SECURITY DYNAMICS TECHNOLOGIES INC /DE/, 10-Q, 1998-11-16

SECURITY DYNAMICS TECHNOLOGIES INC /DE/
10-Q, 1998-11-16
COMPUTER PERIPHERAL EQUIPMENT, NEC

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-Q

(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-25120

SECURITY DYNAMICS TECHNOLOGIES, INC.
(Exact name of Registrant as Specified in Its Charter)

<TABLE>
<S> <C>
DELAWARE 04-2916506
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
</TABLE>

20 CROSBY DRIVE
BEDFORD, MA 01730
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 687-7000

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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [X] No [ ]

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As of October 30, 1998, there were 40,885,439 shares of the Registrant's
Common Stock, $.01 par value per share, outstanding.

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SECURITY DYNAMICS TECHNOLOGIES, INC.
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30,
1998 and December 31, 1997.................................. 3
Condensed Consolidated Statements of Income for the three
and nine months ended September 30, 1998 and 1997........... 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1998 and 1997.................... 5
Notes to Condensed Consolidated Financial Statements........ 6
Management's Discussion and Analysis of Financial Condition
Item 2. and Results of Operations................................... 11
Quantitative and Qualitative Disclosures About Market
Item 3. Risk........................................................ 21
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 22
Signature................................................... 23
</TABLE>

2
<PAGE> 3

PART I. FINANCIAL INFORMATION

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)

ITEM 1. FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents................................... $ 40,540 $ 96,595
Marketable securities.................................. 113,164 68,064
Accounts receivable (less allowance for doubtful
accounts of $715 in 1998 and $742 in 1997)............ 30,635 27,551
Inventory.............................................. 8,214 3,035
Prepaid expenses and other............................. 10,756 9,338
Prepaid income taxes................................... -- 2,562
Deferred taxes......................................... -- 1,426
-------- --------
Total current assets.............................. 203,309 208,571
-------- --------
Property and equipment, net................................. 25,705 17,515
-------- --------
Other assets:
Investments............................................ 21,255 3,699
Purchased technology and capitalized software costs,
net................................................... 27 86
Deferred taxes......................................... 4,724 3,371
Other.................................................. 970 733
-------- --------
Total other assets................................ 26,976 7,889
-------- --------
Total....................................................... $255,990 $233,975
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 6,271 $ 11,137
Accrued payroll and related benefits................... 7,507 5,254
Accrued expenses and other............................. 2,386 7,093
Income taxes payable................................... 3,203 159
Deferred taxes......................................... 3,240 --
Deferred revenue....................................... 8,736 6,580
-------- --------
Total current liabilities......................... 31,343 30,223
-------- --------
Minority interests..................................... 2,564 3,099
-------- --------
Commitments and contingencies: (notes 4 and 7)
Stockholders' equity:
Common stock, $.01 par value; authorized 80,000,000
shares; issued, 41,423,439 and 40,467,118 shares in
1998 and 1997; outstanding, 41,422,930 and 40,466,609
shares in 1998 and 1997............................... 414 405
Additional paid-in capital............................. 171,761 165,751
Retained earnings...................................... 51,713 35,284
Deferred stock compensation............................ (75) (116)
Treasury stock, common, at cost, 509 shares in 1998 and
1997.................................................. -- --
Accumulated other comprehensive income................. (1,730) (671)
-------- --------
Total stockholders' equity........................ 222,083 200,653
-------- --------
Total....................................................... $255,990 $233,975
======== ========
</TABLE>

See notes to condensed consolidated financial statements.
3
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
1998 1997 1998 1997
------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenue........................................... $40,801 $35,928 $124,419 $99,502
Cost of revenue................................... 8,366 6,895 28,874 20,137
------- ------- -------- -------
Gross profit...................................... 32,435 29,033 95,545 79,365
------- ------- -------- -------
Costs and expenses:
Research and development..................... 7,811 5,753 22,448 14,699
Purchased research and development........... -- 3,175 210 3,175
Marketing and selling........................ 16,204 10,593 44,459 29,763
General and administrative................... 4,226 4,434 13,886 12,643
Threatened litigation settlement............. 1,872 -- 1,872 --
Merger and integration....................... -- 7,000 2,600 7,000
------- ------- -------- -------
Total................................... 30,113 30,955 85,475 67,280
------- ------- -------- -------
Income (loss) from operations..................... 2,322 (1,922) 10,070 12,085
Interest income and other......................... 1,993 1,272 6,486 4,031
Gain on sale of marketable securities............. -- 4,399 -- 4,596
Gain on sale of equity investment................. 1,836 -- 1,836 --
Gain from increase in market value of equity
investment...................................... -- -- 11,976 --
Equity in loss from operations of equity
investment...................................... (1,214) -- (2,387) --
------- ------- -------- -------
Income before provision for income taxes.......... 4,937 3,749 27,981 20,712
Provision for income taxes........................ 1,827 1,461 11,690 7,679
Minority interests................................ 78 -- 535 --
------- ------- -------- -------
Net income........................................ $ 3,188 $ 2,288 $ 16,826 $13,033
======= ======= ======== =======
Basic earnings per share:
Per share amount............................. $ 0.08 $ 0.06 $ 0.41 $ 0.34
======= ======= ======== =======
Weighted average shares...................... 41,186 38,629 40,958 38,326
======= ======= ======== =======
Diluted earnings per share:
Per share amount............................. $ 0.08 $ 0.06 $ 0.40 $ 0.32
======= ======= ======== =======
Weighted average shares...................... 41,186 38,629 40,958 38,326
Effect of dilutive options................... 615 1,819 1,049 2,396
------- ------- -------- -------
Adjusted weighted average shares.................. 41,801 40,448 42,007 40,722
======= ======= ======== =======
</TABLE>

See notes to condensed consolidated financial statements.
4
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1998 1997
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................. $ 16,826 $ 13,033
Adjustments to reconcile net income to net cash
provided by operating activities:
Threatened litigation settlement..................... 1,872 --
Gain on sale of marketable securities................ -- (4,596)
Gain on sale of equity investment.................... (1,836) --
Gain from increase in market value of equity
investment.......................................... (11,976) --
Loss from operations of equity investment............ 2,387 --
Deferred taxes....................................... 3,313 (2,831)
Purchased research and development................... 210 3,175
Depreciation and amortization........................ 4,666 2,419
Stock compensation................................... 901 889
License write off.................................... 3,000 --
Minority interests................................... (535) --
Increase (decrease) in cash from changes in:
Accounts receivable............................... (3,141) (4,318)
Inventory......................................... (5,180) (138)
Prepaid expenses and other........................ (1,407) (1,209)
Accounts payable.................................. (10,892) (2,104)
Accrued payroll and related benefits.............. 2,231 2,036
Accrued expenses and other........................ (1,686) 4,599
Prepaid and income taxes payable.................. 5,765 636
Deferred revenue.................................. (865) 499
--------- --------
Net cash provided by operating activities....... 3,653 12,090
--------- --------
Cash flows from investing activities:
Purchases of marketable securities..................... (154,963) (78,753)
Proceeds from sale and maturities of marketable
securities............................................ 110,554 103,291
Purchases of property and equipment.................... (12,812) (7,384)
Proceeds from sale of equity investment................ 1,984 --
Investments............................................ (6,116) (1,000)
Other.................................................. (237) 382
--------- --------
Net cash provided by (used for) investing
activities................................... (61,590) 16,536
--------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options and sales of
common stock, net of issuance costs and other......... 3,330 2,449
Payment to acquisition shareholders.................... -- (6,036)
Minority interests..................................... -- 1,838
--------- --------
Net cash provided by (used for) financing
activities................................... 3,330 (1,749)
--------- --------
Effects of exchange rate changes on cash and equivalents.... (1,448) (56)
--------- --------
Net increase (decrease) in cash and equivalents........ (56,055) 26,821
Cash and equivalents, beginning of period................... 96,595 11,688
--------- --------
Cash and equivalents, end of period......................... $ 40,540 $ 38,509
========= ========
</TABLE>

See notes to condensed consolidated financial statements.
5
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
include the accounts of Security Dynamics Technologies, Inc. (the "Company") and
its wholly owned subsidiaries and have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission regarding interim
financial reporting. Accordingly, they do not include all of the information and
notes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, as amended.

In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments,
consisting only of normal recurring adjustments, necessary for fair presentation
of the results of the interim periods presented. The operating results for the
interim periods presented are not necessarily indicative of the results expected
for the full year.

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 DynaSoft Acquisition and the IDI Acquisition have been
accounted for as poolings of interests and therefore the consolidated financial
statements for all periods prior to the respective acquisitions have been
restated to include the accounts and operations of DynaSoft and IDI with those
of the Company.

2. EARNINGS PER COMMON 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.

3. INCOME TAXES

The Company provides for income taxes at the end of each interim period
based on the estimated effective tax rate for the full year. Cumulative
adjustments to the tax provision are recorded in the interim period in which a
change in the estimated annual effective rate is determined.

Cash payments for income taxes were approximately $ 2,705 and $9,758 for
the nine months ended September 30, 1998, and September 30, 1997, respectively.

4. CONTINGENCIES

The Company is not a party to any litigation that it believes could have a
material adverse effect on the Company or its business.

During the second quarter of 1998, the Company reached a favorable
settlement in lawsuits relating to certain of its intellectual property rights.
The settlement was recorded as revenue and represented less than 5% of
consolidated revenue for the nine months ended September 30, 1998.

In September 1998, the Company granted options to purchase an aggregate of
325,000 shares of common stock in connection with the settlement of threatened
litigation arising out of the IDI Acquisition. The value of the options was
determined, using the Black-Scholes option-pricing model, to be $1,872, based on
an expected life of 2.5 years, an exercise price of $11 13/16 per share, a risk
free interest rate of 6% and expected volatility of the underlying stock of 75%.

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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

5. INVESTMENTS

Investments were as follows as of:

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
VeriSign, Inc........................................ $10,127 $ 687
VPNet Technologies, Inc.............................. 1,620 1,500
Trintech Group....................................... 5,000 --
NCipher Corporation Limited.......................... 3,308 512
C2Net, Inc........................................... 200 --
Finjan Software Ltd.................................. 1,000 1,000
------- ------
$21,255 $3,699
======= ======
</TABLE>

VeriSign, Inc.

In January 1998, VeriSign, Inc. ("VeriSign") had an initial public offering
of three million shares of its common stock. The VeriSign series A and B
convertible preferred stock held by the Company converted to common stock in
connection with the offering. The offering diluted the Company's ownership but
increased the value of 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 recognized as a gain the increase in
the amount of its investment in VeriSign of $11,976, representing its
proportionate share of VeriSign's equity as of December 31, 1997, after
considering VeriSign's net proceeds from the offering. The Company recognizes
its proportionate interest in VeriSign's operating results one quarter in
arrears. The Company recorded its proportionate share of VeriSign's second
quarter net loss of $1,214 in the third quarter of 1998. On October 22, 1998,
VeriSign announced it had incurred a net loss of $7,717 and $17,209 for the
three and nine months ended September 30, 1998, respectively, and at September
30, 1998 had total assets and liabilities of $63,643 and $19,990, respectively.
An executive officer, who is also a Director, of the Company serves as Chairman
of the Board of VeriSign.

In August 1998, the Company sold 65,000 shares of its VeriSign common stock
for a gain of $1,836.

As of September 30, 1998 the Company's ownership percentage in VeriSign was
approximately 20% and the market value of the Company's investment in VeriSign
was approximately $120,800.

VPNet Technologies, Inc.

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 $1,500. VPNet was organized to develop and
market products and technologies for implementing high-performance virtual
private networks. In January 1998, the Company purchased $120 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. An officer of the Company
serves as a director of VPNet.

Trintech Group

In March 1998 the Company purchased, in a non-cash transaction, 482,756
ordinary shares of Trintech Group ("Trintech") valued at $2,000. Trintech is an
Irish development company organized to develop and market software products
designed to enable secure payment in the electronic marketplace. In June 1998,
the Company purchased 500,000 shares of Trintech's Series A Convertible
Preferred Shares for $3,000 cash. The Company's investment represents a minority
interest of less than 10% of Trintech's capitalization. An officer of the
Company serves as a director of Trintech.

7
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

nCipher Corporation Limited

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 and July 1998, the Company purchased 93,896 and 563,910
Ordinary Shares of nCipher for aggregate purchase price of $336 and $2,460,
respectively. The Company's investment in nCipher represents a minority interest
of less than 20% of nCipher's capitalization. An officer of the Company serves
as a director of nCipher.

C2Net, Inc.

In June 1998, the Company made a one-year bridge loan to C2Net, Inc.
("C2Net") in the amount of $200. The debt is convertible at the Company's option
into equity of C2Net or may be used to offset any financial obligation which may
arise from future licensing agreements between the Company and C2Net. C2Net is
located in California and was organized to develop commercial Internet security
software.

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 $1,000.
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.

6. ACQUISITIONS

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 $6,000 in cash to certain of stockholders of
DynaSoft in exchange for the remaining outstanding shares and options. In the
third quarter of 1997, the Company accrued a charge of $7,000, representing
estimated direct costs of the DynaSoft Acquisition. In the fourth quarter of
1997, 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.

In connection with the IDI Acquisition, the Company issued approximately
784,000 shares of Common Stock in exchange for all of IDI's outstanding common
stock. IDI develops and markets intrusion detection software. Merger and
integration expenses incurred in connection with the IDI Acquisition were
approximately $2,600. No adjustments were required to conform accounting
policies of the Company and IDI.

A reconciliation of revenue and net income (loss) for previously separate
Security Dynamics and IDI for the periods before the acquisitions follows.
Security Dynamics revenues and net income were $39,346 and $3,101 for the three
months ended March 31, 1998 and $96,202 and $12,391 for the nine months ended
September 30, 1997, respectively. IDI revenues and net income (loss) were $900
and $(137) for the three months ended March 31, 1998 and $3,300 and $642 for the
nine-months ended September 30, 1997, respectively.

7. COMMITMENTS

Effective April 1, 1998, the Company amended its agreement with Progress
Software Corporation ("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 agreed to prepay $6,000 in
installments over the remaining three quarters of 1998. Installments of $5,000
have been paid as of

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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

September 30, 1998. The prepaid royalty is recorded as a component of cost of
sales as the related products are sold.

In June 1998, the Company entered into an agreement with Aventail
Corporation ("Aventail") under which the Company will distribute Aventail's
products. The Company prepaid fees aggregating approximately $1,200 in July 1998
in connection with the agreement.

8. COMPREHENSIVE INCOME

Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130, "Reporting Comprehensive Income." Comprehensive income, presented in
accordance with SFAS No. 130, was as follows for the three and nine months ended
September 30, 1998 and 1997:

<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------- ------------------
1998 1997 1998 1997
------ ------- ------- -------
<S> <C> <C> <C> <C>
Net income................................ $3,188 $ 2,288 $16,826 $13,033
Other comprehensive income, net of tax:
Unrealized holding (loss) gain on
securities arising during period... 198 (1,869) 112 (3,222)
Foreign currency translation
adjustments........................ (728) 279 (1,171) 200
------ ------- ------- -------
Comprehensive income...................... $2,658 $ 698 $15,767 $10,011
====== ======= ======= =======
</TABLE>

Accumulated other comprehensive income consists of the following:

<TABLE>
<CAPTION>
UNREALIZED
FOREIGN HOLDING ACCUMULATED
CURRENCY (LOSS) OTHER
TRANSLATION GAIN ON COMPREHENSIVE
ADJUSTMENTS SECURITIES INCOME
----------- ---------- -------------
<S> <C> <C> <C>
Balance, December 31, 1997..................... $ (750) $ 79 $ (671)
Period change.................................. (173) (102) (275)
------- ----- -------
Balance, March 31, 1998........................ (923) (23) (946)
Period change.................................. (270) 16 (254)
------- ----- -------
Balance, June 30, 1998......................... (1,193) (7) (1,200)
Period changes................................. (728) 198 (530)
------- ----- -------
Balance, September 30, 1998.................... $(1,921) $ 191 $(1,730)
======= ===== =======
</TABLE>

9. 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, AICPA
postponed the 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 three and nine months ended September 30, 1998.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information". The
Company will be required to adopt the provisions of this statement in its annual
financial statements for fiscal 1998. SFAS No. 131 establishes new standards for
reporting information about operating segments. The Company believes the segment
information required to be disclosed under SFAS No. 131 will be more
comprehensive than previously provided, including expanded

9
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SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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.

10. 1994 STOCK OPTION PLAN

On January 22, 1998 and March 8, 1998, the Board of Directors adopted, and
on April 30, 1998 the stockholders approved, an amendment and restatement of the
1994 Stock Option Plan, as amended (the "Plan") which, among other things,
increased the aggregate number of shares of Common Stock authorized for issuance
thereunder from 6,570,000 to 9,570,000 shares.

On July 24, 1998 and August 6, 1998, the Board of Directors of the Company
approved a stock option repricing program pursuant to which each holder (other
than certain executive officers and the directors of the Company) of an
outstanding stock option granted under the Plan during the period commencing on
January 1, 1996 and ending on June 30, 1998 (collectively, the "Old Options"),
could elect to receive a new stock option (collectively, "New Options") granted
on August 12, 1998 under the Plan in exchange for cancellation of each Old
Option. The Company repriced the options because the exercise prices of such
options were significantly higher than the fair market value of the Company's
Common Stock, and therefore did not provide the desired incentive to employees.
The Company believes that stock options are a valuable tool in retaining
employees. Each New Option is, among other things, (i) exercisable for the
number of shares of the Company's Common Stock covered by the outstanding
unexercised portion of the Old Option canceled in exchange therefore; (ii) has
an exercise price of $12.0625 (equal to the closing price of the Common Stock on
the Nasdaq National Market on August 12, 1998 and the fair market value of the
Common Stock on such date); and (iii) has the identical vesting schedule as the
Old Option, provided, however, that each such New Option shall not be
exercisable prior to February 12, 1999, with such prohibition on exercise
expiring at a rate of 25% at the end of each three-month period thereafter. New
Options to purchase an aggregate of approximately 5.3 million shares of Common
Stock were granted in exchange for Old Options with exercise prices ranging from
$19.00 to $44.125.

11. LICENSE AGREEMENT

During the second quarter of 1998 and in connection with a refinement of
its product offering strategy, the Company determined it will no longer actively
market secure email products obtained from a third party under a license
agreement. Prepaid license fees paid under the license agreement with the third
party of $3,000 were determined to have no future value and were charged to cost
of revenue in the second quarter of 1998.

12. SHARE REPURCHASE PROGRAM

On October 12, 1998, the Company announced that its Board of Directors had
authorized the Company to repurchase up to 4 million shares of its Common Stock
during the 12-month period ending October 11, 1999. The timing and amount of
shares repurchased will be determined by the Company's management based on its
evaluation of market and economic conditions. Repurchased shares will be used
for the Company's stock option plans, employee stock purchase and other stock
benefit plans, and for general corporate purposes. As of October 30, 1998, the
Company had purchased 538,000 shares of its Common Stock for an aggregate
purchase price of $5,836.

13. MANAGEMENT EMPLOYMENT AGREEMENTS

During September 1998, the Company entered into Employment Agreements with
substantially all of the Company's management team, including most of the
Company's executive officers. The Board of Directors determined that such
Employment Agreements were necessary to effectively incent and retain key
management team members in a competitive employment marketplace. The Employment
Agreements generally provide, among other things, that during the period
commencing on September 1, 1998 and ending on March 1, 2000, the Company may
terminate the employee only for nonperformance of his or her duties, or for
cause, subject to criteria and definitions set forth therein.

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<PAGE> 11

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE, PERCENTAGE AND SQUARE FOOTAGE DATA)

OVERVIEW

This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions are intended to identify forward-looking statements. There are a
number of factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements. These
factors include, without limitation, those set forth below under the caption
"Certain Factors That May Affect Future Results."

The DynaSoft Acquisition was completed on July 15, 1997 and the IDI
Acquisition was completed on March 26, 1998. These acquisitions have been
accounted for as poolings of interests. Accordingly, the results of operations
for all periods discussed below have been restated to include the financial
results of DynaSoft and IDI. See Notes 1 and 6 of Notes to Condensed
Consolidated Financial Statements.

RESULTS OF OPERATIONS

The following table sets forth income and expense items as a percentage of
total revenue, and the percentage change in dollar amounts of such items, for
the three and nine months ended September 30, 1998 and 1997.

<TABLE>
<CAPTION>
PERCENTAGE OF PERIOD-TO- PERCENTAGE OF PERIOD-TO-
TOTAL PERIOD TOTAL PERIOD
REVENUE CHANGE REVENUE CHANGE
-------------- ---------- -------------- ----------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Revenue........................................ 100.0% 100.0% 13.6% 100.0% 100.0% 25.0%
Cost of revenue................................ 20.5 19.2 21.3 23.2 20.2 43.4
----- ----- ------ ----- ----- ------
Gross profit................................... 79.5 80.8 11.7 76.8 79.8 20.4
----- ----- ------ ----- ----- ------
Costs and expenses:
Research and development..................... 19.1 16.0 35.8 18.0 14.8 52.7
Purchased research and development........... -- 8.8 (100.0) 0.2 3.2 (93.4)
Marketing and selling........................ 39.7 29.5 53.0 35.7 29.9 49.4
General and administrative................... 10.4 12.3 (4.7) 11.2 12.7 9.8
Threatened litigation settlement............. 4.6 -- 100.0 1.5 -- 100.0
Merger and integration....................... -- 19.5 (100.0) 2.1 7.0 (62.9)
----- ----- ------ ----- ----- ------
Total................................. 73.8 86.1 2.7 68.7 67.6 27.0
----- ----- ------ ----- ----- ------
Income (loss) from operations.................. 5.7 (5.3) (220.8) 8.1 12.2 (16.7)
Interest income and other...................... 4.9 3.5 56.7 5.2 4.0 60.9
Gain on sale of marketable securities.......... -- 12.2 (100.0) -- 4.6 (100.0)
Gain on sale of equity investment.............. 4.5 -- 100.0% 1.5 -- 100.0%
Gain from increase in market value of equity
investment................................... -- -- -- 9.6 -- 100.0%
Equity in loss from operations of equity
investment................................... (3.0) -- 100.0% (1.9) -- (100.0)
----- ----- ------ ----- ----- ------
Income before provision for income taxes....... 12.1 10.4 31.7 22.5 20.8 35.1
Provision for income taxes..................... 4.5 4.1 25.1 9.4 7.7 52.2
Minority interests............................. 0.2 -- 100.0% 0.4 -- 100.0%
----- ----- ------ ----- ----- ------
Net income..................................... 7.8% 6.3% 39.3% 13.5% 13.1% 29.1%
===== ===== ====== ===== ===== ======
</TABLE>

REVENUE

The Company's revenue is derived principally from: sales of SecurID tokens;
licensing of ACE/Server, BoKS and SecurPC software; licensing of BSAFE, JSAFE,
TIPEM and S/MAIL encryption engines; licensing of patents and licensing of Kane
Security Analyst and Kane Security Monitor software and revenues

11
<PAGE> 12

from maintenance and professional services. ACM hardware products are not a
material source of the Company's revenues.

Total revenue increased 13.6% in the third quarter of 1998 to $40,801 from
$35,928 in the third quarter of 1997. Total revenue increased 25.0% in the first
nine months of 1998 to $124,419 from $99,502 in the first nine months of 1997.
During the third quarter and first nine months of 1998, approximately 67% and
54%, respectively, of the increase in revenue was attributable to increased
sales of SecurID tokens, approximately 22% and 24%, respectively, of the
increase in revenue was attributable to increased sales of ACE/Server and ACM
software products, and approximately 14% and 18%, respectively, of the increase
in revenue was attributable to increased sales of encryption engine licenses and
patent licensing. The balance of the increase in revenue during the third
quarter and the first nine months of 1998 resulted from increased sales of BoKS
software products, and maintenance and professional services revenues partially
offset by decreased hardware, Kane Security Analyst and Kane Security Monitor
products and RSA SecurPC revenue. The Company believes that the overall increase
in revenues was attributable in part to growth of the information security
market, with the 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 18.3% in the third
quarter of 1998 to $11,000 from $9,300 in the third quarter of 1997 and
increased 33.8% in the first nine months of 1998 to $32,100 from $24,000 in the
first nine months of 1997. International revenue accounted for 27.0% and 25.9 %
of total revenue in the third quarters of 1998 and 1997, respectively, and 25.8%
and 24.1% of total revenue in the first nine months of 1998 and 1997,
respectively. The increases in international revenue were 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.

During the second quarter of 1998, the Company reached a favorable
settlement in lawsuits relating to certain of its intellectual property rights.
This settlement was recorded as revenue and represented less than 5% of
consolidated revenue for the nine months ended September 30, 1998.

COST OF REVENUE AND GROSS PROFIT

The Company's cost of revenue consists primarily of (i) costs associated
with the manufacture and delivery of SecurID tokens and hardware products; (ii)
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 and (iii) 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.

The Company's gross profit increased 11.7% in the third quarter of 1998 to
$32,435 from $29,033, in the third quarter of 1997 and increased 20.4% in the
first nine months of 1998 to $95,545 from $79,365 in the first nine months of
1997. Gross profit as a percentage of revenue declined, however, in the third
quarter of 1998 to 79.5% from 80.8% of revenues in the third quarter of 1997,
and gross profit in the first nine months of 1998 declined to 76.8% of revenue
from 79.8% of revenue in the first nine months of 1997. The decline in the third
quarter of 1998 compared to the third quarter of 1997 was primarily due to a
lower comparative proportion of software revenues to total revenues in the third
quarter of 1998. Token revenues have a higher cost of revenues than software
revenues. The decline in the first nine months of 1998 compared to the first
nine months of 1997 was primarily attributable to the write-off in the second
quarter of 1998 to cost of revenue of prepaid license fees of $3,000 under a
license agreement with a third party determined to have no further value.
Excluding the effects of this write-off, gross profit as a percentage of revenue
was 79.2% during the first nine months of 1998 compared to 79.8% in the first
nine months of 1997. During the third quarter and first nine months of 1998 and
excluding the effect of the license write-off, approximately 75% and 61%,
respectively, of the increase in gross profit were attributable to increased
unit sales of SecurID tokens, approximately 25% and 22%, respectively of the
increases in gross profit were attributable to increased licensing sales of
encryption engine technology and patent licensing, and approximately 38% and
32%, respectively of the increases in gross profit were attributable to
increased licensing sales of ACE/Server and Boks software, offset by decreased
hardware, Kane Security Analyst and Kane Security Monitor and RSA SecurPC sales.
In addition, during the third quarter of 1998

12
<PAGE> 13

compared to the third quarter of 1997, gross profit increased due to increased
maintenance revenue. Gross profit from maintenance decreased slightly during the
nine months ended September 30, 1998 compared to the comparable prior year
period primarily due to increased 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 increases in material costs associated with the manufacture
of SecurID tokens and hardware products and any software license fees or
royalties payable by the Company) and other factors.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of personnel costs as
well as fees for development services provided by consultants.

Research and development expenses increased 35.8% in the third quarter of
1998 to $7,811 from $5,753 in the third quarter of 1997, and increased 52.7% in
the first nine months of 1998 to $22,448 from $14,699 in the first nine months
of 1997. Research and development expenses increased as a percentage of revenue
to 19.1% and 18.0% in the third quarter and the first nine months of 1998,
respectively, from 16.0% and 14.8% in the third quarter and the first nine
months of 1997, respectively. This was primarily due to increased payroll costs
associated with the employment of additional staff.

PURCHASED RESEARCH AND DEVELOPMENT

During the third quarter of 1997, the Company purchased, and recorded as
purchased research and development expense, certain technology from VeriSign for
$2,700, and from a third party for $475. The Company plans to incorporate the
technologies into products which are expected to offer electronic signature and
certificate authority and a Java-based encryption engine, respectively. The
Java-based encryption engine was released for sale in 1998. Purchased research
and development was $210 during the first quarter of 1998 and is being
incorporated into certain current and planned encryption engine products.

MARKETING AND SELLING

Marketing and selling expenses consist primarily of salaries, commissions
and travel expenses of direct sales and marketing personnel and marketing
program expenses.

Marketing and selling expenses increased 53.0% in the third quarter of 1998
to $16,204 from $10,593 in the third quarter of 1997, and increased 49.4% in the
first nine months of 1998 to $44,459 from $29,763 in the first nine months of
1997. Marketing and selling expenses increased as a percentage of revenue to
39.7% and 29.5% in the third quarter and first nine months of 1998,
respectively, from 35.7% and 29.9% in the third quarter and first nine months of
1997, respectively. Approximately 52% and 61%, respectively, of the increases in
marketing and selling expenses during the third quarter and the first nine
months of 1998 were attributable to increased payroll costs associated with the
employment of additional staff. Approximately 37% and 21% of the increases in
marketing and selling expenses during the third quarter and the first nine
months of 1998, respectively, resulted from increased commissions associated
with higher revenues and the employment of additional sales staff. Approximately
11% and 18% of the increases in marketing and selling expenses during the third
quarter and first nine months of 1998, respectively, resulted from increased
travel expenses and marketing program expenses.

GENERAL AND ADMINISTRATIVE

General and administrative expenses consist primarily of personnel costs
for administration, finance, human resources and general management and legal
and accounting fees.

General and administrative expenses decreased 4.7% during the third quarter
of 1998 to $4,226, or 10.4% of revenue from $4,434, or 12.3% of 1997 primarily
due to expense reduction synergies achieved in connection with the IDI
Acquisition. General and administrative expenses increased 9.8% during the first
nine months of

13
<PAGE> 14

1998 to $13,886, or 11.2% of revenue from $12,643, or 12.7% of revenue, during
the first nine months of 1997 primarily due to increased payroll costs
associated with the employment of additional staff.

THREATENED LITIGATION SETTLEMENT

In September 1998, the Company granted options to purchase an aggregate of
325,000 shares of common stock in connection with the settlement of threatened
litigation arising out of the IDI Acquisition. The value of the options was
determined, using the Black-Scholes option-pricing model, to be $1,872, based on
an expected life of 2.5 years, a risk-free interest rate of 6% and expected
volatility of the underlying stock of 75%.

MERGER AND INTEGRATION

In the third quarter of 1997, the Company accrued a charge of $7,000,
representing estimated direct costs of the DynaSoft Acquisition. In the fourth
quarter of 1997, 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.

Merger and integration expenses incurred in connection with the IDI
Acquisition were approximately $2,600 in the first nine months of 1998.

INTEREST INCOME AND OTHER

Interest income and other consists primarily of interest earned on the
Company's cash balances and marketable securities.

Interest income increased 56.7% and 60.9% in the third quarter and the
first nine months of 1998, respectively, to $1,993 and $6,486 from $1,272 and
$4,031 in the third quarter and the first nine months of 1997, respectively,
primarily due to interest earned on higher cash and marketable securities
balances.

GAIN ON SALE OF MARKETABLE SECURITIES

The gains on sales of marketable securities were $4,399 and $4,596 in the
three and nine months ended September 30, 1997, respectively.

GAIN ON SALE OF EQUITY INVESTMENT

In August 1998, the Company sold 65,000 shares of its VeriSign common stock
for a gain of $1,836.

GAIN FROM INCREASE IN MARKET VALUE OF EQUITY INVESTMENT

The Company recorded a non-recurring gain of $11,976 resulting from the
write-up under the equity method of its investment in VeriSign during the first
nine months of 1998.

EQUITY IN LOSS FROM OPERATIONS OF EQUITY INVESTMENT

The Company's proportionate share of VeriSign's second quarter and first
six months of 1998 loss was $1,214 and $2,387, respectively. See Note 5 of Notes
to Condensed Consolidated Financial Statements.

PROVISION FOR INCOME TAXES

The provision for income taxes increased to $1,827 and $11,690,
respectively, during the third quarter and the first nine months of 1998 from
$1,461 and $7,679, respectively, in the third quarter and the first nine months
of 1997, primarily due to higher income subject to taxation. The Company's
effective tax rates were 37.0% and 41.8%, respectively, for the third quarter
and the first nine months of 1998 compared to 39.0% and 37.1%, respectively, for
the third quarter and the first nine months of 1997. The effective tax rate for
the third quarter of 1998 decreased compared to the effective tax rate for the
third quarter of 1997 primarily due to benefits resulting from the Company's
foreign tax strategy. The effective tax rate for the nine months, ended
September 30, 1998 increased compared to the effective tax rate for the nine
months ended September 30,

14
<PAGE> 15

1997, primarily due to non-deductible merger and integration expenses incurred
in connection with the IDI Acquisition, partially offset by benefits resulting
from the Company's foreign tax strategy.

MINORITY INTERESTS

Minority interests in consolidated net income were $78 and $535, during the
third quarter and the first nine months of 1998, respectively. An aggregate of
26% of RSA's Japanese subsidiary is owned by minority interest stockholders.

NET INCOME

As a result of the above factors, net income in the third quarter and the
first nine months of 1998 increased to $3,188 and $16,826, respectively, or 7.8%
and 13.5% of revenue, respectively, from $2,288 and $13,033, respectively, or
6.3% and 13.1% of revenue, respectively, in the third quarter and the first nine
months of 1997.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

At September 30, 1998, the Company had cash, cash equivalents and
marketable securities of $153,705 and working capital of $171,966. The Company
has historically funded its operations primarily from cash generated from its
operating activities. During the first nine months of 1998 the Company used the
cash provided by operations principally for working capital needs and to finance
certain costs 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 March 26, 1998 the Company issued approximately 784,000 shares of Common
Stock in exchange for all of IDI's outstanding common stock. The IDI Acquisition
costs were approximately $2,600. The DynaSoft Acquisition and the IDI
Acquisition were accounted for as poolings of interests. See Note 6 of Notes to
the Company's Consolidated Financial Statements.

The Company intends to seek acquisitions of businesses, strategic
investments, 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 October 1997, the Company sold 1,626,000 shares of Common Stock in a
follow-on public offering, which generated $61,100 of net cash proceeds to the
Company.

The Company generated $3,330 of cash from employees exercising stock
options and employee stock purchase plan purchases during the first nine months
of 1998.

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<PAGE> 16

Strategic Investments

VeriSign, Inc.

In January 1998, VeriSign had an initial public offering of three million
shares of its common stock. The VeriSign series A and B convertible preferred
stock held by the Company converted to common stock in connection with the
offering. The offering diluted the Company's ownership but increased the value
of 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 recognized as a gain the increase in
the amount of its investment in VeriSign of $11,976, representing its
proportionate share of VeriSign's equity as of December 31, 1997, after
considering VeriSign's net proceeds from the offering. The Company recognizes
its proportionate interest in VeriSign's operating results one quarter in
arrears. The Company recorded its proportionate share of VeriSign's second
quarter net loss of $1,214 in the third quarter of 1998. On October 22, 1998,
VeriSign announced it had incurred a net loss of $7,717 and $17,209 for the
three and nine months ended September 30, 1998, respectively, and at September
30, 1998 had total assets and liabilities of $63,643 and $19,990, respectively.
An executive officer of the Company, who is also a Director, serves as Chairman
of the Board of VeriSign.

In August 1998, the Company sold 65,000 shares of its VeriSign common stock
for a gain of $1,836.

As of September 30, 1998 the Company's ownership percentage in VeriSign was
approximately 20% and the market value of the Company's investment in VeriSign
was approximately $120,800.

VPNet Technologies, Inc.

In December 1996, the Company purchased 250,000 shares of Series B
Preferred Stock of 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 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. An officer of the Company serves as a director of VPNet.

Trintech Group

In March 1998 the Company purchased, in a non-cash transaction, 482,756
ordinary shares of Trintech Group ("Trintech") valued at $2,000. Trintech Group
is an Irish development company organized to develop and market software
products designed to enable secure payment in the electronic marketplace. In
June 1998 the Company purchased an additional 500,000 shares of Trintech's
Series A Convertible Preferred Shares for $3,000 cash. The Company's investment
represents a minority interest of less than 10% of Trintech's capitalization. An
officer of the Company serves as a director of Trintech.

nCipher Corporation Limited

In October 1997, the Company purchased 175,285 Ordinary Shares of nCipher
for an aggregated 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 and
July 1998, the Company purchased 93,896 and 563,910 Ordinary Shares of nCipher
for aggregate purchase prices of $336 and $2,460, respectively. The Company's
investment in nCipher represents a minority interest of less than 20% of
nCipher's capitalization. An officer of the Company serves as a director of
nCipher.

C2Net, Inc.

In June 1998, the Company made a one year bridge loan to C2Net in the
amount of $200. The debt is convertible at the Company's option into equity of
C2Net or may be used to offset any financial obligation which may arise from
future licensing agreements between the Company and C2Net. C2Net is located in
California and was organized to develop commercial Internet security software.

16
<PAGE> 17

Finjan Software, Ltd.

In August 1997, the Company purchased 877,193 Series C Preferred Shares of
Finjan for an aggregate purchase price of $1,000. 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.

Capital Expenditures

The Company's capital expenditures during the first nine months of 1998
were $12,812, 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 worldwide information and
business process needs. The system, which is represented by the manufacturer to
be Year 2000 compliant, became operational in October 1998. See "Year 2000
Issues". The Company estimates the total cost at approximately $5,200, of which
approximately $4,600 was spent in the first nine months of 1998. The Company
continues to configure certain elements of the system in order to, among other
matters, tie in certain subsidiaries. The Company estimates that an additional
$600 will be spent on the system; most of which will be spent in the fourth
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 $2,600 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 San Mateo, California. The
first facility consists of approximately 27,000 square feet of office space, and
the annual base rent is approximately $1,000. The second facility consists of
approximately 31,000 square feet of office space, and the annual base rent is
approximately $912 plus annual operating expenses of approximately $245. Both
leases have rent escalation provisions covering years two through ten based on
the Consumer Price Index.

Prepaid Agreements, Royalty Arrangements, and Purchased Research and
Development

Effective April 1, 1998, 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 agreed to prepay $6,000 in installments over the remaining
three quarters of 1998. Installments of $5,000 have been paid as of September
30, 1998. The prepaid royalty is recorded as a component of cost of sales as
products are sold.

During the second quarter of 1998 and in connection with a refinement of
its product offering strategy, the Company determined it will no longer actively
market secure email products obtained from a third party under a license
agreement. Prepaid license fees paid under the license agreement with the third
party of $3,000 were determined to have no further value and were charged to
cost of revenue in the second quarter of 1998.

In June 1998, the Company entered into an agreement with Aventail under
which the Company will distribute Aventail's products. The Company prepaid fees
aggregating approximately $1,200 in July 1998 in connection with the agreement.

The Company expended approximately $210 for purchased research and
development technology during the first nine months of 1998.

Stock Option Repricing

17
<PAGE> 18

Company) of an outstanding stock option granted under the Plan during the period
commencing on January 1, 1996 and ending on June 30, 1998 (collectively, the
"Old Options"), could elect to receive a new stock option (collectively, "New
Options") granted on August 12, 1998 under the Plan in exchange for cancellation
of such holder's Old Option. The Company repriced the Options because the
exercise prices of such options were significantly higher than the fair market
value of the Company's Common Stock, and therefore did not provide the desired
incentive to employees. The Company believes that stock options are a valuable
tool in retaining employees. Each New Option is, among other things, (i)
exercisable for the number of shares of the Company's Common Stock covered by
the outstanding unexercised portion of the Old Option canceled in exchange
therefore; (ii) has an exercise price of $12.062525 (equal to the closing price
of the Common Stock on the Nasdaq National Market on August 12, 1998 and the
fair market value of the Common Stock on such date); and (iii) has the identical
vesting schedule as the Old Option, provided, however, that each such New Option
shall not be exercisable prior to February 12, 1999, with such prohibition on
exercise expiring at a rate of 25% at the end of each three-month period
thereafter. New Options to purchase an aggregate of approximately 5.3 million
shares of Common Stock were granted in exchange for Old Options with exercise
prices ranging from $19.00 to $44.125.

Share Repurchase Program

On October 12, 1998 the Company announced that its Board of Directors had
authorized the Company to repurchase up to 4 million shares of its Common Stock
during the 12-month period ending October 11, 1999. The timing and amount of
shares repurchased will be determined by the Company's management based on its
evaluation of market and economic conditions. Repurchased shares will be used
for the Company's stock option plans, employee stock purchase and other stock
benefit plans, and for general corporate purposes. As of October 30, 1998 the
Company had repurchased 538,000 shares of its Common Stock, for an aggregate
purchase price of $5,836.

Year 2000 Issues

Overview

Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
must 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.

State of Readiness

Company Products

The Company has implemented a testing program to ensure that its products
continue to operate after December 31, 1999. The testing program has been
completed for the most recent versions of all of the Company's software
products, and the Company is in the process of testing prior versions of certain
of the Company's ACE/Server software products and the Company's ACE/Sentry
hardware product. The Company has not implemented a test plan for the Company's
ACM 100, 400 or 1600 hardware products.

In measuring Year 2000 readiness, the Company has applied the following
specifications: "Year 2000 Ready" means that: (1) no value for current date will
cause any interruption in operation; (2) date-based functionality must be
consistent for dates prior to, during and after Year 2000; (3) in all interfaces
and data storage, the century in any date must be specified either explicitly or
by unambiguous algorithms or inferencing rules; and (4) Year 2000 must be
recognized as a leap year.

The Company's SecurID Tokens are Year 2000 Ready. Assuming that a customer
is utilizing the Company's software products in conjunction with a Year 2000
Ready operating system, then the Company's most recent software releases,
ACE/Server v.3.3, Kane Security Analyst v.4.5, Kane Security Monitor v.3.2, BoKS
Manager v.4.4, BoKS Connect v.4.4, BoKS Connect Toolkit v.4.4, BoKS Desktop
v.2.2, SoftID, RSA SecurPC, BSAFE, JSAFE, TIPEM and S/MAIL, are Year 2000 Ready.
Certain prior versions of the Company's software products, as well as the
Company's ACE/Sentry, ACM 100, 400 and 1600 hardware products, are not fully
Year 2000 Ready, and customers are being informed of the status of the Company's

18
<PAGE> 19

products in the ordinary course of business. In certain circumstances, the
Company may make available to customers who have implemented prior releases of
the Company's software products software patches to make the products Year 2000
Ready. The Company is currently seeking to obtain written representations from
third-party vendors of software contained in the Company's ACE/Server and Kane
software products that such components are Year 2000 Ready.

While the Company has created and implemented what it believes to be an
effective Year 2000 Operability testing program for its products, the Company's
products may contain undetected errors or defects associated with Year 2000 date
functions. Such errors or defects in the Company's products could result in
delay or loss of revenue and diversion of development resources, which might
materially adversely affect the Company's business, financial condition or
results of operations.

Company Systems

The Company has established a Year 2000 task force to determine the state
of readiness of all Company information technology ("IT") and non-IT systems,
including the microprocessors contained in infrastructure products, such as
card-swipe entry devices, which are used at the Company's facilities. The task
force consists of employees with expertise in areas the Company believes could
be affected if any system is not Year 2000 Ready. 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 Ready, and (ii) replace non-Year 2000 Ready
third-party equipment and software with Year 2000 Ready equipment and software.

The Year 2000 compliance plan is divided into the following phases: (1) the
Inventory Phase, in which the Company identifies all products and systems which
are created or used by the Company in the course of its operations; (2) the
Analysis Phase, in which the Company determines what, if any, Year 2000
Operability issues may exist with respect to any product or system; (3) the
Solution Development Phase, in which the Company designs and/or obtains from
third-party vendors methods to correct any Year 2000 Operability issues which
were identified in the prior phase; and (4) the Implementation Phase, in which
the Company deploys solutions for the identified problems.

The Company's Year 2000 task force has substantially completed the
Inventory and Analysis Phases for all of the Company's IT and non-IT systems.
The task force has commenced the Solution Development and Implementation Phases
for all of the Company's systems, and expects the entire project to be
substantially completed by June 30, 1999.

The Year 2000 task force has identified certain IT systems licensed by the
Company's Customer Support and Engineering groups that must be upgraded in order
to make the systems Year 2000 Ready. In each case, the Company has purchased
maintenance and support from those application vendors, and expects to receive
upgrades from the vendors at no additional cost. With respect to certain other
business applications and systems licensed by the Company from third parties
(including but not limited to the Company's PBX), the Company is relying on
those licensors' written representations that the applications are Year 2000
Ready.

Costs to Address Year 2000 Issues

The Company anticipates that it will incur direct costs to modify or
replace existing systems used by the Company in the operation of its business to
ensure that all systems will become Year 2000 Ready. Except for the
implementation of the Worldwide management information system described above,
the Company believes that total amounts spent by it to date and which it expects
to spend during 1999 addressing this issue are not material.

In addition, the Company has spent substantial time and effort testing and
evaluating its own products to determine Year 2000 Operability of those
products. In the case of prior product releases which are not Year 2000 Ready,
the Company expects to devote internal engineering and customer support
resources to resolving issues for existing customers of those products. This
effort may result in a longer development cycle for new Company products.

19
<PAGE> 20

Risks to the Company

In the event of a failure of some or all of the Company's IT and non-IT
systems on January 1, 2000, the Company's operations may be substantially
curtailed until the Company or its third-party suppliers develop a solution to
address each system's failure. In such event, the Company might be unable to:
(a) produce SecurID tokens, (b) track development of Company software products,
(c) book orders for products, (d) access customer support records, (e) operate
its Internet site, (f) receive email, or (g) prepare its financial statements
for fourth quarter 1999 or periods thereafter.

In addition, the Company has made representations and warranties, both in
contracts and in written communications, to certain of its customers regarding
the Year 2000 Readiness of its products. The Company is currently reviewing all
of those representations to determine the accuracy of those statements, given
the ongoing Year 2000 testing of the Company's products. The Company expects to
complete its analysis of customer contracts by December 31, 1998, but it
believes that it has made Year 2000 Readiness representations in fewer than 10%
of its customer contracts.

In the event that any contractual representation made by the Company
regarding Year 2000 Operability is not accurate, the Company will seek to
upgrade the affected customer to the Company's current, Year 2000 Ready, version
of the product(s) being used by that customer. In the event any affected
customer chooses not to upgrade to the most recent versions of the Company's
products, the Company will seek to amend the affected license agreement to
address the error. In the event that the Company: (i) has made a materially
inaccurate statement regarding Year 2000 Operability of its products, and (ii)
is not able to amend the contract to address the error, the Company may face the
risk of one or more lawsuits from its customers alleging breach of
representation. The Company cannot evaluate the nature of this risk until the
Company has analyzed in more detail the nature of the Year 2000 Operability
representations made to third parties.

Contingency Plans

As described above, the Company has identified potential vulnerabilities
associated with the change of the century, both in its own product offerings and
in the systems utilized by the Company in the ordinary course of business. The
Company is devoting resources to resolving the issues inherent in its own
product offerings, as well as working with providers of systems to the Company
to ensure that business is not substantially interrupted as a result of the date
change. However, given the possibility of system failure as a result of the
century change, the Company is currently in the process of formulating one or
more contingency plans. The Company anticipates implementing contingency plans
on or before June 30, 1999.

Recent Accounting Pronouncements

In October 1997, the AICPA issued 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 the 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 nine months ended September 30, 1998.

In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." The
Company will be required to adopt the provisions of this statement in its annual
financial statements for fiscal 1998. SFAS No. 131 establishes new standards for
reporting information about operating segments. The Company believes the segment
information required to be disclosed under SFAS No. 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.

Conversion to Euro

Certain of the common member countries of the European Union have agreed to
adopt a new currency, the Euro, as their legal currency. On January 1, 1999, the
countries will establish fixed conversion rates between their existing
currencies and the Euro. The Company has not yet completed its analysis of the
potential impact the Euro may have on its business, financial position or the
results of its operations.
20
<PAGE> 21

Certain Factors That May Affect Future Results

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 on the success of its SecurSight product
architecture, which is a family of enterprise security solutions 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. 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 materially 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 general economic conditions abroad, 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 certain 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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

21
<PAGE> 22

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

The Exhibits listed in the Exhibit Index immediately preceding such
Exhibits are filed as part of or are included in this Quarterly Report on Form
10-Q.

(b) REPORTS ON FORM 8-K:

The Company filed no Current Reports on Form 8-K during the quarter for
which this report is filed.

22
<PAGE> 23

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 thereunto duly authorized.

SECURITY DYNAMICS TECHNOLOGIES, INC.

/s/ MARIAN G. O'LEARY
--------------------------------------
Marian G. O'Leary
Senior Vice President, Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)

Dated: November 16, 1998

23
<PAGE> 24

EXHIBIT INDEX

<TABLE>
<CAPTION>
ITEM DESCRIPTION
- - ---- -----------
<S> <C>
10.1 Form of Management Employment Agreement.
Computation of Income Per Common and Common Equivalent
11 Share.
27 Financial Data Schedule.
</TABLE>

<PAGE> 1
EXHIBIT 10.1

FORM OF MANAGEMENT
EMPLOYMENT AGREEMENT

This Agreement is made as of the ______ day of August, 1998 between
Security Dynamics Technologies, Inc., a Delaware corporation (the "COMPANY"),
and "Name", an employee of the Company (the "EMPLOYEE").

RECITALS

The Employee is currently employed as a "Title" of the Company. The Company
desires to continue to employ the Employee and the Employee desires to continue
to be employed by the Company.

WITNESSETH

NOW, THEREFORE, in consideration of the mutual covenants and promises
contained herein and other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereto, each intending
to be legally bound hereby, agree as follows:

1. EMPLOYMENT.

(a) The Company hereby agrees to employ the Employee, and the Employee
hereby accepts employment with the Company, upon the terms set forth in this
Agreement, for the period commencing on the date hereof (the "COMMENCEMENT
DATE") and ending on the date that is the 18-month anniversary of the
Commencement Date (the "EMPLOYMENT PERIOD"), unless sooner terminated in
accordance with the provisions of Section 4.

(b) During the Employment Period, the Company shall not:

(i) reduce the Employee's annual base salary or benefits as provided
in Section 3;

(ii) materially diminish the Employee's position, duties,
responsibilities, power, title, capacity or office in effect on the
Commencement Date in order to reduce the Employee's total compensation;
provided however, that the Company may assign the Employee to a new
position within the general function area of the Employee's prior
responsibilities during the Employment Period; or

(iii) require the Employee to relocate the Employee's principal place
of business more than 50 miles from the Employee's principal place of
business as provided in Section 2.

<PAGE> 2

2. TITLE; CAPACITY. During the Employment Period, subject to the terms of
Paragraph 1(b)(ii) above, the Employee shall serve as "FullTitle" and shall have
a principal place of business at the Company's headquarters located at 20 Crosby
Drive, Bedford, Massachusetts. The Employee shall be subject to the supervision
of, and shall have such authority as is delegated to the Employee by, the Board
of Directors of the Company (the "BOARD") or such officer of the Company as may
be designated by the Board. The Employee hereby accepts such employment and
agrees to undertake the duties and responsibilities inherent in such position
and such other duties and responsibilities as the Board or its designee shall
from time to time reasonably assign to him or her. The Employee agrees to devote
the Employee's entire business time, attention and energies to the business and
interests of the Company during the Employment Period. The Employee agrees to
abide by the rules, regulations, instructions, personnel practices and policies
of the Company and any changes therein which may be adopted from time to time by
the Company. The Employee acknowledges receipt of copies of all such rules and
policies committed to writing as of the date of this Agreement.

3. COMPENSATION AND BENEFITS.

(a) SALARY. The Company shall pay the Employee, in bi-weekly installments,
an annual base salary of "Salary". In January of each year during the Employment
Period, the Employee's base salary shall be subject to adjustment as determined
by the Board.

(b) BENEFITS. The Employee shall be entitled to participate in all bonus
and benefit programs that the Company establishes and makes available to its
employees, if any, to the extent that Employee's position, tenure, salary, age,
health and other qualifications make him or her eligible to participate,
including, but not limited to, health, dental, disability and life insurance.

4. EMPLOYMENT TERMINATION DURING THE EMPLOYMENT PERIOD.

(a) During the Employment Period, the employment of the Employee by the
Company pursuant to this Agreement shall terminate only upon the occurrence of
either of the following:

(i) at the election of the Company for "Cause" (as defined below), in
accordance with the terms of Paragraph 4(c) below;

(ii) upon the death or disability of the Employee; or

(iii) at the election of the Employee, upon thirty (30) days prior
written notice of termination.

(b) DEFINITION OF "CAUSE". For purposes of this Agreement, "CAUSE" for
termination shall be deemed to exist upon:

2
<PAGE> 3

(i) a good faith finding by the Company of the failure of the Employee
to perform his or her assigned duties for the Company, in accordance with
the process set forth in Paragraph 4(c) below; or

(ii) the conviction of the Employee of, or the entry of a pleading of
guilty or nolo contendere by the Employee to, any felony involving
dishonesty.

(c) DETERMINATION OF NONPERFORMANCE OF DUTIES. Within ninety (90) days
following the date set forth above, Charles Stuckey or Arthur Coviello
(collectively, the "Managing Executives") and the Employee shall agree in
writing to a set of performance metrics relating to the Employee's duties. At
any time during the Employment Period, either Managing Executive may, at his
reasonable discretion, give the Employee written notice that the Employee has
not performed his or her duties in accordance with such performance metrics. The
Employee shall have sixty (60) days from the date of receipt of such notice (the
"Cure Period") to cure such failure. Upon expiration of the Cure Period, in the
event that either Managing Executive makes a good faith finding that the
Employee has not cured the failure to the Managing Executive's reasonable
satisfaction, then the Employee's employment shall terminate on the 30th day
following expiration of the Cure Period.

(d) DEFINITION OF "DISABILITY". For purposes of this Agreement,
"DISABILITY" shall mean the inability to engage in any substantial gainful
activity by reason of any medically determinable physical or metal impairment
which can be expected to result in death or which has lasted or can be expected
to last for a continuous period of not less than 12 months.

5. TERMINATION DURING THE EMPLOYMENT PERIOD. In the event the Employee's
employment with the Company is terminated during the Employment Period: (i) for
Cause, as set forth in Paragraph 4 above, (ii) voluntarily by the Employee, or
(iii) by reason of the Employee's death or disability, the Company shall pay to
the Employee or his or her estate the compensation and benefits which would
otherwise be payable to the Employee through the last day of his or her actual
employment by the Company.

6. GENERAL.

(a) PRIOR AGREEMENTS. This Agreement shall have no effect on any prior
written agreements between the Company and the Employee relating to the subject
matter covered hereby. Notwithstanding the foregoing, this Agreement supersedes
and replaces any prior oral agreements between the Company and the Employee
relating to the subject matter covered hereby.

(b) GOVERNING LAW. The terms of this Agreement shall be governed by the
internal laws (and not the law of conflicts) of the Commonwealth of
Massachusetts.

(c) BINDING EFFECT. This Agreement shall be binding upon and inure to the
benefit of the Company, its successors and assigns, including any corporation
with which or into which the Company may be merged or which may succeed to the
assets or business of the Company.

3
<PAGE> 4

(d) ENTIRE AGREEMENT; MODIFICATION. This Agreement constitutes the entire
agreement of the parties hereto with respect to the subject matter hereof and
may not be modified or amended in any way except in writing by the parties
hereto.

(e) SAVINGS CLAUSE. In case any provision of this Agreement shall be
invalid, illegal or otherwise unenforceable, the validity, legality and
enforceability of the remaining provisions shall in no way be affected or
impaired thereby.

IN WITNESS WHEREOF, the parties hereto, intending to be legally bound, have
hereunto executed this Agreement the day and year first written above.

SECURITY DYNAMICS
TECHNOLOGIES, INC.

By:_________________________________
Name:
Title:

EMPLOYEE

____________________________________
"Name"

4
<PAGE> 5
This Form of Employment Agreement (or comparable form) was entered into by the
following persons:
<TABLE>
<CAPTION>

Name Date of Agreement Title Annual Base Salary
<S> <C> <C> <C>
John Adams September 4, 1998 Senior Vice President, $190,000
Engineering

September 4, 1998 Senior Vice President, Chief $160,000
Marian G. O'Leary Financial Officer and Treasurer

Gary A. Rogers September 4, 1998 Senior Vice President, Worldwide $190,000
Sales and Field Operations

September 4, 1998 Senior Vice President, Marketing $180,000

Scott T. Schnell

Margaret K. Seif September 4, 1998 Vice President and General $120,000
Counsel

Albert E. Sisto September 4, 1998 Chief Operating Officer of RSA $195,000
Data Security, Inc.
</TABLE>

<PAGE> 1

EXHIBIT 11

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES

COMPUTATION OF INCOME PER COMMON AND COMMON EQUIVALENT SHARE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Basic earnings per share(1):
Net income per common share................... $ 0.08 $ 0.06 $ 0.41 $ 0.34
======= ======= ======= =======
Weighted average number of shares
outstanding................................. 41,186 38,629 40,958 38,326
======= ======= ======= =======
Diluted earnings per share(1):
Net income per common share................... $ 0.08 $ 0.06 $ 0.40 $ 0.32
======= ======= ======= =======
Shares:
Weighted average number of shares
outstanding................................. 41,186 38,629 40,958 38,326
Effect of dilutive options.................... 615 1,819 1,049 2,396
------- ------- ------- -------
Adjusted weighted average number of shares
outstanding...................................... 41,801 40,448 42,007 40,722
======= ======= ======= =======
</TABLE>

- - ---------------

(1) Results for all periods prior to March 26, 1998 and July 15, 1997,
respectively, have been restated for the acquisitions of Intrusion Detection
Inc. and DynaSoft AB, respectively, which acquisitions have been accounted
for as poolings of interests.

<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS

<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 40,540
<SECURITIES> 113,164
<RECEIVABLES> 30,635
<ALLOWANCES> 715
<INVENTORY> 8,214
<CURRENT-ASSETS> 203,309
<PP&E> 25,705
<DEPRECIATION> 0
<TOTAL-ASSETS> 255,990
<CURRENT-LIABILITIES> 31,343
<BONDS> 0
0
0
<COMMON> 414
<OTHER-SE> 221,669
<TOTAL-LIABILITY-AND-EQUITY> 255,990
<SALES> 124,419
<TOTAL-REVENUES> 124,419
<CGS> 28,874
<TOTAL-COSTS> 85,475
<OTHER-EXPENSES> 4,472<F1>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 27,981
<INCOME-TAX> 11,690
<INCOME-CONTINUING> 16,826
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 16,826
<EPS-PRIMARY> 0.41
<EPS-DILUTED> 0.40
<FN>
<F1>OTHER EXPENSES REFERS TO EXPENSES OF $2,600 INCURRED IN CONJUNCTION WITH
THE ACQUISITION AND INTEGRATION OF INTRUSION DETECTION INC. AND OTHER EXPENSES
OF $1,872 INCURRED IN CONNECTION WITH A THREATENED LITIGATION SETTLEMENT.
</FN>

</TABLE>