<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earliest Event Reported): December 16, 1997
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Security Dynamics Technologies, Inc.
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(Exact Name of Registrant as Specified in its Charter)
Delaware
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(State or Other Jurisdiction of Incorporation)
0-25120 04-2916506
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(Commission File Number) (I.R.S. Employer Identification No.)
20 Crosby Drive
Bedford, Massachusetts 01730
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(Address of Principal Executive Offices) (Zip Code)
(781) 687-7000
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(Registrant's Telephone Number, Including Area Code)
Not Applicable
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(Former Name or Former Address, if Changed Since Last Report)
<PAGE> 2
ITEM 5. OTHER EVENTS.
On July 15, 1997, Security Dynamics Technologies, Inc. (the "Company")
acquired DynaSoft AB, a corporation organized under the laws of Sweden
("DynaSoft"), pursuant to Stock Purchase Agreements, dated as of July 12 and 15,
1997, by and among the Company, DynaSoft and the stockholders of DynaSoft (the
"DynaSoft Acquisition").
The Company's Selected Consolidated Financial Data, Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Consolidated Financial Statements, which are filed as Exhibits 99.1, 99.2 and
99.3, respectively, to this Current Report on Form 8-K and are incorporated
herein by reference, have been prepared accounting for the DynaSoft Acquisition
using the pooling-of-interests method of accounting.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) EXHIBITS.
23.1 Consent of Deloitte & Touche LLP.
23.2 Consent of Ernst & Young LLP, independent auditors.
99.1 Selected Consolidated Financial Data.
99.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations.
99.3 Consolidated Financial Statements of Security Dynamics
Technologies, Inc. as of December 31, 1995 and 1996 and
June 30, 1996 (unaudited) and for the years ended December
31, 1994, 1995 and 1996 and the six months ended June 30,
1996 and 1997 (unaudited) and Reports of Independent
Accountants thereon.
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<PAGE> 3
SIGNATURE
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 hereunto duly authorized.
Date: December 16, 1997 SECURITY DYNAMICS TECHNOLOGIES, INC.
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(Registrant)
By: /s/ Marian G. O'Leary
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Marian G. O'Leary
Senior Vice President, Finance,
Chief Financial Officer and Treasurer
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<PAGE> 4
EXHIBIT INDEX
Exhibit
Number Description
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23.1 Consent of Deloitte & Touche LLP.
23.2 Consent of Ernst & Young LLP, independent auditors.
99.1 Selected Consolidated Financial Data.
99.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations.
99.3 Consolidated Financial Statements of Security Dynamics
Technologies, Inc. as of December 31, 1995 and 1996 and
June 30, 1996 (unaudited) and for the years ended December
31, 1994, 1995 and 1996 and the six months ended June 30,
1996 and 1997 (unaudited) and Reports of Independent
Accountants thereon.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors and Stockholders of
Security Dynamics Technologies, Inc. and Subsidiaries:
We consent to incorporation by reference in Registration Statements Nos.
33-87916, 33-88506, 33-88508, 33-88510, 33-08939 and 333-31793 of Security
Dynamics Technologies, Inc. (the "Company") on Forms S-8 of our report dated
November 14, 1997 (which report expresses an unqualified opinion and includes
explanatory paragraphs referring to the restatement of the consolidated
financial statements for a pooling of interests and a change in the Company's
method of accounting for option grants requiring stockholder approval in 1996),
appearing as Exhibit 99.3 to Item 7.(c) in this Current Report on Form 8-K of
Security Dynamics Technologies, Inc.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
December 16, 1997
<PAGE> 1
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the use of our report dated April 8, 1996 with respect to the
consolidated financial statements of RSA Data Security, Inc. (not presented
separately herein) in the Current Report (Form 8-K) of Security Dynamics
Technologies, Inc.
We also consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 33-87916, 33-88506, 33-88508, 33-88510, 333-08939
and 333-31793) pertaining to the 1986 Stock Option Plan, the 1994 Stock Option
Plan, the 1994 Employee Stock Purchase Plan, the 1994 Director Stock Option
Plan, the Amended 1994 Stock Option Plan and the Amended 1994 Stock Option Plan
and the Securix, Inc. 1996 Stock Option Plan and the Registration Statement on
Form S-3 (No. 333-34241) for the registration of 396,387 shares of the common
stock of Security Dynamics Technologies, Inc. of our report dated April 8, 1996
referred to in the preceding paragraph.
/s/ Ernst & Young LLP
Palo Alto, California
December 15, 1997
<PAGE> 1
EXHIBIT 99.1
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's Consolidated Financial Statements
included as Exhibits 99.2 and 99.3, respectively, to this Current Report on
Form 8-K and the Company's Quarterly Reports on Form 10-Q for the quarters ended
March 31, 1997, June 30, 1997 and September 30, 1997.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
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1992 1993 1994 1995 1996 1996 1997
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.............................. $12,574 $16,590 $23,866 $49,412 $83,817 $36,111 $61,374
Cost of revenue...................... 2,987 3,707 4,837 8,920 18,207 7,451 13,147
------- ------- ------- ------- ------- ------- -------
Gross profit....................... 9,587 12,883 19,029 40,492 65,610 28,660 48,227
Costs and expenses:
Research and development........... 2,658 2,817 4,314 6,292 12,382 5,533 8,646
Purchased research and
development...................... -- -- -- 648 1,000 -- --
Marketing and selling.............. 4,437 5,506 8,931 14,263 24,429 10,824 18,770
General and administrative......... 1,672 2,208 3,368 10,375 13,403 6,061 7,609
Merger expenses.................... -- -- -- -- 6,100 -- --
------- ------- ------- ------- ------- ------- -------
Total....................... 8,767 10,531 16,613 31,578 57,314 22,418 35,025
------- ------- ------- ------- ------- ------- -------
Income from operations............... 820 2,352 2,416 8,914 8,296 6,242 13,202
Interest income and other............ 185 90 166 1,843 5,004 2,500 2,717
Gain on sale of marketable securities
and other income (expense)......... 253 73 99 62 10,872 (141) 197
------- ------- ------- ------- ------- ------- -------
Income before provision for income
taxes, extraordinary item and
cumulative effect of change in
accounting......................... 1,258 2,515 2,681 10,819 24,172 8,601 16,116
Provision for income taxes(1)........ 505 908 1,453 3,369 10,997 3,147 6,040
------- ------- ------- ------- ------- ------- -------
Income before extraordinary item and
cumulative effect of change in
accounting(1)...................... 753 1,607 1,228 7,450 13,175 5,454 10,076
Extraordinary item................... 407 -- -- -- -- -- --
Cumulative effect of change in
accounting(1)...................... -- 564 -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Net income........................... $ 1,160 $ 2,171 $ 1,228 $ 7,450 $13,175 $ 5,454 $10,076
======= ======= ======= ======= ======= ======= =======
Per share data(2):
Income before cumulative effect of
change in accounting............. $ 0.06 $ 0.05 $ 0.22 $ 0.34 $ 0.14 $ 0.26
Cumulative effect of change in
accounting....................... 0.03 -- -- -- -- --
------- ------- ------- ------- ------- -------
Net income......................... $ 0.09 $ 0.05 $ 0.22 $ 0.34 $ 0.14 $ 0.26
======= ======= ======= ======= ======= =======
Weighted average number of common and
common equivalent shares
outstanding(2)..................... 25,015 25,231 34,115 38,877 38,398 39,418
======= ======= ======= ======= ======= =======
</TABLE>
<PAGE> 2
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
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1992 1993 1994 1995 1996 1997
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(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................... $ 3,894 $ 3,860 $27,828 $112,367 $106,495 $110,753
Working capital............................ 4,791 6,070 29,007 104,349 109,202 119,658
Total assets............................... 9,109 11,511 37,691 128,659 145,975 157,068
Redeemable convertible preferred stock..... 9,016 8,527 -- -- -- --
Stockholders' equity (deficiency).......... (2,796) (2,001) 29,660 109,026 124,178 134,539
</TABLE>
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(1) Effective January 1, 1993, the Company adopted, prospectively, the
provisions of Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." See Note 6 of Notes to the Company's
Consolidated Financial Statements included as Exhibit 99.3 to this Current
Report on Form 8-K.
(2) Per share and share data for years prior to 1995 are presented on a pro
forma basis. See Note 1 of Notes to the Company's Consolidated Financial
Statements included as Exhibit 99.3 to this Current Report on Form 8-K.
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<PAGE> 1
EXHIBIT 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Security Dynamics Technologies, Inc. (the "Company") is the leading
provider of enterprise network and data security solutions. The Company was
founded in 1984, began shipping its SecurID tokens and Access Control Module
("ACM") hardware products in 1986, and introduced its first ACM software
products for minicomputers and mainframe computers in 1988. Prior to 1986, the
Company was primarily engaged in research and development activities. In
December 1991, the Company introduced its ACE/Server software products for
enterprise information protection using client/server architecture. The Company
believes that its growth has historically been driven by the emergence of local
and wide area networks and a corresponding increase in users with direct access
to core enterprise systems and confidential data. The Company also believes that
the number of users with such direct access is increasing because of the growth
of the Internet and corporate intranets and extranets.
On July 26, 1996, the Company completed a merger (the "RSA Merger") with
RSA Data Security, Inc. ("RSA") and on July 15, 1997, the Company completed the
acquisition (the "DynaSoft Acquisition") of DynaSoft AB ("DynaSoft"). The RSA
Merger and the DynaSoft Acquisition have each been accounted for as a pooling of
interests in the Company's historical consolidated financial statements. All
financial information included in the discussion which follows has been restated
to include the results of RSA and DynaSoft for all periods presented. See the
Company's Consolidated Financial Statements and the Notes thereto included as
Exhibit 99.3 to this Current Report on Form 8-K.
RSA, located in Redwood City, California, is a recognized leader in
cryptography and develops, markets and supports cryptographic data security
products and provides cryptographic consulting services. Products are licensed
to OEMs that incorporate the technology into their products. Developer toolkits
and other products are used to implement cryptographic data security
applications such as electronic mail, communications privacy, client/server data
security, smart cards and other key information technologies.
DynaSoft is based in Stockholm, Sweden and offers a range of software
security solutions, including secure single sign-on solutions, through its BoKS
product family. DynaSoft markets its products worldwide through subsidiaries and
also through OEM licensing agreements with Sun Microsystems, Inc.,
Hewlett-Packard Company and other companies.
The Company's revenue is derived primarily from sales of SecurID tokens;
licensing of ACE/Server, BoKS and SecurPC software; licensing of BSAFE, TIPEM,
BCERT, S/PAY and S/MAIL encryption engines; licensing of patents; and revenues
from maintenance and professional services. Historically, the Company's growth
has been attributable to sales to new customers as well as to existing
customers. Sales to existing customers include sales of SecurID tokens and
ACE/Server software for use by different branches or divisions, sales of
replacement tokens (which are programmed at the request of the customer to
operate for a fixed period of up to four years) and sales of additional tokens
for use by vendors, suppliers, customers and clients of the Company's customers.
Sales to existing ACE/Server and BoKS customers are typically associated with an
increase in the number of users authorized under a license, and the sales of
additional functionality that can be added to the customer installation.
ACE/Server and BoKS software license fee prices are typically based on the
number of users authorized under a license. Sales to existing customers also
include revenue associated with amendments to encryption engine and patent
licensing agreements, usually in order to accommodate licensing of new software
or technology to the customer, to increase the field of use rights of the
customer, or both. Encryption engine software licensing terms vary by product,
and are typically composed of both initial fees plus ongoing royalties paid as a
percentage of the OEM's product or service revenues. Sales of ACM hardware and
software products have been decreasing relative to sales of ACE/Server software
for several years due to increased
<PAGE> 2
emphasis by the Company on sales to customers with larger security needs better
met by client/server software solutions such as ACE/Server software. The Company
believes that this trend will continue.
The Company's direct sales to customers in countries outside of the United
States are denominated in the local currency. As a result, fluctuations in
currency exchange rates could affect the profitability in U.S. dollars of the
Company's products sold in these markets. See Note 9 of Notes to the Company's
Consolidated Financial Statements included as Exhibit 99.3 to this Current
Report on Form 8-K.
The Company's cost of revenue consists primarily of costs associated with
the manufacture and delivery of SecurID tokens and hardware products. The
Company utilizes assembly contractors for most manufacturing. Cost of revenue
also includes royalty fees incurred on the sale of ACE/Server software, royalty
fees payable on the licensing of patent technology and royalties payable under
certain OEM agreements. Cost of revenue includes 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. In
the future, gross profit may be affected by several factors, including changes
in product mix and distribution channels, price reductions (resulting from
volume discounts or otherwise), competition, increases in the cost of revenue
(including any software license fees or royalties payable by the Company) and
other factors.
Operating expenses are incurred for research and development, marketing and
selling and general and administrative activities. Research and development
expenses consist primarily of personnel costs as well as fees for development
services provided by consultants. From time to time the Company has also
purchased, and expensed, research and development technology. Marketing and
selling expenses consist primarily of salaries, commissions and travel expenses
of direct sales and marketing personnel and marketing program expenses. General
and administrative expenses consist primarily of personnel costs for
administration, finance, human resources, general management and legal and
accounting fees.
Interest and other income consists primarily of interest earned on the
Company's cash balances and marketable securities.
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<PAGE> 3
RESULTS OF OPERATIONS
The following table sets forth certain consolidated financial data as a
percentage of revenue for the years ended December 31, 1994, 1995 and 1996 and
the six months ended June 30, 1996 and 1997:
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED JUNE 30,
------------------------- ---------------
1994 1995 1996 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenue......................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue................................. 20.3 18.1 21.7 20.6 21.4
----- ----- ----- ----- -----
Gross profit.................................. 79.7 81.9 78.3 79.4 78.6
Costs and expenses:
Research and development...................... 18.1 12.7 14.8 15.3 14.1
Purchased research and development............ -- 1.3 1.2 -- --
Marketing and selling......................... 37.4 28.9 29.1 30.0 30.6
General and administrative.................... 14.1 21.0 16.0 16.8 12.4
Merger expenses............................... -- -- 7.3 -- --
----- ----- ----- ----- -----
Total...................................... 69.6 63.9 68.4 62.1 57.1
----- ----- ----- ----- -----
Income from operations.......................... 10.1 18.0 9.9 17.3 21.5
Interest income and other....................... 0.7 3.7 5.9 6.9 4.4
Gain on sale of marketable securities and other
income (expense).............................. 0.4 0.2 13.0 (0.4) 0.3
----- ----- ----- ----- -----
Income before provision for income taxes........ 11.2 21.9 28.8 23.8 26.2
Provision for income taxes...................... 6.1 6.8 13.1 8.7 9.8
----- ----- ----- ----- -----
Net income...................................... 5.1% 15.1% 15.7% 15.1% 16.4%
===== ===== ===== ===== =====
</TABLE>
Six Months Ended June 30, 1997 Compared With Six Months Ended June 30, 1996
Revenue. Total revenue increased 70.0% in the first six months of 1997 to
$61.4 million from $36.1 million in the first six months of 1996. This increase
in revenue reflected increases in unit sales of all of the Company's products,
except ACM/400 and ACM/1600 hardware products. During the first six months of
1997, approximately 42% of the increase in revenue was attributable to increased
sales of SecurID tokens, approximately 26% of the increase was attributable to
increased sales of encryption engine licenses and approximately 17% of the
increase was attributable to increased sales of ACE/Server software licenses.
The balance of the increase in revenue primarily resulted from sales of BoKS
software licenses, patent licenses and maintenance revenue, offset by decreased
hardware revenue. The Company believes that the overall increase in sales was
attributable in part to growth of the information security market, with
increased use of the Internet and corporate intranets and extranets continuing
to play significant roles in developing new opportunities for the Company.
International revenue (excluding Canada) increased 83.0% in the first six
months of 1997 to $15.7 million from $8.6 million in the first six months of
1996. International revenue accounted for 25.6% and 23.7% of total revenue in
the first six months of 1997 and 1996, respectively. The 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.
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<PAGE> 4
Cost of Revenue and Gross Profit. The Company's gross profit increased
68.3% in the first six months of 1997 to $48.2 million, from $28.7 million in
the first six months of 1996, and remained relatively constant as a percentage
of revenue at 78.6% in 1997 compared to 79.4% in 1996. Approximately 40% of the
increase in gross profit during the first six months of 1997 was attributable to
increased unit sales of SecurID tokens, approximately 30% to increased licensing
sales of encryption engine technology, approximately 19% to increased licensing
sales of ACE/Server software and approximately 4% to sales of BoKS software
products. In addition, gross profit increased due to increased patent licensing
sales, royalties and maintenance revenue, offset by reduced sales of ACM/400 and
ACM/1600 hardware products.
Research and Development. Research and development expenses increased
56.3% in the first six months of 1997 to $8.6 million from $5.5 million in the
first six months of 1996. Research and development expenses decreased as a
percentage of revenue in the first six months of 1997 to 14.1% from 15.3% in the
first six months of 1996. During the first six months of 1997, approximately 82%
of the increase in research and development expenses resulted from an increase
in payroll costs associated with the employment of additional staff. The
remainder of the increase in research and development was attributable to
purchases of computer equipment, resulting in higher depreciation charges,
occupancy expenses and consulting expenses.
Marketing and Selling. Marketing and selling expenses increased 73.4% in
the first six months of 1997 to $18.8 million from $10.8 million in the first
six months of 1996. Marketing and selling expenses increased as a percentage of
revenue in the first six months of 1997 to 30.6% from 30.0% in the first six
months of 1996. During the first six months of 1997, approximately 42% of the
increase in marketing and selling expenses resulted from an increase in payroll
costs associated with the employment of additional staff, approximately 11% of
the increase was attributable to sales commissions on increased revenues, and
approximately 16% of the increase resulted from increased travel expenses and
marketing program expenses.
General and Administrative. General and administrative expenses increased
25.5% in the first six months of 1997 to $7.6 million, from $6.1 million in the
first six months of 1996, but decreased as a percentage of revenue to 12.4% in
1997 compared to 16.8% in 1996. The increase in general and administrative
expenses was due to the employment of additional staff offset by reduced legal
expenses. Legal expenses decreased approximately $1.3 million from the first six
months of 1996 compared to the first six months of 1997 due to the settlement of
certain of the Company's legal proceedings in 1996.
Interest Income and Other. Interest income increased 8.7% in the first six
months of 1997 to $2.7 million from $2.5 million in the first six months of 1996
due to interest earned on higher cash and marketable securities balances.
Provision for Income Taxes. The provision for income taxes increased to
$6.0 million during the first six months of 1997 from $3.1 million in the first
six months of 1996 due to higher pre-tax income and a higher effective tax rate
during the first six months of 1997. The Company's estimated effective tax rate
increased to 37.5% in the first half of 1997 from 36.6% in the first half of
1996 due to higher tax rates associated with certain foreign income, which
increased relative to domestic income.
Net Income. As a result of the above factors, net income in the first six
months of 1997 increased to $10.1 million, or 16.4% of revenue, from $5.5
million, or 15.1% of revenue, in the first six months of 1996.
1996 Compared With 1995
Revenue. Total revenue increased 69.6% in 1996 to $83.8 million from $49.4
million in 1995. This increase in revenue reflected increases in unit sales and
licensed use of substantially all of the Company's products. Approximately 42%,
22% and 11% of the increase in revenue was attributable
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<PAGE> 5
to the increases in unit sales of SecurID tokens, the increase in unit sales of
ACE/Server software licenses and the issuance of additional encryption engine
and patent licenses, respectively.
International revenue (excluding Canada) increased 114.0% in 1996 to $19.7
million from $9.2 million in 1995 and accounted for 23.5% and 18.6% of total
revenue in 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.
Cost of Revenue and Gross Profit. The Company's gross profit increased
62.0% in 1996 to $65.6 million, or 78.3% of revenue, from $40.5 million, or
81.9% of revenue, in 1995. Approximately 46% of the increase in gross profit was
attributable to an increase in the unit sales and gross margin from the sale of
SecurID tokens. Approximately 26% of the increase in gross profit was
attributable to increased sales of ACE/Server software licenses. Approximately
9% of the increase in gross profit was attributable to increased sales of patent
and encryption engine licenses. Overall, gross margins were lower due primarily
to the higher royalty costs associated with the ACE/Server software and patent
license products and additional investment in the Company's customer support
infrastructure.
In December 1994, the Company entered into an agreement with Progress
Software Corporation ("Progress Software"), a vendor of commercial database
software, for the right to use certain of Progress Software's software to
enhance the functionality of the Company's ACE/Server software. The Company
began incurring royalties, which are charged to cost of revenue, under the
Progress Software agreement upon the commercial introduction of ACE/Server
software version 2.0 in October 1995. These royalties have decreased gross
margins.
Research and Development. Research and development expenses increased
96.8% in 1996 to $12.4 million from $6.3 million in 1995, and increased as a
percentage of revenue to 14.8% in 1996 from 12.7% in 1995. Approximately 54% of
the increase in research and development expenses resulted from an increase in
compensation costs associated primarily with the employment of additional staff.
Approximately 15% of the increase in research and development expenses in 1996
was related to general overhead costs. Approximately 9% of the increase was
attributable to increases in consulting services contracted to develop
enhancements to the Company's ACE/Server software line.
Purchased Research and Development. During the fourth quarter of 1996, the
Company purchased, and recorded as purchased research and development expense,
technology from Worldtalk Corporation for $1.0 million. The technology was
incorporated into the Company's S/MAIL developer kit, a standards-based secure
messaging solution for third-party software developers designed to provide a
secure messaging infrastructure based on the S/MIME protocol.
During 1995, the Company purchased, and recorded as purchased research and
development expense, SecurADM technology for $0.6 million. The technology was
incorporated into products designed to provide secure single sign-on capability
in heterogeneous networked data processing environments.
Marketing and Selling. Marketing and selling expenses increased 71.3% in
1996 to $24.4 million from $14.3 million in 1995, and increased as a percentage
of revenue to 29.1% in 1996 from 28.9% in 1995. Approximately 36% of the
increase in marketing and selling expenses was due to an increase in payroll
costs associated primarily with the employment of additional direct sales and
marketing personnel. Approximately 16% of the increase in marketing and selling
expenses was attributable to the increase in commissions on products sold by the
Company's direct sales force. Approximately 15% of the increase in marketing and
selling expenses was due to an increase in travel-related costs and marketing
programs, such as direct mail and seminar activities, trade shows and public
relations campaigns. Approximately 12% of the increase in marketing and selling
expenses in 1996 was related to general overhead costs.
-5-
<PAGE> 6
During 1996, international sales expenses increased due to the continued
development of the Company's sales offices in Europe and Asia.
General and Administrative. General and administrative expenses increased
29.2% in 1996 to $13.4 million, or 16.0% of revenue, from $10.4 million, or
21.0% of revenue, in 1995. Approximately 29% of the increase was due to an
increase in payroll and recruitment costs associated primarily with the growth
in the Company's staff needed to support the continuing expansion of operations.
Approximately 17% of the increase in general and administrative expense was from
an increase in consulting and temporary administrative services. In addition,
approximately 10% of the increase in general and administrative expenses
consisted of moving costs incurred in relocating to the Company's new corporate
offices.
Merger Expenses. Merger expenses incurred in connection with the RSA
Merger were $6.1 million in the third quarter of 1996. See Note 2 of Notes to
the Company's Consolidated Financial Statements included as Exhibit 99.3 to this
Current Report on Form 8-K.
Interest Income and Other. Interest income increased to $5.0 million in
1996 from $1.8 million in 1995. This increase was due primarily to higher
average daily balances in invested cash resulting from the Company's follow-on
public offering in November 1995.
Gain on Sale of Marketable Securities. The Company realized a gain of
approximately $11.0 million in 1996 on the sale of marketable securities.
Provision for Income Taxes. The provision for income taxes increased to
$11.0 million in 1996 from $3.4 million in 1995. This increase was primarily the
result of higher pre-tax income during 1996. The Company's effective tax rate
increased to 45.5% in 1996 from 31.1% in 1995. The increase in the effective tax
rate was caused principally by the non-deductibility of certain RSA Merger
expenses in the third quarter of 1996. For the year ended December 31, 1995, the
valuation allowance was reduced by approximately $0.9 million, which resulted in
a decrease in the provision for income taxes for 1995. See Notes 1 and 6 of
Notes to the Company's Consolidated Financial Statements included as Exhibit
99.3 to this Current Report on Form 8-K.
Net Income. As a result of the above factors, net income in 1996 increased
to $13.2 million, or 15.7% of revenue, from $7.5 million, or 15.1% of revenue,
in 1995.
1995 Compared With 1994
Revenue. Total revenue increased 107.0% in 1995 to $49.4 million from
$23.9 million in 1994. This increase in revenue reflected increases in unit
sales of all of the Company's products except the ACM/1600 hardware product.
Approximately 39%, 32% and 22% of the increase in revenue was attributable to
the increases in unit sales of SecurID tokens, encryption engine and patent
licenses and sales of ACE/Server software licenses, respectively, offset by a
decrease in unit sales of ACM/1600 hardware products.
International revenue (excluding Canada) increased 74.0% in 1995 to $9.2
million from $5.3 million in 1994 and accounted for 18.6% and 22.2% of total
revenue in 1995 and 1994, respectively. This increase in international revenue
was primarily attributable to expansion of the Company's direct sales force and
increased market acceptance of the Company's products.
Cost of Revenue and Gross Profit. The Company's gross profit increased
112.8% in 1995 to $40.5 million, or 81.9% of revenue, from $19.0 million, or
79.7% of revenue, in 1994. Approximately 36% of the increase in gross profit was
attributable to an increase in the unit sales of SecurID tokens. Approximately
36% of the increase in gross profit was attributable to an increase in the
number of patent and encryption engine licenses sold. Approximately 25% of the
increase in gross profit was attributable to an increase in the number of
ACE/Server software licenses sold. These factors, which contributed to an
improvement in the gross margin in 1995, were partially offset by ongoing
-6-
<PAGE> 7
increases in production costs associated with quality management programs and
continued increases in customer support costs in Europe.
Research and Development. Research and development expenses increased
45.9% in 1995 to $6.3 million from $4.3 million in 1994, but decreased as a
percentage of revenue to 12.7% in 1995 from 18.1% in 1994. Approximately 69% of
the increase in research and development expenses resulted from an increase in
payroll costs associated primarily with the employment of additional staff.
Approximately 20% of the increase was attributable to increases in consulting
expenses to develop enhancements to the Company's product lines, primarily the
Company's ACE/Server software and encryption engine product lines.
Purchased Research and Development. During 1995, the Company purchased,
and recorded as purchased research and development expense, SecurADM technology
for $0.6 million. The technology was incorporated into products designed to
provide secure single sign-on capability in heterogeneous networked data
processing environments.
Marketing and Selling. Marketing and selling expenses increased 59.7% in
1995 to $14.3 million from $8.9 million in 1994, but decreased as a percentage
of revenue to 28.9% in 1995 from 37.4% in 1994. Approximately 36% of the
increase in marketing and selling expenses was due to an increase in payroll
costs associated primarily with the employment of additional direct sales and
marketing personnel. Approximately 27% of the increase in marketing and selling
expenses was attributable to the increase in commissions on products sold by the
Company's direct sales force. Approximately 14% of the increase in marketing and
selling expenses was due to an increase in marketing programs, such as direct
mail and seminar activities, trade shows and public relations campaigns.
During 1995, international sales expenses increased due to the continued
development of the Company's United Kingdom, German, French and Swedish sales
offices and the opening of the Company's office in Singapore.
General and Administrative. General and administrative expenses increased
208.0% in 1995 to $10.4 million, or 21.0% of revenue, from $3.4 million, or
14.1% of revenue, in 1994. Approximately 52% of the increase in general and
administrative expenses was attributable to increases in legal costs and also
accounting and investor relations expenses resulting from the additional costs
incurred in connection with being a public company. Approximately 29% of the
increase was due to increases in executive compensation and to increased payroll
expenses associated with the growth in the Company's staff to support increased
operations.
Interest Income and Other. Interest income increased to $1.8 million in
1995 from $0.2 million in 1994. This increase was due primarily to higher
average daily balances in invested cash resulting from the Company's initial
public offering in December 1994 and its follow-on public offering in November
1995.
Provision for Income Taxes. The provision for income taxes increased to
$3.4 million in 1995 from $1.5 million in 1994. This increase was primarily the
result of higher pre-tax income during 1995. The Company's effective tax rate
decreased to 31.1% in 1995 from 54.2% in 1994. The decrease in the effective tax
rate resulted primarily from the change in the recorded valuation allowance and
a decrease in state taxes. For 1995, the valuation allowance was reduced by
approximately $0.9 million and for 1994 the valuation allowance was increased by
approximately $0.3 million. See Notes 1 and 6 of Notes to the Company's
Consolidated Financial Statements included as Exhibit 99.3 to this Current
Report on Form 8-K.
Net Income. As a result of the above factors, net income in 1995 increased
to $7.5 million, or 15.1% of revenue, from $1.2 million, or 5.1% of revenue, in
1994.
-7-
<PAGE> 8
QUARTERLY OPERATING RESULTS
The following table sets forth unaudited quarterly results of operations of
the Company for each of the quarters in the years ended December 31, 1995 and
1996 and the six months ended June 30, 1997. The Company believes that this
information has been prepared on the same basis as the Company's audited
Consolidated Financial Statements and that all necessary adjustments,
consisting only of normal recurring adjustments, have been included in the
amounts stated below to present fairly, in accordance with generally accepted
accounting principles, the quarterly information when read in conjunction with
the Company's audited Consolidated Financial Statements and the Notes thereto
included as Exhibit 99.3 to this Current Report on Form 8-K. The quarterly
operating results are not necessarily indicative of future results of
operations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1995 1995 1995 1995 1996 1996 1996 1996 1997 1997
-------- -------- --------- -------- -------- -------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue............ $7,387 $11,698 $14,849 $15,478 $16,290 $19,821 $21,143 $26,563 $28,419 $32,955
Cost of revenue.... 1,373 2,111 2,357 3,079 3,671 3,780 5,283 5,473 6,417 6,730
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Gross
profit..... 6,014 9,587 12,492 12,399 12,619 16,041 15,860 21,090 22,002 26,225
Costs and expenses:
Research and
development..... 1,348 1,595 1,509 1,840 2,342 3,191 3,134 3,715 3,848 4,798
Purchased research
and
development..... -- -- 648 -- -- -- -- 1,000 -- --
Marketing and
selling......... 3,084 3,445 3,495 4,239 5,004 5,820 5,988 7,617 8,669 10,101
General and
administrative... 1,629 2,650 2,307 3,789 2,901 3,160 3,208 4,134 3,389 4,220
Merger expenses... -- -- -- -- -- -- 6,100 -- -- --
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Total....... 6,061 7,690 7,959 9,868 10,247 12,171 18,430 16,466 15,906 19,119
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Income (loss) from
operations........ (47) 1,897 4,533 2,531 2,372 3,870 (2,570) 4,624 6,096 7,106
Interest income and
other............. 396 447 379 621 1,274 1,226 1,119 1,385 1,271 1,446
Gain on sale of
marketable
securities and
other income
(expense)......... 86 (157) 46 87 1 (142) 4,553 6,460 (25) 222
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Income before
provision for
income taxes...... 435 2,187 4,958 3,239 3,647 4,954 3,102 12,469 7,342 8,774
Provision for
income taxes...... 667 1,134 338 1,230 1,304 1,843 3,284 4,566 2,781 3,259
------ ------- ------- ------- ------- ------- ------- ------- ------- -------
Net income
(loss)............ $ (232) $ 1,053 $ 4,620 $ 2,009 $ 2,343 $ 3,111 $ (182) $ 7,903 $ 4,561 $ 5,515
====== ======= ======= ======= ======= ======= ======= ======= ======= =======
Net income (loss)
per equivalent
share............. $ (0.01) $ 0.03 $ 0.14 $ 0.06 $ 0.06 $ 0.08 $ (0.00) $ 0.20 $ 0.12 $ 0.14
====== ======= ======= ======= ======= ======= ======= ======= ======= =======
Weighted average
number of common
and common
equivalent shares
outstanding....... 32,411 33,699 33,951 35,445 37,777 39,039 39,168 39,563 39,299 39,527
====== ======= ======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
-8-
<PAGE> 9
The following table sets forth consolidated financial data as a percentage
of revenue for each of the quarters in the years ended December 31, 1995 and
1996 and the six months ended June 30, 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-------------------------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1995 1995 1995 1995 1996 1996 1996 1996 1997 1997
-------- -------- --------- -------- -------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenue.... 18.6 18.0 15.9 19.9 22.5 19.1 25.0 20.6 22.6 20.4
--- --- --- --- --- --- --- --- --- ---
Gross
profit..... 81.4 82.0 84.1 80.1 77.5 80.9 75.0 79.4 77.4 79.6
Costs and expenses:
Research and
development..... 18.2 13.6 10.2 11.9 14.4 16.1 14.8 14.0 13.5 14.6
Purchased research
and
development..... -- -- 4.4 -- -- -- -- 3.8 -- --
Marketing and
selling......... 41.7 29.4 23.5 27.4 30.7 29.4 28.3 28.6 30.5 30.6
General and
administrative... 22.1 22.7 15.5 24.5 17.8 15.9 15.2 15.6 12.0 12.8
Merger expenses... -- -- -- -- -- -- 28.9 -- -- --
--- --- --- --- --- --- --- --- --- ---
Total....... 82.0 65.7 53.6 63.8 62.9 61.4 87.2 62.0 56.0 58.0
--- --- --- --- --- --- --- --- --- ---
Income (loss) from
operations........ (0.6) 16.3 30.5 16.3 14.6 19.5 (12.2) 17.4 21.4 21.6
Interest income and
other............. 5.4 3.8 2.6 4.0 7.8 6.2 5.3 5.2 4.5 4.4
Gain on sale of
marketable
securities and
other income
(expense)......... 1.1 (1.3) 0.3 0.6 -- (0.7) 21.5 24.3 (0.1) 0.6
--- --- --- --- --- --- --- --- --- ---
Income before
provision for
income taxes...... 5.9 18.8 33.4 20.9 22.4 25.0 14.6 46.9 25.8 26.6
Provision for
income taxes...... 9.0 9.7 2.3 7.9 8.0 9.3 15.5 17.2 9.8 9.9
--- --- --- --- --- --- --- --- --- ---
Net income
(loss)............ (3.1)% 9.1% 31.1% 13.0% 14.4% 15.7% (0.9)% 29.7% 16.0% 16.7%
=== === === === === === === === === ===
</TABLE>
The Company's total revenue and operating results have varied substantially
from quarter to quarter and should not be relied upon as an indication of future
results. Quarterly revenue and operating results can be difficult to forecast
because the Company's sales cycle can be relatively long and depends on factors
such as the size and timing of individual transactions, changes in customer
budget authorizations, the level of research and development expenditures and
general economic conditions. The Company has historically allowed customers to
place large order commitments to secure volume price discounts with deliveries
specified at a later time, typically within a 12-month period. As a result, it
is difficult to forecast when the customer will request delivery of these
orders. Gross profit levels are affected by sales volume and mix, and gross
margins are different for SecurID tokens, software licenses, patent licenses and
maintenance and professional services.
The Company's revenue has increased in each of the quarters in the period
January 1, 1995 to June 30, 1997. Future revenue, however, may not increase on a
quarterly basis or may not increase at the same rate in comparison to prior
quarters. The Company has experienced, and expects to continue to experience,
significant seasonality in its business, and the Company's financial condition
or results of operations may be affected by such trends in the future. Revenue
has historically increased at higher rates in the last quarter of the year and
at lower rates in the next succeeding quarter. The Company believes that revenue
tends to increase at higher rates in the last quarter due to the Company's
quota-based compensation policies, year-end budgetary pressures on the Company's
customers and the tendency of certain of the Company's customers to implement
changes in enterprise network or data security prior to the end of the calendar
year. In addition, revenue tends to increase at lower rates in the summer
months, particularly in Europe, when businesses defer purchase decisions.
Because the Company's operating expenses are based on anticipated revenue levels
and a high percentage of the Company's expenses are fixed, a small variation in
the time of recognition of revenue can cause significant variations in operating
results from quarter to quarter.
-9-
<PAGE> 10
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1997, the Company had cash and marketable securities of $110.8
million and working capital of $119.7 million. The Company has historically
funded its operations primarily from cash generated from its operating
activities. During 1996 and 1997, the Company used the cash provided by
operations principally for working capital needs and to finance certain costs in
connection with the RSA Merger. The Company believes that working capital will
be sufficient to meet its anticipated cash requirements through at least 1998.
On July 15, 1997, the Company acquired approximately 95% of the outstanding
shares and certain of the outstanding options to acquire shares of DynaSoft in
exchange for approximately 2.7 million shares of the Company's Common Stock. The
Company also paid approximately $6.0 million in cash to certain stockholders of
DynaSoft in exchange for the remaining outstanding shares and options. The
DynaSoft Acquisition costs recognized during the quarter ended September 30,
1997 were approximately $7.0 million. On July 26, 1996, a wholly owned
subsidiary of the Company acquired RSA. The RSA Merger costs were approximately
$6.1 million. The RSA Merger and the DynaSoft Acquisition have each been
accounted for as a pooling of interests in the Company's historical consolidated
financial statements. See Note 2 of Notes to the Company's Consolidated
Financial Statements included as Exhibit 99.3 to this Current Report on
Form 8-K.
In December 1994, the Company sold 6,000,000 shares of Common Stock in its
initial public offering, which generated $21.6 million 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 $3.8 million in net
cash proceeds. In November 1995, the Company sold an additional 3,120,000 shares
of Common Stock in a follow-on offering, which generated $55.9 million of net
cash proceeds to the Company. In October 1997, the Company sold an additional
1,626,000 shares of Common Stock in a follow-on offering, which generated
approximately $60.8 million of net cash proceeds to the Company.
In October 1997, the Company purchased 175,285 Ordinary Shares of nCipher
Corporation Limited ("nCipher") for an aggregate purchase price of $502,000.
nCipher is a company organized under the laws of England and Wales that develops
products designed to accelerate cryptographic processes in Internet security,
electronic commerce and other applications. The Company's investment in nCipher
represents a minority interest of less than 5% of nCipher's capitalization.
In August 1997, the Company purchased 877,193 Series C Preferred Shares of
Finjan Software Ltd. ("Finjan") for an aggregate purchase price of $1.0 million.
Finjan is an Israeli software company organized to develop and market products
for the Java Internet security market. The Company's investment in Finjan
represents a minority interest of less than 5% of Finjan's capitalization.
In December 1996, the Company purchased 250,000 shares of Series B
Preferred Stock of VPNet Technologies, Inc. ("VPNet") of San Jose, California,
for an aggregate purchase price of $1.5 million. VPNet was organized to develop
and market products and technologies for implementing high-performance virtual
private networks. The Company's investment in VPNet represents a minority
interest of less than 10% of VPNet's capitalization.
On April 17, 1995 and February 20, 1996, the Company purchased 425,000
shares of Series A and 72,091 shares of Series B Convertible Preferred Stock,
respectively, of VeriSign, Inc. ("VeriSign") of Redwood City, California for an
aggregate purchase price of $687,000. VeriSign was organized to provide digital
certificates and related services that use public-key cryptography to ensure
essential privacy and authentication features. During 1995, RSA granted certain
rights and privileges in certain technology to VeriSign in connection with
VeriSign's incorporation and received 4,000,000 shares of VeriSign common stock.
The Company's voting interest in VeriSign was approximately 44%, 24% and 24% at
December 31, 1995 and 1996 and June 30, 1997, respectively.
-10-
<PAGE> 11
Two of the companies in which the Company has equity positions had initial
public offerings in 1996. The Company now considers these investments to be
available for sale marketable securities and the investment cost of $737,000 is
classified with marketable securities at June 30, 1997. See Note 1 of Notes to
the Company's Consolidated Financial Statements included as Exhibit 99.3 to this
Current Report on Form 8-K.
The Company's capital expenditures for the first six months of 1997 were
$4.0 million and were for 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. The Company generated
$1.7 million of cash from the exercise of stock options and generated $1.4
million of cash from the sale of minority interests in RSA's Japan subsidiary in
the first six months of 1997. The Company expended approximately $3.2 million
for purchased research and development during the quarter ended September 30,
1997.
In March 1996, the Company entered into a noncancelable operating lease
expiring in 2006 for corporate executive offices in Bedford, Massachusetts. The
Company commenced its tenancy in August 1996. The facility consists of
approximately 75,000 square feet of office space, and the annual base rent for
the first year is $956,000 increasing annually up to $1.2 million for years five
through ten. In June 1997, the Company entered into a noncancelable operating
lease expiring in 2006 for additional facilities in Bedford, Massachusetts. The
Company commenced its tenancy in August 1997. The new facility consists of
approximately 32,000 square feet of office space, and the annual base rent for
the first four years is $599,000, increasing up to $662,000 for years five
through ten.
In September 1997, the Company announced its SecurMessage email security
solution, which incorporates technology from Worldtalk Corporation ("Worldtalk")
and VeriSign for securing already-deployed enterprise email and groupware
applications. In connection therewith, in September 1997, the Company entered
into an agreement with Worldtalk pursuant to which the Company paid to Worldtalk
in October 1997 a one-time prepaid, nonrefundable license fee of $3.0 million in
order to obtain favorable pricing.
In November 1996, the Company amended its agreement with Progress Software
for the right to use certain of its software to enhance the functionality of the
Company's ACE/Server software. In order to obtain favorable pricing the Company
pre-paid $1.5 million and $1.25 million during the first and fourth quarters of
1996, respectively, and pre-paid $2.5 million during the first quarter of 1997.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share,"
which is required to be adopted in the fourth quarter of 1997. At that time, the
Company will be required to change the method currently used to compute earnings
per share and to restate all prior periods. SFAS 128 supersedes Accounting
Principles Board Opinion No. 15 and is intended to simplify the computation of
earnings per share and to make the U.S. computations more comparable with
international computations. See Note 1 of Notes to the Company's Consolidated
Financial Statements included as Exhibit 99.3 to this Current Report on
Form 8-K.
-11-
<PAGE> 12
In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards Nos. 130 and 131, "Reporting Comprehensive
Income" and "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 130" and "SFAS 131," respectively). The Company will be
required to adopt the provisions of these statements in fiscal 1998. SFAS 130
provides standards for reporting items considered to be "comprehensive income"
and uses the term "other comprehensive income" to refer to revenues, expenses,
gains and losses that are included in comprehensive income under generally
accepted accounting principles but excluded from net income. Currently the only
items presented in the Company's consolidated financial statements that would be
considered other comprehensive income as defined in SFAS 130 are the unrealized
gains and losses on marketable securities and cumulative translation
adjustments, which are recorded as components of stockholders' equity. SFAS 131
establishes new standards for reporting information about operating segments.
The Company believes the segment information required to be disclosed under SFAS
131 will be more comprehensive than previously provided, including expanded
disclosure of income statement and balance sheet items for each reportable
operating segment. The Company has not yet completed its analysis of which
operating segments it will report on. The Company believes that the provisions
of SFAS 130 will not, when adopted, have a material impact on the Company's
financial statements.
ACCOUNTING FOR CERTAIN STOCK OPTIONS
On October 18, 1995, January 24, 1996, April 1, 1996 and April 24, 1996,
the Company's Board of Directors or the Compensation Committee of the Company's
Board of Directors granted stock options to employees to purchase 32,000,
605,600, 200,000 and 38,900 shares of the Company's Common Stock at exercise
prices of $14.25, $24.76, $24.30 and $38.20, respectively, subject to
stockholder approval (obtained on May 22, 1996) of an increase in the number of
shares available for grant. The exercise prices represented the fair market
value on the dates of grant. As permitted by Statement of Financial Accounting
Standard No. 123, which became effective on January 1, 1996, the Company has
elected to continue to apply the intrinsic value method of Accounting Principles
Board Opinion No. 25 for stock-based compensation to employees.
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 is effective for options
granted on or after April 1, 1996. This change resulted in an aggregate
compensation expense of approximately $4.5 million 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 approximately $0.7
million in 1996.
-12-
<PAGE> 1
EXHIBIT 99.3
SECURITY DYNAMICS TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Deloitte & Touche LLP, independent auditors................................. F-2
Report of Ernst & Young LLP, independent auditors..................................... F-3
Consolidated Balance Sheets as of December 31, 1995 and 1996 and
(Unaudited) June 30, 1997........................................................... F-4
Consolidated Statements of Income for the Years Ended December 31, 1994,
1995 and 1996 and (Unaudited) the Six Months Ended June 30, 1996 and 1997........... F-5
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1994, 1995 and 1996 and (Unaudited) the Six Months Ended June 30,
1997................................................................................ F-6
Consolidated Statements of Cash Flows for the Years Ended December 31,
1994, 1995 and 1996 and (Unaudited) the Six Months Ended June 30, 1996 and 1997..... F-7
Notes to Consolidated Financial Statements............................... F-8
</TABLE>
F-1
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Security Dynamics Technologies, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Security
Dynamics Technologies, Inc. (the "Company") and subsidiaries as of December 31,
1995 and 1996, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. The consolidated financial
statements give retroactive effect to the merger of the Company and RSA Data
Security, Inc., which has been accounted for as a pooling of interests as
described in Note 2 of notes to the supplemental consolidated financial
statements. We did not audit the consolidated balance sheet of RSA Data
Security, Inc. as of December 31, 1995, or the related consolidated statements
of income, stockholders' equity, and cash flows of RSA Data Security, Inc. for
the years ended December 31, 1994 and 1995, which consolidated statements
reflect total assets of $24,793,000 as of December 31, 1995, and total revenues
of $3,077,000 and $11,600,000 for the years ended December 31, 1994 and 1995,
respectively. Those consolidated statements were audited by other auditors
whose report has been furnished to us, and our opinion, insofar as it relates
to the amounts included for RSA Data Security, Inc. for 1994 and 1995, is based
solely on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Security Dynamics Technologies,
Inc. and subsidiaries as of December 31, 1995 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1996 in conformity with generally accepted accounting
principles.
As discussed in Note 2 of the notes to the consolidated financial
statements, the historical consolidated financial statements have been restated
to give effect to the acquisition of Dynasoft AB on July 15, 1997, which has
been accounted for as a pooling of interests.
As discussed in Note 5 of the notes to the consolidated financial
statements, in 1996 the Company changed its method of accounting for option
grants requiring stockholder approval in 1996.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
November 14, 1997
F-2
<PAGE> 3
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors
RSA Data Security, Inc.
We have audited the consolidated balance sheet of RSA Data Security, Inc.
as of December 31, 1995, and the related statements of operations, shareholders'
equity and cash flows for the years ended December 31, 1995 and 1994 (none of
which are presented separately herein). These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our 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 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of RSA Data
Security, Inc. as of December 31, 1995, and the consolidated results of its
operations and its cash flows for the years ended December 31, 1995 and 1994 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
April 8, 1996
F-3
<PAGE> 4
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1995 1996 1997
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents.......................................... $ 50,730 $ 11,175 $ 24,316
Marketable securities......................................... 61,637 95,320 86,437
Accounts receivable (less allowance for doubtful accounts of
$724 in 1995, $527 in 1996 and $802 in 1997)................ 8,633 16,500 19,519
Inventory..................................................... 1,445 2,606 3,189
Prepaid expenses and other.................................... 1,537 4,204 6,069
Deferred taxes................................................ -- -- 79
-------- -------- --------
TOTAL CURRENT ASSETS................................... 123,982 129,805 139,609
-------- -------- --------
PROPERTY AND EQUIPMENT
Customer support equipment.................................... 187 294 294
Office furniture and equipment................................ 4,147 11,007 14,562
Leasehold improvements........................................ 309 2,863 3,179
-------- -------- --------
TOTAL PROPERTY AND EQUIPMENT........................... 4,643 14,164 18,035
Less accumulated depreciation and amortization................ (1,998) (3,596) (5,151)
-------- -------- --------
PROPERTY AND EQUIPMENT -- NET.......................... 2,645 10,568 12,884
-------- -------- --------
OTHER ASSETS:
Investments................................................... 872 2,924 2,187
Purchased technology and capitalized software costs -- net.... 446 197 247
Deferred taxes................................................ 414 1,026 1,026
Other......................................................... 300 1,455 1,115
-------- -------- --------
TOTAL OTHER ASSETS..................................... 2,032 5,602 4,575
-------- -------- --------
TOTAL........................................................... $128,659 $145,975 $ 157,068
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.............................................. $ 2,860 $ 5,119 $ 4,481
Accrued payroll and related benefits.......................... 3,187 4,829 5,520
Accrued expenses and other.................................... 2,618 4,269 5,098
Income taxes payable.......................................... 349 51 --
Deferred revenue.............................................. 4,520 5,503 4,852
Deferred taxes................................................ 6,099 832 --
-------- -------- --------
TOTAL CURRENT LIABILITIES.............................. 19,633 20,603 19,951
-------- -------- --------
MINORITY INTERESTS.............................................. -- 1,194 2,578
-------- -------- --------
COMMITMENTS AND CONTINGENCIES (NOTES 8 AND 10)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized, 80,000,000 shares;
issued, 35,137,771, 37,220,893 and 37,903,889 shares in
1995, 1996 and 1997; outstanding, 35,137,475, 37,220,597,
and 37,903,380 shares in 1995, 1996 and 1997................ 351 372 379
Additional paid-in capital.................................... 94,452 102,322 104,607
Retained earnings............................................. 4,510 17,685 27,761
Deferred stock compensation................................... (292) (174) (141)
Treasury stock, common, at cost, 296 shares in 1995 and 1996,
509 shares in 1997.......................................... -- -- --
Cumulative translation adjustment............................. 95 493 (194)
Unrealized gain on marketable securities -- net............... 9,910 3,480 2,127
-------- -------- --------
TOTAL STOCKHOLDERS' EQUITY............................. 109,026 124,178 134,539
-------- -------- --------
TOTAL........................................................... $128,659 $145,975 $ 157,068
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 5
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
--------------------------------- -------------------
1994 1995 1996 1996 1997
--------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE............................ $ 23,866 $49,412 $83,817 $36,111 $61,374
COST OF REVENUE.................... 4,837 8,920 18,207 7,451 13,147
------- ------- ------- ------- -------
GROSS PROFIT....................... 19,029 40,492 65,610 28,660 48,227
COSTS AND EXPENSES:
Research and development......... 4,314 6,292 12,382 5,533 8,646
Purchased research and
development................... -- 648 1,000 -- --
Marketing and selling............ 8,931 14,263 24,429 10,824 18,770
General and administrative....... 3,368 10,375 13,403 6,061 7,609
Merger expenses.................. -- -- 6,100 -- --
------- ------- ------- ------- -------
Total.................... 16,613 31,578 57,314 22,418 35,025
------- ------- ------- ------- -------
INCOME FROM OPERATIONS............. 2,416 8,914 8,296 6,242 13,202
Interest income and other.......... 166 1,843 5,004 2,500 2,717
Gain on sale of marketable
securities and other income
(expense)........................ 99 62 10,872 (141) 197
------- ------- ------- ------- -------
Income before provision for income
taxes............................ 2,681 10,819 24,172 8,601 16,116
Provision for income taxes......... 1,453 3,369 10,997 3,147 6,040
------- ------- ------- ------- -------
NET INCOME......................... $ 1,228 $ 7,450 $13,175 $ 5,454 $10,076
======= ======= ======= ======= =======
Pro Forma
Net income per common and common
equivalent share................. $ 0.05 $ 0.22 $ 0.34 $ 0.14 $ 0.26
======= ======= ======= ======= =======
Weighted average number of common
and common equivalent shares
outstanding...................... 25,231 34,115 38,877 38,398 39,418
======= ======= ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 6
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED DEFERRED TREASURY STOCK CUMULATIVE
------------------- PAID-IN EARNINGS STOCK ---------------- TRANSLATION
SHARES AMOUNT CAPITAL (DEFICIT) COMPENSATION SHARES AMOUNT ADJUSTMENT
---------- ------ ---------- -------- ------------ ------- ------ ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1994............. 11,831,489 $118 $ 1,778 $(3,750) $ -- 90,296 $ (1) $ (146)
Common and Treasury stock
issued for services............... 52,032 -- 21 -- -- (90,000) 1 --
Exercise of stock options........... 152,376 1 41 -- -- -- -- --
Deferred stock compensation......... -- -- 360 -- (360) -- -- --
Amortization of deferred stock
compensation...................... -- -- -- -- 85 -- -- --
Issuance of common stock............ 6,276,854 63 22,041 -- -- -- -- --
Translation adjustment.............. -- -- -- -- -- -- -- (347)
Dividends accrued on preferred
stock............................. -- -- -- (418) -- -- -- --
Conversion of preferred stock to
common stock...................... 11,288,756 113 8,832 -- -- -- -- --
Net income.......................... -- -- -- 1,228 -- -- -- --
---------- ---- -------- ------- ----- ------- --- -----
Balance, December 31, 1994.......... 29,601,507 295 33,073 (2,940) (275) 296 -- (493)
Exercise of stock options........... 957,434 10 632 -- -- -- -- --
Tax benefit arising from exercise
of stock options.................. -- -- 225 -- -- -- -- --
Deferred stock compensation......... -- -- 157 -- (157) -- -- --
Amortization of deferred stock
compensation...................... -- -- -- -- 140 -- -- --
Issuance of common stock............ 4,578,830 46 60,365 -- -- -- -- --
Translation adjustment.............. -- -- -- -- -- -- -- 588
Change in unrealized gain on
marketable securities............. -- -- -- -- -- -- -- --
Net income.......................... -- -- -- 7,450 -- -- -- --
---------- ---- -------- ------- ----- ------- --- -----
Balance, December 31, 1995........... 35,137,771 351 94,452 4,510 (292) 296 -- 95
Exercise of stock options........... 817,123 8 2,598 -- -- -- -- --
Tax benefit arising from exercise
of stock options.................. -- -- 3,702 -- -- -- -- --
Compensation expense................ -- -- 1,049 -- -- -- -- --
Amortization of deferred stock
compensation...................... -- -- -- -- 118 -- -- --
Issuance of common stock............ 1,265,999 13 521 -- -- -- -- --
Translation adjustment.............. -- -- -- -- -- -- -- 398
Change in unrealized gain on
marketable securities............. -- -- -- -- -- -- -- --
Net income.......................... -- -- -- 13,175 -- -- -- --
---------- ---- -------- ------- ----- ------- --- -----
Balance, December 31, 1996........... 37,220,893 372 102,322 17,685 (174) 296 -- 493
Unaudited:
Settlement of RSA escrow.......... (36,037) -- -- -- -- 213 -- --
Exercise of stock options......... 719,033 7 1,697 -- -- -- -- --
Compensation expense.............. -- -- 588 -- -- -- -- --
Amortization of deferred stock
compensation.................... -- -- -- -- 33 -- -- --
Translation adjustment............ -- -- -- -- -- -- -- (687)
Change in unrealized gain
on marketable securities........ -- -- -- -- -- -- -- --
Net income........................ -- -- -- 10,076 -- -- -- --
---------- ---- -------- ------- ----- ------- --- -----
Balance, June 30, 1997 (unaudited)... 37,903,889 $379 $104,607 $27,761 $ (141) 509 $ -- $ (194)
========== ==== ======== ======= ===== ======= === =====
<CAPTION>
UNREALIZED
GAIN ON STOCKHOLDERS'
MARKETABLE EQUITY
SECURITIES (DEFICIENCY)
---------- -------------
<S> <<C> <C>
Balance, January 1, 1994............. $ -- $ (2,001)
Common and Treasury stock
issued for services............... -- 22
Exercise of stock options........... -- 42
Deferred stock compensation......... -- --
Amortization of deferred stock
compensation...................... -- 85
Issuance of common stock............ -- 22,104
Translation adjustment.............. -- (347)
Dividends accrued on preferred
stock............................. -- (418)
Conversion of preferred stock to
common stock...................... -- 8,945
Net income.......................... -- 1,228
------- --------
Balance, December 31, 1994.......... -- 29,660
Exercise of stock options........... -- 642
Tax benefit arising from exercise
of stock options.................. -- 225
Deferred stock compensation......... -- --
Amortization of deferred stock
compensation...................... -- 140
Issuance of common stock............ -- 60,411
Translation adjustment.............. -- 588
Change in unrealized gain on
marketable securities............. 9,910 9,910
Net income.......................... -- 7,450
------- --------
Balance, December 31, 1995........... 9,910 109,026
Exercise of stock options........... -- 2,606
Tax benefit arising from exercise
of stock options.................. -- 3,702
Compensation expense................ -- 1,049
Amortization of deferred stock
compensation...................... -- 118
Issuance of common stock............ -- 534
Translation adjustment.............. -- 398
Change in unrealized gain on
marketable securities............. (6,430) (6,430)
Net income.......................... -- 13,175
------- --------
Balance, December 31, 1996........... 3,480 124,178
Unaudited:
Settlement of RSA escrow.......... -- --
Exercise of stock options......... -- 1,704
Compensation expense.............. -- 588
Amortization of deferred stock
compensation.................... -- 33
Translation adjustment............ -- (687)
Change in unrealized gain
on marketable securities........ (1,353) (1,353)
Net income........................ -- 10,076
------- --------
Balance, June 30, 1997 (unaudited)... $ 2,127 $ 134,539
======= ========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 7
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEARS ENDED DECEMBER 31, 30,
--------------------------------- ---------------------
1994 1995 1996 1996 1997
------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................. $ 1,228 $ 7,450 $ 13,175 $ 5,454 $ 10,076
Adjustments to reconcile net income to
net cash provided by (used for)
operating activities:
Gain on sale of marketable
securities......................... -- -- (11,027) -- --
Deferred taxes........................ 57 (746) (1,548) (50) 224
Purchased research and development.... -- 648 1,000 -- --
Depreciation and amortization......... 633 1,085 1,815 845 1,465
Provision for notes receivable........ -- 200 -- -- --
Stock compensation.................... 48 181 1,167 166 621
Equity in (profits) losses of
investees and minority interest.... (97) 20 (19) -- --
Increase (decrease) in cash from
changes in:
Accounts receivable................ (182) (3,281) (7,950) (3,979) (3,563)
Inventory.......................... (629) (309) (1,161) (920) (583)
Prepaid expenses and other......... (539) (1,125) (2,666) (1,721) (777)
Accounts payable................... 1,021 1,553 2,260 2,392 (611)
Accrued payroll and related
benefits......................... 494 1,808 1,652 (805) 764
Accrued expenses and other......... 99 824 1,938 589 877
Income taxes payable............... 101 265 (298) (373) (946)
Deferred revenue................... 899 2,320 1,000 (764) (573)
------- -------- -------- -------- --------
NET CASH PROVIDED BY (USED FOR)
OPERATING ACTIVITIES........... 3,133 10,893 (662) 834 6,974
------- -------- -------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities....... (7,966) (64,730) (119,619) (75,052) (48,027)
Sales and maturities of marketable
securities............................ -- 27,842 85,975 36,382 55,628
Expenditures for property and
equipment............................. (981) (1,891) (9,418) (2,597) (4,018)
Notes receivable........................ (228) (274) -- -- --
Capitalized software costs and purchased
technology............................ (118) (924) (1,061) 20 (112)
Investments and other................... 9 (734) (3,224) (1,477) 323
------- -------- -------- -------- --------
NET CASH PROVIDED BY (USED FOR)
INVESTING ACTIVITIES........... (9,284) (40,711) (47,347) (42,724) 3,794
------- -------- -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net
of issuance costs..................... 22,104 60,411 534 536 133
Proceeds from exercise of stock options
and from stock purchase plans......... 42 642 2,606 541 1,704
Tax benefit from exercise of stock
options............................... -- 225 3,702 -- --
Minority interests...................... -- -- 1,213 -- 1,384
Other................................... (81) (786) 537 (111) (502)
------- -------- -------- -------- --------
NET CASH PROVIDED BY FINANCING
ACTIVITIES..................... 22,065 60,492 8,592 966 2,719
------- -------- -------- -------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND EQUIVALENTS......................... 88 195 (138) (35) (346)
------- -------- -------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
EQUIVALENTS............................. 16,002 30,869 (39,555) (40,959) 13,141
CASH AND EQUIVALENTS, BEGINNING OF
PERIOD.................................. 3,859 19,861 50,730 50,730 11,175
------- -------- -------- -------- --------
CASH AND EQUIVALENTS, END OF PERIOD....... $19,861 $ 50,730 $ 11,175 $ 9,771 $ 24,316
======= ======== ======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE> 8
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION FOR THE SIX MONTHS ENDED JUNE 30, 1996 AND 1997 IS UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS -- Security Dynamics Technologies, Inc. ("SDI," which,
together with its subsidiaries, is referred to as the "Company") is a leading
provider of enterprise network and data security solutions. The Company's
products help companies conduct business securely, protect corporate information
assets and facilitate business-to-business electronic commerce. The Company's
products include its SecurID "tokens" and ACE/Server software, which
authenticate the identity of users accessing networked or stand-alone computer
resources, RSA developer toolkits and other products used to implement
cryptographic data security applications and the BoKS product family, which
provides a broad range of security solutions, including secure single sign-on
solutions.
The principal markets for the Company's products are the United States,
Canada, Latin America, Europe and the Far East, with the United States, Europe
and Canada currently being the largest.
BASIS OF PRESENTATION -- The consolidated financial statements have been
prepared to give retroactive effect to the acquisition of DynaSoft AB
("DynaSoft") on July 15, 1997 (see Note 2), which has been accounted for as a
pooling of interests. Generally accepted accounting principles proscribe giving
effect to a merger or business combination accounted for as a pooling of
interests in financial statements after financial statements including the
consummation date are issued. On November 14, 1997, the Company issued its
Consolidated Financial Statements for the quarter ended September 30, 1997 in
its Quaterly Report on Form 10-Q as filed with the Securities and Exchange
Commission.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include all accounts of SDI and its subsidiaries. Strategic equity investments
for which the Company does not have the ability to exercise significant
influence are carried at cost. Investments in partnerships are accounted for in
accordance with the allocation of profits and losses under the partnership
agreements.
In the fourth quarter of 1996 and the first half of 1997, RSA sold minority
interests, which aggregate 24% as of June 30, 1997, in its Japanese subsidiary
to third parties for $1,213 and $1,384, respectively. The minority interests in
the subsidiary's profits and losses since the purchase dates are not material
and are included in interest income and other income in the consolidated
statements of income.
INTERIM RESULTS (UNAUDITED) -- In the opinion of management, the
accompanying interim unaudited consolidated financial statements as of June 30,
1997 and for the six-month periods ended June 30, 1996 and 1997 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 a fair presentation of the financial position and operating
results of the Company for such periods.
STOCK SPLITS -- In October 1995 and October 1996, the Board of Directors
declared two-for-one splits of the Company's common stock effected in the form
of stock dividends. All share and per share data have been adjusted to reflect
the two-for-one stock splits of the Company's common stock.
REVENUE RECOGNITION -- Revenue from software license fees, developer
toolkits, patent license fees and the sale of hardware products is recognized
upon shipment of the product, provided that no significant obligations remain
and collection of the receivable is considered probable. Shipments to
distributors are based upon receipt of a purchase order from end users by the
F-8
<PAGE> 9
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
distributor. Revenue from charges for maintenance services is deferred and
recognized ratably over the maintenance period, generally twelve months. No
customer accounted for 10% or more of the Company's revenue in any period
reported.
WARRANTY POLICY -- The Company's standard practice is to provide a warranty
on all SecurID tokens for the customer-selected programmed life of the token and
to replace any damaged tokens (other than tokens damaged by a user's negligence
or alteration) free of charge. The Company generally sells each of its other
products to customers with a warranty for a specified period. The Company
provides a reserve for warranties based upon historical experience.
INVENTORY -- Inventory consists primarily of finished SecurID tokens and
ACM hardware products and is stated at the lower of cost (first-in, first-out
method) or market.
PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost.
Depreciation is computed using the straight-line method over the estimated
useful lives of the related assets (two to five years).
RESEARCH AND DEVELOPMENT, CAPITALIZED SOFTWARE AND PURCHASED TECHNOLOGY
COSTS -- Research and development costs, including purchased research and
development, are expensed as incurred. The Company capitalizes certain software
costs after technological feasibility has been established. Capitalized amounts
are reported at the lower of unamortized cost or net realizable value and are
amortized to cost of revenue over the estimated useful lives (two to three
years) starting at the general release of the software product to customers.
Purchased technology consists of acquired software and is recorded at cost.
Amortization is provided over estimated lives of two years. Amortization expense
for capitalized software and purchased technology approximated $176, $298 and
$330 for 1994, 1995 and 1996, respectively, and $135 and $166 for the six months
ended June 30, 1996 and 1997, respectively.
CASH EQUIVALENTS -- The Company considers all highly liquid investments
purchased with a remaining maturity of three months or less to be cash
equivalents.
MARKETABLE SECURITIES -- The Company classifies its marketable securities
as "available for sale," and, accordingly, carries such securities at aggregate
fair value. Unrealized gains and losses are included as a component of
stockholders' equity, net of tax effect. The Company's marketable securities
consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------
1995 1996 JUNE 30, 1997
-------------------- -------------------- --------------------
AGGREGATE AGGREGATE AGGREGATE
FAIR VALUE COST FAIR VALUE COST FAIR VALUE COST
---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
U.S. Government
obligations.......... $ 43,796 $43,632 $ 88,171 $88,161 $ 69,710 $69,672
Corporate equity
securities........... 16,680 60 5,809 20 4,512 983
Tax-exempt
securities........... 1,013 1,013 -- -- -- --
Corporate debt
securities........... 148 145 1,340 1,340 12,215 12,227
------- ------- ------- ------- ------- -------
Total......... $ 61,637 $44,850 $ 95,320 $89,521 $ 86,437 $82,882
======= ======= ======= ======= ======= =======
</TABLE>
At December 31, 1996 and June 30, 1997, substantially all of the Company's
U.S. Government obligations and corporate debt securities had contractual
maturities of two years or less. There were no sales of marketable securities
for 1994, 1995 or the six months ended June 30, 1997. Proceeds from the sale of
marketable securities for 1996 amounted to $11,067. The specific identified cost
F-9
<PAGE> 10
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
basis of the securities was used to determine the gain. Unrealized gross gains
at December 31, 1995, 1996 and June 30, 1997 were $16,687, $5,799 and $3,555,
respectively.
ADVERTISING -- Advertising costs are expensed as incurred. Total
advertising expense was approximately $424, $501 and $561 for 1994, 1995 and
1996, respectively, and $218 and $145 for the six months ended June 30, 1996 and
1997, respectively.
INCOME TAXES -- The Company utilizes the liability method of accounting for
income taxes. Deferred taxes are determined based on the estimated future tax
effects of differences between the financial statement and tax bases of assets
and liabilities given the provisions of the enacted tax laws. The Company
provides for taxes on the undistributed earnings of foreign subsidiaries which
are ultimately expected to be remitted to the parent company. Unrecognized
provisions for taxes on undistributed earnings of foreign subsidiaries which are
considered permanently invested are not material to the Company's consolidated
financial position or results of operations.
FOREIGN CURRENCY -- The Company considers the local currencies of the
countries in which the Company's branches and subsidiaries are domiciled to be
the functional currencies. Translation adjustments are accumulated in a separate
component of equity.
NET INCOME PER SHARE -- Net income per share is based on the weighted
average number of common shares outstanding which assumes on a pro forma basis
for 1994 that all series of convertible preferred stock had been converted to
common stock as of the original issuance dates. All series of the Company's
preferred stock were converted into shares of common stock on December 21, 1994.
Common equivalent shares are not included in the per share calculations where
the effect of their inclusion would be antidilutive, except in accordance with
Securities and Exchange Commission Staff Accounting Bulletin No. 83 (the
"Bulletin"). The Bulletin requires all shares of common stock issued and options
to purchase shares of common stock granted by the Company during the
twelve-month period prior to the filing of an initial public offering be
included in the calculation as if they were outstanding for all periods. For
1994, historical income per share, which excludes the assumed conversions of the
convertible preferred, was $0.01.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128 "Earnings per Share," which
is required to be adopted in the fourth quarter of 1997. At that time, the
Company will be required to change the method currently used to compute earnings
per share and to restate all prior periods. SFAS No. 128 supersedes Accounting
Principles Board Opinion No. 15 and is intended to simplify the computation of
earnings per share and to make the U.S. computations more comparable with
international computations. The pro forma basic and diluted earnings per share
(as defined by SFAS No. 128) would have been as follows:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------- ---------------
1994 1995 1996 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Basic................................... $0.05 $0.23 $0.36 $0.15 $0.27
Diluted................................. 0.05 0.22 0.34 0.14 0.26
</TABLE>
FINANCIAL INSTRUMENTS -- The carrying values of cash and equivalents,
accounts receivable and accounts payable approximate fair value due to the
short-term nature of these instruments. Marketable securities are carried at
aggregate fair value. The Company's 24% interest in VeriSign, Inc. ("VeriSign")
(Note 3) is accounted for under the equity method. Other investments represent
strategic equity positions in companies and are stated at cost. It is not
practicable to measure the estimated fair value of such investments.
F-10
<PAGE> 11
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Two of the companies in which the Company has equity positions had initial
public offerings in 1996. In April 1997, an amendment to Rule 144 under the
Securities Act of 1933, became effective, which, among other things, shortened
the holding periods for sales of restricted securities under Rule 144. As a
result of this amendment, the Rule 144 holding-period requirements for certain
restricted securities (including shares of common stock of the two companies
which completed initial public offerings in 1996) currently held by the Company
will be met in 1997. Accordingly, these restricted securities, which have a cost
of $737, have been reclassified in 1997 from investments to marketable
securities as of June 30, 1997.
USE OF ESTIMATES -- The preparation of the Company's consolidated
financial statements in conformity with generally accepted accounting
principles necessarily requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting periods.
Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK -- The Company licenses its ACE/Server and
BoKS software and token technology to various customers in a diverse industry
range. Toolkit and patent licenses are issued primarily to companies in the
computer and software industries. The Company performs ongoing credit
evaluations of its customers and maintains allowances for potential credit
losses. The Company generally requires no collateral from its customers.
STOCK-BASED COMPENSATION -- The Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for stock option grants
to employees (and non-employees prior to January 1, 1996). Since January 1,
1996, the Company applies SFAS No. 123, "Accounting for Stock-Based
Compensation" and related interpretations for accounting for stock option grants
to non-employees.
LONG-LIVED ASSETS -- Effective January 1, 1996, the Company adopted the
provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," for 1996. The adoption of SFAS No.
121 did not have an impact on the Company's consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS -- In June 1997, the Financial Accounting
Standards Board issued Statements of Financial Accounting Standards Nos. 130 and
131, "Reporting Comprehensive Income" and "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 130" and "SFAS 131", respectively).
The Company will be required to adopt the provisions of these statements in
fiscal 1998. SFAS 130 provides standards for reporting items considered to be
"comprehensive income" and uses the term "other comprehensive income" to refer
to revenue, expenses, gains and losses that are included in comprehensive income
under generally accepted accounting principles but excluded from net income.
Currently the only items considered other comprehensive income, as defined in
SFAS 130 are the unrealized gains and losses on marketable securities and
cumulative translation adjustments, which are recorded as components of
stockholders' equity. SFAS 131 establishes new standards for reporting
information about operating segments. The Company believes the segment
information required to be disclosed under SFAS 131 will be more comprehensive
than previously provided, including expanded disclosure of income statement and
balance sheet items for each reportable operating segment. The Company has not
yet completed its analysis of which operating segments it will report on. The
Company believes that the provisions of SFAS 130 will not, when adopted, have a
material impact on the Company's financial statements.
F-11
<PAGE> 12
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. MERGER AND ACQUISITION
On July 15, 1997, SDI acquired DynaSoft AB (the "Acquisition" and
"DynaSoft," respectively). On July 26, 1996, SDI completed a merger with RSA
Data Security, Inc. (the "Merger" and "RSA," respectively). The Acquisition and
the Merger have been accounted for as poolings of interests and therefore the
consolidated financial statements for all periods prior to the Merger and the
Acquisition have been restated to include the accounts and operations of RSA
and DynaSoft with those of SDI. Expenses related to these transactions for
investment banking, professional fees and other direct expenses are recorded at
the respective dates of the Acquisition and Merger.
RSA, located in Redwood City, California, is a leader in cryptography and
develops, markets and supports cryptographic data security products and provides
related consulting services. Products are licensed to original equipment
manufacturers ("OEMs"), which incorporate the technology into their products.
Developer toolkits and other products are used to implement cryptographic data
security applications such as electronic mail, communications privacy,
client/server data security, smart cards and other key information technologies.
DynaSoft is based in Stockholm, Sweden and offers a range of software
security solutions, including secure single sign-on ("SSSO") solutions, through
its BoKS product family. Products are sold worldwide through direct sales and
through OEM licensing agreements with Sun Microsystems, Hewlett-Packard, and
other companies.
Under the terms of the Merger, each share of RSA common stock was exchanged
for 1.66112 shares of the Company's common stock and the Company issued a total
of 6,683,078 shares of its common stock to RSA stockholders and options to
purchase a total of 1,316,922 shares of the Company's common stock to option
holders of RSA.
Under the terms of the Acquisition, the Company issued approximately 2.7
million shares of common stock in exchange for approximately 95% of the
outstanding shares and certain of the outstanding options to acquire shares of
DynaSoft. The Company paid $6,035 to certain stockholders of DynaSoft in
exchange for the remaining outstanding shares and options.
Investment banking, professional fees and other direct expenses incurred in
connection with the Merger were approximately $6,100 in 1996. The Company
anticipates expenses in connection with the Acquisition will approximate $7,000
and will be expensed in the third quarter of 1997.
No adjustments to conform accounting policies of the Company and RSA were
required. Adjustments to conform accounting policies of DynaSoft to those of the
Company were not material.
Revenue and net income (loss) for the previously separate companies were:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
--------------------------- -------------------
1994 1995 1996 1996 1997
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
REVENUE
SDI............................ $17,572 $33,804 $70,105 $26,240 $56,097
RSA............................ 3,077 11,600 6,043(a) 6,043(a) --
DynaSoft....................... 3,217 4,008 7,669 3,828 5,277
------- ------- ------- ------- -------
Total.................. $23,866 $49,412 $83,817 $36,111 $61,374
======= ======= ======= ======= =======
NET INCOME (LOSS)
SDI............................ $ 2,315 $ 5,812 $13,428 $ 5,435 $10,231
RSA............................ (1,727) 950 (383)(a) (383)(a) --
DynaSoft....................... 640 688 130 402 (155)
------- ------- ------- ------- -------
Total.................. $ 1,228 $ 7,450 $13,175 $ 5,454 $10,076
======= ======= ======= ======= =======
</TABLE>
- ---------------
(a) Revenue and net loss of RSA for 1996 include only the six month period prior
to the consummation of the Merger.
F-12
<PAGE> 13
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to escrow agreements entered into with the Company by certain of
the stockholders of DynaSoft and by RSA in connection with the Acquisition and
the Merger, respectively, 10.0% of the shares of the Company's common stock
issued to holders of DynaSoft's stock and 12.5% of the shares of the Company's
common stock issued to holders of RSA stock and issuable to holders of RSA
options were placed in escrow, pending settlement of any breaches of
representations, warranties or covenants to the Acquisition and Merger
agreements. In June 1997, the Company and the holders of the RSA shares reached
settlement with respect to claims against the escrow shares and 36,250 shares
were distributed to the Company and 837,957 shares were distributed to the
holders of the RSA shares. Of the shares received by the Company, 213 shares
were accounted for as treasury stock and the remainder were canceled.
3. INVESTMENTS
Investments were as follows:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------- --------
1995 1996 1997
---- ------ --------
<S> <C> <C> <C>
VeriSign, Inc............................................... $510 $ 687 $ 687
VPNet Technologies, Inc..................................... -- 1,500 1,500
Other....................................................... 362 737 --
---- ------ ------
Total............................................. $872 $2,924 $2,187
==== ====== ======
</TABLE>
Prior to 1997, other investments were carried at the lower of cost or
estimated realizable value (See Note 1, "Financial Instruments".)
VeriSign, Inc. -- On April 17, 1995, and February 20, 1996, SDI purchased
425,000 shares of Series A and 72,091 shares of Series B Convertible Preferred
Stock, respectively, of VeriSign of Redwood City, California for an aggregate
purchase price of $687. VeriSign was organized to provide digital certificates
and related services that use public-key cryptography to ensure essential
privacy and authentication features. During 1995, RSA granted certain rights and
privileges in certain technology to VeriSign in connection with VeriSign's
incorporation and received 4,000,000 shares of VeriSign common stock. The
Company's voting interest was approximately 44% and 24%, at December 31, 1995
and 1996, respectively and 24% at June 30, 1997.
VPNet Technologies, Inc. -- On December 2, 1996, the Company purchased
250,000 shares of Series B Preferred Stock of VPNet Technologies, Inc. ("VPNet")
of San Jose, California, for an aggregate purchase price of $1,500. VPNet was
organized to develop and market products and technologies for implementing
high-performance virtual private networks. The Company's investment in VPNet
represents a minority interest of less than 10% of VPNet's voting stock and is
carried at cost.
4. PREFERRED STOCK
In accordance with the Company's Second Restated Certificate of
Incorporation, as in effect immediately prior to the Company's initial public
offering (the "IPO"), all shares of the Company's Series A, B and C preferred
stock were converted into 11,288,756 shares of common stock upon the closing of
the IPO on December 21, 1994. At December 31, 1994, all shares of preferred
stock had been canceled and retired.
F-13
<PAGE> 14
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. STOCK OPTION AND PURCHASE PLANS
1986 STOCK OPTION PLAN ("1986 PLAN") -- The Company's 1986 Plan terminated
by its terms in 1996 although options remain outstanding at June 30, 1997. In
general, options granted under the 1986 Plan become exercisable in equal annual
installments over four years and expire ten years from the date of grant.
1994 STOCK OPTION PLAN ("1994 PLAN") -- In October 1994, the Board of
Directors adopted the Company's 1994 Plan. The 1994 Plan authorizes (i) the
grant of options to purchase common stock intended to qualify as incentive stock
options and (ii) the grant of options that do not so qualify (non-statutory
options) to employees, officers, directors and consultants of the Company.
Option exercise prices for incentive stock options granted under the 1994 Plan
may not be less than 100% of the fair market value of the shares. In general,
options granted under the 1994 Plan become exercisable in equal annual
installments over four years and expire ten years from the date of grant. On
April 24, 1997, at the Annual Meeting of Stockholders of the Company, the
stockholders adopted an amendment increasing the number of shares authorized for
issuance under the 1994 Plan from 4,820,000 to 6,570,000. Shares of common stock
available for option grants were 1,801,185 at June 30, 1997.
1994 DIRECTOR STOCK OPTION PLAN ("DIRECTOR PLAN") -- In October 1994, the
Board of Directors adopted the Company's Director Plan. The Director Plan
permits the granting of options to purchase up to a maximum of 300,000 shares of
common stock to non-employee members of the Board of Directors. The exercise
price of the options may not be less than 100% of the fair market value on the
date of the grant. Options granted under the Director Plan become exercisable at
the earlier of the date of the next Annual Meeting of Stockholders or one year
from the date of grant and expire ten years from the date of grant. Shares of
common stock available for option grant were 103,000 at June 30, 1997.
1994 EMPLOYEE STOCK PURCHASE PLAN ("PURCHASE PLAN") -- In October 1994, the
Board of Directors adopted the Company's Purchase Plan. The Purchase Plan
provides for sales to participating employees of up to 400,000 shares of common
stock, at prices of not less than 85% of the closing price on either the first
day or the last day of the offering period, whichever is lower. Shares purchased
under the Plan were 35,716, and 91,408 and 119,779 at December 31, 1995 and 1996
and at June 30, 1997, respectively.
RSA OPTIONS -- At the effective date of the Merger, the then-outstanding
options to purchase shares of RSA common stock, issued under RSA's 1987 Stock
Option Plan (the "RSA Option Plan"), were exchanged for options to purchase an
aggregate of 1,316,922 shares of the Company's common stock. All option activity
data has been retroactively adjusted to the earliest period presented to give
effect to the conversion of the RSA options. Incentive stock options and
non-statutory stock options were awarded to employees, officers, directors,
consultants and independent contractors and were generally immediately
exercisable for a term of five years. In the event of termination of employment
or consulting services, the Company has the option to repurchase at the original
exercise price any unvested shares. At June 30, 1997, options as to 955,108
shares were subject to repurchase rights, and a total of 69,844 shares were
subject to repurchase which were previously issued upon the exercise of stock
options.
DYNASOFT OPTIONS -- In connection with the Acquisition of DynaSoft, the
Company exchanged options to purchase 44,931 shares of the Company's common
stock for all of the then outstanding options to purchase shares of DynaSoft.
F-14
<PAGE> 15
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of stock option activity under all plans, including converted RSA
and DynaSoft options, is as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE
SHARES PRICE PER SHARE
--------- ----------------
<S> <C> <C>
OUTSTANDING AT JANUARY 1, 1994.......................... 2,181,990 $ 0.29
Granted............................................... 666,082 1.11
Exercised............................................. (152,376) 0.06
---------
OUTSTANDING AT DECEMBER 31, 1994........................ 2,695,696 0.47
Granted............................................... 1,485,486 5.25
Exercised............................................. (921,718) 0.47
Canceled.............................................. (80,269) 0.95
---------
OUTSTANDING AT DECEMBER 31, 1995........................ 3,179,195 2.69
Granted............................................... 2,332,212 29.12
Exercised............................................. (761,633) 2.33
Canceled.............................................. (27,317) 21.57
---------
OUTSTANDING AT DECEMBER 31, 1996........................ 4,722,457 15.71
Granted............................................... 957,383 29.35
Exercised............................................. (690,662) 1.45
Canceled.............................................. (81,796) 26.10
---------
OUTSTANDING AT JUNE 30, 1997............................ 4,907,382 20.26
=========
Exercisable at December 31, 1994...................... 2,293,266 0.31
=========
Exercisable at December 31, 1995...................... 2,261,327 0.40
=========
Exercisable at December 31, 1996...................... 2,127,928 1.69
=========
Exercisable at June 30, 1997.......................... 1,851,971 6.16
=========
</TABLE>
The following table sets forth information regarding stock options
outstanding at December 31, 1996 under all plans:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF NUMBER WEIGHTED REMAINING EXERCISE PRICE
NUMBER OF EXERCISE CURRENTLY AVERAGE CONTRACTUAL LIFE FOR CURRENTLY
OPTIONS PRICES EXERCISABLE EXERCISE PRICE (YEARS) EXERCISABLE
- ---------- --------------- ---------- -------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
324,800... $0.05-0.06 324,800 $ 0.05 1.1 $ 0.05
384,000... 0.10 384,000 0.10 3.3 0.10
28,000.... 0.25-0.35 -- 0.29 5.8 --
76,800.... 0.45 15,200 0.45 7.0 0.45
59,656.... 0.76 27,718 0.76 9.9 0.76
985,414... 0.85-0.90 975,874 0.90 7.8 0.90
39,450.... 1.75-2.55 11,650 2.25 7.6 2.28
197,185... 2.95-4.22 187,185 3.32 8.9 3.34
23,252.... 6.62 23,252 6.62 9.2 6.62
546,000... 9.97-14.31 178,249 10.26 8.6 10.27
1,315,600.. 24.30-35.63 -- 27.91 9.3 --
742,300... 38.00-44.21 -- 40.34 9.7 --
--------- ---------
4,722,457.. 0.05-44.21 2,127,928 15.71 7.8 1.69
========= =========
</TABLE>
F-15
<PAGE> 16
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ACCOUNTING FOR STOCK OPTIONS
For certain options and stock awards granted in 1994, 1995, 1996 and 1997,
the Company is recognizing compensation expense based on the excess of fair
market value over the option exercise or award prices at dates of grant.
Compensation is being recognized ratably over the vesting periods.
On April 1, 1996 and April 24, 1996, options to purchase 200,000 shares and
38,900 shares of common stock were granted at exercise prices of $24.30 and
$38.20, respectively, subject to stockholder approval of an amendment to 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 is recognizing 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 $667 in the year
ended December 31, 1996. Total compensation expense relating to certain options
and stock awards amounted to $48, $181 and $1,167 for the years ended December
31, 1994, 1995 and 1996, respectively, and $166 and $621 for the six months
ended June 30, 1996 and 1997, respectively.
PRO FORMA DISCLOSURE -- Had the Company recognized compensation costs for
the employee and director stock option and purchase plans based on the fair
value for awards under those plans after January 1, 1995, in accordance with
SFAS No. 123 "Accounting for Stock Based Compensation," net income and net
income per share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1995 1996
------ -------
<S> <C> <C>
Net income
As reported........................................... $7,450 $13,175
Pro forma............................................. 7,026 10,745
Net income per share
As reported........................................... $0.22 $0.34
Pro forma............................................. 0.21 0.28
</TABLE>
F-16
<PAGE> 17
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair values used to compute pro forma net income and net income per
share were estimated fair value at grant date using the Black-Scholes
option-pricing model with the following weighted average assumptions:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
---------------
1995 1996
---- ----
<S> <C> <C>
STOCK OPTION PLANS
Risk-free interest rate................................... 6.0% 6.0%
Expected life of option grants (years).................... 4.4 4.4
Expected volatility of underlying stock................... 57.5% 57.5%
Expected dividend payment rate............................ 0.0% 0.0%
Expected forfeiture rate.................................. 4.1% 4.1%
EMPLOYEE STOCK PURCHASE PLAN
Risk-free interest rate................................... 5.9% 5.2%
Expected life of option grants (years).................... 0.5 0.5
Expected volatility of underlying stock................... 57.5% 57.5%
Expected dividend payment rate............................ 0.0% 0.0%
</TABLE>
The weighted average fair value of stock options granted, calculated using the
Black-Scholes option-pricing model, was $2.74 and $15.67 during the years ended
December 31, 1995 and 1996, respectively. The weighted fair value of stock
options granted under the Purchase Plan, calculated using the Black-Scholes
option-pricing model was $6.72 and $25.26 during 1995 and 1996, respectively.
6. INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1994 1995 1996
------ ------ --------
<S> <C> <C> <C>
Current:
Federal............................................. $ 882 $3,049 $ 7,359
State............................................... 281 781 930
Foreign............................................. 265 302 399
------- ------- --------
Total....................................... 1,428 4,132 8,688
Deferred:
Federal............................................. (256) (93) (1,219)
State............................................... (15) (26) (174)
Change in valuation allowance....................... 296 (869) --
------- ------- --------
Total....................................... 25 (988) (1,393)
Tax benefit from exercise of stock options:
Federal............................................. -- 179 3,452
State............................................... -- 46 250
------- ------- --------
Total....................................... -- 225 3,702
------- ------- --------
Total................................................. $1,453 $3,369 $10,997
======= ======= ========
</TABLE>
F-17
<PAGE> 18
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
were as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
-----------------------
1995 1996
------- -------
<S> <C> <C>
Deferred tax assets (liabilities) -- current:
Marketable securities.................................... $(6,877) $(2,319)
Deferred revenue......................................... 98 854
Allowance for doubtful accounts.......................... 293 211
Compensation............................................. 146 205
Inventory reserves....................................... 66 66
Warranty obligation...................................... 42 42
Commissions.............................................. 80 42
Net operating loss carryforwards......................... 81 --
Other.................................................... (28) 67
------- -------
Net deferred tax liabilities -- current.................... $(6,099) $ (832)
======= =======
Deferred tax assets (liabilities) -- non current:
Acquisition of technology................................ 249 733
Compensation............................................. -- 326
Capitalized software development costs................... (89) (79)
Net operating loss carryforwards......................... -- 32
Other.................................................... 254 14
------- -------
Net deferred tax assets -- non current..................... $ 414 $ 1,026
======= =======
</TABLE>
A reconciliation between the statutory and effective income tax rates
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
Statutory tax rate......................................... 34.0% 34.0% 35.0%
State income taxes net of federal benefit.................. 10.5 5.4 3.2
Merger expenses............................................ -- -- 8.3
Foreign income taxes....................................... (13.0) (0.3) 0.3
Change in valuation allowance.............................. 16.5 (8.8) --
Foreign expenses without tax benefit....................... 8.5 -- --
Other...................................................... (2.3) 0.8 (1.3)
----- ----- -----
Effective income tax rate.................................. 54.2% 31.1% 45.5%
===== ===== =====
</TABLE>
The income tax provision for the six months ended June 30, 1996 and 1997 is
based upon the estimated effective tax rates of 36.6% and 37.5%, respectively,
for the full years.
Cash payments for income taxes were approximately $1,323, $4,140 and $8,384
for 1994, 1995 and 1996, respectively, and $3,801 and $7,099 for the six months
ended June 30, 1996 and 1997, respectively.
7. RETIREMENT AND SAVINGS PLAN
The Company has a 401(k) retirement and savings plan (the "Plan")
established in 1986 covering substantially all domestic employees. The Plan
allows each participant to defer up to 15% of annual earnings up to an amount
not to exceed an annual statutory maximum. Subject to the
F-18
<PAGE> 19
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
approval of the Board of Directors on an annual basis, the Company may make, at
its discretion, profit-sharing contributions and/or match employee deferrals. At
December 31, 1995 and 1996, the Company had accrued, and the Board of Directors
had approved, profit-sharing contributions approximating $78 and $305,
respectively. The Board of Directors also approved for 1995 and 1996 matching
contributions in an amount equal to one-third of the employee deferrals up to 6%
of annual earnings (or a total of 2%), subject to certain eligibility
requirements. Matching contributions amounted to $88, $112 and $261 for 1994,
1995 and 1996, respectively.
8. COMMITMENTS
The Company leases office facilities and automobiles under non-cancelable
operating leases expiring through 2006. Future minimum rental payments are as
follows for years ending December 31:
<TABLE>
<S> <C>
1997........................................................ $2,306
1998........................................................ 2,126
1999........................................................ 2,025
2000........................................................ 1,256
2001........................................................ 1,300
Balance thereafter.......................................... 5,934
</TABLE>
Net rent expense for 1994, 1995 and 1996 was approximately $618, $1,026 and
$2,004, respectively, and for the six months ended June 30, 1996 and 1997 was
approximately $788 and $1,359, respectively. Rent collected from a sublease of
the Company's former headquarters was $0, $0 and $108 in 1994, 1995 and 1996,
respectively, and $0 and $216 for the six months ended June 30, 1996 and 1997,
respectively.
During 1996, the Company issued an unsecured irrevocable standby letter of
credit in the amount of $750 to the landlord of its corporate headquarters in
lieu of a security deposit.
As of June 30, 1997, DynaSoft had approximately $673 due to a bank. The
amount, payable upon demand, bears interest at 13% and is included in accrued
expenses and other.
In December 1994, the Company entered into an agreement with Progress
Software Corporation ("Progress Software"), a vendor of commercial database
software, for the right to use certain of Progress Software's 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 as a result of the commercial introduction of ACE/Server v2.0 in
October 1995. The Company renewed this agreement in November 1996, and at
December 31, 1996, the Company had prepaid $1,040 under this agreement. In the
first quarter of 1997, in accordance with the terms of the agreement, and in
order to obtain favorable pricing, the Company prepaid a further $2,500.
RSA has a license for cryptographic communication technology and devices
from the Massachusetts Institute of Technology ("MIT") which granted to RSA,
through September 2000, an exclusive right to use, lease or sell technology,
subject to payment of royalties.
Royalty expense was $118, $706 and $2,009 for 1994, 1995 and 1996,
respectively, and $1,047 and $2,370 for the six months ended June 30, 1996 and
1997, respectively.
F-19
<PAGE> 20
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. SEGMENT INFORMATION
The Company operates in only one industry segment. Export sales are
summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------- ------------------
1994 1995 1996 1996 1997
------ ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
Europe..................................... $2,005 $5,116 $11,616 $4,963 $ 9,205
Canada..................................... 1,230 2,772 4,511 2,038 3,636
Asia/Pacific............................... 176 571 2,518 921 2,574
Latin America.............................. -- -- 198 -- 204
------ ------ ------- ------ -------
$3,411 $8,459 $18,843 $7,922 $15,619
====== ====== ======= ====== =======
</TABLE>
10. LITIGATION
THE CYLINK SETTLEMENT -- Since 1994, RSA had been involved in arbitration
and litigation proceedings (collectively, the "Litigation") relating, among
other things, to (i) the validity of a U.S. patent (the "RSA/MIT Patent")
developed at MIT and licensed to RSA; (ii) the rights of Cylink Corporation
("Cylink") and its subsidiary Caro Kann Corporation ("CKC"), competitors of RSA,
to use and sub-license the RSA/MIT Patent; (iii) the validity and scope of
certain U.S. patents (the "Stanford Patents") which cover Cylink's fundamental
encryption technology and have been licensed to Cylink by the Board of Trustees
of the Leland Stanford Junior University; and (iv) the liability, if any, of RSA
for infringing or contributing to the infringement of the Stanford Patents. On
December 31, 1996, RSA, Cylink and CKC entered into a comprehensive settlement
relating to the Litigation. As part of the settlement, (a) the parties agreed to
dismiss all claims relating to the Litigation, (b) Cylink granted to RSA all
necessary rights to the Stanford Patents and (c) RSA granted to Cylink a license
to RSA's cryptographic software toolkit.
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 judgment 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 Company has been named as a defendant in other legal actions arising
from its normal business activities. The Company carries insurance against
liability for certain types of risks. Although the amount of liability that
could result from any litigation cannot be predicted, in the opinion of
management, after consulting with legal counsel, the Company's potential
liability on all known claims would not have a material adverse effect on the
consolidated financial position or results of operations of the Company.
11. RELATED PARTY TRANSACTIONS
A stockholder provides consulting services to the Company and received $81,
$91 and $97 in 1994, 1995 and 1996, respectively, and $41 and $56 during the six
months ended June 30, 1996 and 1997, respectively. As of June 30, 1997, DynaSoft
had approximately $25 due to a stockholder payable upon demand.
12. SUBSEQUENT EVENT (UNAUDITED)
On October 21, 1997, the Company completed an underwritten public
offering, resulting in the sale of 1,626,000 (unaudited) shares of its common
stock and the raising of approximately $60.8 (unaudited) million in net
proceeds.
F-20
