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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
/x/ Quarterly report pursuant to Section 13 of 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1996
OR
/ / Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number: 0-25120
SECURITY DYNAMICS TECHNOLOGIES, INC.
(Exact name of Registrant as Specified in Its Charter)
DELAWARE 04-2916506
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
20 CROSBY DRIVE
BEDFORD, MA 01730
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (617) 687-7000
----------------------------------------------------------
ONE ALEWIFE CENTER, CAMBRIDGE, MA 02140
(Former Address)
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
--- ---
As of November 1, 1996, there were 34,331,866 shares of the Registrant's Common
Stock, $.01 par value per share, outstanding (after giving effect to the
Company's two-for-one split, in the form of a stock dividend, which will become
effective on or about November 15, 1996 (the "Split")). All share and per share
data set forth in this Quarterly Report on Form 10-Q have been retroactively
adjusted to give effect to the Split.
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SECURITY DYNAMICS TECHNOLOGIES, INC.
FORM 10-Q
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1996
TABLE OF CONTENTS
<TABLE>
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 1996
and December 31, 1995 3
Condensed Consolidated Statements of Income for the three months
and nine months ended September 30, 1996 and September 30, 1995
4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1996 and September 30, 1995 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security-Holders 19
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
September 30, 1996 December 31, 1995
------------------ -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 7,332 $ 49,285
Marketable securities 96,043 61,637
Accounts receivable (less allowance for doubtful
accounts of $488 in 1996 and $724 in 1995) 12,272 7,425
Inventory 2,717 1,445
Prepaid expenses and other 2,233 1,662
--------- ---------
Total current assets 120,597 121,454
Property and equipment - net 8,445 2,408
Capitalized software and purchased technology 226 426
Investments 1,102 872
Deferred taxes 478 478
Other 1,216 300
========= =========
Total $ 132,064 $ 125,938
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,743 $ 2,733
Accrued payroll and related benefits 3,605 2,210
Accrued expenses and other 2,422 2,703
Income taxes payable 1,378 190
Deferred revenue 4,165 4,219
Deferred taxes 3,575 6,006
--------- ---------
Total current liabilities 19,888 18,061
Accrued rent 58 50
--------- ---------
19,946 18,111
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Stockholders' equity:
Common stock, $.01 par value; authorized 80,000,000
shares; issued, 34,154,966 and 33,572,470 shares
in 1996 and 1995; outstanding, 34,154,670 and
33,572,174 shares in 1996 and 1995 342 336
Additional paid-in capital 95,995 94,457
Retained earnings 8,979 3,375
Deferred stock compensation (205) (292)
Treasury stock, common, at cost,
296 shares in 1996 and 1995 -- --
Cumulative translation adjustment (48) 41
Unrealized gain on marketable securities - net of taxes 7,055 9,910
--------- ---------
Total stockholders' equity 112,118 107,827
--------- ---------
Total $ 132,064 $ 125,938
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</TABLE>
See notes to condensed consolidated financial statements
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 20,363 $ 14,145 $ 52,645 $ 31,054
Cost of revenue 5,100 2,308 12,261 5,662
-------- -------- -------- --------
Gross profit 15,263 11,837 40,384 25,392
-------- -------- -------- --------
Costs and expenses:
Research and development 2,752 1,882 7,113 4,166
Marketing and selling 5,331 3,218 14,913 9,236
General and administrative 2,662 2,243 8,280 6,220
Merger expenses 6,100 -- 6,100 --
-------- -------- -------- --------
Total 16,845 7,343 36,406 19,622
-------- -------- -------- --------
(Loss) Income from operations (1,582) 4,494 3,978 5,770
Interest income 1,127 378 3,610 1,108
Gain on sale of marketable securities 4,546 -- 4,546 --
-------- -------- -------- --------
Income before provision for income taxes 4,091 4,872 12,134 6,878
Provision for income taxes 3,540 314 6,530 1,943
-------- -------- -------- --------
Net income $ 551 $ 4,558 $ 5,604 $ 4,935
======== ======== ======== ========
Net income per common and
common equivalent share $ .02 $ .14 $ .15 $ .15
======== ======== ======== ========
Weighted average number of common and
common equivalent shares outstanding 36,592 32,386 36,478 32,034
======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements
4
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------
1996 1995
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<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,604 $ 4,935
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on sale of marketable securities (4,546) --
Deferred taxes (4) (649)
Amortization of purchased technology and capitalized software costs 200 865
Depreciation 1,145 513
Allowance for notes receivable -- 200
Income from partnership -- (87)
Stock option compensation 474 83
Increase (decrease) in cash from:
Accounts receivable (4,907) (1,414)
Inventory (1,272) (228)
Prepaid expenses and other (571) 52
Accounts payable 2,010 292
Accrued payroll and related benefits 1,395 1,072
Accrued expenses and other (281) 9
Income taxes payable 1,188 391
Deferred revenue (54) 595
Accrued rent 8 (16)
-------- --------
Net cash provided by operating activities 389 6,613
-------- --------
Cash flows from investing activities:
Purchase of marketable securities (89,957) (32,312)
Proceeds from sale and maturities of marketable securities 54,815 12,319
Expenditures for property and equipment (7,182) (1,281)
Purchased technology and capitalized software costs -- (832)
Investments (230) (510)
Notes receivable -- (330)
Other assets (916) (13)
-------- --------
Net cash used for investing activities (43,470) (22,959)
-------- --------
Cash flows from financing activities:
Proceeds from sale of common and preferred stock 1,157 4,828
Principal payments on capital lease -- (28)
-------- --------
Net cash from financing activities 1,157 4,800
-------- --------
Effects of exchange rate changes on cash and equivalents (29) 36
-------- --------
Net (decrease) in cash and equivalents (41,953) (11,510)
Cash and equivalents, beginning of period 49,285 18,341
-------- --------
Cash and equivalents, end of period $ 7,332 $ 6,831
======== ========
</TABLE>
See notes to condensed consolidated financial statements
5
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except share and per share data)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of Security Dynamics Technologies, Inc. (the
"Company") and its wholly owned subsidiaries and have been prepared
pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do
not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements and
should be read in conjunction with the audited consolidated financial
statements included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1995.
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared on the same basis
as the audited consolidated financial statements, and include all
adjustments, consisting only of normal recurring adjustments, necessary
for fair presentation of the results of the interim periods presented.
The operating results for the interim periods presented are not
necessarily indicative of the results expected for the full year.
In October 1996, the Board of Directors declared a two-for-one split of
the Company's common stock to be effected in the form of a stock
dividend. Shares are to be distributed on or about November 15, 1996 to
stockholders of record on November 1, 1996. All share and per share
data have been adjusted to reflect the two-for-one split of the
Company's common stock.
In July 1996, the Company completed a Merger (the "Merger") with RSA
Data Security, Inc. ("RSA"). The Merger has been accounted for as a
pooling of interests, and therefore the consolidated financial
statements for all periods prior to the Merger have been restated to
include the accounts and operations of RSA with those of the Company.
2. Income Per Common Share
Income per common share is computed using the weighted average number
of common and common equivalent shares outstanding during each period
presented.
At a Special Meeting of Stockholders of the Company held on July 26,
1996 the stockholders of the Company approved an amendment to the
Company's Third Restated Certificate of Incorporation increasing the
authorized number of shares of Common Stock from 30,000,000 to
80,000,000 shares.
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3. Income Taxes
The Company provides for income taxes at the end of each interim period
based on the estimated effective tax rate for the full year. Cumulative
adjustments to the tax provision are recorded in the interim period in
which a change in the estimated annual effective rate is determined.
4. Accounting for Stock Options
In October 1995, the Financial Accounting Board issued SFAS 123,
"Accounting for Stock-Based Compensation," which became effective for
the Company beginning January 1, 1996. SFAS No. 123 requires expanded
disclosures of stock-based compensation arrangements with employees and
encourages (but does not require) compensation cost to be measured
based on fair value of the equity instrument awarded. Companies are
permitted, however, to continue to apply APB No. 25, which recognizes
compensation cost based on the intrinsic value of the equity instrument
awarded. The Company will continue to apply APB Opinion No. 25 to its
stock-based compensation awards to employees and will disclose the
required pro forma effect on net income and earnings per share in the
annual consolidated financial statements for 1996.
On April 1, 1996 and April 24, 1996, options to purchase 200,000 shares
and 38,900 shares were granted at exercise prices of $24.30 and $38.20,
respectively, subject to stockholder approval of an amendment to the
Company's 1994 Stock Option Plan (the "1994 Plan"), increasing the
number of shares available for grant to 4,820,000 shares. On May 22,
1996, the stockholders approved the amendment to the 1994 Plan.
For options granted prior to April 1, 1996, because approval of the
stockholders was required and considered perfunctory, the Company
measured compensation expense on the date of grant by the Board of
Directors or the Compensation Committee of the Board of Directors. As a
result of discussions with the staff of the Securities and Exchange
Commission, the Company changed its accounting policy on options
requiring stockholder approval to measure compensation expense on the
approval date. This change resulted in an aggregate compensation
expense of approximately $4,500 relating to the April 1, 1996 and April
24, 1996 option grants, which the Company will recognize over the
remainder of the four-year vesting period of the options from May 22,
1996. The effect of this change was to reduce income from operations by
$281 and $389, respectively, in the three months and nine months ended
September 30, 1996. The Company does not plan to grant options in the
future that are subject to approval by the stockholders.
5. Merger
In July 1996, the Company completed a Merger (the "Merger") with RSA
Data Security, Inc. ("RSA"), a Redwood City, California vendor of
encryption software. The Merger, which is being accounted for as a
pooling of interests, was effected through the exchange and reservation
of approximately 8 million shares of the Company's common stock for all
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the issued and outstanding shares of RSA and all the shares of RSA
issuable upon the exercise of outstanding RSA options.
In connection with the acquisition, the consolidated condensed
statements of operations for the three months and nine months ended
September 30, 1996 include a charge for Merger expenses of $6,100. Of
this amount, approximately $5,400 represents direct Merger expenses,
primarily professional fees, and approximately $700 represents various
restructuring charges.
No adjustments to conform accounting methods were required. Certain
amounts have been reclassified with regard to the presentation of the
financial information of the two companies. Revenue and net income for
each of the previously separate companies for the periods prior to the
Merger are as follows:
<TABLE>
<CAPTION>
(In thousands)
Six Months Nine Months Three Months
Ended Ended Ended
June 30, September 30, September 30, Total
1996 1995 1995 1995
--------- ------------- -------------- --------
<S> <C> <C> <C> <C>
REVENUE
Security Dynamics $ 26,240 $ 22,183 $ 8,766 $ 33,804
RSA 6,044 7,871 5,379 11,600
-------- -------- -------- --------
Total $ 32,284 $ 31,054 $ 14,145 $ 45,404
-------- -------- -------- --------
NET INCOME
Security Dynamics $ 5,436 $ 3,853 $ 1,251 $ 5,812
RSA (384) 1,082 3,307 950
-------- -------- -------- --------
$ 5,052 $ 4,935 $ 4,558 $ 6,762
-------- -------- -------- --------
</TABLE>
6. Contingencies
At September 30, 1996, the Company was involved in a number of litigous
proceedings. Management of the Company intends to defend the litigation
vigorously. The outcome of any litigation, including the matters
involving the Company, is uncertain. An unfavourable outcome could
materially adversely affect the financial position, results of
operations and/or cash flows of the Company. See Part II, Other
Information, Item 1, Legal Proceedings.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(In thousands, except share and per share data)
OVERVIEW
This Quarterly Report on Form 10-Q contains forward-looking statements. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions are intended to identify forward-looking statements. There are a
number of factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements. These
factors include, without limitation, those set forth below under the caption
"Certain Factors that May Affect Future Results."
The RSA Merger was completed on July 26, 1996, and has been accounted for as a
pooling of interests. Therefore, the results of operations for all periods
discussed below have been restated to include the financial results of RSA.
See Note 5 of Notes to Condensed Consolidated Financial Statements.
RESULTS OF OPERATIONS
The following table sets forth income and expense items as a percentage of total
revenue, and the percentage change in dollar amounts of such items, for the
three months and nine months ended September 30, 1996 and 1995. These amounts
include restated charges for the pooling of interests.
<TABLE>
<CAPTION>
Percentage of Total Period-to-Period Percentage of Total Period-to-Period
Revenue Change Revenue Change
Three Months Ended September 30, Nine Months Ended September 30,
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenue 100.0% 100.0% 44.0% 100.0% 100.0% 69.5%
Cost of revenue 25.0 16.3 120.9 23.3 18.2 116.5
------- ------- ------- ------- -------
Gross margin 75.0 83.7 28.9 76.7 81.8 59.1
------- ------- ------- ------- -------
Costs and expenses:
Research and development 13.5 13.3 46.3 13.5 13.4 70.8
Marketing and selling 26.2 22.7 65.7 28.3 29.8 61.5
General and administrative 13.0 15.9 18.7 15.7 20.0 33.1
Merger expenses 30.0 -- n\a 11.6 -- n\a
------- ------- ------- ------- -------
Total 82.7 51.9 129.4 69.1 63.2 85.5
------- ------- ------- ------- -------
(Loss) \ income from operations (7.7) 31.8 (135.2) 7.6 18.6 (31.0)
Interest income 5.5 2.7 197.8 6.8 3.6 225.7
Gain on sale of securities 22.3 -- n\a 8.6 -- n\a
------- ------- ------- ------- -------
Income before provision for
income taxes 20.1 34.5 (16.0) 23.0 22.2 10.3
Provision for income taxes 17.4 2.2 1,028.0 12.4 6.3 160.1
------- ------- ------- ------- -------
Net income 2.7% 32.2% (87.9)% 10.6% 15.9% 13.5%
======= ======= ======= =======
</TABLE>
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REVENUE
The Company's revenue is derived principally from the sales of SecurID tokens,
software license fees from the Company's ACE/Server and ACM software products
and licensing of RSA's BSafe/Tipem toolkits, licensing of patent technology and
sales of ACM hardware products and charges for maintenance and professional
services.
Total revenue increased 44% in the third quarter of 1996 to $20,363 from $14,145
in the third quarter of 1995. This increase in revenue reflected increases in
unit sales of all of the Company's products to existing and new customers.
Approximately 67% of the increase in revenue was attributable to the increase in
unit sales of SecurID tokens. Approximately 22% of the increase in revenue was
attributable to increases in the sale of the Company's ACE/Server and ACM
software products. Patent license revenues decreased by approximately 5% in the
third quarter of 1996 from the third quarter of 1995. The balance of the
increase in revenues resulted from increases in unit sales of hardware and
higher maintenance revenues. The Company believes that the increase in unit
sales was attributable in part to continued levels of growth and refinement in
the information security market, with the Internet and corporate intranets
continuing to play crucial roles in developing new opportunities for the
Company's business.
International revenue (excluding Canada and Latin America) increased 149% in the
third quarter of 1996 to $3,676 from $1,474 in the third quarter of 1995 and
accounted for 18% and 10% of total revenue in the third quarters of 1996 and
1995, respectively. This increase in international revenue was primarily
attributable to the continuing expansion of the Company's international direct
sales force and increased market penetration of the Company's products in
foreign markets.
Total revenue increased 70% in the first nine months of 1996 to $52,645 from
$31,054 in the first nine months of 1995. This increase in revenue reflected
increases in unit sales of all of the Company's products. Approximately 43% and
2% of the increase in revenue was attributable to the increase in unit sales and
the average prices of SecurID tokens, respectively. Approximately 26% of the
increase in revenue was attributable to the increase in sales of the ACE/Server
and ACM software products. Approximatently 11% of the increase in revenue was
attributable to the increase in patent license revenues.The remainder of the
increase in revenues was attributable to an increase in hardware unit sales and
to higher maintenance and professional services revenues.
International revenue (excluding Canada and Latin America) increased 161% in the
first nine months of 1996 to $9,414 from $3,609 in the first nine months of 1995
and accounted for 18% and 12% of total revenue in the first nine months of 1996
and 1995, respectively. This increase in international revenue was primarily
attributable to the expansion of the Company's international direct sales force
and increased market penetration in foreign markets.
COST OF REVENUE AND GROSS PROFIT
The Company's cost of revenue consists primarily of costs associated with the
manufacture and delivery of the Company's SecurID tokens and hardware products
from the Company's assembly contractors. Royalty costs, comprising royalty fees
incurred on the sale of Ace/Server software and
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royalty fees payable on the licensing of patent technology; customer support
costs and production costs, which include labor costs associated with the
programming of SecurID tokens, inspection and quality control functions; and
shipping costs, are also included in cost of revenue.
The Company's gross profit increased 29% in the third quarter of 1996 to
$15,263, or 75.0% of revenue, from $11,837, or 83.7% of revenue, in the third
quarter of 1995. Approximately 94% of the increase in gross profit was
attributable to an increase in the unit sales and gross profit from the sale of
SecurID tokens. In addition, gross profit increased in part due to an increase
in the sales of the Company's ACE/Server software and software product upgrades
and was offset in part by a decrease in gross profit from the licensing of
patent technology due to higher royalty costs. Gross profit as a percentage of
revenue declined due to the continuing development of the customer support
infrastructure and royalty expenses related to the Company's ACE/Server software
and product mix.
The Company's gross profit increased 59% in the first nine months of 1996 to
$40,384, or 76.7% of revenue, from $25,392, or 81.8% of revenue, in the first
nine months of 1995. Approximately 53% of the increase in gross profit was
attributable to an increase in the unit sales and gross profit from the sale of
SecurID tokens. Approximately 30% of the increase in gross profit was
attributable to an increase in the unit sales and gross profit from the sale of
the Company's ACE/Server software. Software revenue as a percentage of total
revenue in the first nine months of 1996 increased to 21% of revenue from 18% of
revenue in the first nine months of 1995. Approximately 7% of the increase in
gross profit was attributable to an increase in the revenues from the licensing
of patent technology and toolkit royalties. Gross profit as a percentage of
revenue declined due to higher patent license royalties, continuing development
of the customer support infrastructure, royalty expenses related to the
Company's ACE/Server software and product mix.
In the future, gross margin may continue to be affected by several factors,
including changes in product mix and distribution channels, price reductions
(resulting from volume discounts or otherwise), competition, increase in the
cost of revenue (including increases in material costs associated with the
manufacture of SecurID tokens and hardware products) and other factors.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of personnel costs as well
as fees for development services provided by consultants.
Research and development expenses increased 46% in the third quarter of 1996 to
$2,752 from $1,882 in the third quarter of 1995, and increased as a percentage
of revenue to 13.5% from 13.3%. Approximately 80% of the increase in research
and development expenses in the third quarter of 1996 resulted from employment
of additional staff. The remainder of the increase in research and development
expenses was attributable to increases in consulting expenses to develop
enhancements to the Company's product lines, primarily the Company's ACE/Server
software and toolkit products and due to a general increase in investment in new
computer equipment resulting in higher depreciation charges and maintenance
fees. These increases in expenses were offset in part the absence of purchased
technology in 1996.
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Research and development expenses increased 71% in the first nine months of 1996
to $7,113 from $4,166 in the first nine months of 1995, and increased as a
percentage of revenue to 13.5% from 13.4%. Approximately 51% of the increase in
research and development expenses in the first nine months of 1996 resulted from
employment of additional staff and approximately 25% of the increase was
attributable to increases in consulting expenses and subcontract labor to
develop enhancements to the Company's product lines, primarily the Company's
ACE/Server software and toolkit products. Research and development expenses also
increased due to continuing investment in new computer equipment resulting in
higher depreciation charges and maintenance fees. These increases in expenses
were offset by lower charges for purchased technology.
In the third quarter of 1995, the Company recorded a non-recurring expense of
$648 for purchased research and development associated with the acquisition of
SecurADM technology.
MARKETING AND SELLING
Marketing and selling expenses consist principally of salaries, commissions and
travel expenses of direct sales and marketing personnel and costs associated
with marketing programs.
Marketing and selling expenses increased 66% in the third quarter of 1996 to
$5,331 from $3,218 in the third quarter of 1995, and increased as a percentage
of revenue to 26.2% from 22.7%. Approximately 51% of the increase in marketing
and selling expenses was attributable to the employment of additional staff.
Approximately 19% of the increase in marketing and selling expenses was
attributable to an increase in sales commissions on products sold by the
Company's sales force as a result of an increase in revenue. Approximately 8% of
the increase in marketing and selling expenses resulted from an increase in
travel expenses. General occupancy costs and recruitment expenses primarily
account for the balance of the increase in the marketing and selling expenses.
Marketing and selling expenses increased 62% in the first nine months of 1996 to
$14,913 from $9,236 in the first nine months of 1995, but decreased as a
percentage of revenue to 28.4% from 29.7%. Approximately 43% of the increase in
marketing and selling expenses was attributable to the employment of additional
staff. Approximately 19% of the increase in marketing and selling expenses was
attributable to the increase in sales commissions on products sold by the
Company's sales force and as a result of increase in revenue. Approximately 13%
of the increase in marketing and selling expenses resulted from an increase in
travel expenses relating to the Company's general marketing programs. General
occupancy costs and recruitment expenses primarily account for the balance of
the increase in the marketing and selling expenses.
International sales expenses increased in the third quarter and nine months
ended September 30, 1996 due to the continuing expansion of the Company's United
Kingdom, German, French and Pacific/Asian sales operations and the opening of a
sales office in Norway in January, 1996.
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GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of personnel costs for
administration, finance, human resources and general management as well as legal
and auditing expenses.
General and administrative expenses increased 19% in the third quarter of 1996
to $2,662, or 13.1% of revenue, from $2,243, or 15.9% of revenue, in the third
quarter of 1995. Approximately 31% of the increase in general and administrative
expenses was due to an increase in the Company's use of subcontract labor needed
to support increased levels of operation. Approximately 30% of the increase was
attributable to increased recruitment costs. Increases in general occupancy
costs accounted for substantially all of the remaining increase in general and
administrative expenses.
General and administrative expenses increased 33% in the first nine months of
1996 to $8,280, or 15.7% of revenue, from $6,220, or 20.0% of revenue, in the
first nine months of 1995. Approximately 40% of the increase in general and
administrative expenses was due to the growth in the Company's staff needed to
support increased levels of operation. Approximately 15% of the increase was
attributable to charges related to the Company's relocation of its Corporate
headquarters. Subcontract labor, travel and employment recruitment accounted for
approximately 11%, 11% and 10%, respectively, of the increase in general and
administrative expenses while increases in general occupancy costs accounted for
substantially all of the remaining increase in general and administrative
expenses.
MERGER EXPENSES
During the third quarter of 1996 the Company incurred a charge of $6,100 for
Merger expenses in connection with the acquisition of RSA, which was completed
during the quarter. See Note 5 of Notes to Condensed Consolidated Financial
Statements.
INTEREST INCOME
Interest income consists of interest earned on the Company's cash balances and
marketable securities.
Interest income increased 198% in the third quarter of 1996 to $1,127 from $378
in the third quarter of 1995. Interest income increased 226% in the first nine
months of 1996 to $3,610 from $1,108 in the first nine months of 1995. These
increases were due to higher average daily balances of invested cash resulting
from the Company's follow-on public offering in November 1995.
GAIN ON SALE OF MARKETABLE SECURITIES
During the third quarter of 1996 the Company realized a gain of $4,546 upon the
sale of some of its marketable securities.
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PROVISION FOR INCOME TAXES
The provision for income taxes increased to $3,540 during the third quarter of
1996 from $314 in the third quarter of 1995, and the provision for income taxes
increased to $6,530 in the first nine months of 1996 from $1,943 in the first
nine months of 1995. These increases were primarily the result of higher income
and higher effective tax rates during the third quarter and nine months ended
September 30, 1996.
The Company's estimated effective tax rate increased to 86.5% and 53.8% in the
third quarter and first nine months of 1996 respectively, from 6.4% and 28.2% in
the third quarter and first nine months of 1995 respectively. The increases in
the effective tax rates were caused principally by the non-deductability of
expenses associated with the acquisition of RSA in the three months and nine
months ended September 30, 1996 and a change in valuation allowances in the
three months ended September 30, 1995.
Excluding merger expenses, the effective tax rate during the period ended
September 30, 1996 was 36.5%
Cash payments for income taxes amounted to approximately $5,044 and $5,003 in
the nine months ended September 30, 1996 and 1995, respectively.
NET INCOME
As a result of the above factors, net income in the third quarter of 1996
decreased to $551, or 2.7% of revenue, from $4,558, or 32.2% of revenue, in the
third quarter of 1995. Net income in the first nine months of 1996 increased to
$5,604, or 10.6% of revenue, from $4,935, or 15.9% of revenue, in the first nine
months of 1995.
ACCOUNTING FOR CERTAIN STOCK OPTIONS
See Note 4 of Notes to Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
In December 1994, the Company sold 6,000,000 shares of Common Stock in its
initial public offering which generated $21,600 of net cash proceeds to the
Company. In January 1995, the Company sold 1,020,000 shares of Common Stock
under the terms of an over-allotment option granted to the underwriters as part
of the initial public offering, generating an additional $3,800 in net cash
proceeds. In November 1995, the Company sold an additional 3,120,000 shares of
Common Stock in its follow-on offering, which generated $55,900 of net cash
proceeds to the Company.
At September 30, 1996, the Company had cash and marketable securities of
$103,375 and working capital of $100,709. Since 1990, the Company has funded its
operations primarily from cash generated from its operating activities. During
1995 and 1996, the Company used the cash
14
<PAGE> 15
provided by operations principally for working capital needs and property and
equipment additions necessary to support the Company's growth.
The Company's capital expenditures for the third quarter and first nine months
of 1996 were $4,552 and $7,182, respectively. Capital expenditures for the third
quarter and first nine months of 1996 related primarily to additional leasehold
improvements, office furniture and equipment, as well as computer equipment for
product development, testing and support to accommodate the Company's continued
growth as a result of the Company's move to its new corporate headquarters.
On July 26, 1996, the Company acquired RSA, a Redwood City, California vendor of
encryption software. Merger costs in connection with the acquisition were
approximately $6,100. See Note 5 of Notes to Condensed Consolidated Financial
Statements.
In March 1996, the Company entered into a noncancelable operating lease expiring
in 2006 for it's new corporate executive offices in Bedford, Massachusetts. The
Company commenced its tenancy in August 1996. The new facility consists of
approximately 75,000 square feet of office space, and the annual base rent for
the first year is $956, increasing annually up to $1,180 from years five through
ten.
In December 1994, the Company entered into an agreement with Progress Software
for the right to use certain of its software to enhance the functionality of the
Company's ACE/Server software. The Company began incurring royalties under the
Progress Software agreement in the fourth quarter of 1995 and, in order to
obtain favorable pricing, pre-paid $1,500 during the first quarter of 1996. The
Company is currently renegotiating the contract. It is currently anticipated
that a revised contract will be entered into during the fourth quarter of 1996.
The Company intends to seek acquisitions of businesses, products and
technologies that are complementary to those of the Company. The Company is
continuing to identify and prioritize additional security technologies which it
may wish to develop, either internally or through the licensing or acquisition
of products from third parties. While the Company engages from time to time in
discussions with respect to potential acquisitions, there can be no assurances
that any such acquisitions will be made or that the Company will be able to
successfully integrate any acquired business. In order to finance such
acquisitions, it may be necessary for the Company to raise additional funds
through public or private financings. Any equity or debt financings, if
available at all, may be on terms which are not favorable to the Company and, in
the case of equity financings, may result in dilution to the Company's
stockholders.
The Company believes that the net proceeds from its initial public and follow-on
offerings, together with cash flows from operations and existing cash balances,
will be sufficient to meet its cash requirements through at least 1998.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.
15
<PAGE> 16
A number of uncertainties exist that could affect the Company's future operating
results, including, without limitation, general economic conditions, the
Company's continued ability to develop and introduce products, the introduction
of new products by competitors, pricing practices of competitors, expansion of
its sales distribution capability, the cost and availability of components and
the Company's ability to control costs.
The Company's success is dependent in part on its ability to complete its
integration of the operations of RSA in an efficient and effective manner. The
successful combination of the Company and RSA in a rapidly changing high
technology industry may be more difficult to accomplish than in other
industries. The combination of the two companies will require, among other
things, integration of the companies' respective product offerings and
coordination of their sales and marketing and research and development efforts.
There can be no assurance that such integration will be accomplished smoothly or
successfully. The difficulties of such integration may be increased by the
necessity of coordinating geographically separated organizations. The
integration of certain operations will require the dedication of management
resources which may temporarily distract attention from the day-to-day business
of the combined company. The inability of management to successfully integrate
the operations of the two companies could have a material adverse effect on the
business and results of operations of the Company.
The Company's success is highly dependent on its ability to enhance its existing
products and to develop and introduce new products in a timely manner. If the
Company were to fail to introduce new products on a timely basis, the Company's
operating results could be adversely affected. To date, substantially all of the
Company's revenues have been attributable to sales of its computer and network
security products and related services, all of which are currently used with the
Company's SecurID token technology and the licensing of toolkits and patent
technology. As a result, any factor adversely affecting sales of these products
and services could have a material adverse effect on the Company's financial
condition and results of operations.
Certain components of the Company's products are currently purchased from sole
or limited sources and any interruption in the supply of such components could
adversely affect the Company's operating results.
The Company's quarterly operating results may vary significantly depending on a
number of factors, including the timing of the introduction or enhancement of
products by the Company or its competitors, the sizes, timing and shipment of
individual orders, market acceptance of new products, changes in the Company's
operating expenses, personnel changes, mix of products sold, changes in product
pricing, development of the Company's direct and indirect distribution channels
and general economic conditions.
International sales have represented a significant portion of the Company's
sales. The international business and financial performance of the Company may
be affected by fluctuations in foreign exchange rates, difficulties in managing
accounts receivable, tariff regulations and difficulties in obtaining export
licenses.
16
<PAGE> 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The ActivCard Settlement. In December 1995, the Company, together with
co-plaintiff Vasco Data Security, Inc. ("Vasco"), filed suit in the U.S.
District Court for the Northern District of California against ActivCard, Inc.
and ActivCard S.A. (together, "ActivCard") alleging infringement of certain
patents of the Company and Vasco that collectively cover a range of technology
used to secure data access. The suit sought monetary damages and an injunction
against further infringement. In February 1996, in response to the Company's
repeated infringement allegations and prior to the serving of the Company's
complaint on ActivCard, ActivCard filed a complaint against the Company in the
same court seeking a declaratory judgement of non-infringement, invalidity and
unenforceability of the Company's patents asserted in the suit brought with
Vasco.
In October 1996, Vasco, the Company and ActivCard entered into a
settlement agreement with respect to this litigation. Pursuant to the terms of
the settlement agreement, the Company and Vasco agreed to dismiss with prejudice
their claims against ActivCard and ActivCard similarly agreed to dismiss with
prejudice its claims against the Company and Vasco. In connection with this
settlement, ActivCard agreed to license certain patents from the Company and
Vasco.
The Arbitration. In April 1994, Cylink Corp. and its subsidiary
Caro-Kann Corporation (together, "Cylink") served a demand for arbitration on
RSA alleging that it had or was entitled to an unrestricted license to a patent
licensed exclusively by the Massachusetts Institute of Technology ("MIT") to RSA
(the "RSA/MIT Patent"). In response, in May 1994 RSA filed a counter demand in
the arbitration and filed a lawsuit in Santa Clara Superior Court contesting
certain aspects of the demand. Cylink filed a petition to compel arbitration in
response and the state court granted such a petition.
The MIT Action. In June 1994, Cylink filed an action in the U.S.
District Court for the Northern District of California seeking declaratory
relief that the RSA/MIT Patent is invalid and/or unenforceable. RSA
counterclaimed for infringement of the RSA/MIT Patent, Lanham Act violations and
various business torts.
The Schlafly Action. In July 1994, RSA was named co-defendant with
Public Key Partners ("PKP") in an action filed by an individual, Roger Schlafly,
in the U.S. District Court for the Northern District of California. In this
action Mr Schlafly contests the validity of the RSA/MIT Patent and other patents
sublicensed by MIT to RSA (the "Stanford Patents"); alleges causes of action for
non-infringement, interference with contractual business relationships, unfair
business practices, antitrust, libel and fraud; and seeks injunctive relief and
damages in excess of $2 million. To date the actions for libel, fraud and
interference with contractual business relationships have been resolved in RSA's
favor, either through actions for dismissal or through summary judgment. Cylink
intervened in this action in late 1995.
17
<PAGE> 18
The Stanford Action. Following a September 6, 1995 order in the
Arbitration, Cylink claimed that (i) RSA did not have sufficient rights to grant
RSA's customers the right to make copies of software incorporating the Stanford
Patented Technology and (ii) the Arbitration order required that RSA's OEM
customers obtain an additional license from Cylink. On September 15, 1995, RSA
filed an action in the U.S. District Court for the Northern District of
California seeking an adjudication that RSA's OEM customers do not require any
additional license. RSA requested that the court determine that: (a) RSA's
license under the Stanford Patents allows customers to make copies incorporating
the Stanford Patented Technology; (b) one or more of the Stanford Patents are
invalid; and / or (c) RSA's software does not infringe the Stanford Patents.
Cylink has counterclaimed alleging causes of action against RSA for
contributory infringement and inducing infringement of the Stanford Patents, as
well as various business torts. On May 17, 1996, the Court issued an order
allowing Cylink to file a first supplemental counterclaim containing the
additional allegation that RSA's Stanford Patent License has been canceled. The
trial in this action is scheduled to begin on February 3, 1997.
The Schnorr Action. RSA has entered into an agreement whereby it is the
exclusive agent for licensing a cryptographic patent held by Dr. Claus P.
Schnorr. In November 1995, Cylink field an action in the U.S. District Court for
the District of Columbia seeking a declaratory judgement of patent
non-infringement to the effect that Cylink's product practicing the federal
Digital Signature Standard does not infringe the Schnorr patent. By agreement
with Dr. Schnorr RSA is defending this action.
18
<PAGE> 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
At a Special Meeting of Stockholders of the Company (the "Special
Meeting") held on July 26, 1996, the following matters were acted upon by the
stockholders of the Company:
1. The approval of the issuance of up to 8,000,000 shares of the
Company's Common Stock in order to effect the proposed acquisition of RSA; and
2. The approval of an amendment to the Company's Third Restated
Certificate of Incorporation increasing the authorized number of shares of
Common Stock from 30,000,000 to 80,000,000 shares.
The number of shares of Common Stock outstanding and entitled to vote
at the Special Meeting was 27,313,520, and 23,145,318 shares were represented in
person or by proxy. The results of the voting on each of the matters presented
to stockholders at the Special Meeting are set forth below:
<TABLE>
<CAPTION>
Votes Votes Broker
For Against Abstentions Non-Votes
--- ------- ----------- ---------
<S> <C> <C> <C> <C>
1. Share Issuance in connection
with RSA Acquisition 20,771,822 5,766 2,962 2,364,768
2. Amendment to Third Restated
Certificate of Incorporation 21,195,176 1,945,480 4,662 0
</TABLE>
19
<PAGE> 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
(a) Exhibits - The Exhibits listed in the Exhibit Index immediately
preceding such Exhibits are filed as part of this Quarterly Report on Form 10-Q.
b) Reports on Form 8-K:
On July 30 and August 6, 1996, the Company filed a Current Report on
Form 8-K, dated July 26, 1996 (the "Effective Date"), and an Amendment No. 1 on
Form 8-K/A, respectively, announcing under Item 2 (Acquisition or Disposition of
Assets) that the Company completed its acquisition of RSA pursuant to an
Agreement and Plan of Merger, dated as of April 14, 1996 (the "Merger
Agreement"), among the Company, RSA and Card-Key Inc., a wholly-owned subsidiary
of the Company (the "Merger Subsidiary").
Pursuant to the Merger Agreement, the Merger Subsidiary was merged with
and into RSA on the Effective Date, whereupon RSA became a wholly-owned
subsidiary of the Company. The amendment to Current Report on Form 8-K
incorporated by reference the Consolidated Financial Statements of RSA and Pro
Forma Financial Information of SDI and RSA contained in the Company's
Registration Statement on Form S-4 (File No. 333-7265).
20
<PAGE> 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SECURITY DYNAMICS TECHNOLOGIES, INC.
Dated: November 13, 1996 /s/ Arthur W. Coviello, Jr.
-------------------------------------------
Arthur W. Coviello, Jr.
Executive Vice President,
Treasurer and Chief Financial Officer
(Principal Financial and Accounting Officer)
21
<PAGE> 22
EXHIBIT INDEX
ITEM DESCRIPTION
11 Computation of Income (Loss) Per Common Share.
18 Letter regarding change in accounting principle.
27 Financial Data Schedule.
22
--
<PAGE> 1
EXHIBIT 11
<TABLE>
UNAUDITED UNAUDITED
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<CAPTION>
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY
Weighted average number of common and
common equivalent shares outstanding:
Common stock 34,108 30,026 33,936 29,742
Common stock equivalent shares
resulting from stock options
(treasury stock method) 2,484 2,360 2,542 2,292
------- ------- ------- -------
Total 36,592 32,386 36,478 32,034
======= ======= ======= =======
Net income $ 551 $ 4,558 $ 5,604 $ 4,935
======= ======= ======= =======
Net income per common and common equivalent share $ 0.02 $ 0.14 $ 0.15 $ 0.15
======= ======= ======= =======
FULLY DILUTED
Weighted average number of common and
common equivalent shares outstanding:
Common stock 34,108 30,026 33,936 29,743
Common stock equivalent shares
resulting from stock options
(treasury stock method) 2,484 2,360 2,542 2,292
------- ------- ------- -------
Total 36,604 32,426 36,506 32,034
======= ======= ======= =======
Net income $ 551 $ 4,558 $ 5,604 $ 4,935
======= ======= ======= =======
Net income per common and common equivalent share $ 0.02 $ 0.14 $ 0.15 $ 0.15
======= ======= ======= =======
</TABLE>
<PAGE> 1
EXHIBIT 18
August 13, 1996
The Board of Directors
Security Dynamics Technologies, Inc.
20 Crosby Drive
Bedford, Massachusetts
Dear Sirs:
At your request, we have read the description included in your Quarterly Report
on Form 10-Q to the Securities and Exchange Commission for the quarter ended
June 30, 1996, of the facts relating to Security Dynamics Technologies, Inc.'s
(the "Company") change, effective April 1, 1996, in its accounting policy for
option grants to purchase the Company's common stock requiring stockholder
approval to measure compensation expense on the approval date. We believe, on
the basis of the facts so set forth and other information furnished to us by
appropriate officials of the Company, that the accounting change described in
your Form 10-Q is to an alternative accounting principle that is preferable
under the circumstances.
We have not audited any consolidated financial statements of the Company and its
consolidated subsidiaries as of any date for any period subsequent to December
31, 1995. Therefore, we are unable to express an opinion on the facts set forth
in the above-mentioned Form 10-Q, on the related information furnished to us by
officials of the Company, or on the financial position, results of operations,
or cash flows of the Company and its consolidated subsidiaries as of any date or
for any period subsequent to December 31, 1995.
Yours truly,
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000932064
<NAME> SECURITY DYNAMICS TECHNOLOGIES, INC.
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 7,332
<SECURITIES> 96,043
<RECEIVABLES> 12,760
<ALLOWANCES> 488
<INVENTORY> 2,717
<CURRENT-ASSETS> 120,597
<PP&E> 11,353
<DEPRECIATION> 2,908
<TOTAL-ASSETS> 132,064
<CURRENT-LIABILITIES> 19,888
<BONDS> 0
<COMMON> 342
0
0
<OTHER-SE> 95,995
<TOTAL-LIABILITY-AND-EQUITY> 112,118
<SALES> 52,645
<TOTAL-REVENUES> 52,645
<CGS> 12,261
<TOTAL-COSTS> 48,667
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 104
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 12,134
<INCOME-TAX> 6,530
<INCOME-CONTINUING> 12,134
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,134
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.15
</TABLE>
