SAFENET INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

		For the quarterly period ended September 30, 2004

[ ]		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
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)

4690 Millennium Drive, Belcamp, MD 21017
(Address of principal executive offices)

443-327-1200
(Registrant’s telephone number)

Indicate by a 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 twelve 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 a check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]

APPLICABLE ONLY TO CORPORATE ISSUERS

The number of shares outstanding of the issuer’s Common Stock as of November 5, 2004, was 24,149,513.

INDEX TO FINANCIAL STATEMENTS


	Page
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003		3
Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003		4
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2004 and 2003		5
Consolidated Statements of Stockholders’ Equity for the nine months ended September 30, 2004		6
Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003		7
Notes to Consolidated Financial Statements - September 30, 2004		8
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3: Quantitative and Qualitative Disclosures About Market Risk		30
Item 4: Controls and Procedures		30
PART II: OTHER INFORMATION
Item 1: Legal Proceedings		31
Item 5: Other Information		31
Item 6: Exhibits and Reports on Form 8-K		33
SIGNATURES		34
EXHIBITS
31.1
31.2
32.1
32.2

PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

SAFENET, INC.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)


	September 30,			December 31,
	2004			2003
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	80,672		$	21,651
Restricted cash		4,479			2,800
Short-term investments		93,313			92,280
Accounts receivable, net of allowance for doubtful accounts of $2,538 in 2004 and $940 in 2003		43,283			13,191
Inventories, net of reserve of $1,026 in 2004 and $1,275 in 2003		14,845			3,123
Unbilled costs and fees		957			—
Deferred income taxes		3,293			—
Prepaid expenses and other current assets		4,814			1,414

Total current assets		245,656			134,459
Property and equipment, net of accumulated depreciation and amortization of $5,472 in 2004 and $6,875 in 2003		15,737			3,809
Computer software development costs, net of accumulated amortization of $2,156 in 2004 and $1,696 in 2003		2,600			1,982
Goodwill		308,240			42,407
Other intangible assets, net of accumulated amortization of $23,047 in 2004 and $9,280 in 2003		140,477			23,599
Other assets		3,627			1,900

Total assets	$	716,337		$	208,156

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	11,416		$	3,799
Accrued salaries and commissions		11,661			3,770
Advance payments and deferred revenue		9,236			4,791
Accrued income taxes		9,907			2,294
Other accrued expenses		7,781			2,509
Deferred income taxes		7,538			2,607
Due to former owners of acquired companies		3,850			2,800
Accrued warranty costs		3,296			259
Accrued severance and related acquisition costs		593			—

Total current liabilities		65,278			22,829
Unfavorable lease liability		4,559			4,149
Deferred income taxes		46,532			2,181
Other liabilities		2,813			—

Total liabilities		119,182			29,159

Commitments and contingencies		—			—
Stockholders’ equity:
Preferred stock, $.01 par value per share, authorized 500 shares, no shares issued and outstanding		—			—
Common stock, $.01 par value per share, authorized 50,000 shares, issued and outstanding shares of 24,111 in 2004 and 13,286 in 2003		241			133
Additional paid-in capital		625,572			199,783
Unearned compensation		(8,613	)		—
Accumulated other comprehensive income		5,321			5,394
Accumulated deficit		(25,366	)		(26,313	)

Total stockholders’ equity		597,155			178,997

Total liabilities and stockholders’ equity	$	716,337		$	208,156

See accompanying notes to consolidated financial statements.

SAFENET, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)


	Three Months ended September 30,				Nine Months ended September 30,
	2004		2003		2004		2003
			(Restated - Note 1)				(Restated - Note 1)
Revenues:
Licenses and royalties	$	2,449	$	3,131	$	7,300	$	7,702
Products		51,892		11,071		116,563		32,079
Service and maintenance		5,109		3,183		13,948		7,678

		59,450		17,385		137,811		47,459
Cost of revenues:
Licenses and royalties		126		79		196		203
Products ⁽¹⁾		26,426		3,537		58,869		10,226
Service and maintenance		62		320		1,327		959
Amortization of acquired intangible assets		3,287		353		7,674		2,243

		29,901		4,289		68,066		13,631

Gross profit		29,549		13,096		69,745		33,828

Operating expenses:
Research and development expenses		6,179		3,777		17,180		11,182
Sales and marketing expenses		8,414		3,956		19,723		10,835
General and administrative expenses		4,309		1,729		12,300		4,852
Costs of integration of acquired companies		4,573		138		7,935		3,127
Amortization of acquired intangible assets		2,304		1,313		6,173		3,349
Amortization of unearned compensation (*see detail below)		2,028		—		4,547		—
Write-off of acquired in-process research and development costs		—		—		—		9,681
Restructuring charge		100		—		1,585		—

Total operating expenses		27,907		10,913		69,443		43,026

Operating income (loss)		1,642		2,183		302		(9,198	)
Interest and other income, net		825		207		2,049		449

Income (loss) before income taxes		2,467		2,390		2,351		(8,749	)
Income tax expense		1,471		569		1,404		1,607

Net income (loss)	$	996	$	1,821	$	947	$	(10,356	)

Net income (loss) per common share:
Basic	$	0.04	$	0.14	$	0.05	$	(0.97	)

Diluted	$	0.04	$	0.13	$	0.04	$	(0.97	)

Shares used in computation:
Basic		23,976		12,769		20,998		10,700
Diluted		24,558		13,546		21,686		10,700

*Composition of stock compensation
Cost of revenues	$	160	$	—	$	374	$	—
Research and development		387		—		892		—
Sales and marketing		347		—		774		—
General and administrative		408		—		906		—
Integration		726		—		1,601		—

Total	$	2,028	$	—	$	4,547	$	—


⁽¹⁾	Excludes amortization of earned compensation of $160, $0, $374, $0

See accompanying notes to consolidated financial statements.

SAFENET, INC.
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Nine Months Ended September 30, 2004

(Unaudited, in thousands)



											Accumulated
	Common stock				Additional paid-in			Unearned			other comprehensive			Accumulated			Total stockholders’
	Shares		Amount		capital			compensation			income (loss)			deficit			equity
Balance as of January 1, 2004		13,286	$	133	$	199,783		$	—		$	5,394		$	(26,313	)	$	178,997
Costs incurred in connection with the registration of common stock issued for the asset acquisitions of Raqia Networks, Inc. and Rainbow Technologies, Inc.		—		—		(1,034	)		—			—			—			(1,034	)
Issuance of common stock in connection with the acquisition of Rainbow Technologies, Inc.		10,306		103		375,025			—			—			—			375,128
Assumption of stock options in connection with the acquisition of Rainbow Technologies, Inc.		—		—		44,600			(13,160	)		—			—			31,440
Amortization of unearned compensation		—		—		—			4,547			—			—			4,547
Issuance of common stock under Employee Stock Purchase Plan		23		—		552			—			—			—			552
Issuance of common stock for stock option exercises		476		5		6,646			—			—			—			6,651
Issuance of common stock for stock warrants exercised		20		—		—			—			—			—			—
Foreign currency translation adjustment		—		—		—			—			(73	)		—			(73	)
Net income		—		—		—			—			—			947			947

Balance as of September 30, 2004		24,111	$	241	$	625,572		$	(8,613	)	$	5,321		$	(25,366	)	$	597,155

See accompanying notes to consolidated financial statements.

SAFENET, INC
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)


	Nine Months Ended September 30,
	2004			2003
				(Restated - Note 1)
Cash flows from operating activities:
Net income (loss)	$	947		$	(10,356	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Write-off of acquired in-process research and development costs		—			9,681
Depreciation and amortization of property and equipment		2,237			892
Amortization of computer software development costs		458			207
Amortization of other intangible assets		13,919			5,576
Amortization of unearned compensation		4,547			—
Income tax benefit related to stock option exercises		—			2,458
Restructuring charge		1,585			—
Deferred income taxes		(3,726	)		(1,506	)
Amortization of unfavorable lease liability		(1,174	)		(532	)
Changes in operating assets and liabilities:
Accounts receivable, net		(11,815	)		(739	)
Inventories, net		(1,737	)		1,811
Prepaid expenses and other current assets		(559	)		547
Accounts payable		(1,416	)		785
Accrued salaries and commissions		1,006			(4,253	)
Accrued income taxes		5,788			1,038
Other accrued expenses		(4,161	)		(1,970	)
Advance payments and deferred revenue		807			(358	)

Net cash provided by operating activities		6,706			3,281

Cash flows from investing activities:
Sales of available for sale securities		53,267			48,078
Purchases of available for sale securities		(53,983	)		(36,181	)
Purchases of property and equipment		(4,267	)		(1,474	)
Expenditures for computer software development		(1,078	)		(1,245	)
Cash received upon acquisition of Rainbow, net of cash paid		54,174			—
Cash received upon acquisition of Cylink and SSH, net of cash paid		(474	)		703
Cash paid for Raqia, net of cash acquired		—			(1,390	)
Change in other assets		(1,219	)		791

Net cash provided by investing activities		46,420			9,282

Cash flows from financing activities:
Proceeds from stock options exercised and issuance of stock under Employee Stock Purchase Plan		7,203			8,637
Costs incurred in connection with the registration of common stock issued for the Rainbow, Cylink, SSH, and Raqia acquisitions		(1,034	)		—
Proceeds from public offering, net of costs		—			83,920

Net cash provided by financing activities		6,169			92,557

Effect of exchange rate changes on cash		(274	)		(388	)

Net increase in cash and cash equivalents		59,021			104,732
Cash and cash equivalents at beginning of period		21,651			3,399

Cash and cash equivalents at end of period	$	80,672		$	108,131

See accompanying notes to consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004

(Unaudited, in thousands except per share amounts)

(1) BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to present a fair statement of results for the interim periods presented. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the interim period are not necessarily indicative of results to be expected in future periods.

As disclosed in the Company’s Annual Report on Form 10-K, during the fourth quarter of fiscal year 2003, the Company identified certain adjustments to its financial statements that impacted the results of operations that were previously reported in its quarterly reports on Forms 10-Q. The results of operations and cash flows for the previously reported interim periods in 2003 have been restated to reflect those adjustments that are described in detail in the Form 10-K.

(2) BUSINESS

SafeNet is a global leader in information security. Founded more than 20 years ago, the Company provides complete security utilizing its encryption technologies to protect communications, intellectual property and digital identities, and offers a full spectrum of products including hardware, software, and chips.

In February 2003, the Company acquired Cylink, Inc. (“Cylink”). Cylink developed, marketed and supported a comprehensive portfolio of hardware and software security products for mission-critical private networks and business communications over the Internet. The results of Cylink are included in the Company’s consolidated results of operations beginning on February 6, 2003.

In February 2003, the Company acquired the assets of Raqia Networks, Inc. (“Raqia”), a development stage company that was developing content inspection technology.

In November 2003, the Company acquired the OEM Products Group of SSH Communication Security Corp. (“SSH”), a European developer of VPN client software and security and networking toolkits. The results of operation of SSH have been included in the Company’s consolidated results of operations beginning on November 19, 2003.

On March 15, 2004, the Company acquired Rainbow Technologies, Inc. (“Rainbow”). Rainbow provided information security solutions for mission-critical data and applications used in business, organization and government computing environments. The results of operations of Rainbow have been included in the Company’s consolidated results of operations beginning on March 16, 2004.

(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition

As a result of the acquisition of Rainbow, the Company has added the following significant accounting policies related to revenue recognition for the products and services offered by the acquired business.

Certain products are designed, developed and produced by the Company for use in U.S. Government and commercial high assurance applications. The products consist of application specific integrated circuits (“ASICs”), modules, electronic assemblies and stand-alone products to protect information. Catalog product revenues and revenues under certain fixed-price contracts calling for delivery of a specified number of units are recognized as deliveries are made. Revenues under cost-reimbursement contracts are recognized as costs are incurred and include estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. Certain contracts are awarded on a fixed-price incentive fee basis. Incentive fees on such contracts are considered when estimating revenues and profit rates and are recognized when the amounts can reasonably be determined. The costs attributed to units delivered under fixed-price contracts are based on the estimated average cost per unit at contract completion. Profits expected to be realized on long-term contracts are based on total revenues and estimated costs at completion. Revisions to contract profits are recorded in the accounting period in which the revisions are known. Estimated losses on contracts are recorded when identified. For research and development and other cost-plus-fee type contracts, the Company recognizes contract earnings using the percentage-of-completion method. The estimated contract revenues are recognized based on percentage-of-completion as determined by the cost-to-cost basis whereby revenues are recognized as contract costs are incurred.

Product Warranties

The changes in the carrying amount of accrued warranty costs from December 31, 2003 to September 30, 2004 are as follows:


Balance as of December 31, 2003	$	259
Balance acquired from Rainbow		3,423
Cash payments made		(386	)

Balance as of September 30, 2004	$	3,296

The Company offers warranties on its products ranging from ninety days to two years. The specific terms and conditions of those warranties vary depending upon the product sold and the country in which the Company does business. The Company estimates the costs that may be incurred under its warranties and records a liability at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of installed units, historical and anticipated rates of warranty claims and the estimated cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. While warranty costs have historically been within management’s expectations, it is possible that warranty rates will change in the future based on new product introductions and other factors.

Employee Stock-Based Compensation

As of September 30, 2004, the Company had five stock-based employee compensation plans. The Company accounts for those plans using the intrinsic value method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.

The following table illustrates the effect on net income and loss per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.