLOWANCES> 60,276
<INVENTORY> 2,915,331
<CURRENT-ASSETS> 16,050,085
<PP&E> 2,909,242
<DEPRECIATION> 1,333,465
<TOTAL-ASSETS> 21,531,019
<CURRENT-LIABILITIES> 3,550,919
<BONDS> 0
0
0
<COMMON> 54,627
<OTHER-SE> 17,925,473
<TOTAL-LIABILITY-AND-EQUITY> 21,531,019
<SALES> 16,006,998
<TOTAL-REVENUES> 16,006,998
<CGS> 6,971,144
<TOTAL-COSTS> 6,971,144
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 60,276
<INTEREST-EXPENSE> 11,520
<INCOME-PRETAX> (3,637,702)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,637,702)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,637,702)
<EPS-PRIMARY> (0.67)
<EPS-DILUTED> (0.67)
</TABLE>
