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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-20634
SAFENET, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1287752
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
8029 CORPORATE DRIVE
BALTIMORE, MARYLAND 21236
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 931-7500
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12 (g) of the Exchange Act:
NAME OF EACH
TITLE OF EACH CLASS EXCHANGE ON WHICH REGISTERED
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Common Stock, $.01 par value Nasdaq National Market
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. [X]
The aggregate market value of the Common Stock issued and outstanding and held
by non-affiliates of the Registrant, based upon the closing price for the Common
Stock on the Nasdaq National Market on March 6, 2001 was approximately
$337,878,000. All executive officers and directors of the registrant have been
deemed, solely for the purpose of this calculation, to be "affiliates" of the
registrant. This determination of the affiliate status is not necessarily
conclusive.
The number of shares of the registrant's Common Stock outstanding as of March 6,
2001 was 7,029,963.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the registrant's proxy
statement for the Annual Meeting of Shareholders, which proxy statement in
definitive form will be filed no later than 120 days after the close of the
registrant's fiscal year ended December 31, 2000.
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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements usually contain the words "estimate," "anticipate," "expect" or
similar expressions. All forward-looking statements are inherently uncertain as
they are based on various expectations and assumptions concerning future events
and they are subject to numerous known and unknown risks and uncertainties.
These uncertainties could cause actual results to differ materially from those
expected for the reasons set forth below under Trends and Uncertainties. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. SafeNet, Inc. undertakes no obligation
to publicly release any revisions to "forward looking statements" to reflect
events or circumstances after the date of this report is filed with the
Securities and Exchange Commission or to reflect the occurrence of anticipated
events.
PART 1
ITEM 1. BUSINESS
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COMPANY
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SafeNet, Inc. ("SafeNet"), formerly Information Resource Engineering, was
originally incorporated in Maryland on April 7, 1983 under the name "Industrial
Resource Engineering, Inc." SafeNet reincorporated under Information Resource
Engineering in Delaware by merging with its subsidiary in March 1989. We
completed our initial offering in October of 1989 and our secondary offering in
October of 1992. On November 1, 2000, the Corporate name was changed by a vote
of the stockholders to SafeNet, Inc. SafeNet's executive offices are located at
8029 Corporate Drive, Baltimore, MD 21236. Our main telephone line is
410.931.7500 and website address is www.safenet-inc.com.
GENERAL
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OVERVIEW
SafeNet (Nasdaq: SFNT) delivers a widely deployed Virtual Private Network (VPN)
technology for secure business communications over the Internet. We offer both
Original Equipment Manufacture (OEM) technology and end-user products for VPN
and e-commerce applications. SafeNet's European subsidiary, GRETACODER Data
Systems AG (GDS), designs, manufactures and markets enterprise communications
security technology for the enterprise market. An ISO 9001 certified operation;
GDS has historically focused its product technology on encryption,
authentication, transaction security and secure remote access. GDS is currently
transitioning its focus from legacy networks to VPN technology for the Internet
targeting large enterprises in Europe and OEM developers and technology
integrators.
Since our inception in 1983, SafeNet has been providing network security
solutions worldwide for financial, enterprise, telecommunications and government
use. SafeNet's SecureIP(TM) technology has enjoyed broad market acceptance
through both the end-user and OEM VPN markets. Organizations that depend on
robust security for all communications have been enabled with our technology for
years. Through customer engagements with organizations like the U.S. Department
of State, Internal Revenue Service, U.S. Treasury, Federal Reserve Bank, and
Citibank, we have gained over 17 years of direct experience developing,
deploying, and managing network security systems for Fortune 500 companies and
government organizations around the world.
A VPN, simply put, is a communications system that uses strong encryption and
authentication to create private "tunnels" through the Internet or other shared
networks, allowing businesses to take advantage of the lowest cost network
without exposing their business communications. VPN technology has been a core
competency of SafeNet for over a decade and remains a principal focus of
SafeNet.
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SafeNet has positioned its VPN technology as a provider of choice for leading
Internet infrastructure manufacturers, service providers, and security vendors.
Customers include Cisco Systems, Nortel Networks, Nokia, and 3Com. With SafeNet
securing the infrastructure of today's e-business communications, we are opening
new markets for interoperable, secure, and deployable VPN communications.
SafeNet has taken the vision--to offer a simple, cost-effective approach to
Internet security--and become an innovator in the Internet marketplace, using
its expertise to identify and develop emerging security technologies. In 1995,
SafeNet introduced the first Internet VPN. We have sought to educate the market
and develop leading-edge technology to bring VPNs into the mainstream and make
security on the Internet a reality for business.
VPNs have become one of the most sought after sectors in the networking
communications industry. The tremendous growth of the Internet and the
applications surrounding this pervasive public network has increased the need
for VPN products and technology around the world.
During SafeNet's fiscal year 2000, our VPN technology was adopted by major
industry leaders including Open Reach, 3COM, and Cisco Systems. SafeNet
Soft-PK(TM), our award-winning Internet Protocol Security Standard (IPSec) VPN
Client, penetrated new markets and reached new heights in sales, making it a
leading solution in VPN client software. Soft-PK was adopted by an array of
industry leaders including RSA Security, Furukawa Electric, RapidStream,
NetScreen Technologies, and NetMax. Introduced in August of 2000, SafeNet
CryptPCI, a PCI board that provides high-speed performance and advanced security
for hardware-based acceleration of VPNs, e-commerce applications, firewalls, and
other cryptographic applications, was chosen by Intel and Cisco Systems. Our
SafeNet product line has continued to be a leading choice of security-conscious
organizations including the Internal Revenue Service and Citibank.
During 2000, the company broadened its market focus to include developing
security technology for the broadband and wireless markets. New access
technologies, such as DSL, cable modems, and wireless technologies are becoming
an increasingly popular way to access the enterprise network for remote, mobile,
and at-home workers. These emerging access technologies may also be more
vulnerable to Internet-borne security threats. Recently, SafeNet announced the
availability of it SecureIP(TM) technology for OEM developers and technology
integrators. SecureIP is available in IP modules - whereby selected elements of
the VPN encryption technology can be adapted in single or multiple
implementations. The flexibility of SecureIP will enable SafeNet encryption to
be quickly integrated into emerging technology.
During 2000, GDS has been transitioning its business from security for legacy
networks to encryption technology for Internet based networks. Through
collaboration with SafeNet corporate headquarters, GDS is adopting a similar
business model, focusing on both OEM markets and security-conscious
organizations like government, banking and financial institutions. GDS clients
include both financial institutions and government agencies such as Union Bank
of Switzerland, Swiss Interbank Clearing, SWIFT, European Payment Systems
Services, Societa Interbancaria per l'Automazione S.p.A., and Swiss Securities
Clearing Operation.
INDUSTRY BACKGROUND
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THE VPN MARKET
A VPN is a communications system using strong encryption that creates a private
"tunnel" through the Internet and other communications systems, assuring
authentication of users and privacy of information. This allows businesses to
use the lowest cost network without exposing their business communications. A
VPN can allow an organization's employees to access company-confidential
information over an intranet, or allow trading partners access to a company
extranet for secure business-to-business electronic commerce applications. A
leading market research firm predicts that by the year 2004, the VPN product and
services will reach 39.8 billion dollars.
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VPNs also allow organizations to use public networks for their communications
backbone. This is achieved by protecting the data traffic with data
communications security technology such as: encryption, message authentication,
user authentication, and firewall technology. Since public networks are much
cheaper than private leased lines and dedicated frame relay networks,
corporations can generally achieve substantial cost savings by using VPNs while
taking advantage of the global availability and access to the Internet. With the
increasing use of public and private communications networks and the ability of
different types of computers to communicate with each other, data integrity and
security have gained increased importance. Secure VPNs have three key uses:
secure remote access, secure site-to-site connections and secure extranet
connections.
Management believes that the market for security systems and products providing
VPN solutions has grown over the last several years due to an increase in the
use of the Internet for business communications and electronic commerce
applications such as work-at-home arrangements or telecommuting, electronic
mail, satellite offices connected to a central computer, electronic funds
transfer, electronic data interchange with clients, suppliers and business
customers and numerous other arrangements. The popularity and associated usage
of the Internet has increased the requirements for VPN technology and products
to ensure secure "intra" and "inter" company communications.
VPNs are facilitating growth of e-business or business-to-business online
applications. Growth in this area has been significant and Management believes
it will continue to grow in the future.
PRODUCTS
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SafeNet's VPN technology and product offerings include software and hardware
products, dedicated solutions, and embedded technology for the OEM market.
SAFENET OEM SOLUTIONS
SECUREIP(TM) TECHNOLOGY
SafeNet announced the streamlined delivery of its core technology for
availability to OEM developers and technology integrators. SecureIP is available
for license in IP modules or blocks - whereby selected elements of the VPN
encryption technology can be adapted in single or multiple implementations. This
allows OEMs to incorporate selective blocks in their own ASICs or processors to
allow for very cost-effective, high throughput, low power designs This
flexibility enables SafeNet Technology to quickly secure emerging markets.
SecureIP can be licensed in the following implementations:
- Encryption Engines: DES/3DES, RC4, Rijndael (AES)
- Hash Engines: SHA-1, MD5, RIPEMD-128/160
- Packet Engines: IPSec, SSL, TLS, WTLS, IPComp
- Public Key Accelerator
- Entropy based True Random Number Generator (RNG)
- Deflate Compression Engine
SAFENET CRYPTCORE 1140
Announced on December 13, 2000, SafeNet CryptCore 1140 is a low cost encryption
accelerator chip for cable and DSL modems, routers, residential gateways, and
other small office/home office (SOHO) networking devices. The CryptCore
processor provides unmatched performance at the lowest price point available in
the SOHO market for hardware-based acceleration of VPNs, e-commerce
applications, firewalls, and other cryptographic applications. Because CryptCore
is the only chip in the market designed to seamlessly interface with four of the
industry's most widely-used networking processor interfaces, it provides
customers with a one-stop, IPSec-compliant encryption acceleration solution for
a range of networking products.
SAFENET DSP(TM)
SafeNet DSP(TM) is a hardware acceleration device that is embedded into
networking equipment such as routers, firewalls, and switches to enable highly
secure Virtual Private Networking. Co-developed with Analog Devices,
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Inc., this IPSec-compliant encryption solution delivers the highest performance
and strongest security solution for networking, server, and telecommunications
companies.
The SafeNet DSP provides hardware acceleration of all cryptographic operations
required for IPSec, L2TP, Link-level Encryption, etc. These operations include
DES and triple-DES encryption, SHA-1 and MD5 secure hash, HMAC, Diffie-Hellman,
RSA, DSA public key acceleration, and true random number generation. SafeNet DSP
also incorporates a comprehensive security model and an embedded crypto library
that facilitates designing a truly secure VPN product. Leading networking
vendors such as Cisco Systems, Cabletron Systems and Nortel Networks have
embedded SafeNet DSP into their product line.
SAFENET CRYPTSET(TM)
SafeNet Cryptset is a high throughput chipset that allows ATM, Fast Ethernet and
T-3 Communications.
SAFENET CRYPTPCI(TM)
The SafeNet CryptPCI card is a plug-in PCI board that provides industry-leading
crypto throughput and acceleration for operations such as encryption, hashing,
public key computations, key negotiation, signatures, and random number
generation. With this accelerator installed, host system applications can
off-load the burden of time-consuming crypto applications while improving system
performance. SafeNet CryptPCI features the SafeNet DSP security chip used by
Cisco Systems, Nortel Networks and Cabletron Systems. SafeNet CryptPCI offers
single-pass simultaneous hash and encrypt operation in hardware and provides
accelerated throughput for IPSec applications. SafeNet CryptPCI customers
include Cisco and Intel.
CLIENT SOFTWARE
SAFENET SOFT-PK(TM)
SafeNet Soft-PK is an IPSec-certified, interoperable VPN software product for
Windows 95, 98, and NT 4.0 that allows secure client-to-client or
client-to-gateway communication over TCP/IP networks, including the Internet.
The security services offered by SafeNet Soft-PK include confidentiality via
encryption, packet integrity and authentication via keyed hash, and identity
authentication via Digital Signatures and X.509 certificates, exchanged during
key negotiation. Features include IPComp compression, Certificate Enrollment
Protocol (CEP), Windows 2000 and L2TP Support.
SafeNet Soft-PK is one of only two client software products to be awarded IPSec
certification from the International Computer Security Association (ICSA) and is
being private-labeled by major communications and security vendors. Infonetics
Research, Inc. recently identified SafeNet Soft-PK as one of the two leading
players in the rapidly growing remote access VPN market. SafeNet Soft-PK was
also named "Best Security Solution" by Solutions Integrator's SI Impact Awards
and "Product of the Year" in the VPN category by Internet Telephony Magazine.
SAFENET VPN POLICY MANAGER(TM)
SafeNet VPN Policy Manager(TM) is a Windows NT application that provides
comprehensive policy management for SafeNet Soft-PK(TM) VPN Client. SafeNet VPN
Policy Manager simplifies deployment of SafeNet Soft-PK and enables centralized
management of security policies. SafeNet VPN Policy Manager provides a simple
and flexible way to install and manage large quantities of VPN clients, while
keeping security policy transparent to the end-user. Full compliance with
industry standards ensures interoperability with other networking products;
another feature critical to the successful deployment of VPNs. SafeNet VPN
Policy Manager is used by 3Com Corporation.
SAFENET ENTERPRISE SOLUTIONS:
SAFENET ENTERPRISE(TM)
SafeNet Enterprise(TM) is a deployable VPN solution that integrates the full
range of Internet security needs like access control, encryption, user
authentication, message authentication, and policy management. The SafeNet
Enterprise system consists of two client products (SafeNet Soft(TM) and SafeNet
Smart(TM)) for remote access, a
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high performance gateway (SafeNet Speed(TM)), and a centralized security
management system, providing comprehensive security in an easy-to-use, scaleable
solution (SafeNet Security Center).
SafeNet Enterprise Version 3 introduces an IPSec (IP Security) compliant, public
key mode of operation to SafeNet's family of VPN products. SafeNet Enterprise
Version 3 also features IPSec Plus capabilities that go beyond the current
industry standard to provide integrated security in a deployable solution.
SAFENET SOFT(TM) AND SAFENET SMART(TM)
Both SafeNet Soft and SafeNet Smart provide encryption and authentication for
Internet and private TCP/IP communications in an easy-to-use desktop utility.
SafeNet Soft and SafeNet Smart solve the need for cost-effective products that
can be widely deployed throughout an organization. SafeNet Soft and SafeNet
Smart features include support for dial-up and network connections, support for
Windows 95, 98, and NT, and IPSec compliance. SafeNet Smart features the
addition of a personalized smart card for two-factor user authentication.
SafeNet Smart uses X.509 v.3 certificates and user authentication keys that are
secured and maintained on the smart card for an added level of security.
SAFENET SPEED(TM) FAMILY
SafeNet Speed Family is a dedicated VPN gateway solution that provides users a
scalable, upgradeable architecture to meet the evolving performance, security,
and multi-vendor compatibility requirements for site-to-site and remote access
VPN applications. SafeNet Speed features the SafeNet DSP(TM), which combines
high performance with the industry's strongest encryption and authentication
schemes for tunneling data securely across the Internet or private TCP/IP
networks. SafeNet Speed may be implemented as a standalone "plug and play" unit
for organizations who simply require a high-performance VPN gateway, or as part
of SafeNet's SafeNet Enterprise Version 3 family of products, for those who need
a turnkey VPN solution including clients and management. SafeNet Speed is
offered in 3 configurations to satisfy different levels of requirements:
SAFENET SECURITY CENTER(TM)FAMILY (SAFENET(TM) VPN MANAGEMENT FAMILY)
The SafeNet Security Center Family provides VPN management solutions for
entry-level through high-end network environments and enables organizations to
scale from modest VPN applications to massive deployments quickly and easily.
SafeNet Security Center provides flexibility and resiliency unprecedented in the
VPN industry, which is the result of SafeNet's experience deploying VPN
solutions with customers worldwide.
MANAGED SERVICES
TRUSTED SERVICES(TM)
SafeNet Trusted Services(TM) is a VPN Management Service that provides
consulting, central security management and 24-hour/365 day monitoring of an
organization's network. SafeNet Trusted Services can allow a company to take
advantage of VPN security without paying costs in capital equipment and overhead
while entrusting key management to a professional service. Trained network
security experts perform all the functions for effective VPN deployment
including security policy creation and management, user enrollment, network
management, and help desk support. The center is a highly secure facility
equipped with surveillance cameras and motion detectors.
GDS PRODUCTS
GDS has historically developed encryption technology for legacy networks. Over
the past year, GDS has adopted SafeNet's business model focused on OEM and
end-user segments. GDS is selling encryption technology products to large
security-conscious organizations that want to use the Internet and licensing
SafeNet technology to OEM developers and technology integrators. Their
technology and products mirror what SafeNet develops domestically.
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PRODUCT DEVELOPMENT
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SafeNet conducts product development activities to increase the size of its
available market through broader product offerings and to reduce the cost of its
products, resulting in more competitive pricing and/or better operating margins.
The VPN market, in its growth period, will be continually looking for products
that offer the strongest encryption and the fastest throughput. We will continue
to devote resources to the latest VPN technology to meet the increasing demands
of the market, however there can be no assurance that we will successfully
complete the development of these products in a timely fashion or that our
current or planned products will satisfy the needs of the VPN security market.
PRODUCT DESIGN STANDARDS
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VPN security technologies are utilized by SafeNet to provide secure
communication over public networks including the Internet. This security
technology provides selective access to computer networks, prevents electronic
eavesdropping or alteration during electronic data transmission, provides
message authentication confirming that messages are received in unaltered form,
and enables user authentication and digital signatures verifying the identity of
the message sender and limiting computer access to authorized users. We offer a
choice of encryption algorithms to provide the level of network security
appropriate for each client application.
All of SafeNet's network security systems and products comply with the following
general product design standards:
STANDARDS COMPLIANCE
SafeNet's policy is to offer products based upon encryption algorithms that have
been approved as industry and government standards, providing SafeNet's clients
assurance that they are using products that meet commercial reasonability tests.
NETWORK COMPATIBILITY
SafeNet's systems and products contain sufficient intelligence to accommodate
the specific communication protocols employed by complex computer networks,
including support for Frame Relay, Dial Asynchronous, leased line, X.25, Bisync
and Internet protocol-based networks.
INTEROPERABILITY
Management believes the market opportunity for VPN technology and products
increases when vendors' product offerings become interoperable. Our commitment
to the IPSec standard and multi-vendor interoperability is utilized in existing
and planned product offerings.
EASE OF USE
SafeNet believes that users of its products, while concerned that their data is
secure, do not wish to be required to take specific actions to achieve secure
status. Therefore, our products are designed to function without user
involvement, thus offering an extremely high level of ease of use.
EASE OF MANAGEMENT AND ADMINISTRATION
SafeNet has extended its ease of use concept to the policy management of its
most widely deployed client, SafeNet Soft-PK. The SafeNet VPN Policy Manager is
a Windows NT application that simplifies deployment of SafeNet Soft-PK and
enables centralized management of security policies.
PRICE PERFORMANCE CRITERIA
SafeNet believes that in order for clients to invest in encryption technology,
its products must be implemented cost effectively. As such, our development
staff follows a design approach similar to that used with consumer electronics
products that are designed for low manufacturing cost.
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ENCRYPTION ALGORITHMS
At present, SafeNet's products employ a variety of encryption algorithms
including the Advanced Encryption Standard (AES), U.S. Government Triple Data
Encryption Standard, ("TDES") and Single DES, RSA Data Security Inc. Encryption
Standard, ("RSA") and Gretacoder Data Systems Encryption Standard, ("GDSES").
CUSTOMERS
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During 2000, SafeNet announced relationships with the following Customers and
Partners:
CISCO SYSTEMS
SafeNet has been selling SafeNet Cryptset for integration into Cisco 7000 Series
high-end routers and embedding SafeNet DSP into the Cisco Routers Series 1700,
2600, 3600 small office and mid-range routers. SafeNet DSP is also designed into
Cisco's PIX Firewall. In addition, Cisco is selling SafeNet Soft-PK under the
private label, "Cisco Secure Client". More recently, Cisco has licensed SafeNet
CryptPCI for use in the PIX Firewall. Revenues from Cisco consist mainly of
software licenses and SafeNet Cryptset sales.
IBM
On December 5, 2000, SafeNet announced that its Soft-PK VPN client had
successfully demonstrated interoperability with the IBM VPN server integrated
within OS/390, IBM's S/390's flagship operating system. In a test of four common
VPN solution scenarios, IBM found that Soft-PK worked seamlessly with its server
architecture--providing a secure e-business solution for customers that want to
immediately incorporate a best-of-breed VPN solution into existing
infrastructure. Soft-PK is one of IBM's recommended security solutions.
INTEL
On November 1, 2000, Intel licensed the SafeNet CryptPCI(TM) board to accelerate
encryption functionality of the Intel(R)NetStructure(TM) 3130 VPN Gateway. The
integration of SafeNet PCI into Intel's NetStructure product offers the highest
performing VPN gateway available for fast and secure Internet communications for
mobile users, between offices and partners, and over corporate networks.
3COM
3Com licensed SafeNet Soft-PK(TM) and VPN Policy Manager to provide an
interoperable, IPSec-compliant software product for secure remote access
communications. Soft-PK complements 3Com's VPN strategy, and provides a
best-of-class security solution for client-to-LAN VPN connectivity that can be
used with 3Com's PathBuilder(TM) and NETBuilder(R) VPN products.
RSA SECURITY
On May 8, 2000, SafeNet joined with RSA Security to ensure SafeNet technology
seamlessly interoperated with RSA Security's products. SafeNet joined the RSA
Secured strategic partners program to certify that its popular SafeNet
Soft-PK(TM) VPN client offers one more level of security for corporate users.
The two companies have tested and certified interoperability between SafeNet
Soft-PK Version 4 and the RSA Keon(R).
On September 19, 2000, RSA licensed SafeNet Soft-PK to integrate the VPN client
technology with RSA Keon(R) public key infrastructure (PKI) solutions in order
to help organizations extend their digital certificate solutions to the
industry's leading VPN applications.
SSH
On June 6, 2000, SSH Communications Security (SSH) and SafeNet announced a
partnership to guarantee multi-platform interoperability between the SSH IPSEC
Express(TM) and SSH IKE Toolkit(TM) family of products and SafeNet DSP
hardware-based accelerator chip. This strategic agreement increases the breadth
of security product offerings for both SSH and SafeNet customers, creating a
full VPN solution for enterprises that need to add VPN functionality to their
products without compromising on speed or quality of service.
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NETSCREEN
On August 1, 2000, NetScreen Technologies licensed SafeNet Soft-PK to strengthen
its security offering with an industry-leading, IPSec-compliant VPN client to
quickly and cost-effectively provide customers with a secure remote access
solution that complements its line of security appliances.
FURUKAWA ELECTRIC
On July 10, 2000, Furukawa Electric Company, one of Japan's largest suppliers of
ISDN routers, bundled SafeNet Soft-PK with its own INFONET(TM) router and
gateway.
RADGUARD
On November 27, 2000, RADGUARD selected SafeNet's industry-leading VPN client,
Soft-PK, as a third-party solution integrated into RADGUARD's new Open
Architecture environment. The Open Architecture solution incorporates the best
third-party VPN products into RADGUARD's award-winning cIPro family to provide a
highly secure and flexible IPSec VPN solution that meets the sophisticated
network needs of global customers.
RAPIDSTREAM
On July 18, 2000, RapidStream licensed SafeNet Soft-PK for distribution with its
family of multifunction security appliances. SafeNet Soft-PK is used in large
VPN-based networks to provide a secure solution for remote users.
OPENREACH
On September 26, 2000, SafeNet provided OpenReach with a license to manage and
promote a version of its industry-leading SafeNet Soft-PK VPN client that
includes OpenReach's TrueSpan(TM) Software. The integration of the SafeNet VPN
client with OpenReach's easy and affordable services will allow telecommuters
and mobile professionals to seamlessly and securely connect to corporate
information resources from anywhere and with any Internet connection or access
technology.
NETMAX:
On January 8, 2000 NetMAX(TM), a division of Cybernet Systems Corporation,
licensed our Soft-PK VPN client to provide their customers with a best-of-class
remote access solution that features ease-of-use, robust security functionality,
and compatibility with all Windows operating systems. Soft-PK is bundled with
the NetMAX VPN server to provide immediate support to telecommuting employees or
business partners that are using Windows-based platforms. The NetMAX VPN Server
Suite is designed to leverage the power of the Linux operating system, providing
a cost-effective and reliable VPN solution that is ideal for small to medium
sized businesses.
SALES AND MARKETING
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SALES
SafeNet has continued to sell through both direct sales and indirect
distribution channels in order to expand worldwide sales coverage. In North
America, in addition to some direct sales, we sell our products primarily
through Value Added Resellers and Internet Service Providers. In Europe, we sell
our products through a direct sales force. Outside of such territories, we sell
our products through distributors of communication or information security
products. A global sales organization provides support for these distribution
channels. OEM sales efforts are sold through partners and direct sales.
During the year 2000, SafeNet has put more emphasis on OEM sales channels. Our
business model is one of partnering with large technology producers and leader
networking and security vendors in order to widely deploy SafeNet technology.
SafeNet's European subsidiary is currently adopting the same business model.
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MARKETING
In the second half of 2000, SafeNet began a new initiative to re-brand the
company and strengthen its leadership position with a strong marketing presence.
As we move more into the public eye, we will be building upon and aggressively
promoting the SafeNet brand.
On November 20, 2000 SafeNet announced a new logo. This was the first step in
rolling out a new corporate image that reflects the company's look and feel
since the name change from IRE on November 1, 2000. The logo strengthens the
equity built in the SafeNet brand and reflects the company's emergence as a de
facto Internet security leader. In the beginning of 2001, SafeNet introduced a
new website as another step to strengthen the SafeNet brand.
SafeNet's marketing program also continued lead generation and increased
coverage of SafeNet's technology and products in leading trade publications. We
have increased our emphasis on developing awareness of the SafeNet brand through
our public relations efforts and joint marketing arrangements with our strategic
partners. SafeNet has also increased its use of direct marketing programs
through email, direct mail, and web-based promotions. We have instituted
processes to ascertain the requirements of our existing and prospective end-user
and OEM customers. Our success in embedding our technology in leading networking
vendors has helped us to gain market awareness. SafeNet will continue its
endeavor in co-branding SafeNet technology to industry leaders to increase
market awareness.
CLIENT SUPPORT AND PRODUCT WARRANTIES
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SafeNet provides support for clients through a staff of support engineers
knowledgeable in both SafeNet's network security systems and products and
complex computer networks. In addition to supporting clients, this group of
engineers performs system level quality assurance testing of new products and
product enhancements. SafeNet provides client telephone support, including 24
hour a day "hot line" support. In addition, we offer on-site training,
installation and trouble-shooting services, generally on a fee basis.
SafeNet provides limited warranties on its products for one year from acceptance
of a product. After warranty expiration, clients may purchase an extended
warranty support contract. This contract extends warranty service for an
additional one-year period, providing repair or replacement of defective
products and telephone support. We also offer support on a time and materials
basis.
MANUFACTURING AND INVENTORY
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Components for SafeNet's products are purchased from a limited number of
electronic parts manufacturers and distributors. Electronic assembly firms are
used to mount components onto printed circuit boards according to designs and
instructions provided by SafeNet's engineers. Since the components are readily
available from other suppliers and since there are several electronic assembly
firms available, a change in suppliers would not have a material effect on
SafeNet's operations. However, while we have not experienced any significant
supply problems in the past, it is possible that in the future we may encounter
shortages in parts, components, or other elements vital to the manufacture,
production and sale of its products.
SafeNet anticipates that it will continue to utilize qualified suppliers and
electronic assembly firms to produce sub-assemblies. We presently perform system
integration, final assembly and testing which consists of assembling the cases
containing the product components, attaching integrated circuits which contain
the specific computer instructions and algorithms to printed circuit boards,
labeling, adding serial numbers, testing, packaging, and shipping. SafeNet has
and will continue to utilize contract manufacturers for products requiring high
volume production.
While SafeNet and ADI jointly developed the SafeNet DSP, ADI will be the
manufacturer and point of procurement for the chip. We may seek other partners
similar to ADI for future product manufacturing and procurements.
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COMPETITION
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The VPN market is highly competitive and subject to rapid technological changes.
SafeNet believes that competition in this market is likely to intensify as a
result of increasing demand for Internet security technology and products. There
are several companies in this field that have been established longer than
SafeNet, and have greater financial, research, service support and marketing
resources than those of SafeNet. There is also a number of other hardware and
software data encryption methods and security technologies on the market, which
compete with our products.
Management believes that the principal competitive factors affecting the VPN
market include standards compliance, quality/reliability, technical features,
network compatibility, ease of use, client service and support, distribution and
price. Although SafeNet believes its technology and products currently compete
favorably with respect to such factors, there can be no assurance that SafeNet
can maintain its competitive position against current and potential competitors.
If the VPN market continues to develop, it will likely be characterized by rapid
advances in technology and new products that could render the existing
technology upon which SafeNet's technology and products are based obsolete or
non-competitive. This risk will increase to the extent that our competitors
include manufacturers of computer equipment and Internet appliances to which our
products relate, since such manufacturers may be in a better position than us to
develop security products in anticipation of developments in their computer
equipment.
PATENTS AND INTELLECTUAL PROPERTIES
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Between 1996 and 2000, SafeNet was awarded four United States Patents covering
portable encrypting and authenticating network interface devices, such as
modems. The patents provide SafeNet with ownership rights to a technology that
SafeNet believes will be critical to the growth of computer networks, such as
the Internet. The patents cover various forms of pocket-sized devices including
PCMCIA and Smart card-based secure tokens and are adaptable to modems and newer
network technologies including ISDN, ADSL and cable modems. Our products covered
by the patents include the SafeNet Dial and the AX400. Additional foreign patent
applications, which cover the same products and technology, are pending.
SafeNet has acquired a worldwide license under a United States Patent for a
self-authenticating fingerprint identification card for certain computer
security and financial applications.
The computer software source codes, which are essential elements of SafeNet's
products, are the proprietary trade secrets of and are copyrighted by SafeNet.
The protection of proprietary technology and information developed by us will be
limited to such protection as we may be able to secure pursuant to trade secret
or copyright laws or under any confidentiality agreements which we may enter.
SafeNet owns federally registered trademarks for SafeNet name and for certain of
its products; however, there is no assurance as to the validity, enforceability
or lack of infringement of such trademarks.
At present, SafeNet is a party to confidentiality agreements with its officers,
directors and employees. There can be no assurance that the scope of any such
protection SafeNet is able to secure will be adequate to protect its proprietary
information, or that SafeNet will have the financial resources to engage in
litigation against parties who may infringe such proprietary technology or
copyrights. In addition, there can be no assurance that others will not develop
similar technology independent of SafeNet.
SafeNet believes that its products do not infringe the proprietary rights of
third parties. There can be no assurance, however, that third parties will not
assert infringement claims in the future.
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EMPLOYEES
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As of March 6, 2001, SafeNet had 124 employees, of whom 16 are engaged in
assembly and quality control, 15 in administration and financial control, 63 in
engineering, development and client support, and 30 in marketing and sales.
SafeNet employs 89 employees in the United States and 35 employees in
Switzerland.
RISK FACTORS
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We operate in a rapidly changing environment that involves numerous risks, some
of which are beyond our control. The following discussion highlights some of the
risks we face.
WE HAVE A HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES
Although profitable in 2000, we have experienced substantial net losses in the
prior two years. As of December 31, 2000, we had an accumulated deficit of
$11,924,000. In addition, we intend to increase our expenditures in all areas in
order to execute our business plan. As a result, we may incur substantial
additional losses. The likelihood of our success must be considered in light of
the problems, expenses and delays frequently encountered in connection with new
technologies utilized with the transition to an Internet VPN business with an
original equipment manufacturer (OEM) model and the competitive environment in
which we operate. Although our revenues grew in 2000, you should not consider
our historical results indicative of future revenue levels or operating results.
While we achieved profitability in 2000, we may not be able to sustain it in the
future.
COST OF ESTABLISHING A TECHNOLOGY BUSINESS GROUP
As of January 1, 2000, our United States operations were divided into two
operating groups in order to utilize our resources better. The Products Group is
responsible for the sale, customer support, development and production of our
legacy network security products that are sold directly to end-users. The
Technology Group is responsible for the sale, customer support and development
of products, chips and software that are sold to companies that embed our
products into their products for ultimate sale to end-users.
We and Analog Devices, Inc. (ADI) have jointly developed SafeNet DSP, a chip for
which ADI is the manufacturer and Avnet is the distributor. While we have
several design wins for this chip, there is no assurance that these wins will
generate significant royalty income for us.
We have negotiated several SafeNet Soft-PK license agreements with OEM's;
however, there is always the possibility that new product development by either
our competitors or us will cause this product to become obsolete or
non-competitive.
In order for the Technology group to be successful in this market, new products
that can be embedded in personal computers and other personal communication
devices will have to be developed. The development of this technology, whether
purchased or developed internally, will be costly.
For these reasons, there can be no assurances that the Technology Group will
generate significant revenues or operate profitably in the near future.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE AND OUR FUTURE REVENUES AND
PROFITABILITY ARE UNCERTAIN
We have experienced significant fluctuations in our quarterly operating results
and anticipate continued substantial fluctuations in our future operating
results. A number of factors have contributed to these quarterly fluctuations
including:
[ ] market acceptance and demand for our products
[ ] length of sales cycle including the size, timing, cancellation or delay of
customer orders
[ ] introduction of new products and product enhancements by us or our
competitors
[ ] market acceptance of new products introduced by us or our competitors
[ ] budgeting cycles of customers
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[ ] the timing and execution of individual contracts
[ ] the product mix sold in a given quarter
[ ] changes in the percentage of revenues attributable to OEM license fees and
royalties
[ ] length of time required by OEM's to embed our products into their products
[ ] the percentage of products sold through our direct sales force and our
indirect distribution channels
[ ] product development expenses
[ ] competitive conditions in the industry
[ ] changes in general economic conditions.
Revenues from our Technology Group activities also tend to fluctuate as
development projects, which may continue over several quarters, are undertaken
or completed.
Our expenses are based, in part, on our expectations regarding future revenues,
and are largely fixed in nature, particularly in the short-term. We may be
unable to predict our future revenues accurately or to adjust spending in a
timely manner to compensate for any unexpected revenue shortfall. Accordingly,
any significant shortfall of revenues in relation to our expectations could
cause significant declines in our quarterly operating results.
Due to all of the foregoing factors, our quarterly revenues and operating
results are difficult to forecast. Therefore, we believe that period-to-period
comparisons of our operating results will not necessarily be meaningful, and you
should not rely upon them as an indication of our future performance. Also, it
is likely that our operating results will fall below our expectations and the
expectations of securities analysts or investors in some future quarter. In such
event, the market price of our common stock could be materially adversely
affected.
RISK OF INTERNATIONAL VPN ACCEPTANCE AND OTHER INTERNATIONAL RISKS
On October 31, 1995, we acquired our European subsidiary, GDS. The subsidiary
accounted for approximately 50% of our revenues in 1998, 44% in 1999 and 12% in
2000. Since VPN products are beginning to replace the old legacy networks that
utilize its products, there is no assurance that GDS will continue to be a
significant portion of consolidated revenue. In addition, there can be no
assurance that the subsidiary will develop VPN products that will be marketable
in the European market.
Expansion into the international markets has required and will continue to
require significant management attention and resources. Our international
business is subject to a number of risks including:
[ ] compliance with special telecommunications standards
[ ] export regulations and restrictions
[ ] currency exchange rates, tariffs and other barriers
[ ] difficulties in staffing and managing foreign subsidiary operations
[ ] longer payment cycles
[ ] greater difficulty in accounts receivable collections
[ ] political instability
[ ] potentially adverse tax consequences
[ ] specialized inventory requirements applicable to particular foreign
countries or markets
There can be no assurance that these factors will not have an adverse impact on
our future international sales or operating results. We do not currently engage
in international currency hedging transactions. To the extent that we are unable
to match revenue received in foreign currencies with expenses paid in the same
currency, we may be exposed to possible losses on international currency
transactions that could harm our business.
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RISKS OF CHANGES IN TECHNOLOGY AND INDUSTRY STANDARDS
The network security industry is characterized by rapid changes, including
evolving industry standards, frequent new product introductions, continuing
advances in technology and changes in customer requirements and preferences. We
expect technological developments to continue at a rapid pace in the computer
and communications industries, and there can be no assurance that technological
developments will not cause our technology to be rendered obsolete or
non-competitive.
Our future products may not keep pace with technological changes implemented by
competitors, developers of operating systems or networking systems, or persons
seeking to breach network security. The introduction of new technologies could
also require us to invest in research and development at much higher rates with
no assurance of developing competitive products. Changes in technologies or
customer requirements may also cause the development cycle for our new products
to be significantly longer than our historical product development cycle,
resulting in higher development costs or a loss in market share. Our products
may not satisfy evolving preferences of customers and prospects. Failure to
develop and introduce new products and improve current products in a timely
fashion could adversely affect us. Because of the complexity of our products,
which operate on or utilize multiple platforms and communications protocols, we
have from time to time experienced delays in introducing new products and
product enhancements primarily due to development difficulties or shortages of
development personnel. There can be no assurance that we will not experience
longer delays or other difficulties that could delay or prevent the successful
development, introduction or marketing of new products or product enhancements.
RESTRICTIONS ON THE EXPORT OF SOME OF OUR PRODUCTS.
We currently sell our products internationally and intend to continue to expand
our relationships with international distributors and resellers. Our
international sales and operations could be subject to the following risks:
[ ] the imposition of governmental controls
[ ] export license requirements
[ ] restrictions on the export of critical technology
[ ] trade restrictions
[ ] changes in tariffs
Some of our network security products are cryptographic devices and are subject
to the export restrictions administered by the Bureau of Export Control, U.S.
Department of Commerce. These restrictions permit the export of encryption
products based on country, algorithm and class of end-user. They prohibit the
export of encryption products to a number of countries and to business entities
that are not included in a range of end-users. There is no assurance, however,
that the applicable regulations or policies concerning the export of such
technology will not become more restrictive. Our foreign distributors may also
be required to secure licenses or formal permission before encryption products
can be imported.
WE FACE INTENSE COMPETITION
Our industry is relatively new, highly competitive and subject to rapid
technological changes. Our success will depend, in large part, on our ability to
establish and maintain an advantageous market position. We currently compete
with companies that have substantially greater financial resources, sales and
marketing organizations, market penetration and research and development
capabilities, as well as broader product offerings and greater market presence
and name recognition. We expect to face increasing competitive pressures from
our current competitors and new market entrants. This competitive risk will
increase to the extent that our competitors begin to include software vendors,
network providers, and manufacturers of networking and computer equipment and
communication devices. These manufacturers and network providers may be in a
better
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position to develop security products in anticipation of developments in their
products and networks. Competitive factors in the network security industry
include:
[ ] price
[ ] product features and quality
[ ] degree of security and technical specifications
[ ] product ease of use
[ ] conformance to industry standards
[ ] product support
[ ] the ability to deliver engineering enhancements
There can be no assurance that we can continue to compete successfully against
new or existing competitors.
MARKET CONSOLIDATION MAY CREATE MORE FORMIDABLE COMPETITORS
There has been substantial consolidation in the information security industry,
and we expect that there will be significant additional consolidation in the
near future. As a result of that increasing consolidation, we expect that we
will increasingly compete with larger firms that have broader product offerings
and greater financial resources. We believe that such competition may have a
significant negative effect on our current and developing collaborative,
marketing, distribution and reselling relationships, our product pricing and our
product development budget and capabilities. Any of those negative effects can
significantly impair our financial condition and our results of operations.
RISK OF INADEQUATE PROTECTION FOR OUR PROPRIETARY TECHNOLOGIES
Our success and ability to compete is dependent, in part, upon our ability to
maintain the proprietary nature of our technologies. We rely on a combination of
patent, trade secret, copyright and trademark law and nondisclosure agreements
to protect our proprietary technology. Although we hold several patents and have
several pending patent applications that cover certain aspects of our
technology, such patents and patent applications do not protect some of our
security products. Our current and future patent applications may not be
granted. Additionally, our patents may not be broad enough to protect the core
technology critical to our security products.
Confidentiality agreements and other methods on which we rely to protect our
trade secrets and proprietary information and rights may not be adequate to
protect our proprietary rights. Litigation to defend and enforce our
intellectual property rights could result in substantial costs and diversion of
resources and could have a material adverse effect on our financial condition
and results of operations regardless of the final outcome of such litigation.
Despite our efforts to safeguard and maintain our proprietary rights, we may not
be successful in doing so or the steps taken by us in this regard may not be
adequate to deter misappropriation or independent third-party development of our
technology or prevent an unauthorized third party from copying or otherwise
obtaining and using our products, technology or other information that we regard
as proprietary. Our trade secrets or non-disclosure agreements may not provide
meaningful protection of our proprietary information. Also, others may
independently develop similar technologies or duplicate any technology developed
by us. Our inability to protect our proprietary rights would have a material
adverse effect on our financial condition and results of operations.
Further, as the number of network security products in the industry increases
and the functionality of these products further overlaps, we may become subject
to claims of infringement or misappropriation of the intellectual property or
proprietary rights of others. Third parties could assert infringement or
misappropriation claims against us in the future with respect to current or
future products. We may also be subject to additional risks as we enter into
transactions in countries where intellectual property laws are not well
developed or are poorly enforced. Legal protections of our rights may be
ineffective in such countries, and technology developed in such countries may
not be protected in jurisdictions where protection is ordinarily available. Any
claims or litigation, with or without merit, could be costly and could result in
a diversion of
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management's attention, which could have a material adverse effect on our
financial condition and results of operations. Adverse determinations in such
claims or litigation could also have a material adverse effect on our financial
condition and results of operations.
RISKS RELATING TO EVOLVING DISTRIBUTION CHANNELS
We rely on both our direct sales force and an indirect channel distribution
strategy for the sale and marketing of our products. Our sales and marketing
organization may be unable to successfully compete against the more extensive
and well-funded sales and marketing operations of certain of our current and
future competitors. We may also be unable to continue to attract integrators and
resellers that can market our legacy products effectively and provide timely and
cost-effective customer support and service. Additionally, our distributors,
integrators and resellers may carry competing lines of network security
solutions. The loss of important sales personnel, distributors, integrators or
resellers could adversely affect us.
RISK OF PRODUCT DEVELOPMENT DELAYS
We may experience schedule overruns in product development triggered by factors
such as insufficient staffing or the unavailability of development-related
software, hardware or technologies. Further, when developing new network
security products, our development schedules may be altered as a result of the
discovery of software bugs, performance problems or changes to the product
specification in response to customer requirements, technology market
developments or self-initiated changes. All of these factors can cause a product
to enter the market behind schedule, which may adversely affect market
acceptance of the product or place it at a disadvantage to a competitor's
product that has already gained market share or market acceptance during the
delay.
PRODUCT LIABILITY RISK
The sale and installation of our network security systems and products within
the computer networks of our customers and the operation of our SafeNet(TM)
facility entails a risk of product failure, product liability or other claims.
An actual or perceived breach of network or computer security, regardless of
whether such breach is attributable to our products, could adversely affect our
reputation and our financial condition or results of operations. The complex
nature of our products can make the detection of errors or failures difficult
when products are introduced. If errors or failures are subsequently discovered,
this may result in delays and lost revenues during the correction process. A
malfunction or the inadequate design of our products could result in product
liability claims. We attempt to reduce the risk of such losses through warranty
disclaimers and liability limitation clauses. However, we may not have obtained
adequate contractual protection in all instances or where otherwise required
under agreements we have entered into with others.
We currently maintain product liability insurance. However, our insurance
coverage may not be adequate and any product liability claim for damages
resulting from security breaches could be substantial. In the event of product
liability litigation, insufficient insurance coverage could have a material
adverse effect on our financial condition and results of operations. Further,
certain customers and potential customers may require minimum product liability
insurance coverage as a condition precedent to purchasing our products. Failure
to satisfy such insurance requirements could impede our ability to achieve
product sales, which would have a material adverse effect on our financial
condition and results of operations. There is no assurance that such insurance
will be available at a reasonable cost or will be sufficient to cover all
possible liabilities.
DEPENDENCE UPON THIRD PARTY SUPPLIERS AND CONTRACTORS
We rely upon third party contractors for the manufacture of components and
sub-assemblies for our products. There is no assurance that we will be able to
obtain and/or maintain satisfactory contractual relations with qualified vendors
or suppliers. The unavailability of such third parties may substantially
decrease our control of the cost, quality and timeliness of the manufacturing
process. At present, we are not a party to any exclusive supply contracts with
third party contractors for our legacy products. All purchases of components or
parts for our products are accomplished by the use of purchase orders issued in
the ordinary course of business. While we have not experienced any significant
supply problems in the past, and there have been no materially late
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deliveries of components or parts, it is possible that in the future we may
encounter shortages in parts, components, or other elements vital to the
manufacture, production and sale of our products. Our business would suffer if
the supply of such components were interrupted.
WE DEPEND UPON KEY PERSONNEL
The network security industry is highly specialized and the competition for
qualified employees is intense. We expect this to remain so for the foreseeable
future. We believe our success depends significantly upon a number of key
technical and management employees, and upon our ability to retain and hire
additional key personnel. The loss of the services of key personnel or the
inability to attract additional qualified personnel could materially and
adversely affect our results of operations and product development efforts. We
may be unable to achieve our revenue and operating performance objectives unless
we can attract and retain technically qualified and highly skilled engineers,
sales, technical, marketing, and management personnel. Such personnel are
particularly important to our research and development efforts, and to our
growing Technology group business, where we employ a large number of technical
personnel holding advanced degrees. Further, additions of new and departures of
existing personnel, particularly in key positions, can be disruptive and can
result in further departures of our personnel, which could in turn harm our
business and results of operation.
In 1997, we entered into a five-year employment agreement with Anthony A.
Caputo, our Chairman, Chief Executive Officer and President. However, we have
not historically provided such types of employment agreements to our other
employees. This may adversely impact our ability to attract and retain the
necessary technical, management and other key personnel.
WE DO NOT PAY DIVIDENDS
We have never paid nor declared any cash or other dividends on our common stock
since our inception and we do not presently anticipate that dividends will be
paid on our common stock in the foreseeable future.
PART II
ITEM 2 - PROPERTIES
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SafeNet maintains its corporate and administrative facilities at 8029 Corporate
Drive, Baltimore, Maryland. The building, constructed in 1988, has approximately
25,000 square feet and is also used for SafeNet's executive headquarters, United
States production and SafeNet Trusted Services facilities. The lease, which
expires in June 2003, requires us to pay real estate taxes, insurance and
maintenance. The lease, which provides for annual increases in rentals during
each year of the lease, will require us to pay approximately $197,000 in 2001.
GDS leases approximately 20,000 square feet for its administrative and
production facilities in Regensdorf, Switzerland. The lease, which expires on
December 31, 2003, calls for an annual rental of approximately $248,000.
SafeNet also leases office space in Danvers, Massachusetts with annual rent of
approximately $78,000.
ITEM 3 - LEGAL PROCEEDINGS
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SafeNet knows of no litigation or proceeding, pending or threatened, to which
SafeNet is or may become a party.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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There were no matters submitted to the vote of Security Holders, through the
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.
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ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED MATTERS
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SafeNet's Common Stock is listed on the Nasdaq National Market under the symbol
SFNT. The following table sets forth the quarterly range of per share high and
low sales prices for SafeNet's Common Stock as reported by the Nasdaq National
Market for the periods indicated.
HIGH LOW
------ ------
2001:
----
First Quarter $64.69 $32.50
2000:
----
Fourth Quarter 53.50 22.31
Third Quarter 39.50 24.75
Second Quarter 36.25 14.13
First Quarter 44.56 19.81
1999:
----
Fourth Quarter 25.75 13.00
Third Quarter 31.94 16.00
Second Quarter 32.50 11.00
First Quarter 20.88 9.06
On March 6, 2001, the last reported per share sale price of SafeNet's Common
Stock on the Nasdaq National Market was $48.06. As of that date, there were
approximately 125 holders of record of the Common Stock and 3500 beneficial
holders of the Common Stock. We have not paid dividends on our Common Stock and
intend for the foreseeable future to retain earnings, if any, to finance the
expansion and development of our business.
ITEM 6 - SELECTED FINANCIAL DATA
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The selected financial data set forth below as of and for each of the five years
ended December 31, 2000 is derived from our audited financial statements. The
selected financial data is qualified by and should be read in conjunction with
the Consolidated Financial Statements and Management's Discussion and Analysis
of Financial Condition and Results of Operations included elsewhere herein.
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SAFENET, INC.
AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(In thousands, except per share amounts)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
Revenues $28,826 $18,927 $23,242 $16,007 $14,317
Cost of revenues 7,663 7,228 9,793 6,971 7,672
------- ------- ------- ------- -------
Gross profit 21,163 11,699 13,449 9,036 6,645
------- ------- ------- ------- -------
Research and development expenses 7,381 5,851 4,625 3,756 3,840
Sales and marketing expenses 5,945 6,524 7,312 6,720 4,693
General and administrative expenses 3,643 2,730 2,944 2,571 2,976
Reserve for (recovery of) Cyberguard
advance (275) (375) 772 -- --
Amortization of acquired intangible assets 85 94 122 122 733
Write-off of unamortized acquired
intangible assets from the Connective
Strategies, Inc. acquisition -- -- -- -- 2,216
------- ------- ------- ------- -------
Total operating expenses 16,779 14,824 15,775 13,169 14,458
------- ------- ------- ------- -------
Operating income (loss) 4,384 (3,125) (2,326) (4,133) (7,813)
Interest income 1,373 150 259 495 728
------- ------- ------- ------- -------
Income (loss) before income taxes 5,757 (2,975) (2,067) (3,638) (7,085)
Income taxes -- 85 319 -- --
------- ------- ------- ------- -------
Net income (loss) $ 5,757 $(3,060) $(2,386) $(3,638) $(7,085)
======= ======= ======= ======= =======
Net income (loss) per common share
Basic $ 0.85 $ (0.56) $ (0.44) $ (0.67) $ (1.34)
======= ======= ======= ======= =======
Diluted $ 0.80 $ (0.56) $ (0.44) $ (0.67) $ (1.34)
======= ======= ======= ======= =======
Shares used in computation
Basic 6,751 5,504 5,409 5,462 5,305
======= ======= ======= ======= =======
Diluted 7,194 5,504 5,409 5,462 5,305
======= ======= ======= ======= =======
AT DECEMBER 31,
-----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
Balance Sheet Data:
Working capital $33,695 $23,035 $11,081 $12,499 $16,664
Intangible assets 1,993 2,593 2,159 2,365 2,223
Total assets 43,106 31,896 18,940 21,531 24,653
Long-term debt -- -- -- -- 17
Stockholders' equity 37,723 27,636 15,400 17,980 21,861
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QUARTERLY RESULTS OF OPERATIONS
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The following is a summary of the quarterly results of operations for the year
ended December 3l, 2000 (Unaudited - In thousands, except per share amounts):
RESTATED
--------
MARCH 31 JUNE 30(1) SEPT. 30 DEC. 31
2000 -------- ---------- -------- -------
Revenues $5,838 $6,471 $7,633 $8,884
Cost of revenues 1,700 1,630 2,019 2,314
------ ------ ------ ------
Gross profit 4,138 4,841 5,614 6,570
Operating income 126 536 1,475 2,247
Net income $ 357 $ 841 $1,873 $2,686
Earnings Per Share
Basic $ 0.05 $ 0.13 $ 0.28 $ 0.39
====== ====== ====== ======
Diluted $ 0.05 $ 0.12 $ 0.26 $ 0.36
====== ====== ====== ======
Shares used in computation
Basic 6,611 6,669 6,802 6,909
====== ====== ====== ======
Diluted 7,343 7,011 7,249 7,390
====== ====== ====== ======
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1) During the third quarter of 2000, the Company changed its method of
accounting for income taxes to recognize the tax benefits from current and
prior years' stock option deductions after the utilization of net operating
losses from operations (i.e., net operating losses determined without
deductions for the exercise of non-qualified stock options and disqualified
disposition of incentive stock options) to reduce income tax expense. The
quarterly information for the second quarter of 2000 was restated to increase
net income and reduce additional paid-in capital by $276 resulting from the
reduction of income tax expense representing an increase of $0.04 per diluted
share. No restatement of any information prior to the second quarter of 2000
was necessary.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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Except for historical information contained herein, the statements in this Item
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties,
which may cause SafeNet's actual results in future periods to differ materially
from forecasted results. Those risks include, among others, risks associated
with the receipt and timing of future customer orders, price pressures,
achieving technical and product development milestones, the ability to negotiate
favorable strategic OEM agreements, sufficient cash flow to support SafeNet's
liquidity requirements, other competitive factors leading to a decrease in
anticipated revenues and gross profit margins and product development expenses.
OVERVIEW
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SafeNet designs, manufactures and markets enterprise network security solutions
using encryption technology. Our products are used in electronic commerce
applications by financial institutions, government agencies and large
corporations to secure data transmissions on private and public computer
networks, such as the Internet. Our European operations design, manufacture and
market cryptographic equipment primarily in Switzerland and Europe.
SafeNet's historical operating results have been dependent on a variety of
factors including, but not limited to, the length of the sales cycle, the timing
of orders from and shipments to clients, product development expenses and the
timing of development and introduction of new products. Our expense levels are
based, in part, on expectations of future revenues. The size and timing of our
historical revenues have varied
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substantially from quarter to quarter and year to year. Accordingly, the results
of a particular period, or period-to-period comparisons of recorded sales and
profits may not be indicative of future operating results.
While management is committed to the long-term profitability of SafeNet, the
recent growth of the computer security industry has made it important that
market share be obtained. We have undertaken various strategies in order to
increase our revenues and improve our future operating results, including new
product offerings such as our SafeNet products for the Internet and the SafeNet
Security Center(TM), a high performance workstation that automatically manages
SafeNet products and the development of integrated circuits for the original
equipment market. Management believes that growth in the market for products
that provide secure remote access to computer networks requires SafeNet to
increase its investment in development, sales and marketing activities to allow
SafeNet to take advantage of this market opportunity and to achieve long-term
profitability thereby maximizing shareholder value. However, there can be no
assurance that these strategies will be successful.
RESULTS OF OPERATIONS OF SAFENET
- --------------------------------------------------------------------------------
The following table sets forth certain Consolidated Statement of Operations data
of SafeNet as a percentage of revenues for the years ended December 31:
2000 1999 1998
---- ---- ----
Revenues 100% 100% 100%
Cost of revenues 27 38 42
--- --- ---
Gross profit 73 62 58
--- --- ---
Research and development expenses 26 31 20
Sales and marketing expenses 21 34 31
General and administrative expenses 12 15 14
Reserve for (recovery of) CyberGuard advance (1) (2) 3
--- --- ---
Total operating expenses 58 78 68
--- --- ---
Operating income (loss) 15 (16) (10)
Interest income, net 5 1 1
--- --- ---
Income (loss) before income taxes 20 (15) (9)
Income taxes -- 1 1
--- --- ---
Net income (loss) 20% (16)% (10)%
=== === ===
Beginning in 2000, the Company has three reportable segments: products, chips
and software designed and manufactured in the United States for sale to
companies that will embed the Company's products into their products for
ultimate sale to end-users ("Technology Operations"), network security products
designed and manufactured in the United States for direct sales to end-users
("Product Operations"), and network security products designed and manufactured
outside the United States ("European operations"). The segments are strategic
business units that offer different products. The segments are managed
separately because each segment requires different technology and marketing
strategies (see Note 10 to the audited consolidated financial statements).
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Revenues increased 52%, or $9,899,000, to $28,826,000 for the period ended
December 31, 2000, from $18,927,000 in 1999. The Technology Operations revenues
increased 306% or $12,024,000. Included in Technology revenues are sales of PCI
cards, software licenses and royalties from chip sales. All areas increased
significantly over 1999, however the primary product contributing to the
increase was soft PK. Revenues from the Product Operations segment increased
$2,690,000 primarily due to customer shipments of VPN products to several large
enterprises as well as an overall increase in demand for SafeNet VPN products.
The European
21
22
Operations revenues decreased 58% or $4,815,000 as a result of the reduction in
the sale of legacy products in Europe.
Gross margin increased to 73% for the period ended December 31, 2000, from 62%
in 1999. Margins on sales of software licenses and SafeNet DSP Chips in the
Technology Operations segment led the increase with an overall 84% gross margin
compared to a 1999 gross margin of 71% made up primarily of development project
sales. Product Operations' margins increased to 66% from 52% on strong sales of
higher margin VPN products versus lower margin legacy products in 1999. The
gross margin for the European operations decreased to 49% from 66% in 1999 as a
result of lower revenues available to recover fixed costs.
Research and development expenses increased 26%, or $1,530,000, to $7,381,000
for the period ended December 31, 2000, from $5,851,000 in 1999. The increase is
primarily attributable to increased personnel costs during 2000 related to the
Company's software and integrated circuit development projects in Technology
Operations, and the completion of several large consulting contracts during 1999
under which $1,042,000 of research and development expenses were directly
attributable to cost of goods sold. As a percentage of revenues, the expenses
were 26% and 31% in 2000 and 1999, respectively.
Sales and marketing expenses decreased 9%, or $579,000 to $5,945,000 for the
period ended December 31, 2000, from $6,524,000 in 1999. The decrease is due to
a reduction in personnel and their salaries, telephone, travel and related
expenses as well as scaled down participation in trade shows versus 1999. As a
percentage of revenues, expenses were 21% and 34% in 2000 and 1999,
respectively. Sales and marketing expenses did not increase in proportion to the
revenue increase because SafeNet's OEM technology is integrated into customer's
products saving the cost of direct sales to the end user. Management expects
sales and marketing expenses to increase in future periods at a rate not to
exceed the growth of sales.
General and administrative expenses increased 33%, or $913,000, to $3,643,000
for the period ended December 31, 2000, from $2,730,000 in 1999. The increase is
primarily due to professional fees incurred to export software developed in the
United States to the European Operations segment, costs associated with
strengthening the executive management team in both the U.S. and Europe, and
professional services related to strategic initiative planning. As a percentage
of revenues, the expenses were 12% and 15% of revenues in 2000 and 1999,
respectively.
Interest income increased by $1,223,000, to $1,373,000 for the period ended
December 31, 2000, from $150,000 in 1999. The increase is due to larger cash and
short-term investment holdings in 2000 compared to 1999, which is explained
below in the "Liquidity and Capital Resources" section.
There was no income tax expense for the period ended December 31, 2000 due to
the reversal of the valuation allowance on net operating loss carryforwards
available to offset current year earnings. The 1999 income tax expense of
$85,000 was for taxes on the income of the European Operations that has no
income tax liability in 2000. The Company has not recorded a United States
income tax benefit in either period. A valuation allowance for the full amount
of the United States net deferred tax assets has been established since the
Company's ability to use the remaining United States net operating loss
carryforward is dependent upon future taxable income. The Company has also
recorded a full valuation allowance against the net operating loss of the
European Operations generated during 2000. As discussed in Note 5 to the audited
consolidated financial statements, in 2000 the Company changed its method of
accounting for income taxes
The Company had net income of $5,757,000 for the period ended December 31, 2000
compared to a net loss of $3,060,000 for the same period in 1999. The diluted
income per common share was $0.80 in 2000 compared to a $0.56 loss per common
share in 1999.
22
23
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
Revenues decreased 19%, or $4,315,000, to $18,927,000 for the year ended
December 31, 1999, from $23,242,000 in 1998. Of the decrease, $3,255,000 is the
reduction in revenues of European operations. European operations revenues
decreased as a result of the completion of a large contract during 1999 and a
reduction of sales to financial institutions in Europe due to Year 2000
concerns. The remainder of the decrease, or $1,060,000, is attributable to a
decrease in sales of legacy products in the United States.
Gross margin increased to 62% for the year ended December 31, 1999, from 58% in
1998. Margins on sales of software licenses and encryption chips to OEM
customers were 74% in 1999, leading the increase.
Research and development expenses increased 27%, or $1,226,000, to $5,851,000
for the year ended December 31, 1999, from $4,625,000 in 1998. The increase was
primarily due to increased personnel related costs and increased outside
engineering expenses related to SafeNet's integrated circuit development
projects in its domestic operations. As a percentage of revenues, the expenses
were 31% and 20% in 1999 and 1998, respectively.
Sales and marketing expenses decreased by 11%, or $789,000, to $6,524,000 for
the year ended December 31, 1999, from $7,312,000 in 1998. The decrease is
primarily due to a reduction in personnel costs, reduced travel and
participation in fewer trade shows. As a percentage of revenues, the expenses
were 34% and 31% in 1999 and 1998, respectively.
General and administrative expenses ("G&A") decreased by 7%, or $214,000, to
$2,730,000 for the year ended December 31, 1999, from $2,944,000 in 1998. The
primary reason for the decrease was the professional fees and other costs
incurred in 1998 related to a proxy dispute. As a percentage of revenues, G&A
expenses were 15% and 14% in 1999 and 1998, respectively.
In August 1996, SafeNet signed a two year Joint Development and Marketing
Agreement with CyberGuard Corporation ("CyberGuard"). The companies intended to
develop and market a product that combined SafeNet's products and CyberGuard's
Firewall product. In connection therewith, we prepaid a refundable license fee
to CyberGuard. In June 1998, a Distribution Agreement and an Original Equipment
Agreement replaced the original agreement. Under these agreements, CyberGuard
agreed to repay on December 31, 1998 the original $1,000,000 advance less used
license fees and a right to manufacture fee. CyberGuard failed to honor its
obligation to repay the unused license fee. Since we could not ascertain the
ultimate viability of CyberGuard as a result of its August 1998 announcement
that it was experiencing significant pressure on its liquidity and the January
1999 delisting of CyberGuard's securities from the Nasdaq Stock Market, SafeNet
reserved the remaining balance ($772,000) as of December 31, 1998. During 1999,
we agreed to accept a $650,000 note receivable from CyberGuard as payment in
full on CyberGuard's obligation. SafeNet received $375,000 on the note in 1999
the remaining balance of $275,000 was paid during 2000.
The operating loss increased by 34% or $799,000 to $3,125,000 in 1999 from
$2,326,000 in 1998. The European operations had a $1,690,000 decrease in
operating profit due to the reduction in sales of their products. The domestic
operations had a $891,000 decrease in its operating loss mainly due to increased
sales of software licenses and chips to OEM customers.
Interest income declined from $259,000 in 1998 to $150,000 in 1999 due to lower
interest rates and a decline in funds available for investment.
The income tax expense of $85,000 for the year ended December 31, 1999 was for
taxes on the income of the European operations, which had an income tax
liability of $319,000 in 1998. SafeNet did not record a United States income tax
benefit in either year. A valuation allowance for the full amount of the United
States net deferred tax asset has been established since SafeNet's ability to
use the United States net operating loss is dependent upon future taxable
income.
23
24
SafeNet had a net loss of $3,060,000 for the year ended December 31, 1999
compared to a net loss of $2,386,000 in 1998. The loss per common share (basic
and diluted) was $0.56 for the year ended December 31, 1999, compared to a net
loss of $0.44 per common share in 1998.
LIQUIDITY AND CAPITAL RESOURCES
SafeNet believes that its current cash resources, together with the cash flows
from operations, will be sufficient to meet its needs for the next year. As of
December 31, 2000, SafeNet had working capital of $33,695,000 including cash and
cash equivalents of $25,369,000 and short-term investments of $6,332,000.
In 2000, cash and short-term investments increased $12,040,000. The increase was
mainly attributable to cash provided by operating activities of $9,171,000. Cash
provided by financing activities in 2000 included $4,204,000 from the exercise
of stock options and warrants. Cash used in investing activities during 2000
included investments in computer software development costs and equipment
totaling $1,239,000.
In 1999, cash and cash equivalents increased $13,296,000. The increase was
mainly attributable to proceeds of $14,032,000 from the issuance of common stock
through a private placement in December, 1999. Other cash provided by financing
activities in 1999 included $2,036,000 from the exercise of stock options and
warrants. Cash used in investing activities during 1999 included investments in
computer software development costs and equipment totaling $1,058,000 and
$493,000, respectively.
INFLATION AND SEASONALITY
SafeNet does not believe that inflation will significantly impact its business.
We do not believe our business is seasonal, however, because we generally
recognize product revenues upon shipment and software revenues upon establishing
fair value of undelivered elements, recognition may be irregular and uneven,
thereby disparately impacting quarterly operating results and balance sheet
comparisons.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended, which
the Company is required to adopt effective January, 2001. Because of the
Company's minimal use of derivatives, the adoption of the new Statement will not
have a significant effect on earnings or the financial position of the Company.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SafeNet's major market risk is to fluctuations in foreign currency exchange
rates, principally related to the Swiss Franc. As of December 31, 2000, our
investment in our European operations was approximately $4,578,000. A 10% change
in the average Swiss Franc exchange rate for the year ended December 31, 2000
would have changed our reported earnings for fiscal year 2000 by approximately
$64,000, compared to $37,000 in 1999. A 10% change in the December 31, 2000
Swiss Franc exchange rate would have changed SafeNet's reported currency
translation adjustment for fiscal year 2000 by approximately $354,000, compared
to $398,000 in 1999. A 10% change in the average interest rate for fiscal year
2000 would have changed SafeNet's reported interest income by approximately
$137,000.
At December 31, 2000 and 1999, SafeNet did not have any interest bearing
obligations. In addition, SafeNet does not hold any derivative instruments and
does not have any commodity market risk.
24
25
SAFENET, INC.
AND SUBSIDIARIES
ITEM 8 - FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
INDEX TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
PAGE
------
Reports of Independent Auditors 26-27
Consolidated Balance Sheets as of December 31, 2000 and 1999 28
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998 29
Consolidated Statements of Comprehensive Income (Loss) for
the years ended December 31, 2000, 1999 and 1998 30
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2000, 1999 and 1998 31
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998 32-33
Notes to Consolidated Financial Statements 34-45
Schedule II Valuation and Qualifying Accounts 46
25
26
REPORT OF INDEPENDENT AUDITORS
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS
SAFENET, INC.
We have audited the accompanying consolidated balance sheet of SafeNet, Inc. and
subsidiaries as of December 31, 2000, and the related consolidated statements of
operations, comprehensive income (loss), stockholders' equity and cash flows for
the year then ended. Our audit also included the financial statement schedule
listed in the Index at Item 14(a) for the year ended December 31, 2000. These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. 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 audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of SafeNet, Inc. and
subsidiaries at December 31, 2000, and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule for the year ended December
31, 2000, 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.
As discussed in Note 5 to the consolidated financial statements, in 2000 the
Company changed its method of accounting for income taxes.
/s/ Ernst & Young LLP
Baltimore, Maryland
January 24, 2001
26
27
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
THE BOARD OF DIRECTORS
SAFENET, INC.:
We have audited the accompanying consolidated balance sheet of SafeNet, Inc.
(formerly Information Resource Engineering, Inc.) and Subsidiaries as of
December 31, 1999, and the related consolidated statements of operations,
comprehensive income (loss), stockholders' equity and cash flows for each of the
years in the two-year period ended December 31, 1999. In connection with our
audits of the consolidated financial statements, we have also audited the
financial statement schedule as listed in the accompanying index as of and for
the two-year period ending December 31, 1999. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
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 SafeNet, Inc. and
Subsidiaries as of December 31, 1999 and the results of their operations and
their cash flows for each of the years in the two-year period ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related 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/ KPMG LLP
Baltimore, Maryland
February 9, 2000
27
28
SAFENET, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2000 and 1999
2000 1999
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $25,369,258 $19,161,442
Short-term investments 6,332,488 500,715
Accounts receivable, net of allowance for doubtful
accounts of $231,724 in 2000 and $251,005 in 1999 4,211,589 4,404,560
Inventories 2,908,706 2,945,527
Prepaid expenses 255,731 282,147
----------- -----------
Total current assets 39,077,772 27,294,391
Property and equipment, net 1,375,216 1,423,987
Computer software development costs, net of accumulated
amortization of $2,376,828 in 2000 and $1,226,576 in 1999 1,591,662 2,107,109
Goodwill, net of accumulated amortization of $566,198 in
2000 and $481,334 in 1999 401,036 485,900
Other assets 660,093 584,425
----------- -----------
$43,105,779 $31,895,812
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,737,464 $ 1,153,465
Accrued salaries and commissions 1,829,523 1,110,476
Other accrued expenses 854,063 523,500
Deferred revenue 961,958 1,472,434
Commitments and contingencies -- --
----------- -----------
Total current liabilities 5,383,008 4,259,875
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value per share
Authorized 500,000 shares, no shares issued and
outstanding -- --
Common stock, $.01 par value per share. Authorized
15,000,000 shares, issued 6,940,637 shares in 2000 and
6,541,483 shares in 1999 69,406 65,415
Additional paid-in capital 50,854,155 46,546,647
Accumulated deficit (11,924,068) (17,681,212)
Accumulated other comprehensive loss (1,276,722) (1,294,913)
----------- -----------
Net stockholders' equity 37,722,771 27,635,937
----------- -----------
$43,105,779 $31,895,812
=========== ===========
See notes to consolidated financial statements.
28
29
SAFENET, INC
AND SUBSIDIARIES
Consolidated Statements of Operations
Year ended December 31, 2000, 1999, and 1998
2000 1999 1998
----------- ----------- -----------
Revenues
License and royalties $15,223,215 $ 1,559,557 $ 615,571
Products 10,848,681 13,077,640 16,594,185
Service and maintenance 2,753,688 4,289,696 6,031,954
----------- ----------- -----------
Total revenues 28,825,584 18,926,893 23,241,710
----------- ----------- -----------
Cost of revenues
License and royalties 2,637,157 200,034 282,564
Products 4,248,361 4,823,628 6,090,447
Service and maintenance 777,120 2,204,218 3,419,547
----------- ----------- -----------
Total cost of revenues 7,662,638 7,227,880 9,792,558
----------- ----------- -----------
Gross profit 21,162,946 11,699,013 13,449,152
----------- ----------- -----------
Research and development expenses 7,380,543 5,851,255 4,625,139
Sales and marketing expenses 5,945,218 6,523,441 7,312,497
General and administrative expenses 3,642,988 2,730,322 2,943,794
Amortization of acquired intangible assets 84,864 94,020 122,328
Reserve for (recovery of) CyberGuard advance (275,000) (375,000) 771,655
----------- ----------- -----------
Total operating expenses 16,778,613 14,824,038 15,775,413
----------- ----------- -----------
Operating income (loss) 4,384,333 (3,125,025) (2,326,261)
Interest income 1,372,811 149,636 259,157
----------- ----------- -----------
Income (loss) before income taxes 5,757,144 (2,975,389) (2,067,104)
Income taxes -- 85,133 318,881
----------- ----------- -----------
Net income (loss) $ 5,757,144 $(3,060,522) $(2,385,985)
=========== =========== ===========
Net income (loss) per common share
Basic $ 0.85 $ (0.56) $ (0.44)
=========== =========== ===========
Diluted $ 0.80 $ (0.56) $ (0.44)
=========== =========== ===========
See notes to consolidated financial statements.
29
30
SAFENET, INC.
AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
Year ended December 31, 2000, 1999, and 1998
2000 1999 1998
---------- ----------- -----------
Net income (loss) $5,757,144 $(3,060,522) $(2,385,985)
Other comprehensive income (loss) --
Foreign currency translation adjustment (112,057) (915,038) 389,224
Other 130,248 -- --
---------- ----------- -----------
Comprehensive income (loss) $5,775,335 $(3,975,560) $(1,996,761)
========== =========== ===========
See notes to consolidated financial statements.
30
31
SAFENET, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Year ended December 31, 2000, 1999, and 1998
ACCUMULATED
OTHER
COMMON STOCK ADDITIONAL COMPREHENSIVE
------------------- PAID-IN ACCUMULATED INCOME
SHARES AMOUNT CAPITAL DEFICIT (LOSS)
--------- ------- ----------- ------------ -------------
Balance at January 1, 1998 5,462,727 $54,627 $30,929,277 $(12,234,705) $ (769,099)
Stock options exercised 3,800 38 9,750 -- --
Stock option compensation -- -- 102,827 -- --
Net loss for 1998 -- -- -- (2,385,985) --
Foreign currency translation adjustment -- -- -- -- 389,224
Treasury stock purchases -- -- -- -- --
--------- ------- ----------- ------------ -----------
Balance at December 31, 1998 5,466,527 $54,665 $31,041,854 $(14,620,690) $ (379,875)
Sale of common stock, net of offering
expenses of $968,000 1,000,000 10,000 14,021,812 -- --
Stock options exercised 51,906 519 947,606 -- --
Stock warrants exercised 23,050 231 391,620 -- --
Stock option compensation -- -- 138,255 -- --
Net loss for 1999 -- -- -- (3,060,522) --
Foreign currency translation adjustment -- -- -- -- (915,038)
Other -- -- 5,500 -- --
--------- ------- ----------- ------------ -----------
Balance at December 31, 1999 6,541,483 $65,415 $46,546,647 $(17,681,212) $(1,294,913)
Stock options exercised 392,204 3,922 4,081,936 -- --
Stock warrants exercised 6,950 69 118,081 -- --
Stock option compensation -- -- 127,724 -- --
Net income for 2000 -- -- -- 5,757,144 --
Foreign currency translation adjustment -- -- -- -- (112,057)
Other -- -- (20,233) -- 130,248
--------- ------- ----------- ------------ -----------
Balance at December 31, 2000 6,940,637 $69,406 $50,854,155 $(11,924,068) $(1,276,722)
========= ======= =========== ============ ===========
TREASURY STOCK TOTAL
-------------------------- STOCKHOLDERS'
SHARES AMOUNT EQUITY
-------------- --------- -------------
Balance at January 1, 1998 -- $ -- 17,980,100
Stock options exercised -- -- 9,788
Stock option compensation -- -- 102,827
Net loss for 1998 -- -- (2,385,985)
Foreign currency translation adjustment -- -- 389,224
Treasury stock purchases 174,000 (695,853) (695,853)
-------- --------- -----------
Balance at December 31, 1998 174,000 $(695,853) $15,400,101
Sale of common stock, net of offering
expenses of $968,000 -- -- 14,031,812
Stock options exercised (174,000) 695,853 1,643,978
Stock warrants exercised -- -- 391,851
Stock option compensation -- -- 138,255
Net loss for 1999 -- -- (3,060,522)
Foreign currency translation adjustment -- -- (915,038)
Other -- -- 5,500
-------- --------- -----------
Balance at December 31, 1999 -- $ -- $27,635,937
Stock options exercised -- -- 4,085,858
Stock warrants exercised -- -- 118,150
Stock option compensation -- -- 127,724
Net income for 2000 -- -- 5,757,144
Foreign currency translation adjustment -- -- (112,057)
Other -- -- 110,015
-------- --------- -----------
Balance at December 31, 2000 -- $ -- $37,722,771
======== ========= ===========
See notes to consolidated financial statements.
31
32
SAFENET, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended December 31, 2000, 1999, and 1998
2000 1999 1998
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss) $ 5,757,144 $(3,060,522) $(2,385,985)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Depreciation 679,616 618,744 546,526
Amortization of computer software
development costs 1,150,252 478,498 365,182
Amortization of goodwill 84,864 94,020 122,328
Stock option compensation 127,724 138,255 102,827
Reserve for CyberGuard advance -- -- 771,655
Changes in operating assets and liabilities:
Accounts receivable 125,002 313,966 (1,526,706)
Inventories 18,520 366,171 (511,495)
Accounts payable 615,078 (231,902) 536,047
Accrued salaries and commissions 492,233 135,721 2,195
Other accrued expenses 540,320 (117,877) (67,141)
Deferred revenue (510,563) 1,157,542 (453,064)
Other 90,892 78,528 206,624
----------- ----------- -----------
Net cash provided by (used in) operating
activities 9,171,082 (28,856) (2,291,007)
----------- ----------- -----------
Cash flows from investing activities:
Maturities of short-term investments 500,715 -- 2,839,408
Purchases of short-term investments (6,332,488) (500,715) (500,000)
Purchases of property and equipment (607,251) (493,042) (477,752)
Expenditures for computer software development
costs (631,391) (1,058,408) (508,725)
----------- ----------- -----------
Net cash (used in) provided by investing
activities (7,070,415) (2,052,165) 1,352,931
----------- ----------- -----------
32
33
(Continued)
SAFENET, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year ended December 31, 2000, 1999, and 1998
2000 1999 1998
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock, net of
offering expense $ -- $14,031,812 $ --
Treasury stock purchases -- -- (695,853)
Payments of long-term debt -- -- (16,710)
Proceeds from stock options exercised 4,085,858 1,643,978 9,788
Proceeds from stock warrants exercised 118,150 391,851 --
Other (20,233) 5,500 --
----------- ----------- -----------
Net cash provided by (used in) financing
activities 4,183,775 16,073,141 (702,775)
----------- ----------- -----------
Effect of exchange rate changes on cash (76,626) (696,360) 284,464
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents 6,207,816 13,295,760 (1,356,387)
Cash and cash equivalents at beginning of year 19,161,442 5,865,682 7,222,069
----------- ----------- -----------
Cash and cash equivalents at end of year $25,369,258 $19,161,442 $ 5,865,682
=========== =========== ===========
Cash paid for income taxes $ 56,627 $ 101,170 $ --
=========== =========== ===========
See notes to consolidated financial statements.
33
34
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
(1) BUSINESS
- --------------------------------------------------------------------------------
SafeNet, Inc. (the Company), formerly Information Resource Engineering, Inc., is
engaged in the business of designing, manufacturing and marketing enterprise
network security technology and systems that enable the deployment of secure
Virtual Private Network solutions over the Internet and other shared public
networks.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany transactions have
been eliminated in consolidation.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents. The Company has
approximately $22,630,000 and $16,507,000 of cash equivalents at December 31,
2000 and 1999, respectively, comprised of overnight repurchase agreements,
short-term money market funds and commercial paper.
SHORT-TERM INVESTMENTS
Short-term investments of $6,332,000 and $501,000 at December 31, 2000, and
1999, respectively, consist of held-to maturity corporate debt. Management
determines the appropriate classification of debt securities at the time of
purchase and reevaluates such designation as of each balance sheet date. Debt
securities are classified as held-to-maturity when the Company has the positive
intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included in
interest income. Interest on securities classified as held-to-maturity is
included in interest income. Short-term investments at December 31, 2000 mature
between January and May 2001.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method. Cost is determined by the average cost method for
the Company's subsidiary outside the United States.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS PROPERTY AND EQUIPMENT
Equipment and leasehold improvements are Property and equipment is stated at
cost and depreciated less accumulated depreciation and amortization.
Depreciation of equipment is determined using the straight-line method based on
estimated useful lives of between three and seven years.
COMPUTER SOFTWARE DEVELOPMENT COSTS
Costs for the development of new software products and substantial enhancements
to existing software products are expensed as research and development costs as
incurred until technological feasibility has been established, at which time any
additional development costs are capitalized until the product is available for
34
35
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
general release to customers. The Company defines the establishment of
technological feasibility as the point when product software reaches a working
model.
Computer software development costs are capitalized subsequent to the
establishment of technological feasibility for each software product which is
evidenced by a detailed program design. Capitalization of costs ceases when the
product is available for general release to customers.
Amortization of software development costs begins upon general release of the
software. These costs are amortized on a product by-product basis using the
greater of: (i) the amount computed using the ratio that current gross revenues
for each product bear to the total of current and anticipated future revenue for
that product, or (ii) the amount computed using the straight-line method over
the estimated economic useful life of three to five years. Such costs are
amortized using the straight-line method over a three to five year period
beginning on product release dates. The Company assesses the recoverability of
this intangible asset by comparing the unamortized balance to the undiscounted
future net cash flows to be generated by the asset. Amortization is included in
cost of revenues, and.
GOODWILL
Goodwill consists of the excess of the purchase price over the fair value of net
assets acquired and is being amortized on a straight-line basis over the
estimated useful life of ten years. The Company assesses the recoverability of
this intangible asset by determining whether the amortization of the goodwill
balance over its remaining life can be recovered through undiscounted future
operating cash flows of the acquired operation. The amount of goodwill
impairment, if any, is measured based on projected discounted future operating
cash flows. During 1999 and 1998, the Company realized the benefit of an
acquired net operating loss carryforward. The amounts which totaled $52,017 in
1999 and $203,979 in 1998, were recorded as a reduction to goodwill. No such
benefit was realized in 2000.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
Long-lived assets, including intangible assets, are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be fully recoverable. If an impairment indicator is present,
the Company evaluates whether an impairment exists on the basis of undiscounted
expected future cash flows from operations for the remaining amortization
period. If an impairment exists, the asset is reduced by the estimated
difference between its discounted cash flows and its carrying value.
PRODUCT WARRANTIES
The Company warrants to the original purchaser that each of its hardware
products will be free from defects in materials and workmanship generally for a
period of one year from the date of purchase. Expected future product warranty
expense is recorded when the product is sold.
REVENUE RECOGNITION
The Company derives revenue from software and technology licenses, product
sales, maintenance (post contract customer support), and services. Software and
technology licenses typically contain multiple elements, including the product
license, maintenance, and/or other services. The Company allocates the total
arrangement fee among each deliverable based on the fair value of each of the
deliverables determined based on vendor-specific objective evidence.
35
36
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
LICENSE AND ROYALTIES
License revenue from the sale of third party software and software and
technology developed and licensed by the Company is recognized when
persuasive evidence of an arrangement exists, delivery has occurred, and
the fee is fixed or determinable and probable of collection. License fees
billed and not recognized as revenue are included in deferred revenue.
Royalties are recognized as they are earned.
PRODUCTS
The Company sells hardware and related encryption products. These revenues
are generally recognized when the product is shipped.
CONSULTING SERVICES AND MAINTENANCE
The Company provides engineering and related services to its customers.
Revenue from services is recognized as the services are provided.
Maintenance fees include telephone support, bug fixes, and rights to
upgrades on a when-and-if-available basis associated with software and
technology licenses. These fees are collected in advance and recognized
ratably over the maintenance period. Unrecognized maintenance fees are
included in deferred revenue.
FOREIGN CURRENCY TRANSLATION
The Company's Swiss subsidiary utilizes the Swiss Franc as its functional
currency and its financial statements are translated into U.S. dollars using the
current rate method. All balance sheet accounts have been translated using the
exchange rates at the balance sheet date. Operating and cash flow amounts have
been translated using average exchange rates. Translation gains or losses,
resulting from the changes in exchange rates from year to year, have been
reported as a component of other comprehensive income (loss). The effect on the
consolidated statements of operations of transaction gains and losses is
insignificant for all years presented.
INCOME TAXES
The Company uses the liability method in accounting for income taxes. Under this
method, deferred income tax assets and liabilities are determined based on
difference between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse. As discussed in note 5, in 2000
the Company changed its method of accounting for income taxes.
STOCK OPTIONS GRANTED TO EMPLOYEES
The Company accounts for all stock-based compensation plans using the intrinsic
value method prescribed by APB Opinion 25, Accounting for Stock Issued to
Employees ("APB 25"). Under APB 25, if the exercise price of the employee stock
options equals the estimated fair value of the underlying stock on the date of
grant, no compensation expense is recognized.
The Financial Accounting Standards Board has issued FASB Statement No. 123,
Accounting for Stock-Based Compensation, ("Statement 123") which encourages
companies to recognize expense for stock-based awards based on their estimated
fair value on the date of grant. Statement 123 does not require companies to use
fair value accounting for stock-based awards, but if the fair value method is
not adopted, pro forma income is required to be disclosed in a note to the
financial statements. The Company has supplementally disclosed in Note 8 the
required pro forma information as if the fair value method had been adopted.
36
37
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
NET INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per share is calculated by dividing net income (loss) by the
weighted-average number of common shares outstanding for the period. Diluted
income (loss) per share is calculated after adjusting the numerator and the
denominator of the basic calculation for the dilutive effect, if any, of all
stock options, warrants and convertible securities outstanding during the
period.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes all changes in equity that result from
recognized transactions and other economic events of a period other than
transactions with owners in their capacity as owners. Certain non-owner changes
in equity, consisting of foreign currency translation adjustments, are included
in "other comprehensive income (loss)." The Company reports comprehensive income
(loss) in the statement of comprehensive income (loss) and discloses the
accumulated total of other comprehensive income (loss) in the stockholders'
equity section of the balance sheet.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended, which
the Company is required to adopt effective January 1, 2001. Because of the
Company's minimal use of derivatives, the adoption of the new Statement will not
have a significant effect on earnings or the financial position of the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of financial instruments, including cash and cash
equivalents, short-term investments, accounts receivable, accounts payable and
accrued expenses approximates fair value.
RECLASSIFICATIONS
Certain amounts in the 1999 and 1998 consolidated financial statements have been
reclassified to conform to the 2000 presentation.
(3) INVENTORIES
- --------------------------------------------------------------------------------
Inventories consist of the following:
2000 1999
---------- ----------
Raw materials $1,198,163 $1,365,455
Finished goods 1,710,543 1,580,072
---------- ----------
$2,908,706 $2,945,527
========== ==========
37
38
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
(4) PROPERTY AND EQUIPMENT
- --------------------------------------------------------------------------------
Property and equipment consists of the following:
2000 1999
---------- ----------
Furniture and equipment $3,278,286 $2,933,038
Computer software 445,248 200,174
Leasehold improvements 649,240 637,668
---------- ----------
4,372,774 3,770,880
Less accumulated depreciation and amortization 2,997,558 2,346,893
---------- ----------
$1,375,216 $1,423,987
========== ==========
(5) INCOME TAXES
- --------------------------------------------------------------------------------
Income taxes for the years ended December 31, 1999 and 1998 of $85,133 and
$318,881, respectively, consisted of income tax expense of the Company's Swiss
subsidiary. There were no income taxes for the year ended December 31, 2000.
Deferred tax assets and liabilities are comprised of the following at December
31:
2000 1999
----------- -----------
Deferred tax assets:
Inventories $ 189,000 $ 202,000
Net operating loss carryforward 7,504,000 6,603,000
Reserve for CyberGuard advance -- 106,000
Stock option compensation 142,000 93,000
Other 151,000 130,000
----------- -----------
7,986,000 7,134,000
----------- -----------
Deferred tax liabilities:
Earnings and profits of foreign subsidiary -- (100,000)
Tax over book depreciation -- (46,000)
Other (14,000) (15,000)
----------- -----------
(14,000) (161,000)
----------- -----------
Net deferred tax asset 7,972,000 6,973,000
Less valuation allowance (7,972,000) (6,973,000)
----------- -----------
$ -- $ --
=========== ===========
38
39
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
The reconciliation of the reported income tax expense to the amount that would
be result by applying the U.S. federal statutory tax rate of 34% to net income
(loss) is as follows:
2000 1999 1998
----------- ----------- -----------
Tax expense (benefit) at U.S. statutory
rate $ 1,914,000 $(1,012,000) $ (703,000)
Effect of permanent differences 17,000 32,000 42,000
State income taxes, net of federal benefit 260,000 (149,000) (96,000)
Effect of foreign income taxed at lower
rates -- (51,000) --
Change in valuation allowance, excluding
change related to stock option exercises (2,173,000) 1,327,000 1,035,000
Other, net (18,000) (62,000) 41,000
----------- ----------- -----------
Total $ -- $ 85,000 $ 319,000
=========== =========== ===========
In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that all or some portion of the deferred tax
assets will not be realized. The ultimate realization of the deferred tax assets
is dependent upon the generation of future taxable income during the periods in
which temporary differences are deductible and net operating losses are
utilized. Based on consideration of these factors, the Company has established a
valuation allowance of $7,972,000 and $6,973,000 at December 31, 2000 and 1999,
respectively. The net increase in the valuation allowance of $999,000 is due to
a $3,172,000 increase in the valuation allowance resulting from the current year
exercise of non-qualified stock options and disqualified disposition of
incentive stock options, offset by a $2,173,000 reduction in the valuation
allowance resulting from the use of prior year net operating loss carryforwards.
The tax benefit of the exercise of non-qualified stock options and disqualified
disposition of incentive stock options, which totaled approximately $4,248,000
at December 31, 2000, will be recorded as an increase to stockholders' equity as
it is realized.
Prior to the third quarter of fiscal year 2000, the Company followed the
practice of computing its income tax expense using the assumption that current
year stock option deductions were used first to offset its financial statement
taxable income. The remaining net operating loss carryforwards could then be
used to offset any excess of financial statement taxable income over current
year stock option deductions. Because the stock option deductions are not
recognized as an expense for financial reporting purposes, the tax benefit from
stock option deductions must be credited to additional paid-in capital with an
offsetting charge to income tax expense in the statement of operations.
Effective July 1, 2000, the Company changed its method of accounting for income
taxes to recognize the tax benefits from current and prior years' stock option
deductions after the utilization of net operating losses from operations (i.e.,
net operating losses determined without deductions for the exercise of
non-qualified stock options and disqualified disposition of incentive stock
options) to reduce income tax expense. The Company believes that this change is
to a preferable method because the Company will not realize any tax benefit from
stock compensation deductions until it has fully utilized its current and prior
net operating loss carryforwards from operations. Thus, this method more
accurately reflects the incremental effect of the Company's stock option
deductions in the appropriate accounting period.
Because the Company was generating net operating losses prior to 2000 rather
than utilizing them, this accounting change had no effect on prior years' tax
provisions or additional paid in capital.
39
40
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
At December 31, 2000, the Company had net operating loss carryforwards related
to its Swiss subsidiary of approximately $1,522,000, which expire in seven years
and are available to offset future taxable income of that subsidiary. At
December 31, 2000, the Company had net operating loss carryforwards for U.S.
income tax purposes of approximately $17,908,000, which expire from 2011 to 2020
and are available to offset future U.S. taxable income. The exercise of
non-qualified stock options and disqualified disposition of incentive stock
options ("stock option deductions") have generated approximately $11,100,000 of
the U.S. net operating loss carryforwards. When these net operating loss
carryforwards are utilized, the resulting reduction in the valuation allowance
will be recorded as a direct increase to stockholders' equity.
(6) LEASES
- --------------------------------------------------------------------------------
The Company leases office facilities and equipment under non-cancelable
operating leases expiring at various dates through 2005. The leases require the
Company to pay a proportionate share of real estate taxes, insurance and
maintenance. The Company recognizes rent expense on a straight-line basis. The
future minimum payments under the leases for the years ending December 31, are
as follows:
2001 $ 578,838
2002 490,525
2003 392,636
2004 25,340
2005 14,107
----------
$1,501,446
==========
Rent expense under all operating leases for the years ended December 31, 2000,
1999 and 1998 was $574,771, $629,233, and $609,538, respectively.
(7) PENSION PLANS
- --------------------------------------------------------------------------------
The Company sponsors a defined contribution pension plan for employees who have
completed three months of service. The Plan permits pre-tax contributions by
participants pursuant to Section 401(k) of the Internal Revenue Code (the Code)
of 3% to 15% of base compensation up to the maximum allowable contributions as
determined by the Code ($10,500 in 2000). Prior to December 31, 1999, the
Company made no contributions to the plan. Effective January 1, 2000, the
Company matches up to 50% of the first 4% of employee compensation that is
contributed to the plan. The Company may also make additional discretionary
contributions. The Company accrued $72,777 for matching contributions in 2000.
All of the Company's Swiss employees are participants in a national, compulsory,
contributory pension plan, which is administered by an outside institution. The
employees' contributions are defined and calculated according to age group. The
employer's contributions are then of the same amount. The pension costs for the
Swiss subsidiary during 2000, 1999, and 1998 totaled $217,622, $238,079, and
$252,026, respectively.
(8) STOCK OPTIONS AND WARRANTS
- --------------------------------------------------------------------------------
The Company sponsors stock option plans that provide for the granting of stock
options to officers, directors, consultants and employees of the Company.
Options are exercisable at the fair market value of the common stock on the date
of grant and, subject to termination of employment, expire seven years from the
date of grant. Either incentive stock options or non-qualified stock options may
be granted under the plans. The
40
41
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
vesting and exercise periods are determined by the Board of Directors not to
exceed ten years. Options issued to date vest in equal amounts over a vesting
period of either three of four years. Option activity during 1998, 1999 and 2000
was as follows:
WEIGHTED
AVERAGE
NUMBER RANGE OF EXERCISE
OF SHARES EXERCISE PRICES PRICE
--------- ---------------- --------
Outstanding at January 1, 1998 994,383 $ 1.30 to $20.00 $10.45
Granted 728,700 $ 3.09 to $ 9.31 6.92
Canceled (561,600) $ 4.94 to $17.00 10.49
Exercised (3,800) $ 1.30 to $ 5.25 2.58
---------
Outstanding at December 31, 1998 1,157,683 $ 1.30 to $20.00 8.23
Granted 362,700 $ 9.19 to $31.50 14.91
Canceled (95,105) $ 5.00 to $23.31 9.93
Exercised (225,906) $ 1.30 to $13.00 7.35
---------
Outstanding at December 31, 1999 1,199,372 $ 3.09 to $31.50 10.28
Granted 751,541 $14.75 to $43.50 22.66
Canceled (216,557) $ 4.50 to $25.63 11.25
Exercised (392,204) $ 3.09 to $20.25 10.42
---------
Outstanding at December 31, 2000 1,342,152 $ 3.09 to $43.50 $17.01
========= ======
Exercisable at December 31, 2000 393,916 $ 4.38 to $31.69 $10.58
========= ======
The following table summarizes information about stock options outstanding at
December 31, 2000.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF NUMBER REMAINING EXERCISE NUMBER EXERCISE
EXERCISE PRICES OF SHARES CONTRACTUAL LIFE PRICE OF SHARES PRICE
- --------------- --------- ---------------- -------- --------- --------
$ 3.09 to $10.13 480,792 3.53 years $ 7.86 323,453 $ 7.91
$14.75 to $21.63 459,467 5.73 years $16.98 38,966 $16.42
$24.13 to $43.50 401,893 6.61 years $27.99 31,497 $30.81
--------- ---------- ------ ------- ------
1,342,152 5.20 years $17.01 393,916 $10.58
========= ========== ====== ======= ======
The Company applies the intrinsic value method in accounting for options granted
to employees and directors and, accordingly, no compensation cost has been
recognized for its options in the consolidated financial statements. Pro forma
financial information regarding net income (loss) and income (loss) per share
has been determined as if the Company had accounted for its employee stock
options using the fair value method. For
41
42
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options' vesting period. The Company's pro forma
information follows:
2000 1999 1998
---------- ----------- -----------
Net income (loss)
As reported $5,757,144 $(3,060,522) $(2,385,985)
Proforma $1,640,000 $(5,124,000) $(2,925,000)
Net Income (loss) per common share
As reported
Basic $ .85 $ (.56) $ (.44)
Diluted $ .80 $ (.56) $ (.44)
Proforma
Basic $ .24 $ (.93) $ (.54)
Diluted $ .24 $ (.93) $ (.54)
The weighted-average fair value per share of options granted during 2000, 1999
and 1998 was $20.45, $11.43, and $4.00, respectively, on the dates of grant. The
fair values of options granted was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions for grants
in 2000, 1999 and 1998, respectively: risk-free interest rates of 5.10%, 6.44%,
and 5.25%; expected volatility of 180%, 143%, and 110%; dividend yield and
expected dividend growth rate of 0% in all years; and weighted-average expected
life of 3 to 5 years.
In addition, in November 1995, in connection with the private placement of
300,000 shares of the Company's common stock, the Company issued the placement
agent warrants to purchase 30,000 shares of common stock at $17.00 per share.
Warrants for 23,050 of these shares were exercised in June 1999 and the
remaining 6,950 were exercised in January 2000.
At December 31, 2000, the Company had reserved 1,900,526 shares of common stock
for exercise of outstanding stock options and additional stock options
authorized for granting under existing stock option plans.
(9) CYBERGUARD ADVANCE
- --------------------------------------------------------------------------------
In August 1996, the Company signed a two year Joint Development and Marketing
Agreement with CyberGuard Corporation (CyberGuard). The companies intended to
develop and market a product that combined the Company's SafeNet Enterprise
products and CyberGuard's Firewall product. In connection therewith, the Company
prepaid a refundable $1,000,000 license fee to CyberGuard.
In June 1998, a Distribution Agreement and an Original Equipment Agreement (OEM
Agreement) replaced the original agreement. Under these agreements, CyberGuard
agreed to repay on December 31, 1998 the original $1,000,000 advance less used
license fees and a right to manufacture fee. On December 31, 1998, CyberGuard
failed to honor its obligation to repay the unused license fee.
Since the Company could not ascertain the ultimate viability of CyberGuard as a
result of an August 1998 announcement that CyberGuard was experiencing
significant pressure on its liquidity, as well as the January 1999 delisting of
CyberGuard's securities from the NASDAQ Stock Market, the Company reserved for
the remaining advance as of December 31, 1998.
42
43
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
During 1999, the Company agreed to accept a $650,000 note receivable from
CyberGuard as payment in full of CyberGuard's obligation. CyberGuard fulfilled
their obligation to SafeNet by paying $375,000 in 1999, and $275,000 in 2000 on
the note.
(10) SEGMENTS OF THE COMPANY AND RELATED INFORMATION
- --------------------------------------------------------------------------------
Beginning in 2000, the United States operations were divided into two operating
groups. As a result, the Company now has three reportable segments: products,
chips and software designed and manufactured in the United States for sale to
companies that will embed the Company's products into their products for
ultimate sale to end-users ("Technology Operations"), network security products
designed and manufactured in the United States for direct sales to end-users
("Product Operations"), and security products designed and manufactured outside
the United States ("European Operations"). The reportable segments are strategic
business units that offer different products. The segments are managed
separately because each segment requires different technology and marketing
strategies. The Technology Operations and Product Operations include some
international sales mainly to South America and Asia. Information presented
below is for the years ended December 31, and 1999 and 1998 information has been
restated to reflect the new operating groups:
2000 1999 1998
----------- ----------- -----------
Revenue from external customers:
Technology operations $15,952,594 $ 3,929,064 $ 3,110,620
Product operations 9,325,882 6,635,574 8,513,099
European operations 3,547,108 8,362,255 11,617,991
----------- ----------- -----------
Consolidated revenues $28,825,584 $18,926,893 $23,241,710
=========== =========== ===========
Intersegment revenues:
Technology operations $ -- $ 2,000,000 $ --
Product operations 139,110 12,399 18,354
European operations 32,716 27,318 28,014
----------- ----------- -----------
Intersegment revenues $ 171,826 $ 2,039,717 $ 46,368
=========== =========== ===========
Reconciling items:
Intersegment revenues $ (171,826) $(2,039,717) $ (46,368)
----------- ----------- -----------
Total consolidated revenues $28,825,584 $18,926,893 $23,241,710
=========== =========== ===========
Operating income (loss):
Technology operations $ 4,652,295 $(3,645,922) $(3,963,291)
Product operations 1,287,946 (1,823,782) (2,398,058)
European operations (1,555,908) 2,344,679 4,035,088
----------- ----------- -----------
Consolidated operating income (loss) $ 4,384,333 $(3,125,025) $(2,326,261)
=========== =========== ===========
43
44
SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
2000 1999 1998
----------- ----------- -----------
Income (loss) before income taxes:
Technology operations $ 5,484,095 $(3,598,659) $(3,901,273)
Product operations 1,776,463 (1,776,519) (2,228,328)
European operations (1,503,414) 2,399,789 4,062,497
----------- ----------- -----------
Consolidated income (loss) before
income taxes $ 5,757,144 $(2,975,389) $(2,067,104)
=========== =========== ===========
Depreciation and amortization:
Technology operations $ 1,076,002 $ 269,236 $ 243,441
Product operations 698,552 768,709 638,092
European operations 140,178 153,317 152,503
----------- ----------- -----------
Consolidated depreciation and
amortization $ 1,914,732 $ 1,191,262 $ 1,034,036
=========== =========== ===========
Segment assets:
Technology operations $22,001,187 $ 9,790,620 $ 2,072,187
Product operations 16,337,605 15,792,342 7,530,167
European operations 4,766,987 6,312,850 9,338,350
----------- ----------- -----------
Consolidated segment assets $43,105,779 $31,895,812 $18,940,704
=========== =========== ===========
Expenditures for long-lived assets
Technology operations $ 875,649 $ 833,950 $ 163,520
Product operations 278,556 679,297 675,342
European operations 27,326 113,072 149,309
----------- ----------- -----------
Consolidated segment assets $ 1,181,531 $ 1,626,319 $ 988,171
=========== =========== ===========
GEOGRAPHIC INFORMATION
Revenues:
United States $23,956,018 $10,347,908 $10,023,840
Switzerland 2,097,325 4,179,224 7,941,783
Germany 739,448 2,108,528 1,817,868
Other foreign countries 2,032,793 2,291,233 3,458,219
----------- ----------- -----------
Consolidated revenues $28,825,584 $18,926,893 $23,241,710
=========== =========== ===========
Long-lived assets:
United States $ 2,696,094 $ 3,304,341 $ 2,879,649
Switzerland 270,784 226,755 204,036
----------- ----------- -----------
Consolidated long-lived assets $ 2,966,878 $ 3,531,096 $ 3,083,685
=========== =========== ===========
(11) SIGNIFICANT CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK
- --------------------------------------------------------------------------------
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of accounts receivable. The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. Sales terms with clients, including distributors,
generally do not provide for right of return privileges for credit, refund or
other products. The Company's payment terms are generally 30 days from delivery
of products, but could fluctuate depending on the terms of each specific
contract. The
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SAFENET, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
December 31, 2000
Company's clients, who include both commercial companies and governmental
agencies, are in various industries, including banking, security, communications
and distributors of electronic products.
In 2000, one commercial client of the Technology Group accounted for 25% of the
Company's consolidated revenues. In 1999, no commercial client accounted for
greater than 10% of the Company's consolidated revenues. In 1998, one commercial
client of the Technology Group and one commercial client of the European Group
accounted for 11% and 13%, respectively, of the Company's consolidated revenues.
As of December 31, 2000, one commercial client of the Technology Group accounted
for 22% of accounts receivable.
(12) INCOME (LOSS) PER SHARE
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The following table sets forth the computation of basic and diluted net income
(loss) per common share for the years ended December 31:
2000 1999 1998
---------- ----------- -----------
Numerator:
Net income (loss) $5,757,144 $(3,060,522) $(2,385,985)
========== =========== ===========
Denominator:
Denominator for basic income (loss) per
share -- weighted average shares 6,751,465 5,504,440 5,408,945
Effect of employee stock options 442,698 -- --
---------- ----------- -----------
Denominator for diluted income (loss) per
share -- adjusted weighted-average shares
and assumed conversions 7,194,163 5,504,440 5,408,945
========== =========== ===========
Basic income (loss) per share $ 0.85 $ (0.56) $ (0.44)
========== =========== ===========
Diluted income (loss) per share $ 0.80 $ (0.56) $ (0.44)
========== =========== ===========
Diluted loss per common share in 1999 and 1998 is equal to basic loss per common
share because if potentially dilutive securities were included in the
computation, the result would be anti-dilutive.
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Schedule II
Valuation and Qualifying Accounts
CHARGES
BALANCE AT CHARGED TO OTHER
BEGINNING TO COSTS ACCOUNTS - DEDUCTIONS - BALANCE
OF AND DESCRIBE DESCRIBE OTHER - AT END
PERIOD EXPENSES (a) (b) DESCRIBE (c) OF PERIOD
---------- -------- ---------- ------------ ------------ ---------
Allowance for doubtful accounts:
Year ended December 31, 2000 $251,005 $ 60,000 $ (419) $ 78,862 $ -- $231,724
Year ended December 31, 1999 $ 86,725 $170,842 $(5,720) $ 842 $ -- $251,005
Year ended December 31, 1998 $ 60,276 $ 25,477 $ 972 $ -- $ -- $ 86,725
======== ======== ======= ======== ======== ========
Reserve for CyberGuard advance:
Year ended December 31, 2000 $275,000 $ -- $ -- $ -- $275,000 $ --
Year ended December 31, 1999 $771,655 $ -- $ -- $121,655 $375,000 $275,000
Year ended December 31, 1998 $ -- $771,655 $ -- $ -- $ -- $771,655
======== ======== ======= ======== ======== ========
- ---------------
(a) Charges to other accounts represent the translation effect for the change in
the Swiss Franc exchange rate for balances existing at the beginning of the
period.
(b) Deductions represent write-offs of specifically identified accounts.
(c) Other represents cash received on previously reserved account.
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
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Refer to the Company's current report on Form 8-k dated June 19, 2000.
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PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
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- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the
definitive Proxy Statement of SafeNet, which will be filed with the Securities
and Exchange Commission no later than 120 days after the close of SafeNet's
fiscal year ended December 31, 2000.
ITEM 11 - EXECUTIVE COMPENSATION
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the
definitive Proxy Statement of SafeNet, which will be filed with the Securities
and Exchange Commission no later than 120 days after the close of SafeNet's
fiscal year ended December 31, 2000.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the
definitive Proxy Statement of SafeNet, which will be filed with the Securities
and Exchange Commission no later than 120 days after the close of SafeNet's
fiscal year ended December 31, 2000.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the
definitive Proxy Statement of SafeNet, which will be filed with the Securities
and Exchange Commission no later than 120 days after the close of SafeNet's
fiscal year ended December 31, 2000.
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PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(a) 1. The financial statements filed as part of this report are listed separately
on the Index To Financial Statements on page 31 of this Form.
2. Financial Statement Schedules: Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable therefore have been omitted
(b) Reports on Form 8-K: None
(c) Exhibits required by Item 601 of Regulation S-K:
3A Articles of Incorporation of Registrant, as filed with the
Secretary of State of Delaware on November 1, 1988, as
amended on March 6, 1989, May 19, 1989, September 22, 1992,
June 30, 1995, October 4, 1995, and October 23, 2000 I/B/R(1)
3A.1 Amendment to By-laws for change of Corporation name
3B By-laws of Registrant I/B/R(2)
4 Specimen of Common Stock Certificate of Registrant I/B/R(2)
10A Sublease dated November 2, 1993 for facility at 8029
Corporate Drive, Baltimore, MD. I/B/R(3)
10B Stock Option Plan of 1989 I/B/R(4)
10C Employment Agreement with Douglas Kozlay I/B/R(2)
10D Form Employee Non-Disclosure Agreement I/B/R(2)
10E Employment Agreement between GDS and Dr. Kurt H. Mueller I/B/R(1)
10F Placement Agent Warrant I/B/R(1)
10G Joint Development and Marketing Agreement between the
Registrant and CyberGuard Corporation I/B/R(5)
10H Employment Agreement with Anthony Caputo I/B/R(5)
10I Agreement between SafeNet Secure Solutions, Inc.
(wholly-owned subsidiary of the Registrant) and Analog
Devices, Inc. I/B/R(6)
10J 1999 Employee Stock Option Plan I/B/R(7)
10K 1999 Stock Bonus Plan I/B/R(7)
10L Non-Employee Director Stock Option Plan I/B/R(7)
10M 2000 Employee and Directors Stock Option Plan I/B/R(7)
21 Subsidiaries of Registrant
23.1 Consent of Ernst & Young LLP, independent auditors
23.2 Consent of KPMG LLP, independent auditors
99.1 Ernst & Young LLP, letter dated November 7, 2000 regarding
change in accounting principle.
(1) Filed as an exhibit to the Registration Statement on Form SB-2 (File No.
33-80161) of the Registrant and incorporated herein by reference.
(2) Filed as an exhibit to the Registration Statement on Form S-18 (File No.
33-28673) of the Registrant and incorporated herein by reference.
(3) Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
1993 and incorporated herein by reference.
(4) Filed as an exhibit to the Registration Statement on Form S-1 (File No.
33-52066) of the Registrant and incorporated herein by reference.
(5) Filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1996
and incorporated herein by reference.
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49
(6) Filed as an exhibit to Form 10-Q for the quarterly period ended September
30, 1996 and incorporated herein by reference.
(7) Filed as an exhibit to a Definitive Proxy Statement on Schedule 14A for the
Annual Meeting of Shareholders held on July 28, 1999 and incorporated herein
by reference
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SIGNATURES
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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 behalf
of the undersigned, thereunto duly authorized.
SAFENET, INC.
By: /s/ Anthony A. Caputo
------------------------------------
Anthony A. Caputo
Chairman, Chief Executive Officer
and President
Date: March 7, 2001
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Anthony A. Caputo Chairman, Chief Executive Officer and March 7, 2001
- ------------------------------------- President
Anthony A. Caputo
/s/ Carole D. Argo Senior Vice President and Chief March 7, 2001
- ------------------------------------- Financial Officer
Carole D. Argo (Principal Financial and Accounting
Officer)
/s/ Thomas A. Brooks Director March 7, 2001
- -------------------------------------
Thomas A. Brooks
/s/ Shelley A. Harrison Director March 7, 2001
- -------------------------------------
Shelley A. Harrison
/s/ Ira A. Hunt, Jr. Director March 7, 2001
- -------------------------------------
Ira A. Hunt, Jr.
/s/ Bruce R. Thaw Director March 7, 2001
- -------------------------------------
Bruce R. Thaw
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