<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): May 20, 1998
------------------------------
Security Dynamics Technologies, Inc.
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(Exact Name of Registrant as Specified in Charter)
Delaware
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(State or Other Jurisdiction of Incorporation)
000-25120 04-2916506
- ------------------------ ------------------------------------
(Commission File Number) (I.R.S. Employer Identification No.)
20 Crosby Drive
Bedford, Massachusetts 01730
- --------------------------------------- ----------
(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)
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ITEM 5. OTHER EVENTS
On March 26, 1998, Security Dynamics Technologies, Inc. (the "Company")
acquired Intrusion Detection Inc. ("IDI") pursuant to an Agreement and Plan of
Merger, dated as of March 26, 1998, by and among the Company, IDI, Apple
Acquisition Corp., a wholly owned subsidiary of the Company, and Robert Kane and
Lillian Kane (the "IDI Acquisiton"). The Company issued 784,342 shares of common
stock in exchange for all of IDI's outstanding common stock. 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 IDI Acquisition using the pooling of interests
method of accounting.
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ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) EXHIBITS.
Exhibit No. Description
- ----------- -----------
23.1 Consent of Deloitte & Touche LLP, independent auditors.
23.2 Consent of Ernst & Young LLP, independent auditors.
27.1 Restated Financial Data Schedule for the year ended December 31, 1995
27.2 Restated Financial Data Schedule for the three months ended March 31,
1996
27.3 Restated Financial Data Schedule for the six months ended June 30, 1996
27.4 Restated Financial Data Schedule for the nine months ended September
30, 1996
27.5 Restated Financial Data Schedule for the year ended December 31, 1996
27.6 Restated Financial Data Schedule for the three months ended March 31,
1997
27.7 Restated Financial Data Schedule for the six months ended June 30, 1997
27.8 Restated Financial Data Schedule for the nine months ended September
30, 1997
27.9 Restated Financial Data Schedule for the year ended December 31, 1997
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, 1996 and 1997 and for the years ended December
31, 1995, 1996 and 1997 and Independent Auditors' Reports thereon.
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: May 20, 1998 SECURITY DYNAMICS TECHNOLOGIES, INC.
------------------------------------
(Registrant)
By: /s/ Marian G. O'Leary
----------------------------
Marian G. O'Leary
Senior Vice President, Finance
Chief Financial Officer and Treasurer
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EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
23.1 Consent of Deloitte & Touche LLP, independent auditors.
23.2 Consent of Ernst & Young LLP, independent auditors.
27.1 Restated Financial Data Schedule for the year ended December 31, 1995
27.2 Restated Financial Data Schedule for the three months ended March 31,
1996
27.3 Restated Financial Data Schedule for the six months ended June 30, 1996
27.4 Restated Financial Data Schedule for the nine months ended September
30, 1996
27.5 Restated Financial Data Schedule for the year ended December 31, 1996
27.6 Restated Financial Data Schedule for the three months ended March 31,
1997
27.7 Restated Financial Data Schedule for the six months ended June 30, 1997
27.8 Restated Financial Data Schedule for the nine months ended September
30, 1997
27.9 Restated Financial Data Schedule for the year ended December 31, 1997
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, 1996 and 1997 and for the years ended December
31, 1995, 1996 and 1997 and Independent Auditors' Reports 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 the incorporation by reference in Registration Statements Nos.
33-87916, 33-88506, 33-88508, 33-88510, 333-08939, 333-31793 and 333-52255 of
Security Dynamics Technologies, Inc. (the "Company") on Forms S-8 and
Registration Statements Nos. 333-34241 and 333-49949 of the Company on Forms S-3
of our report dated May 15, 1998 (which report expresses an unqualified opinion,
refers to the report of other auditors and includes explanatory paragraphs
referring to the restatement of the consolidated financial statements for
poolings of interests in 1997 and 1998 and a change in the Company's method of
accounting for option grants requiring stockholder approval in 1996), appearing
in Exhibit 99.3 to Item 7. (c) in this Current Report on Form 8-K of Security
Dynamics Technologies, Inc.
/s/ Deloitte & Touche LLP
Boston, Massachusetts
May 20, 1998
<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,
333-31793 and 333-52255) 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, the Amended 1994 Stock
Option Plan and the Securix, Inc. 1996 Stock Option Plan, and the 1994 Stock
Option Plan, as amended -1998 Restatement and the Registration Statements on
Form S-3 (Nos. 333-34241 and 333-49949) for the registration of 396,387 and
784,342 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
--------------------------
ERNST & YOUNG LLP
Palo Alto, California
May 20, 1998
<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 Report on Form 10-Q for the quarter ended
March 31, 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (1):
Revenue .................................. $16,630 $24,126 $50,812 $86,417 $140,630
Cost of revenue .......................... 3,707 4,927 8,999 18,431 28,704
------- ------- ------- ------- --------
Gross profit ............................. 12,923 19,199 41,813 67,986 111,926
Costs and expenses:
Research and development ............... 2,831 4,344 6,612 12,682 20,970
Purchased research and
development .......................... -- -- 648 1,000 6,210
Marketing and selling .................. 5,526 8,991 14,478 24,829 41,926
General and administrative ............. 2,248 3,428 10,775 14,603 17,171
Merger and integration ................ -- -- -- 6,100 5,700
------- ------- ------- ------- --------
Total ........................... 10,605 16,763 32,513 59,214 91,977
------- ------- ------- ------- --------
Income from operations ................... 2,318 2,436 9,300 8,772 19,949
Interest income and other ................ 163 265 1,917 4,889 6,273
Gain on sale of marketable securities .... -- -- -- 11,027 4,264
------- ------- ------- ------- --------
Income before provision for income
taxes and cumulative effect of change in
accounting ............................. 2,481 2,701 11,217 24,688 30,486
Provision for income taxes(2) ............ 908 1,453 3,487 11,003 13,324
Minority interests ....................... -- -- -- -- (114)
------- ------- ------- ------- --------
Income before cumulative effect of change
in accounting(2)........................ 1,573 1,248 7,730 13,685 17,048
Cumulative effect of change in accounting 564 -- -- -- --
------- ------- ------- ------- --------
Net income ............................... $ 2,137 $ 1,248 $ 7,730 $13,685 $ 17,048
======= ======= ======= ======= ========
BASIC EARNINGS PER SHARE (3):
Income before cumulative effect
of change in accounting ................ $ 0.06 $ 0.05 $ 0.24 $ 0.37 $ 0.44
Cumulative effect of change in
accounting ............................. 0.03 -- -- -- --
------- ------- ------- ------- --------
Net income ............................... $ 0.09 $ 0.05 $ 0.24 $ 0.37 $ 0.44
======= ======= ======= ======= ========
Weighted average shares .................. 24,598 24,382 32,577 37,165 38,956
======= ======= ======= ======= ========
DILUTED EARNINGS PER SHARE (3):
Income before cumulative effect
of change in accounting ................ $ 0.06 $ 0.05 $ 0.22 $ 0.35 $ 0.42
Cumulative effect of change in
accounting ............................. 0.02 -- -- -- --
------- ------- ------- ------- --------
Net income ............................... $ 0.08 $ 0.05 $ 0.22 $ 0.35 $ 0.42
======= ======= ======= ======= ========
Shares:
Weighted average shares ................ 24,598 24,382 32,577 37,165 38,956
Effect of dilutive options ............. 1,201 1,633 2,209 2,533 1,692
------- ------- ------- ------- --------
Adjusted weighted average shares ....... 25,799 26,015 34,786 39,698 40,648
======= ======= ======= ======= ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA (1)
Cash, cash equivalents and marketable
securities ......................... $ 3,990 $28,006 $112,643 $107,008 $164,659
Working capital ...................... (1,018) 28,612 104,753 110,103 178,348
Total assets ......................... 11,650 29,190 129,279 147,355 233,975
Redeemable convertible preferred stock 8,527 -- -- -- --
Stockholders' equity (deficiency) .... (1,885) 29,796 109,442 125,104 200,653
</TABLE>
- ----------
(1) Results for all periods prior to July 26, 1996, July 15, 1997 and March 26,
1998 have been restated for the acquisitions of RSA Data Security, Inc.,
DynaSoft AB and Intrusion Detection Inc., respectively, which have been
accounted for as poolings of interests. See Note 2 of Notes to the
Company's Consolidated Financial Statements.
(2) Effective January 1, 1993, the Company adopted, prospectively, the
provisions of Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." See Note 5 of Notes to the Company's
Consolidated Financial Statements.
(3) In the fourth quarter of 1997, the Company adopted the provisions of
Statement of Accounting Standards No. 128, "Earnings Per Share." As a
result, all periods presented have been restated. See Note 1 of Notes to
the Company's Consolidated Financial Statements.
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EXHIBIT 99.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company is a 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 with RSA Data Security,
Inc. ("RSA") (the "RSA Merger") and on July 15, 1997, the Company completed an
acquisition of DynaSoft AB, ("DynaSoft") (the "DynaSoft Acquisition"). On March
26, 1998 the Company completed an acquisition of Intrusion Detection Inc.
("IDI") (the "IDI Acquisition"). The RSA Merger, the DynaSoft Acquisition and
the IDI Acquisition have been accounted for as poolings 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, DynaSoft and IDI for all periods presented.
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 Original Equipment Manufacturers ("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.
IDI is located in New York, New York and is a leading publisher of network
security software tools, the Kane Security Analyst and the Kane Security
Monitor, designed to manage enterprise-wide security more effectively. IDI
markets its products world-wide through a direct sales force and distributors.
The Company's revenue is derived primarily from sales of SecurID tokens;
licensing of ACE/Server, BoKS, Kane Security Analyst, Kane Security Monitor 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
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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, BoKS, Kane Security Analyst
and Kane Security Monitor 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 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 8 of Notes to the Company's
Consolidated Financial Statements.
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.
The Company has been profitable for each of the years in the eight-year
period ended December 31, 1997.
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RESULTS OF OPERATIONS
The following table sets forth certain consolidated financial data as a
percentage of revenue for the years ended December 31, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Revenue ................................. 100.0% 100.0% 100.0%
Cost of revenue ......................... 17.7 21.3 20.4
------ ------ ------
Gross profit ............................ 82.3 78.7 79.6
Costs and expenses:
Research and development .............. 13.0 14.7 14.9
Purchased research and development .... 1.3 1.2 4.4
Marketing and selling ................. 28.5 28.7 29.8
General and administrative ............ 21.2 16.9 12.2
Merger and integration ................ -- 7.1 4.1
------ ------ ------
Total .............................. 64.0 68.6 65.4
------ ------ ------
Income from operations .................. 18.3 10.1 14.2
Interest income and other ............... 3.8 5.7 4.5
Gain on sale of marketable securities ... -- 12.8 3.0
------ ------ ------
Income before provision for income taxes 22.1 28.6 21.7
Provision for income taxes .............. 6.9 12.7 9.5
------ ------ ------
Net income .............................. 15.2% 15.9% 12.2%
====== ====== ======
</TABLE>
1997 COMPARED WITH 1996
Revenue. Total revenue increased 62.7% in 1997 to $140.6 million from $86.4
million in 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.
Approximately 42% of the increase in revenue in 1997 was attributable to
increased sales of SecurID tokens, approximately 22% of the increase was
attributable to increased sales of encryption engine licenses and approximately
23% 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, Kane Security Analyst and Kane Security Monitor software licenses,
software 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 84.4% in 1997 to $36.7
million from $19.9 million in 1996. International revenue accounted for 26.1%
and 23.0% of total revenue in 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.
Cost of Revenue and Gross Profit. The Company's gross profit increased 64.6%
in 1997 to $111.9 million, from $68.0 million in 1996, and remained relatively
constant as a percentage of revenue at 79.6% in 1997 compared to 78.7% in 1996.
Approximately 37% of the increase in gross profit during 1997 was attributable
to increased unit sales of SecurID tokens, approximately 26% to increased
licensing sales of encryption engine technology and approximately 28% to
increased licensing sales of ACE/Server software. 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 65.4%
in 1997 to $21.0 million from $12.7 million in 1996. In each of 1997 and 1996,
research and development expenses remained relatively
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constant as a percentage of revenue at 14.7% and 14.9% respectively. During
1997, approximately 58% 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
expenses was attributable to occupancy costs, consulting fees and purchases of
computer equipment, resulting in higher depreciation charges.
Purchased Research and Development. During 1997, the Company purchased and
recorded as purchased research and development expense technology from VeriSign,
Inc. ("VeriSign") for $2.7 million, from Baltimore Technologies, Ltd. for $0.5
million and from Netscape Communications Corporation ("Netscape") for $3.0
million. The Company plans to incorporate the technologies, respectively, into
products which are expected to offer electronic signatures and a certificate
authority and a Java-based developer encryption engine as part of its SecurSight
family of enterprise security solutions ("SecurSight").
During the fourth quarter of 1996, the Company purchased and recorded as
purchased research and development expense technology from Worldtalk Corporation
("Worldtalk") 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.
Marketing and Selling. Marketing and selling expenses increased 69.0% in
1997 to $41.9 million from $24.8 million in 1996. Marketing and selling expenses
increased as a percentage of revenue in 1997 to 29.8% from 28.7% in 1996. During
1997, approximately 35% of the increase in marketing and selling expenses
resulted from an increase in payroll costs associated with the employment of
additional staff and approximately 33% of the increase was attributable to sales
commissions on increased revenues. The remainder of the increase in marketing
and selling expenses resulted from increased travel expenses, marketing program
costs and occupancy costs.
General and Administrative. General and administrative expenses increased
17.8% in 1997 to $17.2 million, from $14.6 million in 1996, but decreased as a
percentage of revenue to 12.2% in 1997 compared to 16.9% 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
$2.3 million in 1997 compared to 1996 due to the settlement of certain of the
Company's legal proceedings in 1996.
Merger and Integration. In 1997, the Company incurred direct costs in
connection with the DynaSoft Acquisition and subsequently incurred costs in
connection with the integration of DynaSoft, primarily for severance. Total
merger and integration costs were $5.7 million in 1997. Expenses incurred in
connection with the RSA Merger were $6.1 million in the third quarter of 1996.
See Note 2 to the Company's Consolidated Financial Statements.
Interest Income and Other. Interest income increased 28.6% in 1997 to $6.3
million from $4.9 million in 1996 due to interest earned on higher cash and
marketable securities balances.
Gain on Sale of Marketable Securities. The gain on sale of marketable
securities was $4.3 million in 1997, compared to $11.0 million in 1996.
Minority Interests. Minority interests in the consolidated net income were
$114,000 in 1997. In 1997 and 1996, the Company sold an aggregate of 26%
interest to minority stockholders of RSA's Japanese subsidiary.
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Provision for Income Taxes. The provision for income taxes increased to
$13.3 million during 1997 from $11.0 million in 1996, primarily due to higher
pre-tax income. The Company's estimated effective tax rate decreased to 43.7% in
1997 from 44.6% in 1996 due to differences in amounts of nondeductible merger
expenses in 1997 compared to 1996.
Net Income. As a result of the above factors, net income in 1997 increased
to $17.0 million, or 12.2% of revenue, from $13.7 million, or 15.9% of revenue,
in 1996.
1996 COMPARED WITH 1995
Revenue. Total revenue increased 70.1% in 1996 to $86.4 million from $50.8
million in 1995. This increase in revenue reflected increases in unit sales and
licensed use of substantially all of the Company's products. Approximately 41%,
21% and 11% of the increase in revenue was attributable to the increase 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 $19.9
million from $9.3 million in 1995 and accounted for 23.0% and 18.3% 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 62.7%
in 1996 to $68.0 million, or 78.7% of revenue, from $41.8 million, or 82.3% of
revenue, in 1995. Approximately 44% 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 25% 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 92.4%
in 1996 to $12.7 million from $6.6 million in 1995, and increased as a
percentage of revenue to 14.7% in 1996 from 13.0% 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.
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Purchased Research and Development. During the fourth quarter of 1996, the
Company purchased, and recorded as purchased research and development expense,
technology from Worldtalk 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 71.0% in
1996 to $24.8 million from $14.5 million in 1995, and increased as a percentage
of revenue to 28.7% in 1996 from 28.5% in 1995. Approximately 35% 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.
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
35.2% in 1996 to $14.6 million, or 16.9% of revenue, from $10.8 million, or
21.2% of revenue, in 1995. Approximately 27% 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 16% of the increase in general and administrative expenses was
from an increase in consulting and temporary administrative services. In
addition, approximately 9% of the increase in general and administrative
expenses consisted of moving costs incurred in relocating to the Company's new
corporate offices.
Merger and Integration. Merger and integration 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.
Interest Income and Other. Interest income increased to $4.9 million in 1996
from $1.9 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.
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<PAGE> 7
Provision for Income Taxes. The provision for income taxes increased to
$11.0 million in 1996 from $3.5 million in 1995. This increase was primarily the
result of higher pre-tax income during 1996. The Company's effective tax rate
increased to 44.6% 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 5 of
Notes to the Company's Consolidated Financial Statements.
Net Income. As a result of the above factors, net income in 1996 increased
to $13.7 million, or 15.9% of revenue, from $7.7 million, or 15.2% of revenue,
in 1995.
Page 14
<PAGE> 8
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
At December 31, 1997, the Company had cash, cash equivalents and marketable
securities of $164.7 million and working capital of $178.3 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
incurred in connection with the RSA Merger and the DynaSoft Acquisition. In the
first quarter of 1998, the Company used cash to finance certain costs incurred
in connection with the IDI Acquisition. The Company believes that working
capital will be sufficient to meet its anticipated cash requirements through at
least 1999.
MERGERS AND ACQUISITIONS
On July 26, 1996, a wholly owned subsidiary of the Company acquired RSA. The
RSA Merger costs were approximately $6.1 million. 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 were approximately $5.7 million, which included integration
costs, primarily severance, of $0.3 million. On March 26, 1998, a wholly-owned
subsidiary of the Company acquired 100% of the outstanding shares of IDI in
exchange for 784,342 shares of the Company's Common Stock. The IDI Acquisition
costs were approximately $2.6 million and were expensed in the first quarter of
1998. The mergers and acquisitions were accounted for as poolings of interests.
See Note 2 of Notes to the Company's Consolidated Financial Statements.
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.
SALES OF COMMON STOCK
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
Company's initial public offering, generating $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 $61.1
million of net cash proceeds to the Company.
The Company generated $7.5 million of cash from the exercise of stock
options and related income tax benefits and generated $1.9 million of cash from
the sale of minority interests in RSA's Japanese subsidiary in 1997.
Page 15
<PAGE> 9
STRATEGIC INVESTMENTS
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. 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 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. VeriSign introduced its first products and services
in June 1995; as such, it has a limited operating history and through December
31, 1997 has incurred significant net losses in each year since its inception.
There can be no assurance that VeriSign will achieve profitability in the
foreseeable future. The Company's voting interest in VeriSign was approximately
27% and 26% at December 31, 1996 and 1997, respectively. The Company uses the
equity method to account for its investment in VeriSign. In January 1998,
VeriSign had an initial public offering which diluted the Company's ownership to
approximately 22% (unaudited) but increased the Company's equity in VeriSign.
As a result of VeriSign's initial public offering, in accordance with the
equity method of accounting, the Company will recognize an increase in the
amount of its investment in VeriSign, representing its proportionate share of
VeriSign's equity as of December 31, 1997, after considering VeriSign's net
proceeds from the offering. The increase in the investment will be recorded
with a corresponding increase to additional paid in capital, net of deferred
income taxes payable. On April 23, 1998, VeriSign announced it had incurred a
net loss of $5.2 million for the first quarter of 1998 and at March 31, 1998
had total assets and liabilities of $63.9 million and $12.7 million,
respectively. The Company will record the increase in its investment
(approximately $12 million) and its proportionate share of VeriSign's first
quarter net loss (approximately $1 million) in the second quarter of 1998 as
the Company recognizes its proportionate interest in VeriSign's operating
results one quarter in arrears.
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. In January 1998, the Company purchased $120,000 of VPNet 8%
convertible debt. The debt is convertible into preferred stock which is
convertible into common stock. The Company also received a warrant to purchase
VPNet Common Stock. The Company's investment in VPNet represents a minority
interest of less than 10% of VPNet'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 October 1997, the Company purchased 175,285 Ordinary Shares of nCipher
Corporation Limited ("nCipher") for an aggregate purchase price of $512,000.
nCipher is located in the United Kingdom and develops products designed to
accelerate cryptographic processes in Internet security, electronic commerce
and other applications. In January 1998, the Company purchased 93,896 Ordinary
Shares of nCipher for an aggregate purchase price of $336,418. The Company's
investment in nCipher represents a minority interest of less than 5% of
nCipher's capitalization.
On March 31, 1998 the Company purchased, in a non-cash transaction, 482,765
ordinary shares of Trintech Group ("Trintech") for $2.0 million. Trintech is an
Irish development company organized to develop and market software products
designed to enable secure payment in the electronic marketplace. The Company's
investment represents a minority interest of less than 5% of Trintech's
capitalization. The Company has also agreed to purchase up to $3.0 million of
Trintech's Series A convertible preferred shares at such time as Trintech
completes a private placement of such securities.
CAPITAL EXPENDITURES
The Company's capital expenditures during 1997 were $10.9 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. During the fourth quarter of 1997,
the Company commenced implementation of an information system which is designed
to better meet the Company's growing world-wide
Page 16
<PAGE> 10
information and business process needs. The Company expects the system, which is
represented by the manufacturer to be year 2000 compliant, to be operational in
1998 and estimates the cost at approximately $5.0 million, of which
approximately $3.5 million will be spent in 1998 ($219,000 was spent in the
first quarter of 1998).
LEASING EXPENDITURES
In March 1998, the Company entered into an amendment to its noncancelable
operating lease for facilities in Bedford, Massachusetts. The facilities leased
under the amended agreement provide for approximately 183,000 square feet of
office space, and the annual base rent is approximately $2.6 million per year
through February 2008.
In August and December 1997, the Company entered into two noncancelable
ten-year leases expiring in 2008 for RSA offices in Redwood City, California.
The first facility consists of approximately 27,000 square feet of office
space, and the annual base rent is approximately $1.0 million. The Company
plans to occupy the second facility in June 1998. The second facility consists
of approximately 31,000 square feet of office space, and the annual base rent
is approximately $912,000 and annual operating expenses of approximately
$245,000. Both leases have rent escalation provisions covering years two
through ten based on the Consumer Price Index.
ROYALTY ARRANGEMENTS AND PURCHASED RESEARCH AND DEVELOPMENT
In September 1997, the Company announced its SecurMessage email security
solution, now known as SecurSight for email, which incorporates technology from
Worldtalk and VeriSign for securing already-deployed enterprise email and
groupware applications. In October 1997 the Company paid Worldtalk a one-time
prepaid, nonrefundable license fee of $3.0 million in order to obtain favorable
pricing. The prepaid asset will be recorded as cost of sales as Worldtalk
products are sold.
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
and in April 1998 agreed to prepay $6.0 million during 1998. The prepaid royalty
is recorded as cost of revenue as products incorporating Progress Software
products are sold.
In December 1997, the Company acquired and recorded as purchased technology
rights to certain Netscape technology for approximately $3.0 million. The
Company plans to incorporate the technology in its SecurSight products.
The Company expended approximately $6.2 million for purchased research and
development technology during 1997.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in
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<PAGE> 11
the date code field. These date code fields will need to accept four digit
entries to distinguish 21st century dates from 20th century dates. As a result,
software and computer systems may need to be upgraded or replaced in order to
comply with such "Year 2000" requirements. Although the Company believes that
its products and systems are Year 2000 compliant, the Company utilizes
third-party equipment and software that may not be Year 2000 compliant. Failure
of such third-party equipment or software to operate properly with regard to the
year 2000 and thereafter could require the Company to incur unanticipated
expenses to remedy any problems, which could have a material adverse effect on
the Company's business, operating results and financial condition.
Furthermore, the purchasing patterns of customers or potential customers may
be affected by Year 2000 issues as companies expend significant resources to
correct their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to implement the infrastructure needed to
conduct trusted and secure communications and commerce over information networks
or to purchase products and services such as those offered by the Company, which
could have a material adverse effect on the Company's business, operating
results and financial condition.
The Company has formed a Year 2000 task force. The task force consists of
employees with expertise in areas the Company believes could be affected if not
Year 2000 compliant. The task force has established a Year 2000 compliance
plan. The scope of the plan is to (i) identify the third-party equipment,
software, vendors, systems and suppliers used by the Company which are not Year
2000 compliant, (ii) replace non-compliant third party equipment and software
with compliant equipment and software and find alternatives to non-compliant
vendors, systems and suppliers, and (iii) work with Company customers to
overcome questions and concerns they may have about the impact of Year 2000
compliance on the Company and its products. The task force has almost completed
the identification phase of the project and anticipated completion of the
replacement phase of the project in 1998. Except for the previously described
worldwide business and information system, the Company does not believe the
identification and replacement of third party equipment and software will have
a material cost to the Company.
RECENT ACCOUNTING PRONOUNCEMENTS
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition," which supersedes SOP No. 91-1. The Company adopted SOP No. 97-2
prospectively on January 1, 1998. SOP No. 97-2 generally requires revenue earned
on software arrangements involving multiple elements to be allocated to each
element based on the relative fair values of the elements. In March 1998, the
AICPA postponed this adoption date of certain provisions of SOP No. 97-2. The
adoption of SOP No. 97-2 did not have a material effect on the Company's
revenues and operating results for the first quarter of 1998.
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 adopted the
provisions of SFAS 130 in the first quarter of 1998 and will be required to
adopt the provisions of SFAS 131 in its annual financial statements for 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 the operating segments on which it
will report. The adoption of SFAS 130 did not have a material effect 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
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<PAGE> 12
$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 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 approximately $0.7
million in 1996.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains certain forward-looking statements within the meaning
of Sections 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. For this purpose, any statements contained herein that are
not statements of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words "believes," "anticipates,"
"plans," "expects" and similar expressions are intended to identify
forward-looking statements. The following important factors, among others, could
cause actual results to differ materially from those indicated by
forward-looking statements made in this Annual Report to Stockholders and
presented elsewhere by management from time to time. Such forward-looking
statements represent management's current expectations and are inherently
uncertain. Investors are warned that actual results may differ from management's
expectations.
A number of uncertainties exist that could affect the Company's future
operating results, including, without limitation, general economic conditions,
the Company's continued ability to develop and introduce products, the
introduction of new products by competitors, pricing practices of competitors,
expansion of the Company's sales distribution capability, the cost and
availability of components and the Company's ability to control costs.
The Company's success is dependent in part on its ability to complete its
integration of the operations of RSA, DynaSoft and IDI in an efficient and
effective manner. The successful combination of the Company, RSA, Dynasoft and
IDI in a rapidly changing high technology industry may be more difficult to
accomplish than in other industries. The combination of these companies and any
future acquisitions will require, among other things, integration of the
companies' respective product offerings and coordination of their sales and
marketing and research and development efforts. There can be no assurance that
such integration will be accomplished smoothly or successfully. The difficulties
of such integration may be increased by the necessity of coordinating
geographically separated organizations. The integration of certain operations
will require the dedication of management resources which may temporarily
distract attention from the day-to-day business of the combined company. The
inability of management to successfully integrate the operations of these
companies could have a material adverse effect on the business and results of
operations of the Company.
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<PAGE> 13
The Company's success is also dependent on the success of its SecurSight
strategy, which is a security solution being developed by the Company that would
enable organizations to support and manage the growing use of public and private
keys, digital signatures and digital certificates for assuring confidentiality
and privacy on an enterprise-wide scale. The success of SecurSight is dependent
on a number of factors, including without limitation delays in product
development, undetected software errors or bugs, competitive pressures,
technical difficulties, market acceptance of new technologies, including without
limitation the use and implementation of various certificate management and key
management technologies, changes in customer requirements and government
regulations, delays in developing strategic partnerships and general economic
conditions.
The Company's success is highly dependent on its ability to enhance its
existing products and to develop and introduce new products in a timely manner.
If the Company were to fail to introduce new products on a timely basis, the
Company's operating results could be adversely affected. To date, substantially
all of the Company's revenues have been attributable to sales of its enterprise
network and data security products, the licensing of encryption engines and the
provision of related services, and existing and new versions of such products
are expected to continue to represent a high percentage of the Company's revenue
for the foreseeable future. As a result, any factor adversely affecting sales of
these products and services could have a material adverse effect on the
Company's financial condition and results of operations.
Certain components of the Company's products are currently purchased from a
single or limited sources and any interruption in the supply of such components
could adversely affect the Company's operating results.
The Company's quarterly operating results may vary significantly depending
on a number of factors, including the timing of the introduction or enhancement
of products by the Company or its competitors, the sizes, timing and shipment of
individual orders, market acceptance of new products, changes in the Company's
operating expenses, personnel changes, mix of products sold, changes in product
pricing, development of the Company's direct and indirect distribution channels
and general economic conditions.
International sales have represented a significant portion of the Company's
sales. The international business and financial performance of the Company may
be affected by fluctuations in foreign exchange rates, difficulties in managing
accounts receivable, tariff regulations and difficulties in obtaining export
licenses.
All of the Company's products are subject to export controls under U.S. law
and applicable foreign government restrictions, including without limitation
restrictions on the export of encryption technology. The Company believes it has
obtained necessary export approvals for the export of the products it currently
exports. There can be no assurance, however, that the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, will not be revised from time to time, or that the Company
will be able to obtain necessary regulatory approvals for the export of future
products. The inability of the Company to obtain required approvals under these
regulations could adversely affect the ability of the Company to make
international sales. In addition, the Company may be at a disadvantage in
competing for international sales compared to companies located outside the
United States that are not subject to such restrictions.
Page 20
<PAGE> 1
EXHIBIT 99.3
SECURITY DYNAMICS TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
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, 1996 and 1997................ F-4
Consolidated Statements of Income for the Years ended Decmeber 31, 1995,
1996 and 1997.............................................................. F-5
Consolidated Statements of Stockholders' Equity for the Years ended December
31, 1995, 1996 and 1997.................................................... F-6
Consolidated Statements of Cash Flows for the Years Ended December 31, 1995,
1996 and 1997.............................................................. F-7
Notes to Consolidated Financial Statements.................................. F-8
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, 1996 and 1997, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. 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 acquisitions of DynaSoft AB and Intrusion
Detection Inc., which have been accounted for as poolings of interests as
described in Note 2 of notes to the consolidated financial statements. We did
not audit the consolidated statements of income, stockholders' equity, and cash
flows of RSA Data Security, Inc. for the year ended December 31, 1995, which
consolidated statements reflect total revenues of $11,600,000 for the year
ended December 31, 1995. 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 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, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
As discussed in Note 4 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.
/s/ Deloitte & Touche LLP
May 15, 1998
Boston, Massachusetts
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 year ended December 31, 1995 (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 year ended December 31, 1995 in conformity
with generally accepted accounting principles.
/s/ 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,
------------
1996 1997
--------- ---------
<S> <C> <C>
ASSETS
- ------
CURRENT ASSETS:
Cash and equivalents ....................................... $ 11,688 $ 96,595
Marketable securities ...................................... 95,320 68,064
Accounts receivable (less allowance for doubtful accounts of
$537 in 1996 and $852 in 1997) ............................. 17,342 27,551
Inventory .................................................. 2,606 3,035
Prepaid expenses and other ................................. 4,204 9,338
Prepaid income taxes ....................................... -- 2,562
Deferred taxes ............................................. -- 1,426
--------- ---------
TOTAL CURRENT ASSETS ................................ 131,160 208,571
--------- ---------
PROPERTY AND EQUIPMENT
Furniture and equipment .................................... 11,363 20,909
Leasehold improvements ..................................... 2,863 4,528
--------- ---------
TOTAL PROPERTY AND EQUIPMENT ........................ 14,226 25,437
Less accumulated depreciation and amortization ............. (3,639) (7,922)
--------- ---------
PROPERTY AND EQUIPMENT -- NET ....................... 10,587 17,515
--------- ---------
OTHER ASSETS:
Investments ................................................ 2,924 3,699
Purchased technology and capitalized software
costs -- net ............................................. 197 86
Deferred taxes ............................................. 1,026 3,371
Other ...................................................... 1,461 733
--------- ---------
TOTAL OTHER ASSETS .................................. 5,608 7,889
--------- ---------
TOTAL ........................................................ $ 147,355 $ 233,975
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable ........................................... $ 5,257 $ 11,137
Accrued payroll and related benefits ....................... 4,868 5,254
Accrued expenses and other ................................. 4,319 4,071
Income taxes payable ....................................... 45 159
Deferred revenue ........................................... 5,736 9,602
Deferred taxes ............................................. 832 --
--------- ---------
TOTAL CURRENT LIABILITIES ........................... 21,057 30,223
--------- ---------
Minority interests ........................................... 1,194 3,099
--------- ---------
COMMITMENTS AND CONTINGENCIES (NOTES 7 AND 9)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized, 80,000,000 shares;
issued, 38,005,235 and 40,467,118 shares in 1996 and 1997;
outstanding, 38,004,939 and
40,466,609 shares in 1996 and 1997 ....................... 380 405
Additional paid-in capital ................................. 102,463 165,751
Retained earnings .......................................... 18,462 35,284
Deferred stock compensation ................................ (174) (116)
Treasury stock, common, at cost, 296 shares in 1996,
509 shares in 1997 ....................................... -- --
Cumulative translation adjustment .......................... 493 (750)
Unrealized gain on marketable securities -- net ............ 3,480 79
--------- ---------
TOTAL STOCKHOLDERS' EQUITY .......................... 125,104 200,653
--------- ---------
TOTAL ........................................................ $ 147,355 $ 233,975
========= =========
</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>
YEARS ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
------- ------- ---------
<S> <C> <C> <C>
REVENUE .......................... $50,812 $86,417 $ 140,630
COST OF REVENUE .................. 8,999 18,431 28,704
------- ------- ---------
GROSS PROFIT ..................... 41,813 67,986 111,926
COSTS AND EXPENSES:
Research and development ....... 6,612 12,682 20,970
Purchased research and
development ................. 648 1,000 6,210
Marketing and selling .......... 14,478 24,829 41,926
General and administrative ..... 10,775 14,603 17,171
Merger and integration ......... -- 6,100 5,700
------- ------- ---------
Total .................. 32,513 59,214 91,977
------- ------- ---------
INCOME FROM OPERATIONS ........... 9,300 8,772 19,949
Interest income and other ........ 1,917 4,889 6,273
Gain on sale of marketable
securities ..................... -- 11,027 4,264
------- ------- ---------
Income before provision for income
taxes .......................... 11,217 24,688 30,486
Provision for income taxes ....... 3,487 11,003 13,324
Minority interests ............... -- -- (114)
------- ------- ---------
NET INCOME ....................... $ 7,730 $13,685 $ 17,048
======= ======= =========
BASIC EARNINGS PER SHARE:
Per share amount ............... $ 0.24 $ 0.37 $ 0.44
======= ======= =========
Weighted average shares ........ 32,577 37,165 38,956
======= ======= =========
DILUTED EARNINGS PER SHARE:
Per share amount ............... $ 0.22 $ 0.35 $ 0.42
======= ======= =========
Shares:
Weighted average shares ...... 32,577 37,165 38,956
Effect of dilutive options ... 2,209 2,533 1,692
------- ------- ---------
Adjusted weighted average shares 34,786 39,698 40,648
======= ======= =========
</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
----------------------- PAID-IN EARNINGS STOCK -----------------
SHARES AMOUNT CAPITAL (DEFICIT) COMPENSATION SHARES AMOUNT
----------- ------ ---------- --------- ------------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 ........... 30,385,849 $ 303 $ 33,214 $ (2,953) $(275) 296 $ --
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 -- -- -- --
Comprehensive income:
Translation adjustment .......... -- -- -- -- -- -- --
Change in unrealized gain on
marketable securities ......... -- -- -- -- -- -- --
Net income ...................... -- -- -- 7,730 -- -- --
Total comprehensive income.........
----------- ----- --------- -------- ----- --- -------
Balance, December 31, 1995 ........ 35,922,113 359 94,593 4,777 (292) 296 --
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 -- -- -- --
Comprehensive income:
Translation adjustment .......... -- -- -- -- -- -- --
Change in unrealized gain on
marketable securities ......... -- -- -- -- -- -- --
Net income ...................... -- -- -- 13,685 -- -- --
Total comprehensive income.........
----------- ----- --------- -------- ----- --- -------
Balance, December 31, 1996 ........ 38,005,235 380 102,463 18,462 (174) 296 --
Settlement of RSA escrow ........... (36,037) -- -- -- -- 213 --
Exercise of stock options .......... 1,031,322 10 5,485 -- -- -- --
Other .............................. -- -- -- (226) -- -- --
Tax benefit arising from exercise
of stock options................. -- -- 2,012 -- -- -- --
Payments to Acquisition shareholders (159,402) (1) (6,037) -- -- -- --
Issuance of common stock ........... 1,626,000 16 61,092 -- -- -- --
Compensation expense ............... -- -- 736 -- -- -- --
Amortization of deferred stock
compensation .................... -- -- -- -- 58 --
Comprehensive income:
Translation adjustment ........... -- -- -- -- -- -- --
Change in unrealized gain
on marketable securities ...... -- -- -- -- -- -- --
Net income ....................... -- -- -- 17,048 -- -- --
Total comprehensive income.........
----------- ----- --------- -------- ----- --- -------
Balance, December 31, 1997 ........ 40,467,118 $ 405 $ 165,751 $ 35,284 $(116) 509 $ --
=========== ===== ========= ======== ===== === =======
</TABLE>
<TABLE>
<CAPTION>
UNREALIZED
CUMULATIVE GAIN ON
TRANSLATION MARKETABLE STOCKHOLDERS'
ADJUSTMENT SECURITIES EQUITY
----------- ---------- -------------
<S> <C> <C> <C>
Balance, January 1, 1995 ........... $ (493) $ -- $ 29,796
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
Comprehensive income:
Translation adjustment .......... 588 -- 588
Change in unrealized gain on
marketable securities .......... -- 9,910 9,910
Net income ..................... -- -- 7,730
---------
Total comprehensive income.......... 18,228
------- ------- ---------
Balance, December 31, 1995 ......... 95 9,910 109,442
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
Comprehensive income:
Translation adjustment .......... 398 -- 398
Change in unrealized gain on
marketable securities ......... -- (6,430) (6,430)
Net income ...................... -- -- 13,685
---------
Total comprehensive income.......... 7,653
------- ------- ---------
Balance, December 31, 1996 ......... 493 3,480 125,104
Settlement of RSA escrow ........... -- -- --
Exercise of stock options .......... -- -- 5,495
Other .............................. -- -- (226)
Tax benefit arising from exercise
of stock options ................ -- -- 2,012
Payments to Acquisition shareholders -- -- (6,038)
Issuance of common stock ........... -- -- 61,108
Compensation expense ............... -- -- 736
Amortization of deferred stock
compensation .................... -- -- 58
Comprehensive income:
Translation adjustment ........... (1,243) -- (1,243)
Change in unrealized gain
on marketable securities ...... -- (3,401) (3,401)
Net income ....................... -- -- 17,048
Total comprehensive income.......... ---------
12,404
------- ------- ---------
Balance, December 31, 1997 ......... $ (750) $ 79 $ 200,653
======= ======= =========
</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>
YEARS ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
-------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income .................................. $ 7,730 $ 13,685 $ 17,048
Adjustments to reconcile net income to
net cash provided by (used for)
operating activities:
Gain on sale of marketable
securities ............................. -- (11,027) (4,264)
Deferred taxes ............................ (988) (1,393) (2,337)
Purchased research and development ........ 648 1,000 6,210
Depreciation and amortization ............. 1,089 1,824 4,353
Provision for notes receivable ............ 200 -- --
Stock compensation ........................ 181 1,167 794
Minority interests ........................ -- -- (114)
Increase (decrease) in cash from
changes in:
Accounts receivable .................... (3,563) (8,459) (10,946)
Inventory .............................. (309) (1,161) (429)
Prepaid expenses and other ............. (1,125) (2,672) (5,167)
Accounts payable ....................... 1,571 2,379 1,627
Accrued payroll and related
benefits ............................. 1,808 1,659 471
Accrued expenses and other ............. 837 1,943 15
Prepaid and income taxes payable ....... 612 (459) (4,685)
Deferred revenue ....................... 2,448 1,105 3,983
-------- --------- ---------
NET CASH PROVIDED BY (USED
FOR) OPERATING ACTIVITIES .......... 11,139 (409) 6,559
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities .......... (64,730) (119,619) (104,172)
Sales and maturities of marketable securities 27,842 85,975 133,804
Purchases of property and equipment ......... (1,897) (9,434) (10,896)
Notes receivable ............................ (274) -- --
Capitalized software costs and purchased
technology ................................ (924) (1,061) (1,410)
Investments and other ....................... (734) (3,224) (1,616)
-------- --------- ---------
NET CASH PROVIDED BY (USED
FOR) INVESTING ACTIVITIES .......... (40,717) (47,363) 15,710
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock,
net of issuance costs ..................... 60,411 534 61,108
Payments to Acquisition shareholders ........ -- -- (6,038)
Proceeds from exercise of stock options
and purchase plans ........................ 642 2,606 5,269
Tax benefit from exercise of stock
options ................................... 225 3,702 2,012
Minority interests .......................... -- 1,213 1,905
Other ....................................... (815) 537 --
-------- --------- ---------
NET CASH PROVIDED BY FINANCING
ACTIVITIES ......................... 60,463 8,592 64,256
-------- --------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND EQUIVALENTS ............................. 195 (138) (1,618)
-------- --------- ---------
NET INCREASE (DECREASE) IN CASH
AND EQUIVALENTS ............................. 31,080 (39,318) 84,907
CASH AND EQUIVALENTS, BEGINNING OF
PERIOD ...................................... 19,926 51,006 11,688
-------- --------- ---------
CASH AND EQUIVALENTS, END OF
PERIOD ...................................... $ 51,006 $ 11,688 $ 96,595
======== ========= =========
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE> 8
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 and the Kane Security Analyst and the Kane Security Monitor, which
provide for network security management.
The principal markets for the Company's products are the United States,
Canada, Latin America, Europe and Asia/Pacific, with the United States, Europe
and Asia/Pacific currently being the largest.
BASIS OF PRESENTATION -- The consolidated financial statements have been
prepared to give retroactive effect to the acquisition of Intrusion Detection,
Inc. ("IDI") on March 26, 1998 (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 May 15, 1998, the Company issued its
Consolidated Financial Statements for the quarter ended March 31, 1998 in its
Quarterly 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 including RSA Data Security, Inc.
("RSA"). Strategic equity investments are either accounted for under the equity
method or, for where the Company does not have the ability to exercise
significant influence are carried at cost.
In 1996 and 1997, RSA sold minority interests, aggregating 26% in its
Japanese subsidiary to third parties for $1,213 and $1,905, respectively. The
minority interest in the subsidiaries' profits and losses is separately
presented in the accompanying consolidated income statement.
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
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 SecurID tokens and is stated at
the lower of cost
F-8
<PAGE> 9
(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 ten 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 $298, $330 and
$111 for 1995, 1996 and 1997, respectively.
In December 1997, the Company acquired and recorded as purchased technology
certain rights to Netscape technology for approximately $3,000, which amount is
included in accounts payable as of December 31, 1997. The Company plans to
incorporate the technology in its SecurSight products. The Company expended
approximately $6,200 for purchased research and development technology during
1997.
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,
--------------------------------------------
1996 1997
-------------------- ---------------------
AGGREGATE AGGREGATE
FAIR VALUE COST FAIR VALUE COST
---------- ------- ---------- -------
<S> <C> <C> <C> <C>
U.S. Government
obligations ..... $88,171 $88,161 $67,582 $67,510
Corporate equity
securities ...... 5,809 20 482 422
Corporate debt
securities ...... 1,340 1,340 -- --
------- ------- ------- -------
Total .... $95,320 $89,521 $68,064 $67,932
======= ======= ======= =======
</TABLE>
At December 31, 1996 and 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 in 1995.
Proceeds from the sale of marketable securities were $11,027 and $4,264 in 1996
and 1997, respectively. The specific identified cost basis of the securities was
used to determine the gain. Unrealized gross gains at December 31, 1996 and 1997
were $5,799 and $132, respectively.
ADVERTISING -- Advertising costs are expensed as incurred. Total advertising
expense was approximately $501, $632 and $850 for 1995, 1996 and 1997,
respectively.
F-9
<PAGE> 10
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.
EARNINGS PER SHARE -- In the fourth quarter of 1997, the Company adopted the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 128
"Earnings per Share." The Company changed the method used to compute earnings
per share and restated all prior periods in accordance with SFAS No. 128. 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 by requiring the presentation of
basic and fully diluted earnings per share. The Company's only dilutive stock
equivalents are stock options.
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 interest in 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.
Two 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 have
been met in 1997. Accordingly, these restricted securities, which had a cost of
$737, have been reclassified in 1997 from investments to marketable securities.
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
F-10
<PAGE> 11
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 adopted the provisions of SFAS 130 effective January 1, 1998 and
will be required to adopt the provisions of SFAS 131 in its annual financial
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 the operating segments on which it will report.
The Company believes that the provisions of SFAS 130 did not, when adopted,
have a material impact on the Company's consolidated financial statements.
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition", which supersedes SOP No. 91-1. The Company adopted SOP No. 97-2
prospectively for software transactions entered into after January 1, 1998. SOP
No. 97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements. In March 1998, the AICPA postponed the adoption date of
certain provisions of SOP No. 97-2. The Company's management believes that the
adoption of SOP No. 97-2 will not have a material effect on the Company's
consolidated revenues and operating results.
2. MERGER AND ACQUISITIONS
On July 26, 1996, SDI completed a merger with RSA Data Security, Inc. (the
"Merger" and "RSA," respectively). On July 15, 1997, SDI acquired DynaSoft AB
(the "DynaSoft Acquisition" and "DynaSoft," respectively). On March 26, 1998,
SDI acquired IDI (the "IDI Acquisition") (collectively, the "Acquisitions").
The Acquisitions
F-11
<PAGE> 12
and the Merger have been accounted for as poolings of interests and therefore
the consolidated financial statements for all periods prior to Acquisitions and
the Merger have been restated to include the accounts and operations of RSA,
DynaSoft and IDI, 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 Acquisitions and the 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.
IDI is located in New York, New York and is a leading publisher of network
security software tools designed to manage enterprise-wide security more
effectively. IDI markets its products world-wide through a direct sales force
and distributors.
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 DynaSoft 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 $6,038 to certain stockholders of DynaSoft
in exchange for the remaining outstanding shares and options.
Under the terms of the IDI Acquisition, the Company issued 784,342 shares of
common stock in exchange for all of the outstanding shares of IDI.
Investment banking, professional fees and other direct expenses incurred in
connection with the Merger were approximately $6,100 in 1996. In the third
quarter of 1997, the Company accrued a charge of $7,000 representing the
estimated direct costs of the DynaSoft Acquisition. In the fourth quarter, the
Company's actual direct costs were determined to be approximately $5,400, a
difference of $1,600. The difference came from lower than expected legal and
other professional fees and from a change in the planned use of the DynaSoft
facilities. As a result, the Company reversed $1,600 of the original accrual in
the fourth quarter of 1997. As of December 31, 1997, approximately $325,
representing unbilled professional fees and unsettled lease obligations, remains
unpaid.
F-12
<PAGE> 13
In December 1997, the Company committed to a plan to integrate the DynaSoft
operations into its worldwide structure. The plan of integration encompasses the
severing of nine DynaSoft employees and consultants, all of whom have been
notified of their pending termination from the Company prior to December 31,
1997. In connection with this plan, the Company accrued for severance and other
related costs of $300 in the fourth quarter of 1997. As of December 31, 1997,
four of the employees have been terminated, whereby the company paid severance
of $49. The remaining five employees/consultants were terminated in early 1998,
at which time the Company paid the remaining amounts contemplated under the
plan.
Investment banking, professional fees and other direct expenses incurred in
connection with the IDI acquisition and charged to operations in the first
quarter of 1998 were approximately $2.6 million(unaudited).
No adjustments to conform accounting policies of the Company, RSA and IDI
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>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------------- --------------
1995 1996 1997 1998
------- -------- -------- --------------
(unaudited)
<S> <C> <C> <C> <C>
REVENUE
SDI ............ $33,804 $ 70,105 $130,653 $39,346
RSA ............ 11,600 6,043(a) -- --
DynaSoft ....... 4,008 7,669 5,277 (b) --
IDI ............ 1,400 2,600 4,700 900(c)
------- -------- -------- -------
Total .. $50,812 $ 86,417 $140,630 $40,246
======= ======== ======== =======
NET INCOME
(LOSS)
SDI ............ $ 5,812 $ 13,428 $ 16,523 $ 3,101
RSA ............ 950 (383)(a) -- --
DynaSoft ....... 688 130 (155) (b) --
IDI ............ 280 510 680 (137)(c)
------- -------- -------- -------
Total .. $ 7,730 $ 13,685 $ 17,048 $ 2,964
======= ======== ======== =======
</TABLE>
(a) Revenue and net loss of RSA for 1996 include only the six month period prior
to the consummation of the Merger.
(b) Revenue and net loss of DynaSoft for 1997 include only the six month period
prior to the consummation of the Dynasoft Acquisition.
(c) Revenue and net loss of IDI for 1998 include only the period from January 1,
1998 to March 26, 1998, the consummation date of the IDI Acquisition.
Pursuant to escrow agreements entered into with the Company by
certain of the stockholders of DynaSoft, RSA, and IDI in connection with the
DynaSoft Acquisition, the Merger, and the IDI Acquisition, 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 and 10% of the shares of the
Company's common stock issued to holders of IDI's stock were placed in escrow,
pending settlement of any breaches of representations, warranties or covenants
to the DynaSoft Acquisition, the Merger and the IDI Acquisition agreements. In
June 1997, the Company and the holders of the RSA shares reached a 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 stock. Of the shares received by the Company, 213 shares were accounted
for as treasury stock and the remainder were canceled.
F-13
<PAGE> 14
3. INVESTMENTS
Investments were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1996 1997
------ ------
<S> <C> <C>
VeriSign, Inc. ............ $ 687 $ 687
VPNet Technologies, Inc. .. 1,500 1,500
nCipher Corporation Ltd. .. -- 512
Finjan Software Ltd. ...... -- 1,000
Other ..................... 737 --
------ ------
Total ........... $2,924 $3,699
====== ======
</TABLE>
Prior to 1997, other investments were carried at the lower of cost or
estimated realizable value (See Note 1, "Financial Instruments").
VeriSign, Inc. ("VeriSign") -- 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. 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, 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. The Company's voting interest in
VeriSign was approximately 27% and 26% at December 31, 1996 and December 31,
1997, respectively. The Company uses the equity method to account for its
investment in VeriSign. The Company's equity investment in VeriSign Common Stock
was zero in 1996 and 1997 and the Company recognized no equity interest in
VeriSign's net losses. In January 1998, VeriSign had an initial public offering
of 3 million (unaudited) shares of its common stock. The Company's series A and
B convertible preferred stock converted to common stock in connection with the
offering. The offering diluted the Company's ownership to approximately 22%
(unaudited) but increased the Company's equity in VeriSign. As of December 31,
1997, VeriSign had total assets and liabilities of $24,406 (unaudited) and
$11,937 (unaudited), respectively. For the year ended December 31, 1997,
VeriSign had a net loss of $19,195 (unaudited).
As a result of VeriSign's initial public stock offering, in accordance with the
equity method of accounting, the Company will recognize an increase in its
investment in VeriSign, representing its proportionate share of VeriSign's net
assets as of December 31, 1997, after considering VeriSign's net proceeds from
the offering. The increase in the investment will be recorded with a
corresponding increase to additional paid in capital, net of deferred income
taxes payable. On April 23, 1998, VeriSign announced it recorded a net loss of
$5.2 million (unaudited) for the first quarter of 1998 and at March 31, 1998 had
total assets and liabilities of $63.9 million (unaudited) and $12.7 million
(unaudited), respectively. The Company will record the increase in the
investment (approximately $12.0 million, unaudited) and its proportionate share
of VeriSign's first quarter net loss (approximately $1.1 million, unaudited) in
the second quarter of 1998 as the Company recognizes its proportionate interest
in VeriSign's operating results one quarter in arrears.
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. In January 1998, the Company
purchased $120 (unaudited) of VPNet 8% convertible debt. The debt is convertible
into preferred stock which is convertible into common stock. The Company also
received a warrant to purchase VPNet common stock. The Company's investment in
VPNet represents a minority interest of less than 10% (unaudited) of VPNet's
capitalization and is carried at cost.
nCipher Corporation Ltd. -- In October 1997, the Company purchased 175,285
Ordinary Shares of nCipher Corporation Limited ("nCipher") for an aggregate
purchase price of $512. nCipher is located in the United Kingdom and develops
products designed to accelerate cryptographic processes in Internet security,
electronic commerce and other applications. In January 1998, the Company
purchased 93,896 (unaudited) Ordinary Shares of nCipher for an aggregate
purchase price of $336 (unaudited). The Company's investment in nCipher
represents a minority interest of less than 5% (unaudited) of nCipher's
capitalization and is carried at cost.
F-14
<PAGE> 15
Finjan Software Ltd. -- 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 and is carried at cost.
Trintech Group -- In March 1998 the Company purchased, in a non-cash
transaction, 482,765 (unaudited) ordinary shares of Trintech Group ("Trintech")
for $2.0 million (unaudited). Trintech is an Irish development company organized
to develop and market software products designed to enable secure payment in the
electronic marketplace. The Company's interest represents a minority interest of
less than 5% (unaudited) of Trintech's Capitalization. The Company has agreed to
purchase up to $3.0 million (unaudited) of Trintech's Series A convertible
preferred shares at such time as Trintech completes a private placement of such
securities.
4. STOCK OPTION AND PURCHASE PLANS
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 356,917 at December 31, 1997. On January 22,
1998, the Board of Directors adopted, and on April 30, 1998 the stockholders of
the Company approved, an amendment to the 1994 Plan increasing the number of
shares of common stock authorized for issuance from 6,570,000 to 9,570,000
shares in the aggregate.
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 115,000 at December 31, 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 145,203 in 1995, 1996 and 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
F-15
<PAGE> 16
repurchase at the original exercise price any unvested shares. At December 31,
1997, options as to 871,208 shares were subject to repurchase rights, and a
total of 40,843 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 then outstanding options to purchase shares of DynaSoft.
F-16
<PAGE> 17
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, 1995 ... 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 ........................ 2,437,383 34.29
Exercised ...................... (959,143) 3.58
Canceled ....................... (147,056) 26.43
---------
OUTSTANDING AT DECEMBER 31, 1997 6,053,641 24.87
=========
Exercisable at December 31, 1995 2,261,327 0.40
=========
Exercisable at December 31, 1996 2,127,928 1.69
=========
Exercisable at December 31, 1997 2,120,841 11.45
=========
</TABLE>
The following table sets forth information regarding stock options outstanding
at December 31, 1997 under all plans:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF WEIGHTED REMAINING NUMBER EXERCISE PRICE
EXERCISE NUMBER OF AVERAGE CONTRACTUAL LIFE CURRENTLY FOR CURRENTLY
PRICES OPTIONS EXERCISE PRICE (YEARS) EXERCISABLE EXERCISABLE
- ---------- ----------- -------------- ---------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$ 0.10 302,000 $ 0.10 2.3 302,000 $ 0.10
0.35-0.45 54,247 0.43 6.0 47,084 0.42
0.76-0.90 742,270 0.90 2.3 733,754 0.90
1.75-2.55 27,651 2.31 6.6 18,350 2.33
2.95-4.22 148,235 3.30 3.8 139,294 3.31
6.62 17,557 6.62 3.3 17,557 6.62
9.97-14.31 482,200 10.30 7.7 225,910 10.36
24.30-36.25 2,586,414 29.84 8.9 407,203 27.70
37.59-44.21 1,693,067 39.60 9.2 229,689 40.60
--------- ----------
0.10-44.21 6,053,641 24.87 7.6 2,120,841 11.45
========= ==========
</TABLE>
F-17
<PAGE> 18
ACCOUNTING FOR STOCK OPTIONS
For certain options and stock awards granted in 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 subsequent to April 1, 1996, 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 1996.
Total compensation expense relating to certain options and stock awards amounted
to $181, $1,167 and $1,205 for the years ended December 31, 1995, 1996, and
1997, respectively.
F-18
<PAGE> 19
PRO FORMA DISCLOSURE -- Had the Company recognized compensation costs for
its 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," pro forma net income and pro forma net income per
share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
------- -------- -------
<S> <C> <C> <C>
Pro forma net/income 7,306 11,255 5,697
Pro forma net income
per share
- basic ......... $ 0.22 $ 0.30 $ 0.15
- diluted ....... 0.21 0.28 0.14
</TABLE>
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 1997
------ ------ ------
<S> <C> <C> <C>
STOCK OPTION PLANS
Risk-free interest rate ............... 6.0% 6.0% 6.1%
Expected life of option grants (years) 4.4 4.4 4.3
Expected volatility of underlying stock 57.5% 57.5% 57.5%
Expected dividend payment rate ........ 0.0% 0.0% 0.0%
Expected forfeiture rate .............. 4.1% 4.1% 4.1%
EMPLOYEE STOCK PURCHASE PLAN
Risk-free interest rate ............... 5.9% 5.2% 5.2%
Expected life of option grants (years) 0.5 0.5 0.5
Expected volatility of underlying stock 57.5% 57.5% 57.5%
Expected dividend payment rate ........ 0.0% 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, $17.36 and $19.64 during the
years ended December 31, 1995, 1996 and 1997, respectively. The weighted fair
value of stock options granted under the Purchase Plan, calculated using the
Black-Scholes option-pricing model was $2.30, $8.81 and $10.82 during 1995, 1996
and 1997, respectively.
5. INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
------- -------- --------
<S> <C> <C> <C>
Current:
Federal ........................ $ 3,049 $ 7,359 $ 11,459
State .......................... 899 936 1,759
Foreign ........................ 302 399 431
------- -------- --------
Total .................. 4,250 8,694 13,649
Deferred:
Federal ........................ (93) (1,219) (2,179)
State .......................... (26) (174) (158)
Change in valuation allowance .. (869) -- --
------- -------- --------
Total .................. (988) (1,393) (2,337)
Tax benefit from exercise of stock
options:
Federal ........................ 179 3,452 1,878
State .......................... 46 250 134
------- -------- --------
Total .................. 225 3,702 2,012
------- -------- --------
Total ............................ $ 3,487 $ 11,003 $ 13,324
======= ======== ========
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
at December 31
F-19
<PAGE> 20
were as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1996 1997
------- -------
<S> <C> <C>
Deferred tax assets (liabilities) -- current:
Marketable securities ........................ $(2,319) $ (846)
Deferred revenue ............................. 854 942
Merger and integration ....................... -- 196
Sales returns ................................ 271 524
Allowance for doubtful accounts .............. 211 267
Compensation ................................. 205 185
Inventory reserves ........................... 66 67
Warranty obligation .......................... 42 42
Commissions .................................. 42 22
Other ........................................ (204) 27
------- -------
Net deferred tax asset (liability) -- current .. $ (832) $ 1,426
======= =======
Deferred tax assets (liabilities) -- non current:
Purchased research and development ........... $ 733 $ 2,907
Compensation ................................. 326 575
Capitalized software development costs ....... (79) (34)
Net operating loss carryforwards ............. 32 --
Other ........................................ 14 (77)
------- -------
Net deferred tax assets -- non current ......... $ 1,026 $ 3,371
======= =======
</TABLE>
A reconciliation between the statutory and effective income tax rates
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Statutory tax rate ...................... 34.0% 35.0% 35.0%
State income taxes net of federal benefit 5.4 2.3 3.7
Merger expenses ......................... -- 8.3 6.7
Change in valuation allowance ........... (8.8) -- --
Other ................................... 0.5 (1.0) (1.7)
------ ------ ------
Effective income tax rate ............... 31.1% 44.6% 43.7%
====== ====== ======
</TABLE>
Through the first three quarters of 1997, the Company provided income taxes
based upon an estimated effective income tax rate of 37.5%. In December 1997,
the Company changed its international income tax strategy and, as a result,
recorded an additional income tax provision of $1,900.
Cash payments for income taxes were approximately $4,258, $8,390 and $15,542
for 1995, 1996 and 1997, respectively.
6. 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 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,
1996 and 1997, the Company had accrued, and the Board of Directors had approved,
profit-sharing contributions approximating $305 and $400, respectively. The
Board of Directors also approved for 1996 and 1997 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 $112, $261 and $367 for 1995, 1996 and 1997,
respectively.
F-20
<PAGE> 21
IDI has a non-contributory age weighted Pension Plan. Employees participate
after one year of service. Contributions vest 20% per year and are made at 15%
of annual compensation. The Plan was established in 1995. Contributions vest $39
in 1996 and $43 in 1997.
7. COMMITMENTS
The Company leases office facilities and automobiles under non-cancelable
operating leases expiring through 2008. Future minimum rental payments are as
follows for years ending December 31:
<TABLE>
<S> <C>
1998.................... $ 5,418
1999.................... 4,916
2000.................... 4,217
2001.................... 4,197
2002.................... 4,228
Balance thereafter...... 18,561
</TABLE>
Net rent expense for 1995, 1996 and 1997 was approximately $1,037, $2,069
and $3,437, respectively. Rent collected from a sublease of the Company's former
headquarters was $108 and $527 in 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 December 31, 1996 and 1997, the Company 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.
Effective April 1, 1998, the Company agreed to prepay in 1998 $6.0 million
(unaudited) in order to obtain favorable pricing. The prepaid royalty will be
recorded as a component of cost of revenue as the related products are sold.
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.
In September 1997, the Company entered into an agreement with Worldtalk
Communications Corporation ("Worldtalk"), a vendor of directory-based messaging
and security solutions that support organizations in transforming Intranets into
secure platforms, for the right to distribute certain of Worldtalk's software
products to help complement the Company's future product lines. The Company had
prepaid $3,000 under this agreement as of December 31, 1997 and has not yet
incurred any royalty expense under the agreement.
F-21
<PAGE> 22
Royalty expense was $706, $2,009 and $6,061 for 1995, 1996 and 1997,
respectively.
As of April 14, 1996 and November 1, 1997, the Company entered into
employment agreements with two of its executive officers, which require total
annual minimum salaries of $500 and expire in July 1998 and November 1999,
respectively. One of the agreements includes a post retirement benefit, to be
paid by the Company for the executive. The Company is recognizing the present
value of the benefit over the applicable service period.
8. SEGMENT INFORMATION
The Company operates in only one industry segment. Export sales are
summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Europe ......... $ 5,116 $11,796 $29,020
Canada ......... 2,772 4,511 6,606
Asia/Pacific ... 571 2,518 7,059
Latin America .. -- 198 630
------- ------- -------
$ 8,459 $19,023 $43,315
======= ======= =======
</TABLE>
9. LITIGATION
The Company has been named as a defendant in legal actions arising from its
normal business activities. The Company is not a party to any litigation that it
believes could have a material adverse effect on the Company or its business.
10. RELATED PARTY TRANSACTIONS
A Company officer and director serves as VeriSign's (Note 3) Chairman of the
Board of Directors. Two Company directors (one of whom is also an officer) also
serve as VPNet directors (Note 3).
In September 1997, the Company and VeriSign (Note 3) entered into a Master
Development License Agreement (the "Development Agreement"), pursuant to which
VeriSign will develop certain technology for the Company. The Development
Agreement provides that the Company will pay VeriSign an aggregate of $2.7
million as an initial license fee, $900 of which was paid in October 1997 and
the remainder of which will be payable upon the achievement of certain
milestones of which $1.8 million was recorded as accounts payable at December
31, 1997. Commencing in March 1998, the Company will also be required to pay
VeriSign a monthly product support fee for a three-year period, and thereafter
for successive annual terms, unless either of the parties elects to terminate
such product support within 60 days prior to the end of the term or the Company
terminates support services at any time on 60 days prior written notice to
VeriSign. For a yearly fee, the Company can purchase product maintenance
services. For so long as the Company is paying such maintenance fees, VeriSign
will be obligated, at no additional cost, to provide the Company with
non-exclusive first-to-market access to new technologies developed by VeriSign
that are relevant to the business of providing enterprise security solutions or
solutions for secure business communications. VeriSign is also obligated, upon
the request of the Company, to make its other technology available to the
Company on certain "most favored pricing" terms.
F-22
<PAGE> 23
Since September 1996, the Company subleases its former headquarters in
Cambridge, Massachusetts, to VeriSign pursuant to a sublease that expires in
March 1998. The Company has received lease payments from VeriSign of $18 and
$105 in 1996 and 1997, respectively.
A stockholder, who owns less than 5% of the Company's common stock, provides
consulting services to the Company and received $91, $97 and $104 in 1995, 1996
and 1997 respectively. As of December 31, 1997, the Company has approximately
$25 due to a less than 5% stockholder payable upon demand.
F-23
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<EXCHANGE-RATE> 1
<CASH> 51,006
<SECURITIES> 61,637
<RECEIVABLES> 9,699
<ALLOWANCES> 734
<INVENTORY> 1,445
<CURRENT-ASSETS> 124,590
<PP&E> 4,655
<DEPRECIATION> 1,998
<TOTAL-ASSETS> 129,279
<CURRENT-LIABILITIES> 19,837
<BONDS> 0
0
0
<COMMON> 359
<OTHER-SE> 109,083
<TOTAL-LIABILITY-AND-EQUITY> 129,279
<SALES> 50,812
<TOTAL-REVENUES> 50,812
<CGS> 8,999
<TOTAL-COSTS> 41,512
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 541
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 11,217
<INCOME-TAX> 3,487
<INCOME-CONTINUING> 7,730
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,730
<EPS-PRIMARY> .24
<EPS-DILUTED> .22
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<EXCHANGE-RATE> 1
<CASH> 23,134
<SECURITIES> 88,592
<RECEIVABLES> 10,628
<ALLOWANCES> 517
<INVENTORY> 1,322
<CURRENT-ASSETS> 125,787
<PP&E> 5,758
<DEPRECIATION> 2,340
<TOTAL-ASSETS> 131,382
<CURRENT-LIABILITIES> 20,100
<BONDS> 0
0
0
<COMMON> 364
<OTHER-SE> 110,918
<TOTAL-LIABILITY-AND-EQUITY> 131,382
<SALES> 16,590
<TOTAL-REVENUES> 16,590
<CGS> 3,697
<TOTAL-COSTS> 14,419
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 56
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,456
<INCOME-TAX> 1,302
<INCOME-CONTINUING> 2,154
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,154
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<EXCHANGE-RATE> 1
<CASH> 9,845
<SECURITIES> 107,244
<RECEIVABLES> 13,134
<ALLOWANCES> 636
<INVENTORY> 2,365
<CURRENT-ASSETS> 135,620
<PP&E> 7,454
<DEPRECIATION> 2,692
<TOTAL-ASSETS> 143,995
<CURRENT-LIABILITIES> 15,102
<BONDS> 0
0
0
<COMMON> 370
<OTHER-SE> 128,523
<TOTAL-LIABILITY-AND-EQUITY> 143,995
<SALES> 36,911
<TOTAL-REVENUES> 36,911
<CGS> 7,520
<TOTAL-COSTS> 30,888
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 111
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 8,402
<INCOME-TAX> 3,145
<INCOME-CONTINUING> 5,257
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,257
<EPS-PRIMARY> .14
<EPS-DILUTED> .13
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 9,218
<SECURITIES> 96,043
<RECEIVABLES> 15,898
<ALLOWANCES> 587
<INVENTORY> 2,717
<CURRENT-ASSETS> 125,491
<PP&E> 12,091
<DEPRECIATION> 3,229
<TOTAL-ASSETS> 137,971
<CURRENT-LIABILITIES> 19,002
<BONDS> 0
0
0
<COMMON> 375
<OTHER-SE> 118,961
<TOTAL-LIABILITY-AND-EQUITY> 137,971
<SALES> 58,854
<TOTAL-REVENUES> 58,854
<CGS> 12,872
<TOTAL-COSTS> 49,045
<OTHER-EXPENSES> 6,100<F1>
<LOSS-PROVISION> 167
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 11,770
<INCOME-TAX> 6,432
<INCOME-CONTINUING> 5,338
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,338
<EPS-PRIMARY> .15
<EPS-DILUTED> .14
<FN>
<F1>Other expenses refer to merger expense incurred during merger with RSA Data
Security, Inc.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 11,688
<SECURITIES> 95,320
<RECEIVABLES> 17,879
<ALLOWANCES> 537
<INVENTORY> 2,606
<CURRENT-ASSETS> 131,160
<PP&E> 14,226
<DEPRECIATION> 3,639
<TOTAL-ASSETS> 147,355
<CURRENT-LIABILITIES> 21,057
<BONDS> 0
0
0
<COMMON> 380
<OTHER-SE> 124,724
<TOTAL-LIABILITY-AND-EQUITY> 147,355
<SALES> 86,417
<TOTAL-REVENUES> 86,417
<CGS> 18,431
<TOTAL-COSTS> 71,545
<OTHER-EXPENSES> 6,100<F1>
<LOSS-PROVISION> 223
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<INCOME-TAX> 11,003
<INCOME-CONTINUING> 13,685
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<CHANGES> 0
<NET-INCOME> 13,685
<EPS-PRIMARY> .37
<EPS-DILUTED> .35
<FN>
<F1>Other expense refers to merger expenses incurred with the merger of RSA Data
Security, Inc. in July 1996.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 1
<CASH> 17,386
<SECURITIES> 89,208
<RECEIVABLES> 17,794
<ALLOWANCES> 617
<INVENTORY> 2,798
<CURRENT-ASSETS> 132,010
<PP&E> 15,387
<DEPRECIATION> 4,374
<TOTAL-ASSETS> 148,226
<CURRENT-LIABILITIES> 16,427
<BONDS> 0
0
0
<COMMON> 386
<OTHER-SE> 129,727
<TOTAL-LIABILITY-AND-EQUITY> 148,226
<SALES> 29,319
<TOTAL-REVENUES> 29,319
<CGS> 6,456
<TOTAL-COSTS> 22,862
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 62
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 7,732
<INCOME-TAX> 2,863
<INCOME-CONTINUING> 4,869
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,869
<EPS-PRIMARY> .13
<EPS-DILUTED> .12
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<EXCHANGE-RATE> 1
<CASH> 25,768
<SECURITIES> 86,437
<RECEIVABLES> 21,430
<ALLOWANCES> 912
<INVENTORY> 3,189
<CURRENT-ASSETS> 142,061
<PP&E> 18,079
<DEPRECIATION> 5,191
<TOTAL-ASSETS> 159,524
<CURRENT-LIABILITIES> 20,807
<BONDS> 0
0
0
<COMMON> 387
<OTHER-SE> 135,747
<TOTAL-LIABILITY-AND-EQUITY> 159,524
<SALES> 63,574
<TOTAL-REVENUES> 63,574
<CGS> 13,242
<TOTAL-COSTS> 49,567
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 124
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 16,962
<INCOME-TAX> 6,218
<INCOME-CONTINUING> 10,744
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,744
<EPS-PRIMARY> .28
<EPS-DILUTED> .27
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 38,509
<SECURITIES> 70,774
<RECEIVABLES> 21,997
<ALLOWANCES> 897
<INVENTORY> 2,744
<CURRENT-ASSETS> 140,028
<PP&E> 21,335
<DEPRECIATION> 5,864
<TOTAL-ASSETS> 163,428
<CURRENT-LIABILITIES> 28,470
<BONDS> 0
0
0
<COMMON> 388
<OTHER-SE> 131,538
<TOTAL-LIABILITY-AND-EQUITY> 163,428
<SALES> 99,502
<TOTAL-REVENUES> 99,502
<CGS> 20,137
<TOTAL-COSTS> 80,417
<OTHER-EXPENSES> 7,000<F1>
<LOSS-PROVISION> 187
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 20,710
<INCOME-TAX> 7,679
<INCOME-CONTINUING> 13,031
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,031
<EPS-PRIMARY> .34
<EPS-DILUTED> .32
<FN>
<F1>Other expenses refers to expenses incurred in conjunction with the acquisition
and integration of DynaSoft AB.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 96,595
<SECURITIES> 68,064
<RECEIVABLES> 28,403
<ALLOWANCES> 852
<INVENTORY> 3,035
<CURRENT-ASSETS> 208,571
<PP&E> 25,437
<DEPRECIATION> 7,922
<TOTAL-ASSETS> 233,975
<CURRENT-LIABILITIES> 30,223
<BONDS> 0
0
0
<COMMON> 405
<OTHER-SE> 200,248
<TOTAL-LIABILITY-AND-EQUITY> 233,975
<SALES> 140,630
<TOTAL-REVENUES> 140,630
<CGS> 28,704
<TOTAL-COSTS> 114,981
<OTHER-EXPENSES> 5,700<F1>
<LOSS-PROVISION> 249
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 30,486
<INCOME-TAX> 13,324
<INCOME-CONTINUING> 17,048
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,048
<EPS-PRIMARY> .44
<EPS-DILUTED> .42
<FN>
<F1>Other expenses refers to expenses incurred in conjunction with the acquisition
and integration of DynaSoft AB.
</FN>
</TABLE>
