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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NO. 000-25120
SECURITY DYNAMICS TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 04-2916506
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
36 CROSBY DRIVE 01730
BEDFORD, MASSACHUSETTS
(Address of principal executive offices) (Zip Code)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 301-5000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
(Title of class)
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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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
The approximate aggregate market value of the Common Stock held by
non-affiliates of the registrant was $624,667,428 based on the last reported
sale price of the registrant's Common Stock on the Nasdaq National Market as of
the close of business on March 4, 1999. There were 39,182,097 shares of Common
Stock outstanding as of March 4, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
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PART OF FORM 10-K
DOCUMENT INTO WHICH INCORPORATED
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Portions of the Registrant's Items 6, 7, 7A & 8 of Part II
1998 Annual Report to Stockholders
Portions of the Registrant's Proxy Items 10, 11, 12 & 13 of Part III
Statement for the 1999 Annual Meeting
of Stockholders
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This Annual Report on Form 10-K 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. The important factors discussed
under the caption "Certain Factors That May Affect Future Operating Results" in
the Company's 1998 Annual Report to Stockholders and incorporated herein by
reference, among others, could cause actual results to differ materially from
those indicated by forward-looking statements made herein and presented
elsewhere by management. 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.
Security Dynamics, SecurID, ACE/Server, SoftID, WebID and RSA SecurPC are
registered trademarks, and Keon and SecurSight are trademarks, of Security
Dynamics Technologies, Inc. RSA, RC2, RC4, RC5, BSAFE, JSAFE, TIPEM, BCERT and
S/MAIL are trademarks of RSA Data Security, Inc. BoKS is a trademark of DynaSoft
AB. All other trademarks or trade names referenced in this Annual Report on Form
10-K are the property of their respective owners.
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PART I.
ITEM 1. BUSINESS
The Company is a leading provider of enterprise network and data security
solutions. The Company helps enable electronic business by providing
technologies, products and services that secure access to and protect
information in networks, systems, applications and Internet commerce
initiatives. The Company leverages its expertise in authentication management,
public key encryption and access control to help organizations in a range of
industries conduct business securely, protect corporate information assets and
facilitate business-to-business and electronic commerce. Historically, the
Company has delivered security solutions that provide secure remote access to
corporate networks. Through its family of enterprise security solutions
(formerly known as SecurSight), partnerships and acquisitions, the Company
intends to expand its addressable market by delivering solutions that provide
secure access to information wherever it resides in an enterprise. As used in
this Annual Report on Form 10-K, the term "the Company" refers to Security
Dynamics Technologies, Inc. ("SDI") and its subsidiaries.
INDUSTRY BACKGROUND
Historically, computer and enterprise network security has been the focus
of businesses engaged in security-conscious industries such as banking,
telecommunications, aerospace and defense. However, a number of factors have
contributed to an increased awareness of, and need for, enterprise security
solutions for companies that use and rely on network-based information
resources. These factors include the growing complexity of enterprise networks
and a shift in network security requirements driven by increased use of the
Internet and corporate intranets and extranets.
Enterprise computing has evolved over the past three decades from
host-based systems to a distributed model where individuals are accessing
corporate resources from virtually anywhere inside or outside of an
organization. Enterprise computing environments today consist of heterogeneous
computer resources coupled with converging public and private networks. As such,
they require comprehensive, flexible products and solutions that can be deployed
to a large number of users in a consistent, manageable and secure fashion.
In addition, the traditional security model of network perimeter defense is
being expanded in light of increased use of the Internet. The growth of the
Internet as a business tool has led to a rapid increase in corporate intranets,
where employees share information, and extranets, where companies share
information with their suppliers, partners and customers. Companies that have
traditionally relied solely on static password protection or on corporate
firewalls are now seeking to adopt more sophisticated, comprehensive security
strategies to protect corporate information assets and to conduct business
securely. Companies today require scaleable enterprise security solutions that
can be easily integrated, deployed and managed across complex, heterogeneous
enterprise environments.
Classes of Enterprise Network and Data Security
The Company believes that enterprise network and data security requirements
can be grouped into the following four classes: (i) user identification and
authentication; (ii) access control and privilege management; (iii) data
privacy, integrity and authentication (encryption); and (iv) security
administration and audit.
User Identification and Authentication. Reliable authentication of the
identity of users is necessary to prevent unauthorized access to computer and
network resources. There are three generally accepted methods of user
identification: (i) something secret the user knows, such as a word, phrase,
PIN, code or fact; (ii) something physical the user possesses, such as a key,
smart card, badge or other form of discrete "token," which is resistant to
counterfeiting, and (iii) something unique to the user, such as a fingerprint,
signature, retinal pattern, voice print or other measurable personal
characteristic or "biometric." The Company believes that the use of a two-factor
authentication system, combining two of the three generally accepted methods of
user identification, is required for reliable enterprise network and data
security.
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Access Control and Privilege Management. One of the key challenges facing
organizations is the proliferation of passwords required for users to access
disparate operating systems, applications and databases. Products addressing
access control and privilege management must protect and manage access to
corporate information and applications and control user privileges at multiple
levels within the enterprise, including the network, application and data
levels. Single sign-on ("SSO") represents the ability to provide authenticated
users with transparent access to a variety of services, thereby improving user
productivity and reducing the frustration caused by users having to enter
multiple passwords. Early SSO solutions did not require authentication from a
security server; data centers could establish trust between two devices through
a direct connection in a static environment. With the growth in distributed
networks and the variety of operating systems and client/server applications,
reliable SSO now requires authentication, encryption and key exchange to ensure
secure communication between the desktop and the application. Together with
traditional SSO solutions, user authentication and application session
encryption capabilities make up a more complete solution called secure single
sign-on ("SSSO").
Data Privacy, Integrity and Authentication. In addition to authenticating
the identity of users and ensuring that only authorized users can access, view
or modify certain data, a comprehensive security solution must ensure that the
data transmitted over a network are not disclosed to unauthorized persons (data
privacy), have not been altered or compromised by unauthorized manipulation
(data integrity) and were actually transmitted by the purported sender (data
authentication). Such data privacy, integrity and authentication are provided by
encryption and data authentication technologies.
Encryption. In traditional cryptography, known as secret key or symmetric
cryptography, the sender and receiver of a message know and use the same secret
keys. The sender uses the secret key to encrypt a message by transforming data
into a form unreadable by anyone without a secret decryption key. The receiver
uses the same secret key to decrypt the message by transforming the encrypted
data into the original readable message. A key is a value or series of bits used
by the cryptographic system to convert the original text into an encrypted text
or to decrypt the encrypted text back into the original text.
The principal problem with secret key cryptography is communicating the
secret key between the sender and receiver without anyone else discovering it.
If the sender and receiver are in separate physical locations, they must trust a
courier, a phone system or some other transmission medium to prevent the
disclosure of the secret key being communicated. Anyone who overhears or
intercepts the key in transit can later read, modify and forge messages
encrypted or authenticated using that key. Because all keys in a secret key
cryptosystem must remain secret, secret key cryptography often has difficulty
providing secure key management, especially in open systems like the Internet.
The concept of public key cryptography attempts to solve the key management
problem by giving each person a pair of keys, one called the public key and the
other called the private key. Each person's public key is published while the
private key is kept secret. The sender encrypts a message using the public key
of the intended recipient and communicates it via a public mode of
communication. If implemented properly, the message can only be decrypted with
the recipient's private key, which is in the sole possession of the intended
recipient. All communications involve only public keys, and no private key is
ever transmitted or shared. With public key cryptography, it is not necessary to
trust a communications channel to be secure against eavesdropping or betrayal.
In general, public key cryptography requires only that public keys be associated
with their users in a trusted manner, for instance, by maintaining the key in a
trusted directory and that the private key not be disclosed. Public key
cryptography, and the infrastructure needed to support its deployment in an
enterprise, has emerged as a key security requirement for organizations seeking
to protect data and applications.
Data Authentication. Data authentication is a process whereby the receiver
of a digital message can be confident of the identity of the sender and/or the
integrity of the message. In public key cryptosystems, authentication is enabled
by the use of digital signatures. Digital signatures play in the digital world a
function similar to that played by handwritten signatures for printed documents.
The signature is an authentic piece of data asserting that a named person wrote
or otherwise agreed to the document to which the signature is attached. The
recipient, as well as a third party, can verify both that the document
originated from the person
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whose signature is attached and that the document has not been altered since it
was signed. Secure digital signatures may be used to refute a claim by the
signer of a document that it was forged.
Security Administration and Audit. With the growth of distributed
computing environments, including those utilizing the Internet, organizations
are increasingly concerned about various administrative issues relating to
network security, including the scalability of their security solutions and the
ability of the solutions to cover multiple geographic regions. Security
administration and audit solutions must also monitor user activity for purposes
of detection and deterrence and in order to ensure that the network or data have
not been compromised.
Enterprise Security
The Company believes that there is an emerging market for enterprise-wide
security solutions in several categories, including secure remote access via
dial-up and virtual private networks; secure access to corporate networks and
resources; secure access to applications, intranets and extranets; email
security; and platform security for desktops and UNIX hosts. These enterprise
security solutions must incorporate elements of all four classes of security and
address the need for: (i) ease of use; (ii) interoperability within
heterogeneous enterprise environments; (iii) scalability; (iv) integrated
network security administration; (v) integration with existing customer
applications; (vi) secure access to information, including secure remote access;
(vii) information privacy, integrity and authentication; and (viii) system
reliability and availability.
To date, most approaches to network security have been limited in scope and
have failed to address one or more of these requirements. The Company believes
that, in order to compete effectively in this market, network security vendors
must develop comprehensive network security services that can accommodate a
large number of local and remote users and integrate security management across
heterogeneous computing resources.
SECURITY DYNAMICS SOLUTION
Security Dynamics is a leading provider of enterprise network and data
security solutions. The Company's products help companies conduct business
securely, protect information assets and facilitate business-to-business and
business-to-consumer electronic commerce. The Company's solutions employ a
patent-protected combination of access control and privilege management
products, public key encryption technology and security administration software
to protect information wherever it resides in an enterprise.
A key element of the Company's strategy has been and continues to be the
expansion of its product offerings to address each of the four classes of
enterprise network and data security and deliver integrated solutions for
protecting information resources. Since its inception, the Company has focused
on the fundamental need for user identification and authentication with an
emphasis on solutions for secure remote access to enterprise networks. In
furtherance of its strategy to expand product offerings within the security
classes, in July 1996, the Company acquired RSA Data Security, Inc. ("RSA"), a
leader in cryptography, to address the need for data privacy, integrity and
authentication.
The Company's solutions have historically focused on addressing secure
remote access through: (i) SecurID tokens for user identification and
authentication; (ii) ACE/Server administration software; and (iii) ACE/Agent
code embedded in remote access devices such as remote access servers and
firewalls. The RSA SecurPC product and RSA encryption engines have contributed
to secure remote access by allowing customers to control access to the network
and by providing data privacy, integrity and authentication.
As businesses expand their networks to make use of the Internet, intranets
and extranets, companies have begun to realize that the internal network is
becoming more vulnerable and that there is a critical need for products and
services that allow system administrators to control user privileges at multiple
levels within an enterprise and encrypt information within an internal network.
Through its family of enterprise security solutions, the Company intends to
address these needs by moving beyond securing remote access to securing
information access, thereby providing security across an enterprise. The
Company's security solutions address three critical areas of an information
technology security infrastructure: (i) network and system security,
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(ii) applications security and (iii) electronic commerce security. The Company's
principal product lines, ACE/Server, Keon and RSA BSAFE, as well as its SecurID
family of authentication devices, address these three security categories,
respectively.
In 1998, the Company launched the SecurSight architecture initiative
designed to assist in the development of systems and applications that
facilitate and control secure access to information. In support of the
SecurSight strategy, in July 1997, the Company acquired DynaSoft AB
("DynaSoft"), a leading vendor of platform-independent security solutions for
distributed client/server networks. The DynaSoft BoKS product family includes
technologies for access control and privilege management. In January 1999, the
Company introduced Keon, a family of public key infrastructure-based (PKI)
products designed to provide organizations with application security and
flexible electronic commerce solutions. As part of this introduction, the
Company renamed the DynaSoft BoKS product family "Keon." Today, the Company's
ACE/Server, SecurID, Keon and RSA BSAFE product lines are all delivered as part
of the SecurSight architecture.
SECURITY DYNAMICS STRATEGY
The Company's objective is to continue as a leading provider of enterprise
network and data security solutions. Key elements of the Company's strategy to
achieve this objective include the following:
- Deliver Enterprise Security Services. The Company's strategy has been
and continues to be to expand the depth and breadth of its product
offerings across the classes of enterprise network and data security to
meet the evolving requirements for the protection of its customers'
information assets. The Company plans to continue to develop and deliver
scaleable, reliable enterprise security solutions that enable companies
to conduct business securely, protect corporate information assets and
facilitate electronic commerce. For instance, the Company intends to
introduce or acquire products and technologies and form partnerships that
are expected to enable delivery of security services such as certificate
management and key management. In addition, through partnerships the
Company plans to expand its agent roster to include application-specific
agents and add additional authentication form factors, including smart
cards.
- Maintain Technological Leadership. The Company plans to continue to add
new capabilities and features to its enterprise network and data security
products to meet its customers' identification and authentication needs
within the context of evolving enterprise environments. The Company
maintains a leading role in basic cryptographic research, develops new
encryption technologies and maintains close working relationships with
leading academic centers and custom development teams.
- Expand Market Opportunities. The Company intends to expand its market
opportunities through strategic partnerships, industry initiatives and
marketing designed to heighten awareness of security issues. The Company
has strategic partnerships with more than 70 industry-leading vendors and
plans to continue to foster and leverage these partnerships and enter
into additional relationships with companies that can provide
complementary technologies for its SecurSight solutions. The Company also
seeks to heighten awareness regarding enterprise network and data
security issues through marketing programs such as the annual RSA Data
Security Conference.
- Expand Indirect Sales and Support Channel. The Company currently sells
its products through a direct sales force and through relationships with
a significant number of original equipment manufacturers ("OEMs"),
value-added resellers ("VARs") and distributors. The Company's
SecureWorld program is designed to develop and expand its indirect sales
and support channel through the establishment of two-tier distribution of
the Company's solutions. The Company believes that an expanded indirect
sales and support channel enables it to enter new markets and gain access
to a larger installed base of potential customers in a cost-effective
manner.
Expand International Presence. The Company believes that international
markets present a large, relatively new market for enterprise network and data
security products. Sales outside the United States were approximately 27.6% in
1996, 30.9% in 1997 and 34.6% in 1998. The Company plans to continue to expand
its
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business outside North America through the hiring of sales personnel, the
establishment of additional distribution arrangements, primarily in Europe and
Asia, and the development of local presence in key markets.
PRODUCTS
Historically, organizations have focused primarily on protecting remote
access into corporate networks. The Company has addressed this need through its
line of SecurID and ACE/Server authentication products. Today, as public and
private networks merge, organizations are increasingly interested in protecting
not just access to networks, but to the mission-critical applications and
electronic commerce initiatives that drive their businesses. The Company's core
product and solution offerings are continually evolving to address the following
three critical areas of an information technology security infrastructure:
- Network and Systems Security -- The Company delivers a range of products
and solutions that help organizations assess, enforce and monitor
security for their corporate networks and operating systems. With
offerings spanning user authentication, intrusion detection and desktop
encryption, the Company provides customers with a comprehensive family of
tools and services to address their network and systems security needs.
- Applications Security -- The Company helps organizations protect vital
data stored across mission-critical, enterprise applications by providing
a strong level of application security to protect against both internal
and external threats and unauthorized access to sensitive information.
- Electronic Commerce ("eCommerce") Security -- The Company is expanding
the market for software components that secure electronic data. The
Company is focused on meeting customer needs for secure applications and
solutions in the Internet, consumer and enterprise markets with
state-of-the-art security software components and products.
CORE PRODUCT LINES
The Company delivers a range of products and technologies that help
companies and third-party developers secure their computing environments. The
Company's core competencies can be found in its three major product lines:
ACE/Server and SecurID
The Company's ACE/Server and SecurID solutions provide centralized, strong,
two-factor authentication services for enterprise networks and operating
systems, ensuring that only authorized users gain access to network files,
applications and communications. Supporting a range of authentication devices,
including SecurID tokens, smart cards and software tokens, these solutions
create a barrier against unauthorized access, protecting network and data
resources from potentially devastating accidental or malicious intrusion.
The Company's SecurID user identification and authentication products
combine two methods of user identification - something secret the user knows (a
"PIN") and something the user possesses (the SecurID token). To gain access to a
protected resource, a user enters his or her PIN and the token code
automatically computed and displayed on the liquid crystal display ("LCD") of
the user's SecurID token. The PIN and the token code together form the user's
"PASSCODE." With a valid PASSCODE, the authorized user is identified,
authenticated and granted access to appropriate information resources.
Each SecurID token contains the Company's proprietary algorithm and is
programmed with a secret, randomly generated seed number which is unique to the
token. The algorithm uses the seed number and Greenwich Mean Time to produce a
sequence of token codes at set intervals (typically every 60 seconds). The
Company's ACE/Server software uses the same algorithm, seed number and Greenwich
Mean Time to generate a token code corresponding to the token code generated by
the user's SecurID token.
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Keon
Keon is a family of products based on the Company's public key technology
and application security solution, BoKS. Keon software enhances security for
applications by providing authorized applications access and encrypted
communications through the use of digital certificates, as well as by supporting
strong, two-factor user authentication. Keon technology simplifies user
management and authorized applications access by providing a single
administrative console for access to all public key-based applications, and by
providing end users with single sign-on to all public key-based applications.
The Keon family of products also include agents that allow existing
client/server applications to be upgraded to take advantage of public key-based
security. The Keon product line contains offerings for both enterprise customers
who need turn-key solutions, and for enterprise customers and developers who
want to build their own standards-based, native PKI applications or take
advantage of them. The Company currently offers a SecurID smart card for Keon,
and plans to support all SecurID authenticators, including hardware and soft
tokens, in future releases of Keon software.
Keon components include:
- Keon Security Server, currently available for UNIX, provides centralized
security administration, user management and access control. Keon
Security Server facilitates single sign-on across supported applications
and scales for use in large deployments.
- Keon Desktop, currently available for Windows NT and 95, provides desktop
file encryption, manages single sign-on and user credentials at the
desktop, and delivers services for securing email, Web browsers and
access to applications.
- Keon Agents are installed on protected application servers and create the
authenticated, secure connection from the desktop to the application
server.
- Keon Agent SDK (software developers kit) provides developers with the
ability to build Agents for in-house applications.
- Keon Unix Platform Security, available for a wide variety of popular UNIX
OS versions, enhances and makes consistent user access policies to the
UNIX operating system.
- Keon Certificate Server provides a powerful and flexible system for
issuing and managing digital certificates.
- Cryptographic Software Development Components allow enterprise and
commercial software developers to use high-level APIs to incorporate
public key security options into applications they build without
requiring that they become low-level experts in encryption. These
components consist of the RSA BSAFE product line.
RSA BSAFE Encryption
The Company develops and markets platform-independent crypto-security
components and development tools that enable third-party developers to
incorporate security into a wide variety of applications. The Company's
encryption components are used to secure applications for electronic commerce
and services over the Internet and intranets, enterprise security,
entertainment, wireless communications, delivery of digital information over
cable and other uses. The award-winning RSA BSAFE product line includes:
- RSA BSAFE Crypto-C, a popular cryptography component;
- RSA BSAFE Crypto-J, state-of-the-art cryptographic software designed for
Java developers;
- RSA BSAFE Cert-C, X.509 certificate processing toolkit;
- RSA BSAFE S/MIME-C toolkit for adding security to messaging applications;
and
- RSA BSAFE SSL-C, a protocol product which enables secure point-to-point
communications over the Internet.
- RSA BSAFE SSL-J, Java-based protocol product which enables secure
point-to-point communications over the Internet.
The Company believes that its RSA RC series of symmetric, or secret key,
encryption technologies are among the highest performing and most secure
techniques of their class available to encrypt electronic data.
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RC2 and RC4 are designed to handle block and streaming data types, respectively,
and are designed to provide for easy adjustment of key size for exportability as
well as high performance without specialized hardware.
ADDITIONAL PRODUCT LINES
Kane Security Analyst and Kane Security Monitor
The Company's family of Kane Security solutions helps organizations perform
analyses of their security systems and monitor systems for suspicious
activities. Kane Security Analyst is a front-line analysis tool that is designed
to perform security assessments and report security exposures. Kane Security
Monitor software is a real-time intrusion detection system that filters through
security and audit data to identify unauthorized activities. The Company
acquired the Kane product family as part of its acquisition of Intrusion
Detection, Inc. ("IDI") in March 1998.
RSA SecurPC
RSA SecurPC is a powerful, easy-to-use file encryption software based on
the Company's leading RSA encryption technologies that protects data stored in
laptop and desktop computer files. In particular, RSA SecurPC software is
designed to help enforce security for Windows-based systems by protecting vital
files against theft, hackers and industrial espionage.
Pricing
Subject to volume discounts and other licensing terms and conditions, the
suggested U.S. list prices for the Company's products range as follows: SecurID
tokens from $34 to $86 per token; ACE/Server software products from $3,950 to
$940,000; RSA encryption engine and toolkit licenses from $25,000 to $50,000;
and Keon products from $80 to $300 per user for Keon Desktop and from $1,250 to
$3,100 per server for Keon Manager. The Company continually reviews and adjusts
its product pricing policies in light of factors such as relative value,
industry standards and demand.
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STRATEGIC PARTNERS
To enhance its enterprise network and data security solutions, the Company
has established relationships with more than 70 vendors of remote access
products, Internet firewalls, network and applications software and virtual
private network ("VPN") products. Most of these vendors integrate the Company's
client software into one or more of their products to provide compatibility
between their product offerings and the Company's ACE/Server software. Other
vendors build call routines, software hooks or APIs into their products to
provide compatibility with the Company's ACE/Server software. The Company has
also entered into strategic relationships with vendors that share technical
information with the Company to enable it to develop products which will be
interoperable with the vendors' products. The Company's strategic partners
include the following:
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VPN REMOTE ACCESS RADIUS SERVERS INTERNET FIREWALLS NETWORK AND APPLICATIONS
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3COM 3COM 3COM Alta Vista Apple
AltaVista Access Beyond Ascend ANS Atlantic Systems
Communications Group
Altiga Apple Computer Cisco Ascend BDM International
Communications
Ascend Ascend Funk Software Axent CCT
Communications Communications
Aventail Attachmate NextCom Check Point Cisco Systems
Check Point Bin Tec Nortel Networks Cisco Systems Citrix Systems
Compatible Systems Cabletron Systems PFU Ltd CyberGuard CyberSAFE
Fortress Cisco Systems Shiva (Intel) IBM Data General
Indus River Differential
InfoExpress Citrix Systems Soliton Systems K.K. Internet Dynamics EnCommerce
Internet Devices Compaq Milkyway Networks Gradient
Network Associate Computer Security NEC Technologies Lyrix Systems
Products Network Associates
Network TeleSystemss Digi International Secure Computing Microsoft
Nortel Networks Dynatech Network
Communications Sun Microsystems Information
Red Creek Technologic Technology
Semaphore Emulex V-ONE Novell
Shiva (Intel) Funk Software Oracle
Gandalf Ottawa Telephony
Sun Microsystems Technologies Group
TimeStep Hewlett-Packard Platinum
V-ONE IBM Process Software
VPNet HTK Progress Software
Kasten Chase Snare Networks
Lantronix Unisys
Microsoft WorldTalk
Mulilink
Nortel Networks
Novell
Perle Systems
RAScom
Shiva (Intel)
Xplex Networks
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SALES AND MARKETING
The Company has established a multi-channel distribution and sales network
to serve the enterprise network and data security market. The Company sells and
licenses its products directly to end users through its direct sales force and
indirectly through a network of OEMs, VARs and distributors. In addition, the
Company supports its direct and indirect sales efforts through strategic
marketing relationships and public relations programs, trade shows and other
marketing activities. In October 1997, the Company announced the SecurWorld
program designed to enhance its indirect channel through the establishment of
two-tier distribution.
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The Company's direct sales staff focuses on major accounts, provides
technical advice and support with respect to the Company's products and works
closely with the Company's customers, OEMs, VARs and distributors. As of
December 31, 1998, the Company's direct sales organization consisted of 282
sales, marketing and technical support personnel located throughout the world.
The Company also markets, sells and licenses its products indirectly
through its SecurWorld network OEMs, VARs and distributors. As of December 31,
1998, the Company had relationships with approximately 600 OEMs, VARs and
distributors.
In support of its sales efforts, the Company conducts sales training
courses, comprehensive targeted marketing programs including direct mail, public
relations, advertising, seminars, trade shows and telemarketing and ongoing
customer and third-party communications programs. The Company also seeks to
stimulate interest in enterprise network and data security through its public
relations program, speaking engagements, white papers, technical notes and other
publications.
The Company has entered into strategic marketing relationships with various
vendors of operating systems and network operating systems, remote access
products, Internet-related products and application software. The Company has
also entered into strategic relationships with vendors that share technical
information with the Company to enable it to develop products which will be
interoperable with the vendors' products. The Company has developed a separate
program, the SecurID Ready strategic partner program, to market the
compatibility between the vendors' products and the Company's ACE/Server
software. The end-user customers of all of these vendors must purchase tokens
and license ACE/Server software directly from the Company. The Company believes
that these relationships help the Company and its customers to expand their
enterprise network coverage and assist the Company in increasing its installed
customer base and SecurID token usage.
To enhance demand for its products, the Company has participated in the
development of various industry-specific protocols that rely on its RSA
cryptographic data security technologies. The Company also hosts its own annual
industry conference, the RSA Conference, and participates in others to increase
demand for its products. Through its RSA Laboratories division, the Company
maintains a leading role in basic cryptographic research, develops new
encryption technologies and maintains close working relations with leading
academic centers and customer development teams.
CUSTOMERS
As of December 31, 1998, the Company had sold or licensed more than 4,600
ACE/Server products and over 4,000,000 SecurID tokens to more than 3,500
customers worldwide. Historically, the Company's principal customers have been
in the telecommunications, pharmaceutical, financial and healthcare industries
as well as academic institutions, research laboratories and government
organizations. These customers are generally sophisticated and knowledgeable
purchasers of security systems and work with highly confidential information.
The Company believes that as corporate networks proliferate and become more
complex, the number of industries concerned with system security and access to
information will grow.
As of December 31, 1998, the Company had licensed its RSA encryption engine
and patent technology to more than 400 OEMs that typically incorporate the
encryption technology into their products. The Company's RSA encryption
technology is embedded in current versions of Microsoft Windows NT, Netscape
Navigator, Quicken by Intuit, Lotus Notes and numerous other products. The
Company also licenses its RSA encryption technology directly to customers for
incorporation into customers' business, financial and electronic commerce
networks. The Company's RSA technologies are part of existing and proposed
standards for the Internet and World Wide Web, ITU, ISO, ANSI and IEEE.
As of December 31, 1998, the Company had sold or licensed its BoKS systems,
now known as "Keon," to more than 130 customers worldwide, representing more
than 110,000 users.
No customer accounted for more than 5% of the Company's total revenue in
1996, 1997 or 1998.
11
<PAGE> 12
CUSTOMER SERVICE AND SUPPORT
The Company maintains a customer support help desk and technical support
organization at its headquarters in Bedford, Massachusetts and at other
locations throughout the world and offers telephone support for certain of its
products 24 hours a day, seven days a week. The Company continues to add
advanced technical support and professional service personnel to its staff to
address anticipated additional demands arising from the deployment of the
Company's security solutions into larger and more complex user environments. The
Company also has field technical support personnel who work directly with the
Company's direct sales force, distributors and customers. The Company's had 80
customer service and support employees world-wide as of December 31, 1998.
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 specified periods. After the expiration of the
applicable warranty period, customers may elect to purchase a maintenance
contract for 12-month renewable periods. Under these contracts, the Company
agrees to provide (i) corrections for documented program errors; (ii) version
upgrades for both software and, if applicable, firmware; and (iii) telephone
consultation.
PRODUCT DEVELOPMENT
The Company's product development efforts are focused on enhancing the
functionality, reliability, performance and flexibility of its existing
products. The Company is developing technology to enhance the administrative
capabilities and scalability of its ACE/Server products and to increase
interoperability with additional network operating systems and directory
services. The Company also is developing tools to assist customers, strategic
marketing partners and other third-party integrators in integrating the
Company's products with custom and other third-party network or system
applications.
The Company plans to increase its competitive position by developing
standards, protocols and applications that address the needs of specific market
segments and build on its RSA proprietary technology. In the latter case, the
Company may choose to partner with other parties to develop and/or market the
products. The Company is currently developing enhanced RSA toolkits to enable
emerging new applications. Each of these value-added toolkits is being designed
to address the needs of a specific market segment.
In addition to enhancing its existing products, the Company continues to
identify and prioritize various technologies for potential future product
offerings. The Company may develop these products internally or enter into
arrangements to license or acquire products or technologies from third parties.
There can be no assurance, however, that the Company will be successful in
enhancing or developing existing products or identifying and successfully
acquiring new technologies.
As of December 31, 1998, the Company's product development staff consisted
of 235 full-time employees engaged in engineering and development including
software and hardware engineering, testing and quality assurance and technical
documentation. The Company also engages outside contractors where appropriate to
supplement the Company's in-house expertise or expedite projects based on
customer or market demand. Research and development expenses, including
purchased research and development expenses, were $13.7 million in 1996, $27.2
million in 1997 and $32.0 million in 1998.
MANUFACTURING AND SUPPLIERS
Manufacturing
SecurID Tokens. The Company contracts for the manufacture of its SecurID
tokens with two suppliers in the United States, only one of which, Pemstar,
Inc., has been qualified to manufacture the Company's SecurID key fob. The
Company has generally been able to obtain adequate supplies of SecurID tokens in
a timely manner and believes that alternate vendors can be identified if current
vendors are unable to fulfill its needs. However, delays or failure to identify
alternate vendors, if required, or a reduction or interruption in
12
<PAGE> 13
supply or a significant increase in the manufacturing costs could adversely
affect the Company's financial condition or results of operations and could
impact customer relations.
RSA SecurPC and ACE/Server Software Products. The Company's RSA SecurPC and
ACE/Server software products are distributed on standard magnetic diskettes,
compact disks and tapes together with printed documentation. The Company
contracts with media duplication subcontractors for the majority of its media
duplication. The Company has the capability to do all media duplication
in-house, but limits its use to small production runs such as beta programs.
Suppliers
Although the Company generally uses standard parts and components for its
products, certain components are currently available only from a single source
or from limited sources. For example, the microprocessor chips contained in the
Company's SecurID tokens are currently purchased only from Sanyo Electric Co.,
Ltd., a Japanese computer chip manufacturer, and the lithium batteries contained
in the Company's SecurID tokens are purchased from Gould Electronics, a supplier
located in the United States. The inability to obtain sufficient sole or limited
source components as required or to obtain or develop alternative sources at
competitive prices and quality if and as required in the future, could result in
delays in product shipments or increase the Company's material costs either of
which would adversely affect the Company's financial condition or results of
operations.
The Company believes that it would take approximately six months to
identify and commence production of suitable replacements for the microprocessor
chip or lithium battery used in the Company's SecurID tokens. The Company
attempts to maintain a three-month supply of SecurID tokens in inventory.
COMPETITION
The market for enterprise network and data security products is highly
competitive and subject to rapid technological change. The Company believes that
competition in this market is likely to intensify as a result of increasing
demand for security products. The Company currently experiences competition from
a number of sources, including (i) software operating systems suppliers and
application software vendors that incorporate a single-factor static password
security system into their products; (ii) token-based password generator vendors
promoting challenge/response technology; (iii) smart card security device
vendors; (iv) biometric security device vendors; (v) public key infrastructure
and cryptographic software firms; and (vi) Application access providers. In some
cases, these vendors also support the Company's products and those of its
competitors. The Company may also face competition from these and other parties
in the future that develop enterprise network and data security products based
upon approaches similar to or different from those employed by the Company
including operating system or network suppliers not currently offering
competitive enterprise-wide security products. There can be no assurance that
the market for enterprise network and data security products will not ultimately
be dominated by approaches other than the approaches marketed by the Company.
The Company has agreed, in connection with the April 1995 formation of VeriSign,
Inc. ("VeriSign"), not to engage, directly or indirectly, in the business of
issuing public key certificates acting in the capacity of a certificate
authority for a period of five years from the date of such formation.
The Company believes that the principal competitive factors affecting the
market for enterprise network and data security products include technical
features, ease of use, quality/reliability, level of security, customer service
and support, distribution channels and price. Although the Company believes that
its products currently compete favorably with respect to such factors, there can
be no assurance that the Company can maintain its competitive position against
current and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other competitive
resources.
PROPRIETARY RIGHTS
The Company relies on a combination of patent, trade secret, copyright and
trademark laws, software licenses, nondisclosure agreements and technical
measures to establish and protect its proprietary technology. The Company
generally enters into confidentiality and/or license agreements with its
employees and
13
<PAGE> 14
distributors as well as with its customers and potential customers seeking
proprietary information, and limits access to and distribution of its software,
documentation and other proprietary information. Despite these precautions, it
may be possible for unauthorized third parties to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary.
The Company's 18 issued U.S. patents expire at various dates ranging from
2005 to 2017. The Company's 34 foreign patents expire at various dates between
2006 to 2015. In addition, the Company has filed patent applications on
inventions embodied in new technologies developed by the Company. There can be
no assurance that any of these applications will result in an issued patent.
Upon expiration of the Company's patents, competitors may develop and sell
products based on technologies similar or equivalent to those currently covered
by the Company's patents. A patent developed at the Massachusetts Institute of
Technology and licensed to the Company (the "RSA/MIT Patent"), the claims of
which cover significant elements of the Company's RSA products, will expire on
September 20, 2000, which may enable competitors to thereafter market competing
products which previously would have infringed the RSA/MIT Patent. There can be
no assurance that any patent owned or held by the Company or its licensers will
not be invalidated, circumvented, challenged or terminated, that any of the
Company's pending or future patent applications will be within the scope of
claims sought by the Company, if at all, or that the steps taken by the Company
to protect its rights will be adequate to prevent misappropriation of the
Company's technology or to preclude competitors from developing products with
features similar to the Company's products. Further, there can be no assurance
that others will not develop technologies that are similar or superior to the
Company's technology or duplicate the Company's technology. In addition, the
laws of certain countries in which the Company's products are or may be
developed or sold may not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States. The
inability of the Company to protect its intellectual property adequately could
have a material adverse effect on its financial condition and results of
operations.
The Company has registered, or is seeking to register, its trademarks and
servicemarks in countries where the Company has sold its products. There can be
no assurance that any such trademark application currently pending will not be
opposed by a third party.
GOVERNMENT REGULATION AND EXPORT CONTROLS
All of the Company's products are subject to U.S. export control laws and
applicable foreign government import, export, and/or use restrictions. Minimal
U.S. export restrictions apply to all products, whether or not they perform
encryption. Current U.S. export regulations require export licenses, or at least
a one-time technical review, before most encryption products may be exported to
countries other than Canada. The Company believes that it has obtained necessary
approvals for the export of the products it currently exports. There can be no
assurance, however, that the list of products and countries requiring Government
approvals and the applicable regulatory policies 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.
Exports of RSA's encryption products, or third-party products bundled with
RSA encryption technology, are expected to continue to be restricted by the
United States and various foreign governments. Exports of commercial encryption
products are regulated by the Export Administration Regulations of the U.S.
Commerce Department, while exports of encryption products designed or adapted
for military use require export licenses under the International Traffic in Arms
Regulations of the U.S. State Department. Until recently, the U.S. government
generally prohibited exports of encryption products with key lengths of greater
than 40 bits. Under new regulations issued in 1996 and 1998, commercial
encryption products with key lengths of up to 56 bits may be widely exported
after a one-time technical review by the U.S. Commerce Department. "Key
recovery" encryption products which enable authorized law enforcement agencies
to obtain readable text without the knowledge or cooperation of the end-user may
be exported, regardless of key length, after a one-time technical review.
Certain non-recovery products of any key length are eligible for export to
limited classes of end-users in certain countries, following a one-time
technical review and subject to various post-shipment reporting requirements;
eligible recipients include subsidiaries of U.S. companies, banks and financial
14
<PAGE> 15
institutions, health and medical organizations, and online merchants. Other
non-recovery encryption products may be exported to other countries and
end-users under special Encryption Licensing Arrangements or individual export
licenses which may be issued at the discretion of the U.S. Commerce Department.
These regulations may be modified at any time, and there can be no assurance
that RSA will be authorized to export encryption products from the United States
in the future. As a result, RSA 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.
In the fourth quarter of 1998, the Company established a subsidiary in
Australia which developed a protocol-level encryption technology known as "SSL"
without using any export-controlled U.S.-origin encryption technologies or
software and without "technical assistance" from any U.S. persons. Accordingly,
the Company obtained a written opinion from the U.S. Commerce Department that
this technology is not subject to the jurisdiction of the U.S. export laws. The
technology, however, is subject to the export laws of Australia, and the Company
has received a one-year license from the Australian Government to export object
code versions of the SSL technology to specified countries, including the United
States. In order to remain outside of U.S. export control jurisdiction, the
Company has implemented policies and procedures to ensure that U.S. personnel
working for the Company do not inadvertently provide technical assistance to the
Company's Australian subsidiary which is developing future versions of the SSL
technology. However, there can be no assurance that the U.S. government will not
deem the SSL technology to be subject to U.S. export laws in the future, or that
the applicable Australian export restrictions will not be modified in the
future, or that the Company will continue to receive the required Australian
export authorizations.
EMPLOYEES
At December 31, 1998, the Company employed 764 employees. Of these
employees, 235 were involved in research and development; 282 in sales and
marketing, 80 in customer service and support; 98 in production and information
technology; and 69 in administration, human resources and finance. No employees
are covered by any collective bargaining agreements. The Company believes that
its relationships with its employees are good.
RECENT EVENTS
In the first quarter of 1999, the Company commenced consolidation of
certain operations in order to promote operational efficiency. The Company
expects to incur costs, mostly in the first quarter of 1999 and primarily
severance and facilities exit costs, of between $5.0 million and $7.0 million in
connection with this effort.
ITEM 2. PROPERTIES
The Company's principal administrative, sales and marketing, research and
development and support facilities are located in Bedford, Massachusetts under
non-cancelable ten year leases expiring in August 2008. The facilities aggregate
approximately 183,000 square feet of office space, and the annual base rents
aggregate approximately $3.0 million including certain operating expenses. The
Company also leases facilities for research and development and sales and
marketing in San Mateo, California under non-cancelable ten-year leases expiring
in 2008. The facilities aggregate approximately 58,000 square feet of office
space, and the annual base rents aggregate approximately $2.0 million including
certain operating expenses. Annual rent escalation provisions for all of theses
leases are based on the Consumer Price Index. The Company also leases facilities
for administration, field sales and customer support throughout the United
States, Canada, Asia, and Europe at annual base rents aggregating approximately
$1.4 million.
In connection with the consolidation of certain operations commenced in
January 1999, the Company is actively seeking to sublet a total of approximately
50,000 square feet of facilities at various locations. The successful sublet of
these facilities will reduce the Company's rental payment obligations by
approximately $0.1 million per month.
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<PAGE> 16
ITEM 3. LEGAL PROCEEDINGS
The Company and certain of its directors and officers are defendants in
Fitzer v. Security Dynamics Technologies, Inc., Charles R. Stuckey, Jr., D.
James Bidzos, Arthur W. Coviello, Jr., John Adams, Marian G. O'Leary and Linda
B. Saris, Civil Action No. 98-CV-12496-WGY, a purported class action lawsuit
filed on December 11, 1998 in the United States District Court for the District
of Massachusetts (the "Complaint"). The plaintiff subsequently dismissed without
prejudice claims against Ms. Saris. The plaintiff claims to represent all
purchasers of the Company's Common Stock during the period from September 30,
1997 through July 15, 1998, and seeks unspecified damages on their behalf. The
plaintiff alleges that the defendants misled the investing public concerning
demand for the Company's products, the strengths of its technologies, and
certain trends in the Company's business. The plaintiff and certain others have
moved to be appointed as lead plaintiff and to appoint lead counsel. No response
has been made to the Complaint by agreement with the plaintiff. The lead
plaintiff chosen by the Court is expected to file an amended complaint, to which
the defendants will respond. The Company intends to contest the lawsuit
vigorously. Although the amounts claimed may be substantial, the Company cannot
predict the ultimate outcome or estimate the potential loss, if any, related to
the lawsuit. The Company believes that the disposition of this matter will not
have a material adverse effect on the Company's consolidated financial position.
However, the adverse resolution of the lawsuit could materially affect the
Company's results of operations or liquidity in any one annual or quarterly
reporting period.
On November 2, 1998 the Company commenced litigation in a patent
infringement lawsuit filed in the United States District Court for the District
of Massachusetts against VASCO Data Security, Inc. ("VASCO"). The suit alleges
that VASCO's Digipass token products infringe certain of the Company's patents.
The Company seeks monetary damages for such infringement and injunctive relief.
In connection with this litigation, VASCO has filed counterclaims against the
Company seeking a declaratory judgement of noninfringement and invalidation of
the Company's patents at issue and alleging that the Company's infringement suit
against VASCO represents a breach of contract between the parties.
On January 6, 1999, the Company commenced litigation in a patent
infringement lawsuit filed in the United States District Court for the District
of Massachusetts against VASCO. The suit alleges that VASCO's RSA cards and RSA
chips products infringe the RSA/MIT Patent. The Company seeks monetary damages
for such infringement and injunctive relief. In connection with this litigation,
VASCO has filed counterclaims against the Company seeking a declaratory
judgement of non-infringement and invalidation of the patent at issue, and
alleging that the Company's suit against VASCO represents a violation of
antitrust laws.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
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<PAGE> 17
EXECUTIVE OFFICERS OF THE COMPANY
The Company's executive officers are:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Charles R. Stuckey, Jr............... 56 Chairman of the Board and Chief Executive Officer
Arthur W. Coviello, Jr............... 45 President and Director
John Adams........................... 57 Senior Vice President, Engineering
Marian G. O'Leary.................... 44 Senior Vice President, Finance, Chief Financial Officer
and Treasurer
Linda E. Saris....................... 46 Senior Vice President, Customer Support and Operations
Scott Schnell........................ 41 Senior Vice President, Marketing
Margaret K. Seif..................... 38 Vice President, General Counsel and Secretary
</TABLE>
Mr. Stuckey has served as Chief Executive Officer and a member of the Board
of Directors of the Company since March 1987. He has served as Chairman of the
Board since July 1996. From January 1987 to March 1999, Mr. Stuckey served as
President of the Company.
Mr. Coviello joined the Company as Executive Vice President in September
1995 and was appointed Chief Operating Officer in January 1997 and President in
March 1999. Mr. Coviello was also elected to the Board of Directors in March
1999. From October 1995 to August 1997, Mr. Coviello also served as the
Company's Chief Financial Officer and Treasurer. Prior to joining the Company,
Mr. Coviello served in various capacities with CrossComm Corporation, a
developer of inter-networking products, including Chief Operating Officer and
Chief Financial Officer.
Dr. Adams joined the Company as Senior Vice President, Engineering in March
1996 after over twenty years of management, engineering and network service for
Digital Equipment Corporation ("Digital"). From 1976 to 1996, Dr. Adams served
in a number of positions with Digital, including Vice President and Technical
Director of Digital's Network Operating Systems Division from 1991 to 1996.
Ms. O'Leary joined the Company as Senior Vice President, Finance, Chief
Financial Officer and Treasurer in August 1997. From 1987 to 1997, Ms. O'Leary
held a number of positions with Digital, including Vice President, Finance for
the Systems Business Unit from 1994 to 1997.
Ms. Saris joined the Company as Vice President, Finance and Operations,
Treasurer and Chief Financial Officer in June 1989, and has served as Senior
Vice President, Customer Support and Operations since July 1998 and as Chief
Information Officer since August 1997. From January 1997 to July 1998, Ms. Saris
served as Vice President, Customer Support and Operations of the Company. From
October 1995 to January 1997, Ms. Saris served as the Company's Vice President,
Operations.
Mr. Schnell joined RSA as Vice President of Marketing in 1996, and was
appointed Senior Vice President, Marketing of the Company in July 1998. Prior to
joining RSA, Mr. Schnell spent 15 years in product and strategic marketing
positions at leading technology and consulting firms, including Apple Computer,
Photonics Corp and McKinsey and Company.
Ms. Seif joined the Company as General Counsel in March 1998, and was
appointed Vice President and Secretary in June 1998. From 1996 to 1998, Ms. Seif
was Vice President and General Counsel of Firefly Network, Inc., a personal
information software company. Prior to joining Firefly Network, Ms. Seif was
Vice President - Legal Affairs, of the AT&T New Media Services division from
1994 to 1996.
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<PAGE> 18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been trading on the Nasdaq National Market
under the symbol "SDTI" since the Company's initial public offering on December
14, 1994. The following table sets forth for the fiscal periods indicated the
high and low sales prices per share of Common Stock as reported on the Nasdaq
National Market.
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
1997
First Quarter............................................... $39 1/4 $21
Second Quarter.............................................. $38 1/4 $22 3/4
Third Quarter............................................... $44 3/8 $32 5/8
Fourth Quarter.............................................. $41 5/8 $29 3/4
</TABLE>
<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
1998
First Quarter............................................... $42 1/8 $29 1/2
Second Quarter.............................................. $42 3/4 $15 1/8
Third Quarter............................................... $20 3/4 $ 9 3/8
Fourth Quarter.............................................. $23 1/2 $ 5 7/16
</TABLE>
There were 319 stockholders of record of the Company's Common Stock as of
March 4, 1999.
The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain earnings, if any, to support its
growth strategy and does not anticipate paying cash dividends in the foreseeable
future. Payment of future dividends, if any, will be at the discretion of the
Company's Board of Directors after taking into account various factors,
including the Company's financial condition, operating results, current and
anticipated cash needs and plans for expansion.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is contained under the caption
"Selected Consolidated Financial Data" appearing in the Company's 1998 Annual
Report to Stockholders (the "1998 Annual Report") and is incorporated herein by
this reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by this item is contained under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing in the 1998 Annual Report and is incorporated herein by
this reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is contained under the caption
"Market Risk" appearing in the 1998 Annual Report and is incorporated herein by
this reference.
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<PAGE> 19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the Consolidated
Financial Statements appearing in the 1998 Annual Report and is incorporated
herein by this reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is contained in part under the
caption "Executive Officers of the Company" in Part I hereof, and the remainder
is contained in the Company's Proxy Statement for the Company's Annual Meeting
of Stockholders to be held on April 22, 1999 (the "1999 Proxy Statement") under
the captions "Proposal 1 -- Election of Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance" and is incorporated herein by this reference.
Officers are elected on an annual basis and serve at the discretion of the
Board of Directors.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is contained under the captions
"Director Compensation" and "Compensation of Executive Officers" in the 1999
Proxy Statement and is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is contained under the caption "Stock
Ownership of Certain Beneficial Owners and Management" in the 1999 Proxy
Statement and is incorporated herein by this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is contained under the caption
"Certain Relationships and Related Transactions" in the 1999 Proxy Statement and
is incorporated herein by reference.
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<PAGE> 20
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this Form 10-K:
1. Financial Statements. The Consolidated Financial Statements are
included in the 1998 Annual Report, portions of which are filed as an exhibit to
this Annual Report on Form 10-K. The Consolidated Financial Statements include:
Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
2. Financial Statement Schedules. Financial Statement Schedule II,
"Valuation and Qualifying Accounts" and the Report of Deloitte & Touche LLP
immediately following the "Exhibit Index" are filed as part of this Annual
Report on Form 10-K.
3. Exhibits. The Exhibits listed in the Exhibit Index immediately
preceding such Exhibits are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K:
On October 13, 1998, the Company filed a Current Report on Form 8-K, dated
October 12, 1998, to report under Item 5 (Other Events) the Company's financial
results for the third quarter of 1998 and the authorization of the Company's
stock repurchase program. No financial statements were required to be filed with
such report.
On December 11, 1998, the Company filed a Current Report on Form 8-K, dated
December 11, 1998, to report under Item 5 (Other Events) the purported class
action lawsuit against the Company and certain of its officers and directors. No
financial statements were required to be filed with such report.
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<PAGE> 21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SECURITY DYNAMICS TECHNOLOGIES, INC.
BY: /s/ CHARLES R. STUCKEY, JR.
------------------------------------
CHARLES R. STUCKEY, JR.
CHAIRMAN OF THE BOARD AND CHIEF
EXECUTIVE OFFICER
Date: March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<C> <S> <C>
/s/ CHARLES R. STUCKEY, JR. Chairman of the Board and Chief March 30, 1999
- --------------------------------------------------- Executive Officer (Principal
CHARLES R. STUCKEY, JR. Executive Officer)
/s/ MARIAN G. O'LEARY Senior Vice President, Finance, Chief March 30, 1999
- --------------------------------------------------- Financial Officer and Treasurer
MARIAN G. O'LEARY (Principal Financial and Accounting
Officer)
/s/ D. JAMES BIDZOS Vice Chairman of the Board March 30, 1999
- ---------------------------------------------------
D. JAMES BIDZOS
/s/ ARTHUR W. COVIELLO, JR. President and Director March 30, 1999
- ---------------------------------------------------
ARTHUR W. COVIELLO, JR.
/s/ RICHARD L. EARNEST Director March 30, 1999
- ---------------------------------------------------
RICHARD L. EARNEST
/s/ TAHER ELGAMAL Director March 30, 1999
- ---------------------------------------------------
TAHER ELGAMAL
/s/ JOSEPH B. LASSITER, III Director March 30, 1999
- ---------------------------------------------------
JOSEPH B. LASSITER, III
/s/ GEORGE M. MIDDLEMAS Director March 30, 1999
- ---------------------------------------------------
GEORGE M. MIDDLEMAS
/s/ JAMES K. SIMS Director March 30, 1999
- ---------------------------------------------------
JAMES K. SIMS
</TABLE>
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<S> <C>
2 Agreement and Plan of Merger by and among the Registrant,
Intrusion Detection Inc., Apple Acquisition Corp., Robert
Kane and Lillian Kane, dated March 26, 1998, is incorporated
herein by reference to Exhibit 2.1 to the Registrant's
Current Report on Form 8-K, dated March 26, 1998
3.1 Third Restated Certificate of Incorporation, as amended, of
the Registrant is incorporated herein by reference to
Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q
for the Quarter Ended June 30, 1996
3.2 Amended and Restated By-Laws, as amended, of the Registrant
is incorporated herein by reference to Exhibit 3.3 to the
Registrant's Registration Statement on Form S-1 (File No.
33-85606) (the "Form S-1")
4 Specimen Certificate for shares of Common Stock, $.01 par
value per share, of the Registrant is incorporated herein by
reference to Exhibit 4.1 to the Form S-1
*10.1 1986 Stock Option Plan, as amended, is incorporated herein
by reference to Exhibit 10.1 to the Form S-1
*10.2 1994 Stock Option Plan, as amended, is incorporated herein
by reference to Exhibit 10.2 to the Registrant's Annual
Report on Form 10-K for the Year Ended December 31, 1996
*10.3 Amendment No. 3 to 1994 Stock Option Plan, as amended, is
incorporated herein by reference to Exhibit 10.1 to the
Registrant's Quarterly Report on Form 10-Q for the Quarter
Ended June 30, 1997
*10.4 Amendment No. 4 to 1994 Stock Option Plan, as amended, is
incorporated herein by reference to Exhibit 10.3 to the
Registrant's Quarterly Report on Form 10-Q for the Quarter
Ended March 31, 1998
*10.5 1994 Stock Option Plan, as amended -- 1998 Restatement is
incorporated herein by reference to Annex A to the
Registrant's Definitive Schedule 14A filed April 1, 1998
*10.6 1994 Director Stock Option Plan, as amended, is incorporated
herein by reference to Exhibit 10.3 to the Registrant's
Annual Report on Form 10-K for the Year Ended December 31,
1996
*10.7 1998 Deferred Compensation Plan is incorporated herein by
reference to Exhibit 10.4 to the Registrant's Quarterly
Report on Form 10-Q for the Quarter Ended March 31, 1998
*10.8 Employment Agreement between the Registrant and Charles R.
Stuckey, Jr., dated as of November 1, 1997, is incorporated
herein by reference to Exhibit 10.5 to the Registrant's
Annual Report on Form 10-K for the Year Ended December 31,
1997
*10.9 Letter Agreement between the Registrant and Arthur W.
Coviello, Jr., dated as of August 21, 1995, is incorporated
herein by reference to Exhibit 10 to the Registrant's
Quarterly Report on Form 10-Q for the Quarter Ended
September 30, 1995
*10.10 Letter Agreement between the Registrant and Linda E. Saris,
dated as of May 1, 1989, is incorporated herein by reference
to Exhibit 10.7 to the Form S-1
*10.11 Form of Management Employment Agreement is incorporated
herein by reference to Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the Quarter Ended
September 30, 1998
10.12 Amended and Restated Registration Rights Agreement, dated as
of September 7, 1988, as amended, among the Registrant and
certain stockholders of the Registrant, is incorporated
herein by reference to Exhibit 10.11 to the Form S-1
10.13 Amendment to Amended and Restated Registration Rights
Agreement, dated as of October 31, 1995, among the
Registrant and certain stockholders of the Registrant, is
incorporated herein by reference to Exhibit 10.19 to the
Registrant's Registration Statement on Form S-1 (File No.
33-98818)
10.14 Registration Rights Agreement by and among the Registrant
and the parties named on Schedule I thereto, dated July 15,
1997, is incorporated herein by reference to Exhibit 10.1 to
the Registrant's Current Report on Form 8-K, dated July 15,
1997
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C>
10.15 Registration Rights Agreement by and among the Registrant,
Robert Kane and Lillian Kane, dated March 26, 1998, is
incorporated herein by reference to Exhibit 10.1 to the
Registrant's Current Report on Form 8-K, dated March 26,
1998
10.16 Stock Purchase Agreement, dated as of November 6, 1997,
between the Registrant and James K. Sims, is incorporated
herein by reference to Exhibit 10.24 to the Registrant's
Annual Report on Form 10-K for the Year Ended December 31,
1997
+10.17 Terms and Conditions of Purchase, dated January 1, 1994,
between the Registrant and Gould Electronics is incorporated
herein by reference to Exhibit 10.15 to the Form S-1
+10.18 Letter, dated October 12, 1994, from Sanyo Electric Co.,
LTD. to the Registrant is incorporated herein by reference
to Exhibit 10.16 to the Form S-1
+10.19 Progress Software Application Partner Agreement between the
Registrant and Progress Software Corporation, dated December
5, 1994, as amended, is incorporated herein by reference to
Exhibit 10.17 to the Form S-1
+10.20 Second Amendment to Progress Software Application Partner
Agreement, dated as of November 29, 1995, between the
Registrant and Progress Software Corporation is incorporated
herein by reference to Exhibit 10.13 to the Registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30,
1997
+10.21 Third Amendment to Progress Software Application Partner
Agreement, dated as of November 15, 1996, between the
Registrant and Progress Software Corporation is incorporated
herein by reference to Exhibit 10.14 to the Registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30,
1997
+10.22 Fourth Amendment to Progress Software Application Partner
Agreement, dated as of April 1, 1998, between the Registrant
and Progress Software Corporation, is incorporated herein by
reference to Exhibit 10.18 to the Registrant's Quarterly
Report on Form 10-Q for the Quarter Ended June 30, 1998
10.23 Indenture of Lease, dated as of March 11, 1996, between the
Registrant and Beacon Properties, L.P. is incorporated
herein by reference to Exhibit 10.17 to the Registrant's
Registration Statement on Form S-4 (File No. 333-7265)
10.24 Rider to Indenture of Lease, dated as of March 11, 1996
between the Registrant and Beacon Properties, L.P., is
incorporated herein by reference to Exhibit 10.6 to the
Registrant's Quarterly Report on Form 10-Q for the Quarter
Ended March 31, 1998
10.25 First Amendment to Lease, dated as of May 10, 1997, between
the Registrant and Beacon Properties, L.P. is incorporated
herein by reference to Exhibit 10.2 to the Registrant's
Quarterly Report on Form 10-Q for the Quarter Ended June 30,
1997
10.26 Second Amendment to Lease, dated as of April 8, 1998, by and
between the Registrant and EOP -- Crosby Corporate Center,
L.L.C., is incorporated herein by reference to Exhibit 10.5
to the Registrant's Quarterly Report on Form 10-Q for the
Quarter Ended March 31, 1998
10.27 Lease Agreement, dated as of August 15, 1997, by and between
the Registrant and Peninsula Office Park Associates, L.P.,
is incorporated herein by reference to Exhibit 10.7 to the
Registrant's Quarterly Report on Form 10-Q for the Quarter
Ended March 31, 1998
10.28 Lease Agreement, dated as of December 19, 1997, by and
between the Registrant and Peninsula Office Park Associates,
L.P., is incorporated herein by reference to Exhibit 10.8 to
the Registrant's Quarterly Report on Form 10-Q for the
Quarter Ended March 31, 1998
10.29 Master Development and License Agreement, dated September
30, 1997, between the Registrant and VeriSign, Inc.
("VeriSign") is incorporated herein by reference to Exhibit
10.19 to VeriSign's Registration Statement on Form S-1 (File
No. 333-40789)
10.30 Amendment Number One to Master Development and License
Agreement dated as of December 31, 1998 between the
Registrant and VeriSign is incorporated herein by reference
to Exhibit 10.30 to VeriSign's Registration Statement on
Form S-1 (File No. 333-70121)
11 Computation of Income per Common Share
</TABLE>
23
<PAGE> 24
<TABLE>
<S> <C>
13 Portions of the Registrant's 1998 Annual Report to
Stockholders (which is not deemed to be "filed" except to
the extent that portions thereof are expressly incorporated
by reference in this Annual Report on Form 10-K)
21 Subsidiaries of the Registrant
23 Consent of Deloitte & Touche LLP, Independent Auditors
27 Financial Data Schedule for the year ended December 31, 1998
</TABLE>
- ---------------
* Management contract or compensatory plan or arrangement filed in response to
Item 14(a)(3) of the instructions to Form 10-K.
+ Confidential treatment previously granted by the Securities and Exchange
Commission as to certain portions.
24
<PAGE> 25
SCHEDULE II
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS
For the year ended December 31, 1998............ $852 $122 $264 $710
For the year ended December 31, 1997............ 537 349 34 852
For the year ended December 31, 1996............ 734 223 420 537
ACCRUED WARRANTY COSTS
For the year ended December 31, 1998............ $105 $ -- $ -- $105
For the year ended December 31, 1997............ 105 -- -- 105
For the year ended December 31, 1996............ $105 $128 $128 $105
</TABLE>
25
<PAGE> 26
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Security Dynamics Technologies, Inc. and Subsidiaries:
We have audited the consolidated financial statements of Security Dynamics
Technologies, Inc. (the "Company") as of December 31, 1997 and 1998, and for
each of the three years in the period ended December 31, 1998, and have issued
our report thereon dated January 27, 1999 (which report expresses an unqualified
opinion and includes explanatory paragraphs referring to the restatement of the
consolidated financial statements for a pooling of interests in 1998 and a
change in the Company's method of accounting for option grants requiring
stockholder approval in 1996); such consolidated financial statements and report
are included in the 1998 Annual Report to stockholders and are incorporated
herein by reference.
Our audits also included the consolidated financial statement schedule of
the Company listed in Item 14 (a) 2. of this Annual Report. This consolidated
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits. In our opinion,
such consolidated financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
January 27, 1999
26
<PAGE> 1
EXHIBIT 11
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
COMPUTATION OF INCOME PER COMMON AND COMMON EQUIVALENT SHARE
YEARS ENDED DECEMBER 1996, 1997 AND 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Basic earnings per share (1):
Net income per common share............................... $ 0.37 $ 0.44 $ 0.72
======= ======= =======
Weighted average number of shares outstanding............. 37,165 38,956 40,909
======= ======= =======
Diluted earnings per share (1):
Net income per common share............................... $ 0.35 $ 0.42 $ 0.69
======= ======= =======
Shares:
Weighted average number of shares outstanding............. 37,165 38,956 40,909
======= ======= =======
Effect of dilutive options................................ 2,533 1,692 1,588
======= ======= =======
Adjusted weighted average number of shares outstanding...... 39,698 40,648 42,497
======= ======= =======
</TABLE>
- ---------------
(1) Results for all periods prior to the acquisitions have been restated for the
acquisitions of Intrusion Detection, Inc., DynaSoft AB and RSA Data
Security, Inc., respectively, which have been accounted for as poolings of
interests.
27
<PAGE> 1
EXHIBIT 13
13
Selected Consolidated Financial Data
(In thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA (1):
Revenue $ 24,126 $ 50,812 $ 86,417 $ 140,630 $ 171,334
Cost of revenue 4,927 8,999 18,431 28,704 40,781
Gross profit 19,199 41,813 67,986 111,926 130,553
Costs and expenses:
Research and development 4,344 7,260 13,682 27,180 31,981
Marketing and selling 8,991 14,478 24,829 41,926 66,788
General and administrative 3,428 10,775 14,603 17,171 19,007
Legal settlement -- -- -- -- 1,872
Merger and integration -- -- 6,100 5,700 2,600
-------------------------------------------------------
Total 16,763 32,513 59,214 91,977 122,248
-------------------------------------------------------
Income from operations 2,436 9,300 8,772 19,949 8,305
Interest income and other 265 1,917 4,889 6,273 8,676
Gain on sale of marketable securities -- -- 11,027 4,264 --
Gain on sale of VeriSign common stock -- -- -- -- 31,285
Gain from increase in investment value -- -- -- -- 11,976
Equity in loss from operations of equity investment -- -- -- -- (4,187)
Investment valuation adjustment -- -- -- -- (3,647)
Income before provision for income taxes 2,701 11,217 24,688 30,486 52,408
Provision for income taxes 1,453 3,487 11,003 13,324 23,571
Minority interests -- -- -- (114) 578
-------------------------------------------------------
Net income $ 1,248 $ 7,730 $ 13,685 $ 17,048 $ 29,415
-------------------------------------------------------
BASIC EARNINGS PER SHARE:
Net income $ 0.05 $ 0.24 $ 0.37 $ 0.44 $ 0.72
-------------------------------------------------------
Weighted average shares 24,382 32,577 37,165 38,956 40,909
-------------------------------------------------------
DILUTED EARNINGS PER SHARE:
Net income $ 0.05 $ 0.22 $ 0.35 $ 0.42 $ 0.69
-------------------------------------------------------
Shares:
Weighted average shares 24,382 32,577 37,165 38,956 40,909
Effect of dilutive options 1,633 2,209 2,533 1,692 1,588
-------------------------------------------------------
Adjusted weighted average shares 26,015 34,786 39,698 40,648 42,497
=======================================================
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------
(in thousands) 1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA (1):
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and marketable securities $ 28,006 $ 112,643 $ 107,008 $ 164,659 $ 158,236
Working capital 28,612 104,753 110,103 178,348 180,885
Total assets 29,190 129,279 147,355 233,975 280,855
Stockholders' equity 29,796 109,442 125,104 200,653 242,720
</TABLE>
(1) Selected Consolidated Financial Data for all periods prior to the
acquisitions have been restated for the acquisitions of Intrusion
Detection, Inc., Dynasoft AB and RSA Data Security, Inc., respectively,
which have been accounted for as poolings of interests. See Note 2 of Notes
to the Company's Consolidated Financial Statements.
<PAGE> 2
14
Management's Discussion and Analysis of Financial Condition and Results of
Operations
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
OVERVIEW
This Annual Report to Stockholders 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
statement contained herein that are not statements of historical fact may be
deemed 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 Company is a leading provider of enterprise network and data security
solutions to corporate end user ("Enterprise") and to original equipment
manufacturer ("OEM") customers. 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 March 26, 1998, the Company completed the acquisition of Intrusion Detection,
Inc. ("IDI") (the "IDI Acquisition"); on July 15, 1997, the Company completed
the acquisition of DynaSoft AB, ("DynaSoft") (the "DynaSoft Acquisition"), and
on July 26, 1996, the Company completed a merger with RSA Data Security, Inc.
("RSA") (the "RSA Merger"). The IDI Acquisition, the DynaSoft Acquisition and
the RSA Merger 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 prior to the acquisition has been restated to
include the results of IDI, DynaSoft and RSA for all periods presented.
The Company's revenue is derived primarily from sales of SecurID tokens;
licensing of ACE/Server, Keon (formerly known as BoKS) and RSA SecurPC software;
licensing of BSAFE, TIPEM, and SSL encryption engines and protocol products;
licensing of Kane Security Analyst and Kane Security Monitor software; licensing
of patents; and revenues from maintenance and professional services. Sales to
existing customers typically 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 Keon 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, Keon,
Kane Security Analyst and Kane Security Monitor software license fees 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 and protocol 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 sales through indirect
distribution channels are generally denominated in U.S. dollars.
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, changes 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 expenses as well as fees for
<PAGE> 3
15
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 personnel expenses, commissions and travel
expenses of direct sales and marketing personnel and marketing program expenses.
General and administrative expenses consist primarily of personnel expenses 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 nine-year period
ended December 31, 1998.
In the first quarter of 1999, the Company commenced consolidation of certain
operations in order to promote operational efficiency. The Company expects to
incur costs, mostly in the first quarter of 1999 and primarily severance and
facilities exit costs, of between $5.0 million and $7.0 million in connection
with this effort.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated financial data as a
percentage of revenue:
<TABLE>
<CAPTION>
Years Ended December 31
------------------------
1996 1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue 100.0% 100.0% 100.0%
Cost of revenue 21.3 20.4 23.8
----- ----- -----
Gross profit 78.7 79.6 76.2
Costs and expenses:
Research and development 15.9 19.3 18.6
Marketing and selling 28.7 29.8 39.0
General and administrative 16.9 12.2 11.1
Legal settlement -- -- 1.1
Merger and integration 7.1 4.1 1.5
Total 68.6 65.4 71.3
Income from operations 10.1 14.2 4.9
Interest income and other 5.7 4.5 5.1
Gain on sale of marketable securities 12.8 3.0 --
Gain on sale of VeriSign common stock -- -- 18.3
Gain from increase in investment value -- -- 7.0
Equity in loss from operations of equity investment -- -- (2.4)
Investment valuation adjustment -- -- (2.1)
Income before provision for income taxes 28.6 21.7 30.6
Provision for income taxes 12.7 9.5 13.8
Minority interests -- -- 0.3
------------------------
Net income 15.9% 12.2% 17.2%
========================
</TABLE>
<PAGE> 4
16
Management's Discussion and Analysis of Financial Condition and Results of
Operations
continued
1998 Compared with 1997
REVENUE
Total revenue increased 21.8% in 1998 to $171.3 million from $140.6 million in
1997. Approximately 50% of the increase in revenue in 1998 was attributable to
increased sales of SecurID tokens, approximately 24% of the increase was
attributable to increased sales of encryption engine licenses, approximately 26%
of the increase was attributable to increased sales of ACE/Server software
licenses and approximately 13% of the increase was attributable to increased
maintenance and professional services revenues. These increases in revenue were
offset in part by decreased revenues from sales of RSA SecurPC software and from
decreased revenue from sales of hardware. Revenue from sales of Keon software
and from sales of Kane Security Analyst and Kane Security Monitor software
decrease slightly in 1998 compared to 1997. 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 (outside of the United States) increased 36.4% in 1998 to
$59.3 million from $43.5 million in 1997 and was 34.6% of revenue in 1998 and
30.9% of revenue in 1997. The increase in international revenue was primarily
attributable to the continuing expansion of the Company's international sales
force and increased market penetration of the Company's products in foreign
markets.
During 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 in 1998.
COST OF REVENUE AND GROSS PROFIT
The Company's gross profit increased 16.6% in 1998 to $130.6 million, from
$111.9 million in revenue in 1997. Gross profit as a percentage of revenue
declined, however, in 1998 to 76.2% from 79.6% of revenue in 1997, primarily due
to write-offs in 1998 to cost of revenue of prepaid license fees of $4.1 million
under secure VPN and secure email license agreements with a third parties
determined to have no future value and costs of $1.2 million associated with
exiting certain hardware product lines. The proportion of software revenues to
total revenue in 1998 approximated those in 1997. Excluding the effects of the
write-offs, gross profit remained relatively consistent and as a percentage of
revenue was 79.3% in 1998 compared to 79.6% in 1997. During 1998 and excluding
the effect of the write-offs, approximately 75% of the increase in gross profit
was attributable to increased unit sales of SecurID tokens, approximately 31% of
the increase in gross profit was attributable to increased licensing sales of
ACE/Server software and approximately 27% of the increase in gross profit was
attributable to increased licensing sales of encryption engine technology and
patent licensing. Gross profit from maintenance and professional services in
1998 approximated those in 1997. Gross profit increases in 1998 were offset in
part by decreased gross profit associated with decreased revenue from sales of
RSA SecurPC software, hardware, Keon and Kane Security Analyst and Kane Security
Monitor software compared to 1997.
RESEARCH AND DEVELOPMENT
Research and development expenses increased 17.7% in 1998 to $32.0 million from
$27.2 million in 1997. Research and development expenses decreased as a
percentage of revenue to 18.6% in 1998 from 19.3% in 1997. Excluding purchased
research and development, the majority of the increase in research and
development expenses resulted from increased payroll expenses associated with
the employment of additional staff. During 1998 the Company purchased and
recorded as purchased research and development expense certain technology from
VeriSign, Inc. ("VeriSign") for $0.5 million and, from other parties for $1.3
million. The Company is incorporating these technologies into PKI ("Public Key
Infrastructure") based products offered for sale worldwide.
During 1997, the Company purchased, and recorded as purchased research and
development expense, certain technology from Netscape Communications Corporation
("Netscape") for $3.0 million, VeriSign for $2.7 million, and from another third
party for $.5 million. The Company plans to incorporate the technologies into
products which are expected to offer electronic signature, certificate authority
and a Java-based encryption engine, respectively. The Java-based encryption
engine was released for sale in 1998.
MARKETING AND SELLING
Marketing and selling expenses increased 59.3% in 1998 to $66.8 million from
$41.9 million in 1997. Marketing and selling expenses increased as a percentage
of revenue in 1998 to 39.0% from 29.8% in 1997. Approximately 52% of the
increase in marketing and selling expenses in 1998 resulted from an increase in
payroll costs associated with the employment of additional staff and
approximately 31% of the increase was attributable to increased sales
commissions. Sales commissions increased due to increased revenues and due to
compensation programs designed to incent sales personnel to increase sales
through the indirect channel and, in particular, the Internet and
telecommunication service provider channels. The remainder of the increase in
marketing and selling expenses resulted primarily from increased marketing
program costs.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 10.7% in 1998 to $19.0 million,
from $17.2 million in 1997, but decreased as a percentage of revenue to 11.1% in
1998 compared to 12.2% in 1997. Approximately 68% of the increase in general and
<PAGE> 5
17
administrative expenses was due to increased payroll expenses associated with
the employment of additional staff and approximately 31% of the increase in
general and administrative expenses was due to increased professional fees
offset by expense reduction synergies achieved in connection with the DynaSoft
and IDI Acquisitions.
LEGAL 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 $1.9 million,
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 1998 the Company incurred merger and integration expenses in connection with
the IDI Acquisition of approximately $2.6 million.
In the third quarter of 1997, the Company accrued a charge of $7.0 million,
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 $5.4 million, a difference of $1.6 million. The difference
resulted 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 $1.6 million of the original accrual in the fourth quarter of 1997.
In December 1997, the company commenced a plan to integrate certain DynaSoft
operations and accrued $.3 million for severance and related costs.
INTEREST INCOME AND OTHER
Interest income increased 38.3% in 1998 to $8.7 million from $6.3 million in
1997 due to interest earned on higher cash and marketable securities balances.
GAIN ON SALE OF MARKETABLE SECURITIES
In 1997, the Company had a gain on sale of marketable securities of $4.3
million.
GAIN ON SALE OF VERISIGN COMMON STOCK
In 1998, the Company sold 895,500 shares of its VeriSign common stock for a gain
of $31.3 million.
GAIN FROM INCREASE IN INVESTMENT VALUE
In 1998 the Company recorded a gain of $12.0 million from the write-up under the
equity method of its investment in VeriSign upon VeriSign's initial public
offering.
EQUITY IN LOSS FROM OPERATIONS OF EQUITY INVESTMENT
The Company recognizes its proportionate interest in VeriSign's operating
results one quarter in arrears. The Company's proportionate share of VeriSign's
losses were $4.2 million in 1998.
INVESTMENT VALUATION ADJUSTMENT
The Company routinely evaluates the realizable value of its investments using
qualitative and quantitative factors including discounted cash flow analysis and
liquidation value assessments. Based on these evaluations, the Company reduced
investments by $3.6 million in December 1998.
MINORITY INTERESTS
An aggregate 26% of RSA's Japanese subsidiary is owned by minority stockholders.
Minority interests in the subsidiary's net (income), loss were $0.6 million in
1998 and $(0.1) million in 1997.
PROVISION FOR INCOME TAXES
The provision for income taxes increased to $23.6 million during 1998 from $13.3
million in 1997, primarily due to higher pre-tax income. The Company's estimated
effective tax rate increased to 45.0% in 1998 from 43.7% in 1997 primarily due
to the effect of state income taxes on investment gains and differences in
amounts of nondeductible merger expenses in 1998 compared to 1997.
NET INCOME
As a result of the above factors, net income in 1998 increased to $29.4 million,
or 17.2% of revenue, from $17.0 million, or 12.2% of revenue, in 1997.
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
41% of the increase in revenue in 1997 was attributable to increased sales of
SecurID tokens, approximately 19% of the increase was attributable to increased
sales of ACE/Server software licenses and approximately 26% of the increase was
attributable to increased sales of encryption engine licenses. The balance of
the increase in revenue primarily resulted from sales of Keon, Kane Security
Analyst and Kane Security Monitor software licenses, software patent licenses
and maintenance revenue, offset by decreased hardware revenue.
International revenue (outside of the United States) increased 82.4% in 1997 to
$43.5 million from $23.8 million in 1996. International revenue accounted for
30.9% and 27.6% 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
<PAGE> 6
18
Management's Discussion and Analysis of Financial Condition and Results of
Operations
continued
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 98.7% in 1997 to $27.2 million from
$13.7 million in 1996. Research and development expenses increased as a
percentage of revenue to 19.3% in 1997 from 15.9% in 1996. Excluding purchased
research and development, approximately 58% of the increase in 1997 in research
and development expenses resulted from an increase in payroll costs associated
with the employment of additional staff, with the remaining attributable to
occupancy costs, consulting fees and purchases of computer equipment, resulting
in higher depreciation charges. During 1997, the Company purchased, and recorded
as purchased research and development expense, certain technology from Netscape
for $3.0 million, from VeriSign for $2.7 million and from another third party
for $0.5 million. The Company plans to incorporate the technologies into
products which are expected to offer electronic signature, certificate authority
and a Java-based encryption engine, respectively.
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 BSAFE S/MIME-C 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 $(0.1) million in 1997.
In 1997 and 1996, the Company sold an aggregate of 26% interest to minority
stockholders of RSA's Japanese subsidiary.
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.
Liquidity and Capital Resources
LIQUIDITY
At December 31, 1998, the Company had cash, cash equivalents and marketable
securities of $158.2 million and working capital of $180.9 million. The Company
has historically funded its operations primarily from cash generated from its
operating activities. During 1998 the Company used the cash provided by
investment sales and common stock sales principally for working capital needs,
to finance marketable securities purchases, property and equipment purchases, a
share repurchase program and to
<PAGE> 7
19
finance IDI Acquisition costs. The Company believes that working capital will be
sufficient to meet its anticipated cash requirements through at least 2001.
MERGERS AND ACQUISITIONS
On July 26, 1996, 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. 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 $2.6 million. These 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, 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 financing. Any equity or debt
financing, if available at all, may be on terms which are not favorable to the
Company and, in the case of equity financing, 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 $61.1 million of net cash proceeds to
the Company. The Company generated approximately $3.4 million of cash from the
exercise of stock options and employee stock purchase plan purchases during 1998
and realized tax benefits from option exercises of approximately $4.5 million.
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 $12.0 million, representing its
proportionate share of VeriSign's equity as of December 31, 1997, after
considering VeriSign's net proceeds from the offering. The Company sold 895,500
shares of its VeriSign common stock for a gain of $31.3 million in 1998. As of
December 31, 1998 the Company owned approximately 3.6 million shares of VeriSign
common stock, an approximate ownership percentage of 16%, with a market value of
approximately $213.0 million. In January 1999 VeriSign completed a secondary
offering of 3.2 million shares of its common stock, including the sale of 1.0
million shares held by the Company. The Company realized a gain of $74.7 million
on the sale in January 1999. In the second quarter of 1999, the Company will
recognize, as a gain the increase in the amount of its investment in VeriSign of
$12.6 million, representing its proportionate share of VeriSign's net increase
in equity from this offering.
The Company recognizes its proportionate interest in VeriSign's operating
results one quarter in arrears. The Company's proportionate share of VeriSign's
net loss was $4.2 million in 1998. On January 25, 1999, VeriSign announced that
it had incurred a net loss of $19.7 million for the year ended December 31, 1998
and $2.5 million for the three months ended December 31, 1998 and at December
31, 1998 had total assets and liabilities of $64.3 million and $22.6 million
respectively. A Director of the Company serves as Chairman of the Board of
VeriSign.
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 $1.5 million. VPNet was organized to develop and
market products and technologies for implementing high-performance virtual
private networks. In January 1998, the Company purchased $0.1 million 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. A Director of the Company
serves as a director of VPNet.
<PAGE> 8
20
Management's Discussion and Analysis of Financial Condition and Results of
Operations
continued
TRINTECH GROUP
In March 1998 the Company purchased, in a non-cash transaction, 482,756 ordinary
shares of Trintech Group ("Trintech") valued at $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. In June 1998,
the Company purchased 500,000 shares of Trintech's Series A Convertible
Preferred Shares for $3.0 million cash. The Company's investment represents a
minority interest of less than 10% of Trintech's capitalization.
NCIPHER CORPORATION LIMITED
In October 1997, the Company purchased 175,285 ordinary shares of nCipher
Corporation Limited ("nCipher") for an aggregate purchase price of $0.5 million.
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 $0.3 million
and $2.5 million, respectively. The Company's investment in nCipher represents a
minority interest of less than 20% of nCipher's capitalization.
C2NET, INC.
In June 1998, the Company made a one-year bridge loan to C2Net, Inc. ("C2Net")
in the amount of $0.2 million. 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 $1.0 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.
INVESTMENT VALUATION ADJUSTMENT
The Company routinely evaluates the realizable value of its investments using
qualitative and quantitative factors including discounted cash flow analysis and
liquidation value assessments. Based on these evaluations the Company reduced
investments by $3.6 million in December 1998.
CAPITAL EXPENDITURES
The Company's capital expenditures during 1998 were $18.9 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 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 $5.2 million, of which approximately
$4.8 million was spent in 1998. The Company continues to configure certain
elements of the system in order to, among other matters, include the operations
of certain subsidiaries. The Company estimates that an additional $4.0 million
will be spent on the system; most of which will be spent in the first quarter of
1999.
LEASING EXPENDITURES
The Company's principal administrative, sales and marketing, research and
development and support facilities are located in Bedford, Massachusetts under
non-cancelable ten year leases expiring in August 2008. The facilities aggregate
approximately 183,000 square feet of office space, and the annual base rents
aggregate approximately $3.0 million including certain operating expenses. The
Company also leases facilities for research and development and sales and
marketing in San Mateo, California under non-cancelable ten-year leases expiring
in 2008. The facilities aggregate approximately 58,000 square feet of office
space, and the annual base rents aggregate approximately $2.0 million including
certain operating expenses. Annual rent escalation provisions for all of theses
leases are based on the Consumer Price Index. The Company also leases facilities
for administration, field sales and customer support throughout the United
States, Canada, Asia, Japan and Europe at annual base rents aggregating
approximately $1.4 million.
In connection with the consolidation of certain operations commenced in January
1999, the Company is actively seeking to sublet approximately 50,000 square feet
of facilities at various locations. The successful sublet of these facilities
will reduce the Company's annual rental payment obligations by approximately
$0.1 million per month.
CERTAIN AGREEMENTS
The Company has an 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 and Keon software. The agreement has
been amended several times. In order to obtain favorable pricing, the Company
has, from time to time, prepaid Progress Software royalties due under the
agreement. In the first quarter of 1997 the Company prepaid $2.5 million and in
1998 the Company prepaid an aggregate of $6.0 million in three installments. The
prepaid royalty is recorded as a
<PAGE> 9
21
component of cost of sales as the related products are sold. Un-amortized
prepaid royalties were $4.5 million at December 31, 1997 and $4.8 million at
December 31, 1998.
In connection with refinements of its product offering strategy, the Company
determined it will no longer actively market certain secure VPN and secure email
products obtained from third parties under license agreements. Fees prepaid
under the license agreements of $4.1 million were determined to have no future
value and were charged to cost of revenue in 1998.
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 $.5 million 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.
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 for minimum annual salaries aggregating $1.9
million, and, 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.
In December 1998, the Company and VeriSign amended the Development Agreement
(the "Amendment") to appoint the Company the exclusive distributor of VeriSign's
certificate authority software. The Amendment provides, among other things, that
each year during the first five years following the date of the Amendment, the
Company may elect to retain its exclusive status, subject to payment by the
Company of certain prepaid license fees each year during that five year period.
In addition to $.5 million paid at the execution of the agreement, prepaid
license fees are due in minimum quarterly installments and aggregate $1.1
million in 1999, $2.3 million in 2000, $3.0 million in 2001, $4.0 million in
2002, and $4.0 million in 2003.
In December 1998, RSA and VeriSign amended its BSAFE/TIPEM OEM Master License
Agreement with VeriSign to provide, among other things, that VeriSign will
execute RSA's support and maintenance agreement in order to receive upgrades and
updates to RSA's BSAFE software.
STOCK OPTION REPRICING
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 Company's 1994 Stock Option Plan, as
amended and restated (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 Old 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, among other things, (i) is 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.
SHARE REPURCHASE PROGRAM
On October 12, 1998 the Company announced that its Board of Directors had
authorized the Company to repurchase up to four 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 plan and
other stock benefit plans, and for general corporate purposes. As of December
31, 1998 the Company had repurchased 1,058,000 shares of its Common Stock, for
an aggregate purchase price of $12.1 million.
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.
<PAGE> 10
22
Management's Discussion and Analysis of Financial Condition and Results of
Operations
continued
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 does not expect to implement 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
v3.3, Kane Security Analyst v4.5, Kane Security Monitor v3.2, Keon Security
Server v4, Keon Desktop v4, Keon Agents v4, Keon Agent SDK, Keon UNIX Platform
Security v4, (Keon software products were formerly known as BoKS), SoftID, RSA
SecurPC, BSAFE-Crypto-C, BSAFECrypto-J, BSAFE Cert-C, BSAFE SSL-C and BSAFE
SSL-J, 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 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 Readiness 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
Readiness 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 Readiness 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 and the Company's management
information system installed in 1998), 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. See "Capital Expenditures."
In addition, the Company has spent substantial time and effort testing and
evaluating its own products to determine Year 2000 Readiness of those products.
In the case of prior
<PAGE> 11
23
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.
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 has reviewed all of those
representations to determine the accuracy of those statements, given the ongoing
Year 2000 testing of the Company's products. The Company has determined that it
made Year 2000 Readiness representations in fewer than 10% of its customer
contracts; many of those customers have requested, and received, Year 2000 Ready
versions of the Company products. The cost of compliance with these
representations and warranties has not been and is not expected to be material.
In the event that any contractual representation made by the Company regarding
Year 2000 Readiness 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 Readiness 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.
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. The foregoing shall be considered a Year 2000
readiness disclosure to the maximum extent allowed under the Year 2000
Information and Readiness Disclosure Act.
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 1998.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." The
Company adopted the provisions of this statement in its annual financial
statements in 1998. SFAS No. 131 established new standards for reporting
information about operating segments.
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 established fixed conversion rates between their existing currencies
and the Euro. The Company's systems are configured to process Euro denominated
transactions. The Company does not believe the Euro will have a significant
effect on its business, financial position, cash flows or the results of its
operations.
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 Keon product line,
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
verifying user identities and establishing information access privileges for
such users in an enterprise. The success of the Keon software 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,
<PAGE> 12
24
Management's Discussion and Analysis of Financial Condition and Results of
Operations
continued
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 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 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.
LEGAL PROCEEDINGS
On December 11, 1998, a purported class action lawsuit was filed against the
Company and certain of its officers and directors in the United States District
Court for the District of Massachusetts. The plaintiff claims to represent all
purchasers of the Company's common stock during the period from September 30,
1997 through July 15, 1998, and seeks unspecified damages on their behalf. The
plaintiff alleges that the defendants misled the investing public concerning
demand for the Company's products, the strengths of its technologies, and
certain trends in the Company's business. The company is vigorously contesting
the suit and believes the plaintiff's allegations are without merit.
<PAGE> 13
25
On November 2, 1998 the company commenced litigation in a patent infringement
lawsuit filed in the United States District Court for the District of
Massachusetts against VASCO Data Security, Inc. ("VASCO"). The suit alleges that
VASCO's Digipass token products infringe certain of the Company's patents. The
company seeks monetary damages for such infringement and injunctive relief. In
connection with this litigation, VASCO has filed counterclaims against the
Company seeking a declaratory judgement of noninfringement and invalidation of
the Company's patents at issue and alleging that the Company's infringement suit
against VASCO represents a breach of contract between the parties.
On January 6, 1999, the Company commenced litigation in a patent infringement
lawsuit filed in the United States District Court for the District of
Massachusetts against VASCO. The suit alleges that VASCO's RSA cards and RSA
chips products infringe the RSA patent. The Company seeks monetary damages for
such infringement and injunctive relief. In connection with this litigation,
VASCO has filed counterclaims against the Company seeking a declaratory
judgement of non-infringement and invalidation of the patent at issue, and
alleging that the Company's suit against VASCO represents a violation of
antitrust laws.
MARKET RISK
The Company does not use derivative financial instruments. The Company generally
places its marketable security investments in high credit quality instruments,
primarily U.S.Government and Federal Agency obligations, tax-exempt municipal
obligations and corporate obligations with contractual maturities of ten years
or less. The Company does not expect any material loss from its marketable
security investments and therefore believes that its potential interest rate
exposure is not material. The Company also makes strategic equity investments
determined by the Board of Directors to be strategically synergistic to the
Company. The Company routinely evaluates the realizable value of these
investments using qualitative and quantitative factors including discounted cash
flow analysis and liquidation value assessments. Based on these evaluations the
Company reduced investments by $3.6 million in December 1998.
The Company invoices customers primarily in U.S. Dollars and in local currency
in those countries in which the Company has branch and subsidiary operations.
The Company is exposed to foreign exchange rate fluctuations from when customers
are invoiced in local currency until collection occurs. The company does not
enter into foreign currency hedge transactions. Through December 31, 1998,
foreign currency fluctuations have not had a material impact on the Company's
financial position or results of operation, and therefore the Company believes
that its potential foreign currency exchange rate exposure is not material.
The forgoing risk management discussion and the effects thereof are
forward-looking statements. Actual results in the future may differ materially
from these projected results due to actual developments in global financial
markets. The analytical methods used by the Company to assess and mitigate risk
discussed above should not be considered projections of future events or losses.
<PAGE> 14
26
Independent Auditors' Report
[Deloitte &
Touche LLP LOGO]
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,
1997 and 1998, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. 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 acquisition of Intrusion Detection, Inc., which has
been accounted for as a pooling of interests as described in Note 2 of notes to
the consolidated financial statements.
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 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, 1997 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 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
Boston, Massachusetts
January 27, 1999
<PAGE> 15
27
Consolidated Balance Sheets
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
DECEMBER 31,
ASSETS 1997 1998
- -----------------------------------------------------------------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 96,595 $ 33,178
Marketable securities 68,064 125,058
Accounts receivable 27,551 36,712
(less allowance for doubtful accounts
of $852 in 1997 and $710 in 1998)
Inventory 3,035 7,025
Prepaid expenses and other 9,338 10,596
Prepaid income taxes 2,562 3,930
Deferred taxes 1,426 --
----------------------
TOTAL CURRENT ASSETS 208,571 216,499
----------------------
PROPERTY AND EQUIPMENT
Furniture and equipment 20,909 37,269
Leasehold improvements 4,528 6,486
----------------------
TOTAL PROPERTY AND EQUIPMENT 25,437 43,755
Less accumulated depreciation and amortization (7,922) (14,187)
----------------------
PROPERTY AND EQUIPMENT NET 17,515 29,568
----------------------
OTHER ASSETS
Investments 3,699 14,248
Deferred taxes 3,371 19,285
Other 819 1,255
----------------------
TOTAL OTHER ASSETS 7,889 34,788
TOTAL $ 233,975 $ 280,855
======================
</TABLE>
See notes to consolidated financial statements
<PAGE> 16
28
Consolidated Balance Sheets
continued
<TABLE>
<CAPTION>
DECEMBER 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1998
- -----------------------------------------------------------------------
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable $ 11,137 $ 8,169
Accrued payroll and related benefits 5,254 9,695
Accrued expenses and other 4,071 4,659
Income taxes payable 159 --
Deferred revenue 9,602 10,971
Deferred taxes -- 2,120
----------------------
TOTAL CURRENT LIABILITIES 30,223 35,614
----------------------
MINORITY INTERESTS 3,099 2,521
----------------------
COMMITMENTS AND CONTINGENCIES (Notes 7 and 9)
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized,
80,000,000 shares; issued, 40,467,118
shares in 1997 and 41,534,359 shares in 1998;
outstanding, 40,466,609 shares in 1997 and
40,475,850 shares in 1998 405 415
Additional paid-in capital 165,751 191,185
Retained earnings 35,284 64,302
Deferred stock compensation (116) (74)
Treasury stock, common, at cost, 509 shares
in 1997 and 1,058,509 shares in 1998 -- (12,135)
Accumulated other comprehensive income (671) (973)
----------------------
TOTAL STOCKHOLDERS' EQUITY 200,653 242,720
----------------------
TOTAL $ 233,975 $ 280,855
======================
</TABLE>
See notes to consolidated financial statements
<PAGE> 17
29
Consolidated Statements of Income
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
(In thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1996 1997 1998
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
REVENUE $86,417 $140,630 $171,334
Cost of revenue 18,431 28,704 40,781
--------------------------------
GROSS PROFIT 67,986 111,926 130,553
--------------------------------
COSTS AND EXPENSES
Research and development 13,682 27,180 31,981
Marketing and selling 24,829 41,926 66,788
General and administrative 14,603 17,171 19,007
Legal settlement -- -- 1,872
Merger and integration 6,100 5,700 2,600
--------------------------------
Total 59,214 91,977 122,248
--------------------------------
INCOME FROM OPERATIONS 8,772 19,949 8,305
Interest income and other 4,889 6,273 8,676
Gain on sale of marketable securities 11,027 4,264 --
Gain on sale of VeriSign common stock -- -- 31,285
Gain from increase in investment value -- -- 11,976
Equity in loss from operations of equity investment -- -- (4,187)
Investment valuation adjustment -- -- (3,647)
Income before provision for income taxes 24,688 30,486 52,408
Provision for income taxes 11,003 13,324 23,571
Minority interests -- (114) 578
--------------------------------
NET INCOME $13,685 $ 17,048 $ 29,415
--------------------------------
BASIC EARNINGS PER SHARE
Per share amount $ 0.37 $ 0.44 $ 0.72
--------------------------------
Weighted average shares 37,165 38,956 40,909
--------------------------------
DILUTED EARNINGS PER SHARE
Per share amount $ 0.35 $ 0.42 $ 0.69
--------------------------------
Weighted average shares 37,165 38,956 40,909
Effect of dilutive options 2,533 1,692 1,588
--------------------------------
Adjusted weighted average shares 39,698 40,648 42,497
================================
</TABLE>
See notes to consolidated financial statements
<PAGE> 18
30
Consolidated Statements of Stockholders' Equity
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
(In thousands, except share data)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK
------------------- ADDITIONAL RETAINED DEFERRED STOCK ----------------
SHARES AMOUNT PAID-IN CAPITAL EARNINGS COMPENSATION SHARES AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996 35,922,113 $359 $ 94,593 $ 4,777 $(292) 296 --
Exercise of stock options
and purchase plans 817,123 8 2,598 -- -- -- --
Tax benefit arising from
exercise of stock options -- -- 3,702 -- -- -- --
Compensation expense and amortization
of deferred stock compensation -- -- 1,409 -- 118 -- --
Issuance of common stock 1,265,999 13 521 -- -- -- --
Comprehensive income:
Translation adjustment -- -- -- -- -- -- --
Unrealized (loss) on marketable
securities, net -- -- -- -- -- -- --
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
and purchase plans 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 and amortization
of deferred stock compensation -- -- 736 -- 58 -- --
Comprehensive income:
Translation adjustment -- -- -- -- -- -- --
Unrealized (loss) on marketable
securities, net -- -- -- -- -- -- --
Net income -- -- -- 17,048 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 40,467,118 405 165,751 35,284 (116) 509 --
Exercise of stock options
and purchase plans 1,067,241 10 3,354 -- -- -- --
Tax benefit arising from
exercise of stock options -- -- 4,482 -- -- -- --
Compensation expense and amortization -- --
of deferred stock compensation -- -- 1,941 -- 42
Tax benefit arising from foreign
acquisition net assets -- -- 13,835 -- -- -- --
Legal settlement -- -- 1,872 -- -- -- --
Other -- -- (50) (397) -- -- --
Share repurchase program -- -- -- -- -- 1,058,000 $(12,135)
Comprehensive income:
Translation adjustment -- -- -- -- -- -- --
Unrealized gain on marketable
securities, net -- -- -- -- -- -- --
Net income -- -- -- 29,415 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total comprehensive income -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 41,534,539 $415 $191,185 $64,302 $(74) $1,058,509 $(12,135)
============================================================================================
</TABLE>
<TABLE>
ACCUMULATED OTHER TOTAL
COMPREHENSIVE STOCKHOLDERS'
INCOME EQUITY
- --------------------------------------------------------------------------
<S> <C> <C>
BALANCE, JANUARY 1, 1996 $10,005 $109,442
Exercise of stock options
and purchase plans -- 2,606
Tax benefit arising from
exercise of stock options -- 3,702
Compensation expense and amortization
of deferred stock compensation -- 1,167
Issuance of common stock -- 534
Comprehensive income:
Translation adjustment -- 398
Unrealized (loss) on marketable
securities, net (6,430) (6,430)
Net income -- 13,685
- -------------------------------------------------------------------------
Total comprehensive income -- 7,653
- -------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 3,973 125,104
Settlement of RSA escrow -- --
Exercise of stock options
and purchase plans -- 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 and amortization
of deferred stock compensation -- 794
Comprehensive income:
Translation adjustment (1,243) (1,243)
Unrealized (loss) on marketable
securities, net (3,401) (3,401)
Net income -- 17,048
- ------------------------------------------------------------------------
Total comprehensive income -- 12,404
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 (671) 200,653
Exercise of stock options
and purchase plans -- 3,364
Tax benefit arising from
exercise of stock options -- 4,482
Compensation expense and amortization -- 1,983
of deferred stock compensation
Tax benefit arising from foreign
acquisition net assets -- 13,835
Legal settlement 1,872
Other -- (447)
Share repurchase program -- (12,135)
Comprehensive income:
Translation adjustment (425) (425)
Unrealized gain on marketable
securities, net 123 123
Net income -- 29,415
- ------------------------------------------------------------------------
Total comprehensive income -- 29,113
- ------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ (973) $242,720
================================
</TABLE>
See notes to consolidated financial statements
<PAGE> 19
31
Consolidated Statements of Cash Flows
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
(In Thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1996 1997 1998
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 13,685 $ 17,048 $ 29,415
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Legal settlement -- -- 1,872
Gain on sale of VeriSign common stock -- -- (31,285)
Gain from increase in investment value -- -- (11,976)
Equity in loss from operations of equity investment -- -- 4,187
Investment valuation adjustment -- -- 3,647
Non cash investment -- -- (2,000)
Gain on sale of marketable securities (11,027) (4,264) --
Deferred taxes (1,393) (2,337) 1,366
Depreciation and amortization 1,824 4,353 6,845
Stock compensation 1,167 794 1,983
Minority interests -- (114) (578)
Increase (decrease) in cash from changes in:
Accounts receivable (8,459) (10,946) (9,074)
Inventory (1,161) (,429) (3,993)
Prepaid expenses and other (2,672) (5,167) (7,529)
Accounts payable 2,379 1,627 (5,874)
Accrued payroll and related benefits 1,659 471 4,370
Accrued expenses and other 2,943 6,225 3,593
Prepaid and income taxes payable (459) (4,685) 4,828
Deferred revenue 1,105 3,983 1,356
-----------------------------------
NET CASH PROVIDED BY (USED FOR) OPERATING
ACTIVITIES (409) 6,559 (8,858)
-----------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of marketable securities (119,619) (104,172) (211,393)
Sales and maturities of marketable securities 85,975 133,804 154,399
Purchases of property and equipment (9,434) (10,896) (18,850)
Capitalized software costs and purchased
technology (1,061) (1,410) --
Investments and other (3,224) (1,616) 26,328
-----------------------------------
NET CASH PROVIDED BY (USED FOR) INVESTING
ACTIVITIES (47,363) 15,710 (49,516)
-----------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net of
issuance costs 534 61,108 --
Payments to Acquisition shareholders -- (6,038) --
Proceeds from exercise of stock options and
purchase plans 2,606 5,269 3,364
Tax benefit from exercise of stock options 3,702 2,012 4,482
Minority interests 1,213 1,905 --
Share repurchase program -- -- (12,135)
Other 537 -- (447)
-----------------------------------
NET CASH PROVIDED BY (USED FOR) FINANCING
ACTIVITIES 8,592 64,256 (4,736)
-----------------------------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND EQUIVALENTS (138) (1,618) (307)
-----------------------------------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (39,318) 84,907 (63,417)
CASH AND EQUIVALENTS, BEGINNING OF YEAR 51,006 11,688 96,595
-----------------------------------
CASH AND EQUIVALENTS, END OF YEAR $ 11,688 $ 96,595 $ 33,178
===================================
</TABLE>
See notes to consolidated financial statements
<PAGE> 20
32
Notes to Consolidated Financial Statements
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
(In thousands, except lease, 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 to corporate end user
("Enterprise") and original equipment manufacturer ("OEM") customers. The
Company helps enable electronic business by providing technologies, products and
services that secure the access to and protect the information in networks,
systems, applications and Internet commerce initiatives. Leveraging its
expertise in authentication management, public key encryption and access
control, the Company helps organizations in a range of industries conduct
business securely, protect corporate information assets and facilitate
business-to-business and 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 Keon product family, which provides a broad range of
application security solutions, including secure single sign-on solutions. The
Keon family includes the products formerly known as "BoKS" and acquired by the
Company as part of the acquisition of DynaSoft AB in July 1997.
The Company's principal markets for its products are, in order of significance,
the United States, Europe, Canada, Asia/Pacific and Latin America.
RECLASSIFICATION -- Certain prior year amounts have been reclassified to conform
to the 1998 presentation.
BASIS OF PRESENTATION -- The consolidated financial statements have been
prepared to give retroactive effect to the acquisitions of Intrusion Detection,
Inc. ("IDI") on March 26, 1998, DynaSoft AB ("DynaSoft") on July 14, 1997 and
RSA Data Security ("RSA") on July 26, 1996 (see Note 2), which have been
accounted for as poolings of interests.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include all
accounts of SDI and its subsidiaries. Strategic equity investments are accounted
for using the equity method in situations where the Company has the ability to
exercise significant influence over the investee's business. All other strategic
investments are accounted for using the cost method (See Note 3).
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 statements.
REVENUE RECOGNITION -- Revenues are recognized when software and hardware
products are shipped, no significant obligations remain and collection is
considered probable. Revenue from shipments to distributors are recognized upon
receipt of evidence of sale to end users by the distributors. Revenues from
licensing intellectual property such as patents and cryptographic data security
applications are recognized when contracts are entered into, no significant
obligations remain and collection is considered probable. Maintenance services
revenues are deferred and recognized ratably over the maintenance period,
generally twelve months. Professional services revenues are recognized as
services are provided. No customer accounted for 10% or more of the Company's
revenue in any period reported.
WARRANTY POLICY -- The Company provides warranties on SecurID tokens for the
customer-selected programmed life of the token and replaces damaged tokens
(other than tokens damaged by a user's negligence or alteration) free of charge.
The Company generally sells its other products to customers with warranties for
specified periods. 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 (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. Purchased technology and capitalized software
costs, net of accumulated amortization, were $86 as of December 31, 1997 and $14
as of December 31, 1998 and are included in Other Assets. Amortization expense
for capitalized software and purchased technology approximated $330, $111 and
$73 for 1996, 1997 and 1998, respectively.
CASH EQUIVALENTS -- The Company considers all highly liquid investments
purchased with a remaining maturity of three months or less to be cash
equivalents.
<PAGE> 21
33
MARKETABLE SECURITIES -- The Company classifies its marketable securities as
"available for sale," and carries them at aggregate fair value. Unrealized gains
and losses are included as a component of stockholders' equity, net of tax
effect. Realized gains are determined based on the specific identified cost of
the securities. The Company's marketable securities have various contractual
maturities through 2008. Unrealized gross gains were $132 at December 31, 1997
and $500 at December 31, 1998.
Marketable securities were as follows:
<TABLE>
<CAPTION>
December 31,
1997 1998
- ---------------------------------------------------------------------------------------------------------------
AGGREGATE AGGREGATE
FAIR VALUE COST FAIR VALUE COST
----------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government and Federal Agency obligations $ 67,582 $ 67,510 $ 32,370 $ 32,193
State and municipal government tax-exempt obligations 482 422 34,920 35,002
Corporate obligations -- -- 57,768 57,526
----------------------------------------------------
Total $ 68,064 $ 67,932 $ 125,058 $ 124,721
====================================================
</TABLE>
ADVERTISING -- Advertising costs are expensed as incurred. Advertising expense
was approximately $632 in 1996, $850 in 1997 and $837 in 1998.
INCOME TAXES -- The Company uses 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.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 109
the Company records valuation allowances against net deferred tax assets, if
based upon the available evidence, it is more likely than not that some or all
of the deferred tax assets will not be realized. In assessing the realizability
of deferred assets, management considers whether it is more likely than not that
some or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income and when temporary differences become deductible. The Company
considers, among other available information, uncertainties surrounding the
recoverability of deferred tax assets, scheduled reversals of deferred tax
liabilities, projected future taxable income, and other matters in making this
assessment.
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 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 (Note 3). It is not practicable to measure the
estimated fair value of such investments.
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 Keon
software and token technology to various customers in a diverse industry range.
Toolkit and patent licenses are issued primarily to companies in the computer
and software industries. The Company performs ongoing credit evaluations of its
customers and maintains allowances for potential credit losses. The Company
generally requires no collateral from its customers.
<PAGE> 22
34
Notes to Consolidated Financial Statements
continued
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 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, as amended, 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.
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 and the Merger have been accounted for as poolings of interests and
therefore the consolidated financial statements for all periods prior to the
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.
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.
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 were 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 were 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.
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.
Revenues and net income (loss) for previously separate Companies for the periods
before the acquisitions follow. IDI revenues and net income (loss) were $2,600
and $510, respectively, in 1996, $4,700 and $ 680, respectively, in 1997 and
$900 and $(137), respectively for the period January 1, 1998 to March 26, 1998,
the date Security Dynamics acquired IDI. DynaSoft revenues and net income (loss)
were $7,669 and $130, respectively, in 1996 and $5,277 and $(155), respectively,
for the period January 1, 1997 to July 15, 1997, the date Security Dynamics
acquired DynaSoft. RSA revenues and net (loss) were $6,043 and $(383),
respectively, for the period January 1, 1996 to July 26, 1996, the date Security
Dynamics merged with RSA.
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
<PAGE> 23
35
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. In July 1998, the shares held in escrow
in connection with the DynaSoft Acquisition were released and in September 1998,
the shares held in escrow in connection with the IDI Acquisition were released.
3. 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 $12.0 million, representing its
proportionate share of VeriSign's equity as of December 31, 1997, after
considering VeriSign's net proceeds from the offering. The Company sold 895,500
shares of its VeriSign common stock for a gain of $31.3 million in 1998. As of
December 31, 1998 the Company owned approximately 3.6 million shares of VeriSign
common stock, an approximate ownership percentage of 16%, with a market value of
approximately $213.0 million. In January 1999 VeriSign completed a secondary
offering of 3.2 million shares of its common stock, including the sale of 1.0
million shares held by the Company. The Company realized a gain of $74.7 million
on the sale in January 1999. In the second quarter of 1999, the Company will
recognize as a gain the increase in the amount of its investment in VeriSign of
$12.6 million, representing its proportionate share of VeriSign's net increase
in equity from this offering.
The Company recognizes its proportionate interest in VeriSign's operating
results one quarter in arrears. The Company's proportionate share of VeriSign's
net loss was $4.2 million in 1998. On January 25, 1999, VeriSign announced it
had incurred a net loss of $19.7 million for the year ended December 31, 1998
and $2.5 million for the three months ended December 31, 1998 and at December
31, 1998 had total assets and liabilities of $64.3 million and $22.6 million
respectively. A Director of the Company serves as Chairman of the Board of
VeriSign.
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.
A Director 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.
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.
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.
INVESTMENT VALUATION ADJUSTMENT -- The Company routinely evaluates the
realizable value of its investments using qualitative and quantitative factors
including discounted cash flow analysis and liquidation value assessments. Based
on these evaluations the Company reduced investments by $3.6 million in December
1998.
<PAGE> 24
36
continued
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, 1994 Plan option grants become exercisable as to 25%
on the first anniversary of the grant date, and in equal quarterly amounts
thereafter for three years. Options generally expire eight years from the grant
date. On April 30, 1998, at the Annual Meeting of Stockholders of the Company,
the stockholders adopted an amendment and restatement of the 1994 Plan which,
among other things, increased the number of shares authorized for issuance under
the 1994 Plan from 6,570,000 to 9,570,000. Shares of common stock available for
option grants were 567,390 at December 31, 1998. On January 6, 1999, the Board
of Directors adopted, subject to stockholder approval, an amendment to the 1994
Plan which, among other things, increases the number of shares of common stock
authorized for issuance from 9,570,000 to 11,570,000 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 up to ten years from the date of grant. Shares of
common stock available for option grant were 55,000 at December 31, 1998. On
January 6, 1999, the Board of Directors adopted, subject to stockholder
approval, an amendment to the Director Plan increasing the number of shares of
common stock authorized for issuance from 300,000 to 500,000 shares in the
aggregate.
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 91,408 in 1996, 145,203 in 1997 and 100,997 in 1998.
1998 NON-OFFICER EMPLOYEE STOCK INCENTIVE PLAN ("1998 PLAN") -- In December
1998, the Board of Directors adopted the Company's 1998 Plan. The 1998 Plan, as
amended, authorizes the grant of non-statutory stock options, restricted stock
awards, and other stock-based awards covering up to an aggregate of 625,750
shares of Common Stock to employees, consultants and advisors of the Company,
other than those who are also officers (within the meaning of Section 16 of the
Exchange Act). In general, stock options granted under the 1998 Plan become
exercisable as to 25% of the shares covered thereby on the first anniversary of
the grant date and in equal quarterly installments thereafter for three years.
Options generally expire eight years from the grant date. No shares of Common
Stock were available for awards under the 1998 Plan as of December 31, 1998.
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 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
had the option to repurchase at the original exercise price any unvested shares.
No options were subject to repurchase rights as of December 31, 1998.
<PAGE> 25
37
A summary of stock option activity under all plans follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE
SHARES PRICES PER SHARE
- -------------------------------------------------------------------
<S> <C> <C>
Outstanding at January 1, 1996 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
Granted 9,125,937 15.09
Exercised (972,740) 1.85
Canceled (6,178,366) 32.59
--------------------------
Outstanding at December 31, 1998 8,028,472 $ 13.35
==========================
Exercisable at December 31, 1996 2,127,928 $ 1.69
==========================
Exercisable at December 31, 1997 2,120,841 $ 11.45
==========================
Exercisable at December 31, 1998 2,629,914 $ 13.63
==========================
</TABLE>
The following table sets forth information regarding stock options outstanding
at December 31, 1998 under all plans:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
RANGE WEIGHTED REMAINING NUMBER WEIGHTED AVERAGE
EXERCISE NUMBER OF AVERAGE CONTRACTUAL LIFE CURRENTLY EXERCISE PRICE FOR
PRICES OPTIONS EXERCISE PRICE (YEARS) EXERCISABLE CURRENTLY EXERCISABLE
- ------------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C>
$ 0.10 52,000 $ 0.10 1.3 52,000 $ 0.10
0.45 22,397 0.45 4.9 22,397 0.45
0.76 - 0.90 145,085 0.90 1.2 144,828 0.90
1.75 - 2.55 21,663 2.36 5.7 21,663 2.36
2.95 - 3.31 109,262 3.27 2.7 107,431 3.27
6.62 4,959 6.62 2.3 4,959 6.62
9.97 - 14.31 6,523,957 11.95 7.6 1,829,732 11.70
16.00 - 19.00 417,339 16.73 7.7 -- --
24.13 - 35.63 638,250 28.95 7.7 382,748 29.22
37.59 - 44.21 93,500 40.70 8.1 64,156 41.66
- -------------------------------------------------------------------------------------------------------------------
$ 0.10 - 44.21 8,028,472 $ 13.35 7.3 2,629,914 $ 13.63
===================================================================================================================
</TABLE>
ACCOUNTING FOR STOCK OPTIONS
For certain options and stock awards granted in 1996, 1997 and 1998, 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 $1,167 in 1996, $1,205 in 1997 and $1,982 in 1998.
<PAGE> 26
38
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.
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, 1996, 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,
-------------------------------
1996 1997 1998
- --------------------------------------------------------------
<S> <C> <C> <C>
Pro forma net income $ 11,255 $ 5,697 $ 4,598
Pro forma net income
per share
-- basic $ 0.30 $ 0.15 $ 0.11
-- diluted $ 0.28 $ 0.14 $ 0.11
</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,
-----------------------------
1996 1997 1998
- -------------------------------------------------------------------------
<S> <C> <C> <C>
STOCK OPTION PLANS
Risk-free interest rate 6.0% 6.1% 5.2%
Expected life of option grants (years) 4.4 4.3 4.1
Expected volatility of underlying stock 57.5% 57.5% 70.0%
Expected dividend payment rate 0.0% 0.0% 0.0%
Expected forfeiture rate 4.1% 4.1% 7.5%
EMPLOYEE STOCK PURCHASE PLAN
Risk-free interest rate 5.2% 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% 70.0%
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 $17.36 in 1996, $19.64 in 1997 and $6.50
in 1998. The weighted fair value of stock options granted under the Purchase
Plan, calculated using the Black-Scholes option-pricing model was $8.81 in 1996,
$10.82 in 1997 and $5.58 in 1998.
<PAGE> 27
39
5. INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1996 1997 1998
- ------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 7,359 $ 11,459 $ 14,583
State 936 1,759 2,342
Foreign 399 431 798
-----------------------------------
Total 8,694 13,649 17,723
Deferred:
Federal (1,219) (2,179) (387)
State (174) (158) 2,050
Foreign -- -- (297)
-----------------------------------
Total (1,393) (2,337) 1,366
Tax benefit from exercise
of stock options:
Federal 3,452 1,878 4,137
State 250 134 345
-----------------------------------
Total 3,702 2,012 4,482
-----------------------------------
Total $ 11,003 $ 13,324 $ 23,571
===================================
</TABLE>
Significant components of the Company's deferred tax assets and liabilities at
December 31 were as follows:
<TABLE>
<CAPTION>
1997 1998
- -------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets (liabilities) current
Marketable securities $ (846) $ (5,760)
Deferred revenue 942 1,107
Royalty valuation -- 920
Merger and integration 196 --
Sales returns 524 605
Allowance for doubtful accounts 267 284
Compensation 185 237
Inventory reserves 67 225
Warranty obligation 42 42
Commissions 22 95
Other 27 195
---------------------
Net deferred tax asset (liability) current $ 1,426 $ (2,120)
=====================
Deferred tax assets (liabilities) non current:
Foreign acquisition asset $ -- $ 39,333
Purchased research and
development 2,907 2,642
Compensation 575 2,269
Investment valuation -- 1,459
Capitalized software development costs
and other (111) (920)
Valuation allowance -- (25,498)
---------------------
Net deferred tax assets -- non current $ 3,371 $ 19,285
=====================
</TABLE>
<PAGE> 28
40
Notes to Consolidated Financial Statements
continued
A reconciliation between the statutory and effective income tax rates follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1996 1997 1998
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory tax rate 35.0% 35.0% 35.0%
State income taxes net of federal benefit 2.3 3.7 7.0
Merger expenses 8.3 6.7 0.1
Other (1.0) (1.7) 2.9
Effective income tax rate 44.6% 43.7% 45.0%
===================================
</TABLE>
In the fourth quarter of 1998, the Company made certain elections for U.S. tax
reporting purposes that resulted in a deferred tax asset of approximately $39.3
million relating to the DynaSoft Acquisition, a taxable business combination in
1997 which was accounted for as a pooling of interests. In accordance with
provisions of SFAS No. 109, the Company simultaneously recorded a $25.5 million
valuation allowance, reducing the deferred tax asset to an amount that
management believes is more likely than not to be realized. The net deferred tax
asset of $13.8 million was recorded with a corresponding increase to additional
paid in capital.
Cash payments for income taxes were approximately $8,390 in 1996, $15,542 in
1997 and $18,249 in 1998.
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 20% 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. Profit-sharing contributions were
$305 in 1996, $400 in 1997 and $336 in 1998. The Board of Directors also
approved for 1996, 1997 and 1998 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 were
$261 in 1996, $367 in 1997 and $582 in 1998.
7. COMMITMENTS
The Company leases office facilities and automobiles under non-cancelable
operating leases expiring through 2009. Future minimum rental payments are as
follows:
YEARS ENDED DECEMBER 31,
1999 $ 6,354
2000 6,820
2001 6,809
2002 6,891
2003 6,843
Net rent expense was approximately $2,069 in 1996, $3,437 in 1997 and $4,884 in
1998. Rent collected from subleases of the Company's former headquarters was
$108 in 1996, $527 in 1997 and $81 in 1998.
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 plus interest at 13%. The amount, included in accrued expenses and other,
was repaid in 1998.
The Company has an 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 and Keon software. The agreement has
been amended several times. In order to obtain favorable pricing, the Company
has, from time to time, prepaid Progress Software royalties due under the
agreement. In the first quarter of 1997 the Company prepaid $2.5 million and in
1998 the Company prepaid an aggregate of $6.0 million in three installments. The
prepaid royalty is recorded as a component of cost of revenue as the related
products are sold. Unamortized prepaid royalties were $4.5 million at December
31, 1997 and $4.8 million at December 31, 1998.
<PAGE> 29
41
In connection with refinements of its product offering strategy, the Company
determined it will no longer actively market certain secure VPN and secure email
products obtained from third parties under license agreements. Fees prepaid
under the license agreements of $4.1 million were determined to have no future
value and were charged to cost of revenue in 1998.
The Company has a license for cryptographic communication technology and devices
from the Massachusetts Institute of Technology ("MIT") which granted, through
September 2000, an exclusive right to use, lease or sell technology, subject to
payment of royalties.
Royalty expense was $2,009 in 1996, $6,061 in 1997 and $6,235 in 1998.
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.
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 for minimum annual salaries aggregating $1.9
million, and, 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.
In the first quarter of 1999, the Company entered into an agreement with a
former officer, who is a director, for consulting services for a 2 year term at
$120 per year.
8. SEGMENT INFORMATION
The following is presented in accordance with SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." This statement establishes
new standards for defining and disclosing information about a company's business
segments and requires a company to define its segments along its internal
structure and reporting methodology. The Company has identified only one
distinct and reportable segment: enterprise network and data security solutions.
The segment generates revenue from two distinct product lines: Enterpise
Solutions (which include sales of SecurID tokens, licensing of ACE/Server, Keon
(formerly known as BoKS), Kane Security Analyst and Kane Security Monitor and
RSA SecurPC software) and OEM Solutions (which include licensing of BSAFE,
TIPEM, SSL encryption engines and protocol products). The Company determined
that it has only one reportable segment meeting the criteria established under
SFAS No. 131. The Company's chief operating decision maker, as defined,
(determined to be the Chief Executive Officer and the President) and the Board
of Directors do not manage any part of the Company separately, and the
allocation of resources and assessment of performance is based solely on the
Company's consolidated operations and operating results. As there is only
segment, refer Note 1 for the significant accounting policies.
The Company's operations are conducted throughout the world. Operations in the
United States represent individually more than 10% of revenues or income from
operations. The Company's operations in other countries are individually
insignificant and have been included in "Rest of world" below. The following
table presents information about the Company's operating segments:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
PRODUCTS AND SERVICES 1996 1997 1998
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Securid Tokens $ 34,826 $ 57,028 $ 72,328
Encryption Engine Licenses 16,781 30,765 38,205
Ace/Server Licenses 16,297 26,378 34,344
Maintenance and Professional Services 5,729 10,468 14,573
Other Software, Hardware 12,784 15,991 11,920
==================================
Total $ 86,417 $ 140,630 $ 171,334
==================================
</TABLE>
<TABLE>
<CAPTION>
GEOGRAPHIC AREAS
YEARS ENDED DECEMBER 31,
----------------------------------
REVENUES 1996 1997 1998
- --------------------------------------------------------------------------
<S> <C> <C> <C>
United States $62,587 $ 97,162 $112,042
Rest of World 23,830 43,468 59,292
----------------------------------
Total $86,417 $140,630 $171,334
==================================
</TABLE>
<PAGE> 30
42
Notes to Consolidated Financial Statements
continued
9. LITIGATION
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%.
On December 11, 1998, a purported class action lawsuit was filed against the
Company and certain of its officers and directors in the United States District
Court for the District of Massachusetts. The plaintiff claims to represent all
purchasers of the Company's common stock during the period from September 30,
1997 through July 15, 1998, and seeks unspecified damages on their behalf. The
plaintiff alleges that the defendants misled the investing public concerning
demand for the Company's products, the strengths of its technologies, and
certain trends in the Company's business. The company is vigorously contesting
the suit and believes the plaintiff's allegations are without merit.
On November 2, 1998 the company commenced litigation in a patent infringement
lawsuit filed in the United States District court for the District of
Massachusetts against VASCO Data Security, Inc. ("VASCO"). The suit alleges that
VASCO's Digipass token products infringe certain of the Company's patents. The
company seeks monetary damages for such infringement and injunctive relief. In
connection with this litigation, VASCO has filed counterclaims against the
Company seeking a declaratory judgement of noninfringement and invalidation of
the Company's patents at issue and alleging that the Company's infringement suit
against VASCO represents a breach of contract between the parties.
On January 6, 1999, the Company commenced litigation in a patent infringement
lawsuit filed in the United States District Court for the District of
Massachusetts against VASCO. The suit alleges that VASCO's RSA cards and RSA
chips products infringe the RSA patent. The Company seeks monetary damages for
such infringement and injunctive relief. In connection with this litigation,
VASCO has filed counterclaims against the Company seeking a declaratory
judgement of non-infringement and invalidation of the patent at issue, and
alleging that the Company's suit against VASCO represents a violation of
antitrust laws.
The Company has been named as a defendant in other legal actions arising from
its normal business activities, none of which it believes could have a material
adverse effect on the Company or its business.
10. RELATED PARTY TRANSACTIONS
VERISIGN
The Company has a Master Development and License Agreement (the "Development
Agreement") and an RSA BSAFE /TIPEM OEM Master License Agreement (the "OEM
Agreement") with VeriSign (Note 3). Pursuant to the terms of the Development
Agreement, VeriSign developed certain technology for the Company in exchange for
an initial license fee of $2.7 million. In December 1998, the Company and
VeriSign amended the Development Agreement (the "Amendment") to appoint the
Company the exclusive distributor of VeriSign's certificate authority software.
The Amendment provides, among other things, that each year during the first five
years following the date of the Amendment, the Company may elect to retain its
exclusive status, subject to payment by the Company of certain prepaid license
fees each year during that five year period. In addition to $.5 million paid at
the execution of the agreement, prepaid license fees are due in minimum
quarterly installments and aggregate $1.1 million in 1999, $2.3 million in 2000,
$3.0 million in 2001, $4.0 million in 2002, and $4.0 million in 2003.
In December 1998, the Company and VeriSign also amended OEM Agreement to
provide, among other things, that VeriSign will execute RSA's support and
maintenance agreement in order to receive upgrades and updates to RSA's BSAFE
software.
From September 1996 to March 1998, the Company sublet its former headquarters in
Cambridge, Massachusetts, to VeriSign in exchange for lease payments from
VeriSign of $18 in 1996, $105 in 1997 and $81 in 1998. A Company director serves
as VeriSign's (Note 3) Chairman of the Board of Directors.
OTHER
A stockholder, who owns less than 5% of the Company's common stock, provides
consulting services to the Company and received $97 in 1996, $104 in 1997 and
$82 in 1998. The Company has approximately $25 payable on demand to a less than
5% stockholder as of December 31, 1997 and 1998.
<PAGE> 31
43
11. COMPREHENSIVE INCOME
The Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive
Income" effective January 1, 1998. Accumulated other comprehensive income was:
<TABLE>
<CAPTION>
UNREALIZED
FOREIGN HOLDING GAIN ACCUMULATED
CURRENCY (LOSS) ON OTHER
TRANSLATION MARKETABLE COMPREHENSIVE
ACCUMULATED OTHER COMPREHENSIVE INCOME ADJUSTMENTS SECURITIES INCOME
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, January 1, 1997 $ 493 $3,480 $3,973
Period change (1,243) (3,401) (4,644)
-------------------------------------------
Balance, December 31, 1997 (750) 79 (671)
Period change (425) 123 (302)
-------------------------------------------
Balance, December 31, 1998 $(1,175) $ 202 $ (973)
===========================================
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
UNREALIZED GAINS (LOSSES) ON MARKETABLE -------------------------------------
SECURITIES, NET: 1996 1997 1998
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Unrealized holding gains (losses) arising
during year, net of tax (expense) benefit
of ($329), $442 and ($82), respectively $ 572 $ (736) $123
Less; reclassification adjustment for gains
included in net income, net of tax (expense)
benefit of $4,025, $1,599 and $0 respectively (7,002) (2,665) --
Unrealized gains (losses) on marketable -------------------------------------
securities, net $(6,430) $(3,401) $123
=====================================
</TABLE>
================================================================================
12. SUBSEQUENT EVENTS (UNAUDITED)
In the first quarter of 1999, the Company commenced consolidation of certain
operations in order to promote operational efficiency. The Company expects to
incur costs, primarily severance and facilities exit costs, of between $5.0
million and $7.0 million in connection with this effort.
================================================================================
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF SECURITY DYNAMICS TECHNOLOGIES, INC.
Subsidiary Name Jurisdiction of Organization
- --------------- ----------------------------
SD Securities Corp. Massachusetts
SD Investments Corp. Massachusetts
Security Dynamics (France) S.A.R.L. France
Security Dynamics Technologies GmbH Germany
Security Dynamics International Pte. Ltd. Singapore
Security Dynamics Nordic A.S. Norway
RSA Data Security, Inc. Delaware
Nihon RSA Company, Ltd. Japan
RSA Technology Holdings, Inc. Delaware
DynaSoft AB Sweden
Dynamic Software AB Sweden
DynaSoft Limited United Kingdom
Securix, Inc. California
Intrusion Detection Inc. New York
Security Dynamics Technologies Holdings, Inc. Delaware
Security Dynamics Technologies Ireland Limited Ireland
Security Dynamics Technologies (Malaysia)
Sdn Bhd Malaysia
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITOR'S 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, 333-52255 and
333-71075 of Security Dynamics Technologies, Inc. (the "Company") on Forms S-8
and Registration Statement No. 333-49949 of the Company of Form S-3 of our
reports dated January 27, 1999 (which report on consolidated financial
statements expresses an unqualified opinion and includes explanatory paragraphs
referring to the restatement of the consolidated financial statements for
pooling of interests in 1998 and a change in the Company's method of accounting
for option grants requiring stockholder approval in 1996), appearing in and
incorporated by reference in this Annual Report on Form 10-K of the Company for
the year ended December 31, 1998.
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 33,178
<SECURITIES> 125,058
<RECEIVABLES> 36,712
<ALLOWANCES> 710
<INVENTORY> 7,025
<CURRENT-ASSETS> 216,499
<PP&E> 43,755
<DEPRECIATION> (14,187)
<TOTAL-ASSETS> 280,855
<CURRENT-LIABILITIES> 35,614
<BONDS> 0
0
0
<COMMON> 415
<OTHER-SE> 242,305
<TOTAL-LIABILITY-AND-EQUITY> 280,855
<SALES> 171,334
<TOTAL-REVENUES> 171,334
<CGS> 40,781
<TOTAL-COSTS> 117,776
<OTHER-EXPENSES> 4,472 <F1>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 52,408
<INCOME-TAX> 23,571
<INCOME-CONTINUING> 29,415
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 29,415
<EPS-PRIMARY> 0.72
<EPS-DILUTED> 0.69
<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>
