-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CObum9LV3abnSyStcM1BnkoA07kF4V1nCZYIZuHzGVzf8KdI4U9GaR6HPqrvnw2n c7SobK/QhQB6fPXs3lIqtw== 0000950133-98-001001.txt : 19980330 0000950133-98-001001.hdr.sgml : 19980330 ACCESSION NUMBER: 0000950133-98-001001 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INFORMATION RESOURCE ENGINEERING INC CENTRAL INDEX KEY: 0000850313 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 521287752 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-20634 FILM NUMBER: 98575669 BUSINESS ADDRESS: STREET 1: 8029 CORPORATE DRIVE CITY: BALTIMORE STATE: MD ZIP: 21236 BUSINESS PHONE: 4109317500 MAIL ADDRESS: STREET 1: 8029 CORPORATE DR CITY: BALTIMORE STATE: MD ZIP: 21236 10-K405 1 FORM 10-K405 DATED DECEMBER 31, 1997 1 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, 1997 Or [ ] Transition Report Pursuant to Section 13 OR 15 (d) Of the Securities Exchange Act of 1934 Commission File Number 0-20634 INFORMATION RESOURCE ENGINEERING, 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) 8029 Corporate Drive BALTIMORE, MARYLAND 21236 ------------------- ----- (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 exchange on Title of each class which registered ------------------- ---------------- 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] Revenues for the most recent fiscal year were $16.0 million. The aggregate market value of the voting stock held by non-affiliates of the Registrant as of March 20, 1998, based upon the closing price on that date, on the Nasdaq National Market, was approximately $30.0 million. The number of shares of the registrant's Common Stock outstanding as of March 20, 1998 was 5,463,727. 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, 1997. 2 PART I ITEM 1 - BUSINESS 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 the Company'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, other competitive factors leading to a decrease in anticipated revenues, achieving technical and product development milestones, the ability to manufacture product in a timely manner to meet market demand, market acceptance of products, the ability to negotiate favorable purchase and sale agreements, and sufficient cash flow for future liquidity and capital resource needs. Gross margins can vary from quarter to quarter based on product and channel mix, and current gross margin levels may not be indicative of future results. The Company's historical and prospective operating results have been and are expected to continue to be 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. The Company's expense levels are based, in part, on expectations of future revenues. The size and timing of the Company's historical revenues have varied 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. These factors, among others, could cause results to differ materially from those in the forward looking statements. See "Glossary of Technical Terms" on page 12 for explanation of certain technical terms used herein. GENERAL Information Resource Engineering, Inc. (the "Company") designs, manufactures and markets enterprise network communications systems secured by encryption technology. The Company's products are used in Virtual Private Network ("VPN") applications, and 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. GRETACODER Data Systems AG ("Gretacoder"), a subsidiary of the Company, manufactures and markets cryptographic equipment primarily in Switzerland and Europe. Encryption technologies are utilized by the Company to provide selective access to computer networks, prevent electronic eavesdropping or alteration during electronic data transmission; to provide message authentication confirming that messages are received in unaltered form; and to enable user authentication and digital signatures verifying the identity of the message sender and limiting computer access to authorized users. The Company offers a choice of encryption algorithms to provide the level of network security appropriate for each client application. The Company's clients include seven of the largest banks in the U.S., Union Bank of Switzerland, the Society for Worldwide Interbank Financial Telecommunications ("SWIFT") an international financial clearing house, The Euroclear System ("Euroclear"), TRW Inc., major federal, state and international law enforcement agencies and the U.S. Department of Treasury. While the network security market has traditionally been limited to financial institutions and government agencies, the Company believes that emerging electronic commerce applications, particularly business-to-bank and business-to-business, provide new market opportunities. In the second half of 1996, the Company introduced "SafeNet/Enterprise(TM)", a comprehensive, centrally managed VPN security system that enables secure use of public networks, such as the Internet, for private business transactions. In 1997 software and smartcard based product members were added to the SafeNet product family. 2 3 This product introduction substantially increased unit sales and expanded the market for SafeNet products by lowering significantly the cost per client device. The Company was originally incorporated in Maryland on April 7, 1983 under the name "Industrial Resource Engineering, Inc." The Company reincorporated under its present name in Delaware by merging with its subsidiary in March 1989. The Company's executive offices are located at 8029 Corporate Drive, Baltimore, Maryland 21236, and its telephone number is (410) 931-7500. The Market for Enterprise Network Security Solutions Virtual Private Networks allow corporations 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 Frame Relay networks corporations can generally achieve substantial cost savings by using VPNs. 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. Remote access to computers has increased substantially due to the use of remote databases, 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 partners and numerous other arrangements. 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. Unsecured data transmitted over public networks, such as the Internet, is subject to interception, electronic vandalism or terrorism, and alteration. The increased use of networked computers also increases risk, both by multiplying the number of access points to valuable data and the number of personal computers which can be utilized to obtain unauthorized information. The Company believes that the use of computer networks such as the Internet, will continue to expand and that, as the reliance on these networks grows, organizations will become more dependent on the integrity and security of the network. BUSINESS STRATEGY The Company's objective is to be a leading provider of secure network systems, services and products to the growing market for Virtual Private Networks. The key elements of the Company's strategy are as follows: Provide Clients with a Broad Range of Enterprise Network Security Solutions The Company has historically grown by applying its technological competence to the development of network security systems and products for use in the complex computer networks of financial, corporate and government clients. The Company's focus on technology has led to a family of products which have reduced the complexity and cost associated with applying encryption technology to computer networks. The SafeNet/Enterprise(TM) product line includes firewalls, encryption and user identification tokens in a comprehensive, centrally managed system. The Company believes that this focus on technology is vital for its future growth and will continue to invest its resources accordingly. Develop an Original Equipment Manufacturer Business The Company believes that, due to the fact that security is a major concern among network users, manufacturers of computer and communications products are seeking to add security capabilities to their products. Consequently, the Company is developing a family of products which can be incorporated into computers and communications products manufactured by others. Such products include smart card readers, a secure communications chip and a line of products designed around the chip. 3 4 Develop a Transaction Services Business The Company is leveraging its network security expertise to develop a transaction services business since it believes that the recurring revenue stream and strategic relationships generated from such business will be instrumental to its future growth. In the second half of 1996, the Company established the SafeNet/Trusted Services facility at Company headquarters to provide security management services such as subscriber enrollment, product configuration, digital certificates, and key management services to Internet access providers and directly to end users. The Company expects to receive both monthly fixed and fee per transaction revenue for providing such services. Establish Key Strategic Relationships The Company seeks to establish domestic and international relationships with organizations that have the ability to expand the use of encryption technology. Relationships currently exist with the following: Analog Devices Inc. ("ADI"), a leading manufacturer of high-performance integrated circuits, is assisting the Company in the design, manufacture and marketing of the Company's new secure communications chip. The new chip will provide organizations with a highly secure, inexpensive solution to conducting business over computer networks. CyberGuard Corporation, a leading provider of network security solutions, has entered into a joint product development and marketing agreement aimed at providing a comprehensive security solution for Internet business communications. Financial Services Technology Consortium is a group of leading financial institutions whose goal is to utilize emerging technologies to enhance the competitiveness of the financial services industry. The Company is a member of a multiple industry team formed to design and implement an electronic check for use on the Internet by consumers and businesses. PRODUCT DESIGN STANDARDS Encryption technologies are utilized by the Company to provide selective access to computer networks, prevent electronic eavesdropping or alteration during electronic data transmission; to provide message authentication confirming that messages are received in unaltered form; and to enable user authentication and digital signatures verifying the identity of the message sender and limiting computer access to authorized users. The Company offers a choice of encryption algorithms to provide the level of network security appropriate for each client application. All of the Company's network security systems and products comply with the following general product design standards: Standards Compliance The Company's policy is to offer products based upon encryption algorithms that have been approved as industry and government standards. This provides the Company's clients assurance that they are using interoperable products which meet commercial reasonability tests as applied by both government regulation and courts of law. Network Compatibility The Company's systems and products contain sufficient intelligence to accommodate the specific communication protocols employed by complex computer networks. Appropriate models of each product type are provided to support Frame Relay, Dial Asynchronous, leased line, X.25, Bisync and Internet protocol-based networks. This network compatibility results in security systems that are completely independent of the computer 4 5 hardware systems and software application programs used by clients. No modifications to hardware or application software are required to implement the Company's systems and products. Ease of Use The Company 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, the Company's products are designed to function without user involvement, thus offering an extremely high level of ease of use. Ease of Administration The Company has extended its ease of use concept to the central management of a secure network with a product known as the SafeNet/Security Center(TM) ("SSC"). The SSC provides central management and tracking capability for the entire encrypted network thus reducing the cost of implementing security for client organizations. For organizations aiming to defer capital and personnel investment, the Company's SafeNet/Trusted Services facility provides comprehensive security management as an optional service performed at the Company's headquarters. Price Performance Criteria The Company believes that in order for clients to invest in encryption technology, its products must be implemented cost effectively. As such, the Company's development staff follows a design approach similar to that used with consumer electronics products that are designed for low manufacturing cost. ENCRYPTION ALGORITHMS At present, the Company's products employ a variety of encryption algorithms including the U.S. Government Data Encryption Standard, ("DES"), RSA Data Security Inc. Encryption Standard, ("RSA") and Gretacoder Data Systems Encryption Standard, ("GDS"). DES, as described in American National Standards Institute ("ANSI") Standard X3.92, has been certified by the National Institute of Standards and Technology ("NIST") and is the accepted encryption algorithm for commercial and non-classified government applications in the U.S. as well as financial applications worldwide. The Company has received export approval from the U.S. Commerce Department to export its products with the DES algorithm. The Company holds a license to use RSA; a leading public key based encryption algorithm. RSA is used in Company products to generate and verify digital signatures as well as for key management purposes. GDS is a strong algorithm employing encryption keys which are much longer than keys in algorithms that are exportable from the United States. GDS is used by security conscious European organizations including banks and governments. New encryption algorithms are periodically proposed as industry standards. The Company's policy is to adopt and offer its clients new algorithms for various applications as they become certified by standards organizations such as ANSI, NIST and the Internet Engineering Task Force. The Company is currently developing products which include Triple DES, a longer key length version of DES. CURRENT NETWORK SECURITY PRODUCTS AND SYSTEMS The Company's principal network security systems and products secure information transmissions on public and private networks. 5 6 Public Network/Internet Products SAFENET/ENTERPRISE(TM). In the second half of 1996, the Company introduced SafeNet/Enterprise(TM), a comprehensive, centrally managed security system that enables secure use of public networks, such as the Internet, for private business transactions. By providing a high level of security, SafeNet/Enterprise(TM) will allow organizations to reduce their networking costs by using the Internet instead of costly private networks. The product line includes: - SafeNet/Smartcard(TM) is a credit card user token that stores user identification and encryption keys in an advanced computer chip, - SafeNet/Soft(TM) is a Windows compatible software package that provides continuous user authentication, one-time password generation and data encryption, - SafeNet/LAN(TM) Encrypting Firewall which provides security for LAN connections to the Internet, as well as packet filtering, - SafeNet/Firewall(TM) is a highly secure proxy firewall based on the CyberGuard Firewall, - SafeNet/Dial(TM), a secure pocket modem operating at 28.8 bps for secure dial access to the Internet by remote users such as traveling professionals and telecommuters, - SafeNet/Dial-R(TM) provides security identical to the SafeNet/Dial(TM), without the integral modem, - SafeNet/Security Center(TM), a high performance workstation which automatically manages the entire suite of SafeNet/Enterprise(TM) products, - SafeNet/Trusted Services(TM) provides central management of VPN security as a service 24 hours a day, 365 days a year. Private Network Products SECURE MODEMS. In 1994, the Company introduced its AX400 Secure Modem. The AX400 is a portable device that fits in the palm of a user's hand, weighs just a few ounces and uses power from the remote computer. It contains an internal modem that delivers a 14.4K bps data rate while in secure operation using standards compliant encryption technology. The AX400 also generates a random password for each communications session when a user enters the appropriate personal identification number. Due to its small size, user authentication and data protection capabilities, the AX400 is convenient for mobile or remote users. SECURE DIAL ACCESS SYSTEMS. These products are designed to protect data communications when remote users access host computers via the voice telephone network and are most commonly employed when personal computers are communicating with central computer sites, such as company headquarters. Since computer communications are taking place over normal, unsecured telephone lines, some type of security is frequently required in these applications. GRETACODER FRAME RELAY ENCRYPTORS. The GDS Frame Relay encryptor combines the advantages of circuit and packet switched services: small delays over the network and lower transmission cost. The properties of Frame Relay make it especially suitable for LAN interconnections where bursty traffic has to be transmitted. X.25 SECURITY SYSTEMS. Complex computer networks such as X.25 networks break down the data stream sent from computers into smaller, more manageable pieces called, "packets" which contain address and routing information as well as user data. The X.25 Security System selectively applies encryption technology only to the users data while leaving address and routing information intact, thus assuring proper delivery of user data in secure form at minimal expense. The Company markets X.25 Security Systems under both the IRE and GDS names. 6 7 LINK SECURITY SYSTEMS. While dedicated links are inherently more secure than dial networks, the nature of the data that is frequently transmitted over dedicated lines (the connections to bank branch offices, for instance) often requires a high level of security. IRE's products are designed to protect synchronous or asynchronous communications at speeds up to 64K bps over dedicated telephone lines. GDS products are designed to protect synchronous or asynchronous communications at speeds up to 2M bps over dedicated telephone lines. The Link Security Systems are protocol transparent and supports asynchronous, bisynchronous, SDLC and HDLC communications protocols. NEW PRODUCT DEVELOPMENT The Company 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. New products, capable of a high level of security on the Internet, were introduced under the SafeNet/Enterprise(TM) brand name in the second half of 1996. The Company intends to continue to develop new versions of the SafeNet/Enterprise(TM) products to support growth of both its product and service businesses. New encryption algorithms such as the digital signature standard, escrowed encryption and RSA utilize a technology generally known as public key encryption. The Company believes that this new technology has potential widespread demand, and is therefore developing products that utilize this new technology to manage the security of large computer networks. In January 1997, the Company announced that it is developing a low-cost secure communications chip with ADI. The new chip can combine encryption and communications functions, such as modems and LAN adapters, on a single integrated circuit. The chip supports current and future security standards and can be software personalized for communications applications such as LAN, ADSL, ISDN and cable modems. The initial secure communications chip will be aimed at environments which require encrypted communications at high speed. Gretacoder is also developing a high performance encryption chip which will employ the Triple DES Encryption algorithm. Since this chip was entirely developed and manufactured outside the United States, the Company believes that it is not subject to U.S. Government export controls. The Company is currently devoting significant resources toward the foregoing product development activities. There can be no assurance that the Company will successfully complete the development of these products in a timely fashion or that the Company's current or planned products will satisfy the needs of the computer and network security market. PRINCIPAL CLIENTS The Company focuses its marketing efforts on both commercial and U.S. government sales. The Company's largest clients vary from year to year and the Company has experienced shifts in sales patterns with large clients in the past. Accordingly, the complete loss of any large client or substantial reduction of sales to such clients could have a material adverse effect on the Company. Principal commercial clients of the Company, which accounted for more than 10% of total revenues, by year and percentage of revenue were Lockheed Martin with 15%, in 1997, and MCI with 27% and 13% of revenues in 1996 and 1995, respectively. For the year ended December 31, 1995, the percentage of revenues from sales to agencies of the U.S. government was 26%. Commercial Clients Sales to financial institutions are a central part of the Company's business. Banks use the Company's network security systems and products to protect corporate cash management applications. In these systems, financial 7 8 officers located at corporations use personal computers to dial into the bank's computing facility in order to transfer funds electronically. In the past year the Company received orders from TRW Inc., the prime contractor for the development and maintenance of the Treasury Communications System (TCS) of the U.S. Department of Treasury. The Company's AX Family and SafeNet/Enterprise(TM) products are being used to protect communications between Treasury departments and offices nationwide. The Company's automated key management center was also purchased by TRW for user identification and authentication, real-time security monitoring, audit services and electronic key delivery. In addition to TRW Inc., several other customers placed orders for the Company's SafeNet/Enterprise(TM) products including Credit Management Solutions, Inc. ("CMSI"), a provider of consumer credit applications on the Internet; State of Maryland Motor Vehicle Administration, a provider of on-line applications including electronic vehicle registration; and Interbanking S.A., a financial institution providing Internet protocol based communications with 3,000 corporate customers in Argentina. Euroclear is the world's largest provider of security clearinghouse services to over 1,400 large international banks and brokerage firms. Euroclear is owned by a consortium of 120 international financial institutions. The Company's network security systems and products are used to protect the money transfer service available to Euroclear participants. When the participant authorizes a wire transfer for payment, the transfer is protected by the Company's network security systems and products. Participants who wish to use the wire transfer service are required to purchase the Company's remote security devices which provide message authentication, user authentication and data encryption for the participant's funds transfers communications. GDS has also recognized the emerging information security needs of commercial clients, primarily transactions between banks. GDS products are utilized commercially in several countries to protect financial transactions from wiretapping and fraudulent data manipulation. Several Swiss banks and other financial institutions use GDS units to protect their electronically transmitted transactions, including 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. Government Clients The U.S. Department of Treasury uses the Company's network security systems and products to protect the electronic payment of the government's bills for civilian agencies, securing approximately 750 million payment requests each year, with an annual value of more than $700 billion. In the electronic certification system provided to the U.S. Department of Treasury, the Company's products verify the integrity of electronic payment orders using message and user authentication. The U.S. Department of Energy uses a large installation of the Company's Link Security System in a communications network that is part of a premises security system at a highly classified location. The Department of Energy has deployed the Company's Link Security System at an additional installation. Other government agencies deploying the Company's systems and products include the Federal Bureau of Investigation, National Crime Information Network, U.S. Drug Enforcement Agency and U.S. Customs Service. The Company's security systems and products are utilized by these law enforcement agencies to protect sensitive information traveling across telephone and computer networks. CLIENT SUPPORT AND PRODUCT WARRANTIES The Company provides support for clients through a staff of support engineers knowledgeable in both the Company'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. 8 9 The Company provides client telephone support, including 24 hour a day "hot line" support. In addition, the Company offers on-site training, installation and trouble-shooting services, generally on a fee basis. The Company 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, telephone support, software and firmware support, regular maintenance releases for products and early access to major product enhancements. The Company also offers support on a time and materials basis. SALES AND MARKETING Sales In 1997, the Company continued to transition to indirect distribution channels in order to expand worldwide sales coverage. In North America, IRE sells its products through a direct sales force and selected distributors which include Value Added Resellers and Internet Service Providers. In Switzerland, GDS sells its products through a direct sales force reporting to a sales manager at GDS. Outside of such territories, the Company and GDS sell their products through distributors of communication or information security products. Support for these distributors is provided by a sales force headed by a Vice President of International Sales. Marketing In 1997, the Company's marketing program emphasized continued trade show participation to generate sales leads resulting in increased coverage of the Company's products in leading trade publications. In addition, the Company has upgraded the quality of its sales materials, equipping each sales employee with the capability to make live demonstrations illustrating the value and efficacy of secure communications to prospective clients. INVENTORY, SUPPLIES AND MANUFACTURING Components for the Company'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 the Company'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 the Company's operations. However, while the Company has not experienced any significant supply problems in the past, it is possible that in the future the Company may encounter shortages in parts, components, or other elements vital to the manufacture, production and sale of its products. GDS operations are quality certified according to ISO 9001 and EN 29001. This is meant to ensure that quality control procedures satisfying the requirements of these standards are maintained in all processes performed by GDS. Actual compliance and control are checked by semi-annual third party audits. In addition to manufacturing, such certifications also extend to marketing, sales and administration. The Company anticipates that it will continue to utilize qualified suppliers and electronic assembly firms to produce sub-assemblies. The Company presently performs 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. The Company has and will continue to utilize contract manufacturers for products requiring high volume production. COMPETITION The network security market is relatively new, highly competitive and subject to rapid technological changes. The Company believes that competition in this market is likely to intensify as a result of increasing demand for network security products. There are several companies in this field that have been established longer than the 9 10 Company, and have greater financial, research, service support and marketing resources than those of the Company. There are also a number of other data encryption methods on the market, both hardware and software, which compete with the Company's products. Management believes that the principal competitive factors affecting the network security market include standards compliance, quality/reliability, technical features, network compatibility, ease of use, client service and support, distribution and price. Although the Company believes its products currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors. If the network security market continues to develop, it will likely be characterized by rapid advances in technology and the continuing introduction of new products which could render the existing technology upon which the Company's products are based obsolete or non-competitive. This risk will increase to the extent that the Company's competitors include manufacturers of computer equipment and modems to which the Company's products relate, since such manufacturers may be in a better position than the Company to develop security products in anticipation of developments in their computer equipment. INTELLECTUAL PROPERTY In September 1996, the Company was awarded a United States Patent covering portable encrypting and authenticating network interface devices such as modems. The new patent provides the Company with ownership rights to a technology that the Company believes will be applicable to the growth of computer networks, such as the Internet. The patent covers various forms of pocket-sized devices including PCMCIA and Smartcard-based secure tokens and is adaptable to modems and newer network technologies including ISDN, ADSL and cable modems. The Company's products covered by the patent include the SafeNet/Dial(TM) and the AX400. Two additional U.S. patent applications and an international (PCT) patent application, which cover the same products and technology, are pending. The Company has acquired a worldwide license under a United States Patent for a self authenticating fingerprint identification card for certain computer security and financial applications from CardGuard International, Inc. The Company has filed ten (10) provisional applications related to its chip development activities. The computer software source codes, which are essential elements of the Company's products, are the proprietary trade secrets of and are copyrighted by the Company. The protection of proprietary technology and information developed by the Company will be limited to such protection as the Company may be able to secure pursuant to trade secret or copyright laws or under any confidentiality agreements which it may enter. The Company owns federally registered trademarks for the Company 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, the Company is a party to confidentiality agreements with its officers, directors and employees. There can be no assurance that the scope of any such protection the Company is able to secure will be adequate to protect its proprietary information, or that the Company 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 independently of the Company. The Company 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. 10 11 EMPLOYEES As of March 20, 1998, the Company had approximately 129 full time employees, of whom 17 are engaged in assembly and quality control, 15 in administration and financial control, 53 in engineering, development and client support, and 44 in marketing and sales. The Company employs 99 full time employees in the U.S. and 30 persons are in Switzerland. 11 12 GLOSSARY OF TECHNICAL TERMS ALGORITHM A process or procedure, generally expressed as a set of instructions for carrying out a particular task. ASYNCHRONOUS Data transmission that takes place one character (of 5 to 8 bits) at a time, with each character preceded by a start code and followed by a stop code of set duration. BISYNCHRONOUS (BISYNC) A type of synchronous communication protocol characterized by bi-directional transmission of character-oriented data. DEDICATED LINK A type of network wherein telecommunications lines are dedicated to particular clients along predetermined routes. DIAL ASYNCHRONOUS A type of network wherein remote computers access a host computer through dial telephone lines and the clocks need not be synchronous. DIGITAL SIGNATURE A mechanism that allows the recipient of information stored in digital form to prove that the information originated from the claimed source. DIGITAL SIGNATURE STANDARD A U.S. Government standard for digital signatures using the Digital Signature Algorithm, proposed by NIST. ENCRYPT, ENCRYPTION TECHNOLOGY The protection of data employing cryptographic procedures to convert it to a form that is unintelligible until it is converted back to its original form. FIREWALL Hardware or software devices which screen data traffic at Internet access points in order to assure that only authorized data and users can reach computers that are connected to the network. FRAME RELAY A data communication technology that is used to provide higher speed for Internet connections. Its usual application is in connecting work groups rather than individuals. HDLC High Level Data Link Control. A well-known family of data link layer protocols defined by the International Standards Organization. INTERNET A global collection of interconnected computer networks which use TCP/IP, a common communications protocol. INTRANET A network within an organization which provides similar services to the Internet but is not necessarily connected to it. ISDN A collection of telecommunications protocols and standards for high-speed, error-minimized, digital data and voice transmission at speeds up to 128 Kbps worldwide. KEY, CRYPTOGRAPHIC KEY A sequence of letters/numbers/bits which is used by a cryptographic algorithm to transform data from plaintext to ciphertext or vice versa. DES uses a key which is 56 bits long. KEY MANAGEMENT SYSTEM OR CENTER The physical place or workstation running specialized programs that are responsible for generating, disseminating, distributing, changing, replacing, storing, checking, and destroying cryptographic keys. 12 13 LAN Local-Area Network. An interconnected set of systems and devices--such as PCs, mainframes, workstations, minicomputers, file servers, terminals, printers, and other communications and computing devices--within a localized environment. LINK ENCRYPTION The use of encryption at the beginning, and decryption at the end, of each link in a communications chain. MESSAGE AUTHENTICATION A system in which a cryptographic checksum/checkfunction is created for a message, and the result added to the message. The recipient performs the same procedure on the message and compares the computed result to that appended to the original message to verify that it is complete and has not been modified in any way. PACKET A collection of data and control characters in a specified format that are transferred as a whole. PRIVATE KEY One of the two keys in a public-key cryptographic system--normally the key used for decryption--which is kept secret. PROTOCOL A set of rules and conventions for communications, especially those in a network, that include specifications of syntax, semantics, and timing. PUBLIC KEY One of the two keys in a public-key cryptographic system, normally made public or distributed to others for their use in encrypting messages to a particular recipient. PUBLIC-KEY CRYPTOGRAPHY A cryptographic system employing separate keys for encryption and decryption. One of the keys can be made public, thus enabling a message to be encrypted for transmission to a particular recipient, preserving its confidentiality because no one without the private key can decipher the message. SDLC Synchronous Data Link Control. A bit-oriented IBM version of HDLC protocol, as used in IBM's Systems Network Architecture. SMARTCARD A plastic card resembling a credit card containing one or more computer chips and logic for identification, special-purpose processing, and data storage and distribution. SYNCHRONOUS DATA Transmission that takes place with predictable, exact departure or arrival times regulated by clocking data. TCP/IP Transmission Control Protocol/Internet Protocol. A suite of network protocols that allow computers with different architectures and operating system software to communicate with other computers on the Internet. USER AUTHENTICATION Generally, a means of verifying the claimed identity of an individual computer user or terminal so as to properly determine what access rights are to be given. VPN Virtual Private Network. A virtual network created by using encryption to create a secure "tunnel" through a public network, thereby allowing companies to use the lowest cost network infrastructure for their business communications. X.25 A widely used protocol standard for telecommunications between a computer and a packet-switched data network; it encompasses layers 2 and 3 of the OSI model. 13 14 ITEM 2 - PROPERTIES The Company 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 the Company's executive headquarters, United States production and SafeNet Trusted Services facilities. The lease, which expires in June 2003, requires the Company to pay real estate taxes, insurance and maintenance. The lease, which provides for annual increases in rentals during each year of the lease, requires the Company to pay approximately $170,000 in 1998. GDS leases approximately 20,000 square feet for its administrative and production facilities in Regensdorf, Switzerland. The lease, which expires on December 31, 2002, calls for an annual rental of approximately $268,000. The Company also leases office space in Danvers, Massachusetts, Bethesda, Maryland, Princeton, New Jersey, and Dallas, Texas. ITEM 3 - LEGAL PROCEEDINGS The Company knows of no litigation or proceeding, pending or threatened, to which the Company is or may become a party. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 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. PART II ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED MATTERS The following table sets forth the range of high and low sales prices for the Company's Common Stock, as reported by the Nasdaq National Market under the symbol IREG.
HIGH LOW ---- --- 1998: First Quarter (through March 20, 1998) $7.38 $5.88 1997: Fourth Quarter 11.38 6.00 Third Quarter 15.75 10.63 Second Quarter 14.50 6.25 First Quarter 10.75 6.88 1996: Fourth Quarter 20.25 8.75 Third Quarter 24.75 10.50 Second Quarter 29.50 17.75 First Quarter 25.50 16.00
14 15 On March 20, 1998, the last reported sale price of the Company's Common Stock was $7.25, as reported by the Nasdaq National Market. As of that date, there were approximately 198 holders of record of the Common Stock and 4,000 beneficial holders of the Common Stock. The Company has not paid dividends on its Common Stock and intends for the foreseeable future to retain earnings, if any, to finance the expansion and development of its business. ITEM 6 - SELECTED FINANCIAL DATA The selected financial data set forth below as of and for each of the five-years ended December 31, 1997 are derived from the Consolidated Financial Statements of the Company, which financial statements have been audited by KPMG Peat Marwick LLP. The Consolidated Financial Statements as of December 31, 1996 and 1997 and for each of the years in the three year period ended December 31, 1997 are included elsewhere herein. The selected financial data is qualified by and should be read in conjunction with the Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
Year ended December 31, ------------- ------------- ------------- ------------ ------------ 1993 1994 1995 1996 1997 ------------- ------------- ------------- ------------ ------------ STATEMENT OF OPERATIONS DATA Revenues $ 2,631 $ 3,424 $ 8,149 $ 14,317 $ 16,007 Cost of Revenues 871 1,233 3,318 7,672 6,971 ------------- ------------- ------------- ------------ ------------ Gross Profit 1,760 2,191 4,831 6,645 9,036 Operating expenses Research and development expenses 627 906 1,299 3,840 3,756 Sales and marketing expenses 665 1,083 1,979 4,692 6,720 General and administrative expenses 541 705 1,331 2,976 2,570 Amortization of acquired intangible assets - 410 631 733 122 Write-off of unamortized acquired intangible assets from the Connective Strategies, Inc. acquisition - - - 2,216 - ------------- ------------- ------------- ------------ ------------ Operating loss (73) (913) (409) (7,812) (4,132) Interest income (expense), net 117 24 (96) 728 494 ------------- ------------- ------------- ------------ ------------ Earnings (loss) before income taxes 44 (889) (505) (7,084) (3,638) Income tax expense (benefit) (15) (173) 190 - - ------------- ------------- ------------- ------------ ------------ Net earnings (loss) 59 (716) (695) (7,084) (3,638) Preferred stock dividends 128 85 82 - - ------------- ------------- ------------- ------------ ------------ Net loss attributable to common stock $ (69) $ (801) $ (777) $ (7,084) $ (3,638) ============= ============= ============= ============ ============ Loss per common share-basic and diluted $ (0.02) $ (0.25) $ (0.20) $ (1.34) $ (0.67) ============= ============= ============= ============ ============
15 16
Year ended December 31, ------------ ------------ ------------ ------------ ------------ 1993 1994 1995 1996 1997 ------------ ------------ ------------ ------------ ------------ BALANCE SHEET DATA Working Capital $ 3,536 $ 671 $ 2,186 $16,664 $12,499 Intangible Assets 384 3,974 4,927 3,223 3,503 Total Assets 4,812 7,724 15,472 24,653 21,531 Long-term debt - 116 47 17 - Stockholders' equity 4,236 5,405 8,216 21,861 17,980
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 the Company'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, other competitive factors leading to a decrease in anticipated revenues, achieving technical and product development milestones, the ability to manufacture product in a timely manner to meet market demand, market acceptance of products, the ability to negotiate favorable purchase and sale agreements, and sufficient cash flow for future liquidity and capital resource needs. Gross margins can vary from quarter to quarter based on product and channel mix, and current gross margin levels may not be indicative of future results. The Company's historical and prospective operating results have been and are expected to continue to be 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. The Company's expense levels are based, in part, on expectations of future revenues. The size and timing of the Company's historical revenues have varied 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. These factors, among others, could cause results to differ materially from those in the forward looking statements. OVERVIEW The Company designs, manufactures and markets enterprise network security solutions using encryption technology. The Company's 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. In order to expand its product offerings, the Company acquired GDS in October 1995. GDS designs, manufactures and markets cryptographic equipment primarily in Switzerland and Europe. While Management is committed to the long-term profitability of the Company, the recent growth of the computer security industry has made it important that market share be obtained. The Company has undertaken various strategies in order to increase its revenues and improve its future operating results, including the GDS 16 17 acquisition and new product offerings such as its SafeNet/Enterprise(TM) products for the Internet and the SafeNet/Security Center(TM), a high performance workstation which automatically manages SafeNet/Enterprise(TM) products. Management believes that growth in the market for products that provide secure remote access to computer networks requires the Company to increase its investment in development, sales and marketing activities to allow the Company 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 THE COMPANY The following table sets forth certain Consolidated Statement of Operations data of the Company as a percentage of revenues for the years ended December 31:
1995 1996 1997 ------------ ------------- ------------- Revenues ................................................ 100 % 100 % 100 % Cost of Revenues ........................................ 41 54 44 ------------ ------------- ------------- Gross profit ..................................... 59 46 56 Operating Expenses Research and development expenses ....................... 16 27 23 Sales and marketing expenses ............................ 25 32 43 General and administrative expenses ..................... 16 21 16 Amortization of acquired intangible assets .............. 7 5 1 Write-off of unamortized acquired intangible assets ..... from the CSI acquisition ......................... - 15 - ------------ ------------- ------------- Operating loss ................................... (5) (54) (27) Interest income (expense), net .......................... (1) 5 3 ------------ ------------- ------------- Loss before income tax expense ................... (6) (49) (24) Income tax expense ...................................... 2 - - ============ ============= ============= Net loss ................................................ (8) % (49) % (24)% ============ ============= =============
Year ended December 31, 1997, Compared to Year ended December 31, 1996 Revenues increased 12%, or $1.7 million, to $16.0 million for the year ended December 31, 1997, from $14.3 million in 1996. During 1997, the Company was able to generate revenues from new and existing clients that more than offset the loss of revenue due to the termination of the product agreement with MCI Telecommunications Corporation ("MCI"), and lower revenues from GDS. The revenue increase in 1997 was primarily a result of the increased level of product development services provided by the engineering group in Danvers, MA. Gross margin increased to 56% for the year ended December 31, 1997, from 46% for 1996. During 1996, the Company realized a lower gross margin on the SafeNet dial access products sold to MCI. In 1997, the shift towards sales of higher gross margin products, the decrease in sales of low margin products to MCI, and the shift in the product mix towards software-based products, contributed to the increased margin. Sales and marketing expenses accounted for more than the entire increase in expenses, with a total of $6.7 million in 1997 compared to $4.7 million in 1996, an increase of $2.0 million, or 43%. The increase in sales and marketing expense was primarily a result of increased spending on personnel, mostly in the North American territory, and increased focus on marketing efforts. 17 18 Research and development expenses were at the same level in 1997 compared to 1996, with expenses totaling approximately $3.8 million. General and administrative expense decreased by 14% to $2.6 million in 1997, compared to $3.0 million in 1996 which included start up expenses associated with SafeNet Trusted Services facility. The Company had a net operating loss of $4.1 million for the year ended December 31, 1997, compared to $7.8 million in 1996. The 1996 operating loss includes charges for amortization of acquired intangible assets from the acquisitions of CSI and GDS of approximately $0.7 million. The 1996 loss also includes a one-time charge of $2.2 million for the write-off of unamortized acquired intangible assets from the Connective Strategies, Inc. acquisition. Net interest income totaled $0.5 million in 1997, compared to $0.7 million in 1996, due to the lower level of investable funds. The Company had a net loss of $3.6 million for the year ended December 31, 1997, compared to a net loss of $7.1 million in 1996. The loss per common share - - basic and diluted, was $0.67 for the year ended December 31, 1997, compared to a loss of $1.34 per share in 1996. Year ended December 31, 1996, Compared to Year ended December 31, 1995 Revenues increased 76%, or $6.2 million, to $14.3 million for the year ended December 31, 1996, from $8.1 million in 1995. Of the increase, $2.2 million is attributable to network security systems and products, mainly the SafeNet/Dial(TM) products. The remainder of the increase, $3.9 million, is attributable to the inclusion of GDS revenues for twelve months in 1996 but only for two months in 1995. Revenues for 1995 on a pro forma basis, which includes GDS, were $13.2 million. The Company concluded discussions with MCI in the fourth quarter of 1996 to terminate a previous product agreement under which MCI was obligated to purchase $7.0 million of SafeNet/ Enterprise(TM) products during the twelve month period ending September 30, 1997. As a result, the Company experienced only a nominal increase in network security systems and products when the revenues for the last six months of 1996 are compared to revenues for the same period in 1995 and revenues from MCI are removed from both periods. Gross margin decreased to 46% for the year ended December 31, 1996, from 59% in 1995. On a pro forma basis, which includes GDS, the gross margin was 61% in 1995. The decrease was caused by higher costs associated with the production of SafeNet/Dial(TM) products, changes in the GDS product mix and a favorable profit margin on a large purchase order in 1995. The Company realized a lower gross profit on the SafeNet/Dial(TM) products sold to MCI in 1996 in order to obtain market share. Research and development expenses increased 196%, or $2.5 million, to $3.8 million for the year ended December 31, 1996, from $1.3 million for 1995. The inclusion of GDS for the entire year in 1996 accounted for $1.4 million of the increase. The remainder of the increase was primarily due to higher personnel related costs associated with the expansion of the engineering staff. Sales and marketing expenses increased by 138%, or $2.7 million, to $4.7 million for the year ended December 31, 1996, from $2.0 million in 1995. The inclusion of GDS for the entire year accounted for $1.1 million of the increase. The remainder of the increase was primarily due to higher personnel related costs associated with the expansion of the sales and marketing staffs and from increased sales and marketing activities. General and administrative expenses increased by 124%, or $1.6 million, to $3.0 million for the year ended December 31, 1996, from $1.3 million in 1995. The inclusion of GDS for the entire year accounted for $0.5 million of the increase. The remainder of the increase was primarily due to start-up costs associated with the Safe/Net Trusted Services facility and the establishment of a management information function. 18 19 The Company had an operating loss of $7.8 million for the year ended December 31, 1996, compared to $0.4 in 1995. The 1996 operating loss includes charges for amortization of acquired intangible assets from the acquisitions of Connective Strategies, Inc. ("CSI") and GDS of $0.7 million, compared to $0.6 million in 1995. The 1996 loss also includes a one-time charge of $2.2 million for the write-off of unamortized acquired intangible from the CSI acquisition. Net interest income for the year ended December 31, 1996 was $0.7 million compared to net interest expense of $0.1 million for 1995. The increase resulted from the temporary investment of surplus cash that resulted mainly from the Company's public offering of common stock in 1996. The Company had no income tax expense for the year ended December 31, 1996, compared to $0.2 million for 1995. A valuation allowance has been established since the Company's ability to fully use the net operating loss is dependent upon future taxable income. The Company had a net loss of $7.1 million for the year ended December 31, 1996 compared to a net loss of $0.7 million in 1995. The loss per common share was $1.34 for the year ended December 31, 1996, of which $0.42 is due to the one-time charge, compared to a net loss of $0.20 per common share in 1995. On a pro forma basis, which includes GDS, the net loss per common share was $0.30 in 1995 LIQUIDITY AND FINANCIAL POSITION OF THE COMPANY The Company believes that its current cash resources, together with the cash flows from operations, will be sufficient to meet its needs for its 1998 fiscal year. As of December 31, 1997, the Company had cash and short-term investments of $9.6 million, and working capital of $12.5 million. Significant uses of the Company's financial resources in 1997 include $3.5 million in operating activities, and $1.0 million in investing activities. Accounts receivable increased $1.7 million in the year, primarily a result of a large volume of shipments at the end of the fourth quarter. Inventories decreased by approximately $629,000. In August 1996, the Company signed a two year Joint Development and Marketing Agreement with CyberGuard. The companies have developed and intend to market a product that combines the Company's SafeNet/Enterprise(TM) products and CyberGuard's Firewall product. In connection therewith, the Company has prepaid a refundable $1.0 million license fee to CyberGuard. As of December 31, 1997, the Company has utilized $27,500 in credits against the prepaid license fee. The agreement provides that in the event that it is terminated prior to such credit aggregating $1.0 million, then Cyberguard shall repay to the Company the balance of the $1.0 million prepaid license fee within one year of the termination with interest at the prime rate. In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. It does not, however, specify when to recognize or how to measure items that make up comprehensive income. SFAS No. 130 is effective for both interim and annual periods beginning December 15, 1997. Earlier application is permitted. Comparative financial statements provided for earlier periods are required to be reclassified to reflect the provisions of this statement. In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial statements issued to shareholders. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. Management intends to adopt its provisions during 1998. 19 20 Management has initiated a program to prepare the Company's computer systems and applications for the year 2000. The Company expects to incur internal staff costs as well as other expenses related to infrastructure and facilities enhancements necessary to prepare the systems for the year 2000. A significant proportion of these costs are not likely to be incremental costs to the Company, but rather will represent the redeployment of existing information technology resourses. The costs incurred to date and future costs are not expected to be material to the financial statements. INFLATION AND SEASONALITY The Company does not anticipate that inflation will significantly impact its business. The Company does not believe its business is seasonal, however, because the Company recognizes revenues upon shipment of finished products, such recognition may be irregular and uneven, thereby disparately impacting quarterly operating results and balance sheet comparisons. 20 21 ITEM 8 - FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report 22 Consolidated Balance Sheets as of December 31, 1996 and 1997 23 Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997 24 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997 25 Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997 26 Notes to Consolidated Financial Statements 28
21 22 INDEPENDENT AUDITORS' REPORT The Board of Directors Information Resource Engineering, Inc.: We have audited the accompanying consolidated balance sheets of Information Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 Information Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Baltimore, Maryland March 13, 1998 22 23 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1996 and 1997
======================================================================================================================= 1996 1997 - ----------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 11,916,991 7,222,069 Short-term investments 2,311,980 2,339,408 Accounts receivable, net of allowance for doubtful accounts of $60,276 for 1997 (note 4) 1,564,381 3,216,542 Inventories (note 5) 3,543,995 2,915,331 Prepaid expenses 101,843 356,735 - ----------------------------------------------------------------------------------------------------------------------- Total current assets 19,439,190 16,050,085 Equipment and leasehold improvements, net (notes 6 and 8) 1,842,725 1,575,777 Computer software development costs, net of accumulated amortization of $336,525 and $498,430 1,142,352 1,407,076 Goodwill, net of accumulated amortization of $142,662 and $264,986 1,080,568 958,244 Prepaid license fees (note 14) 1,000,000 1,137,500 Other assets 148,406 402,337 - ----------------------------------------------------------------------------------------------------------------------- $ 24,653,241 21,531,019 ======================================================================================================================= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt (note 8) $ 18,480 16,710 Accounts payable 1,288,929 1,034,667 Accrued expenses (note 7) 1,317,389 1,736,963 Deferred revenue 150,498 762,579 - ----------------------------------------------------------------------------------------------------------------------- Total current liabilities 2,775,296 3,550,919 Long-term debt, less current maturities (note 8) 16,710 - - ----------------------------------------------------------------------------------------------------------------------- Total liabilities 2,792,006 3,550,919 - ----------------------------------------------------------------------------------------------------------------------- Stockholders' equity (notes 9 and 13): Preferred stock, $.01 par value per share. Authorized 500,000 shares - - Common stock, $.01 par value per share. Authorized 15,000,000 shares, issued and outstanding 5,458,127 shares in 1996 and 5,462,727 shares in 1997 54,581 54,627 Additional paid-in capital 30,917,584 30,929,277 Deficit (8,597,003) (12,234,705) Cumulative foreign currency translation adjustment (513,927) (769,099) - ----------------------------------------------------------------------------------------------------------------------- Net stockholders' equity 21,861,235 17,980,100 Commitments (notes 11 and 14) - - ----------------------------------------------------------------------------------------------------------------------- $ 24,653,241 21,531,019 =======================================================================================================================
See accompanying notes to consolidated financial statements. 23 24 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 1995, 1996 and 1997
============================================================================================================= 1995 1996 1997 - ------------------------------------------------------------------------------------------------------------- Revenues (note 4) $ 8,149,224 14,317,423 16,006,998 Cost of revenues 3,318,605 7,671,957 6,971,144 - ------------------------------------------------------------------------------------------------------------- Gross profit 4,830,619 6,645,466 9,035,854 Research and development expenses 1,298,808 3,840,475 3,755,766 Sales and marketing expenses 1,979,356 4,692,556 6,720,075 General and administrative expenses 1,331,194 2,976,273 2,570,200 Amortization of acquired intangible assets (note 3) 630,658 732,644 122,324 Write-off of unamortized acquired intangible assets from the Connective Strategies, Inc. acquisition - 2,216,200 - - ------------------------------------------------------------------------------------------------------------- Operating loss (409,397) (7,812,682) (4,132,511) Interest income (expense), net (95,854) 728,132 494,809 - ------------------------------------------------------------------------------------------------------------- Loss before income tax expense (505,251) (7,084,550) (3,637,702) Income tax expense (note 10) 190,000 - - - ------------------------------------------------------------------------------------------------------------- Net loss (695,251) (7,084,550) (3,637,702) Preferred stock dividends (82,270) - - - ------------------------------------------------------------------------------------------------------------- Net loss attributable to common stockholders $ (777,521) (7,084,550) (3,637,702) ============================================================================================================= Loss per common share - basic and diluted $ (.20) (1.34) (.67) ============================================================================================================= Weighted average number of common shares outstanding 3,826,831 5,304,984 5,461,611 =============================================================================================================
See accompanying notes to consolidated financial statements. 24 25 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended December 31, 1995, 1996 and 1997
=============================================================================================================================== 9% Convertible 9% Convertible redeemable cumulative redeemable cumulative preferred stock preferred stock --------------------------- ------------------------- Shares Amount Shares Amount - ------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1994 75,086 $ 751 65 $ 1 Sale of common stock, net of offering expenses - - - - Stock options exercised - - - - Conversion of preferred stock (74,586) (746) (65) (1) Redemption of preferred stock (500) (5) - - Issuance of common stock upon exercise of warrants, net of registration expense - - - - Preferred stock dividends declared - - - - Net loss for 1995 - - - - Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1995 - - - - Sale of common stock, net of offering expenses - - - - Stock options exercised - - - - Net loss for 1996 - - - - Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1996 - - - - Stock options exercised - - - - Net loss for 1997 - - - - Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1997 - $ - - $ - ===============================================================================================================================
============================================================================================================================== Common stock Additional --------------------------- paid-in Shares Amount capital Deficit - ------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1994 3,638,063 $ 36,380 6,103,099 (734,932) Sale of common stock, net of offering expenses 300,000 3,000 3,331,036 - Stock options exercised 300 3 1,478 - Conversion of preferred stock 240,464 2,405 (1,924) - Redemption of preferred stock - - (5,495) - Issuance of common stock upon exercise of warrants, net of registration expense 66,000 660 284,583 - Preferred stock dividends declared - - - (82,270) Net loss for 1995 - - - (695,251) Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1995 4,244,827 42,448 9,712,777 (1,512,453) Sale of common stock, net of offering expenses 1,172,500 11,725 21,023,046 - Stock options exercised 40,800 408 181,761 - Net loss for 1996 - - - (7,084,550) Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1996 5,458,127 54,581 30,917,584 (8,597,003) Stock options exercised 4,600 46 11,693 - Net loss for 1997 - - - (3,637,702) Foreign currency translation adjustment - - - - - ------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1997 5,462,727 $ 54,627 30,929,277 (12,234,705) ===============================================================================================================================
================================================================================================== Cumulative foreign currency Net translation stockholders' adjustment equity - -------------------------------------------------------------------------------------------------- Balance at December 31, 1994 - 5,405,299 Sale of common stock, net of offering expenses - 3,334,036 Stock options exercised - 1,481 Conversion of preferred stock - (266) Redemption of preferred stock - (5,500) Issuance of common stock upon exercise of warrants, net of registration expense - 285,243 Preferred stock dividends declared - (82,270) Net loss for 1995 - (695,251) Foreign currency translation adjustment (26,310) (26,310) - -------------------------------------------------------------------------------------------------- Balance at December 31, 1995 (26,310) 8,216,462 Sale of common stock, net of offering expenses - 21,034,771 Stock options exercised - 182,169 Net loss for 1996 - (7,084,550) Foreign currency translation adjustment (487,617) (487,617) - -------------------------------------------------------------------------------------------------- Balance at December 31, 1996 (513,927) 21,861,235 Stock options exercised - 11,739 Net loss for 1997 - (3,637,702) Foreign currency translation adjustment (255,172) (255,172) - -------------------------------------------------------------------------------------------------- Balance at December 31, 1997 (769,099) 17,980,100 ==================================================================================================
See accompanying notes to consolidated financial statements. 25 26 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1995, 1996 and 1997
=================================================================================================================== 1995 1996 1997 - ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net loss $ (695,251) (7,084,550) (3,637,702) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 515,647 659,792 840,499 Amortization of acquired intangible assets 630,658 732,644 122,324 Write-off of unamortized acquired intangible assets from the Connective Strategies, Inc. acquisition - 2,216,200 - Deferred income taxes 215,300 - - Changes in operating assets and liabilities: (Increase) decrease in accounts receivable (2,040,764) 2,608,430 (1,707,438) Decrease in costs and estimated earnings in excess of billing on uncompleted contracts 248,700 - - (Increase) decrease in inventories 677,587 (1,425,750) 511,506 Decrease in recoverable income taxes 184,872 32,369 - Increase (decrease) in accounts payable 136,106 (53,635) (208,882) Increase (decrease) in accrued expenses 384,301 (112,880) 468,364 Decrease in billings in excess of costs and estimated earnings on uncompleted contracts (199,225) - - Increase (decrease) in deferred revenue 64,759 (41,290) 616,561 Other 45,152 (137,878) (549,383) - ------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 167,842 (2,606,548) (3,544,151) - ------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Acquisition of GRETACODER Data Systems AG, net of cash acquired of $131,798 (439,602) - - Maturities of short-term investments 399,409 - 7,054,000 Purchase of short-term investments (902) (2,311,980) (7,081,428) Equipment expenditures (154,862) (1,274,770) (307,258) Additions to computer software development costs (538,200) (440,568) (506,042) Prepaid license fees - (1,000,000) (137,500) - ------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities $ (734,157) (5,027,318) (978,228) - -------------------------------------------------------------------------------------------------------------------
(Continued) 26 27 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued Years ended December 31, 1995, 1996 and 1997
==================================================================================================== 1995 1996 1997 - ---------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from notes payable $ 589,000 - Payments of notes payable (1,081,351) (4,053,416) - Proceeds from issuance of common stock, net of offering expense 3,619,279 21,034,771 - Redemption of preferred stock (5,766) - - Payment of preferred stock dividends (127,118) - - Payments of long-term debt (67,345) (80,979) (18,480) Stock options exercised 1,481 182,169 11,739 - ---------------------------------------------------------------------------------------------------- Net cash provided by (used in ) financing activities 2,928,180 17,082,545 (6,741) - ---------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 3,266 (188,182) (165,802) - ---------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 2,365,131 9,260,497 (4,694,922) Cash and cash equivalents at beginning of year 291,363 2,656,494 11,916,991 - ---------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 2,656,494 11,916,991 7,222,069 ==================================================================================================== Cash paid for: Interest expense $ 66,481 159,509 11,520 ==================================================================================================== Income taxes $ 800 - - ====================================================================================================
See accompanying notes to consolidated financial statements. 27 28 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended December 31, 1996 and 1997 ================================================================================ (1) BUSINESS Information Resource Engineering, Inc. (the Company) is engaged in the business of designing, manufacturing and marketing a line of products which secure data transmissions on computer networks through the use of encryption technology. During 1994, the Company acquired Connective Strategies, Inc. (CSI), which designs, manufactures and markets communications equipment enabling data and voice connectivity via the Integrated Services Digital Network (ISDN). In 1996, the Company invested in the development of a new secure communications chip. Due to this new superseding technology, which does not utilize CSI's ISDN product, the Company no longer markets its CSI products to new customers. Consequently, the Company has taken a one-time charge in 1996 of $2,216,200 related to the write-off of the unamortized acquired intangible assets from this acquisition. Future CSI ISDN product sales are not expected to be significant since the products will only be sold pursuant to commitments to existing customers. On October 31, 1995, the Company acquired all of the issued and outstanding stock of GRETACODER Data Systems AG (formerly Gretag Data Systems AG) (GDS), a company which designs, manufactures and markets cryptographic equipment. Results of operations for GDS are included in the accompanying consolidated statement of operations for the period after October 31, 1995. (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 balances have been eliminated in consolidation. CASH EQUIVALENTS The Company considers investments purchased with maturities, at date of purchase, of three months or less to be cash equivalents. SHORT-TERM INVESTMENTS Short-term investments, which consist of commercial paper and corporate bonds which mature within one year, are stated at the lower of cost or market. (Continued) 28 29 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (2) CONTINUED REVENUES Revenue is recognized from sales when the product is shipped. Unearned income on maintenance contracts is amortized by the straight-line method over the terms of the contracts. Revenues from engineering services are recognized as the services are provided. There was no material accounts receivable related to unbilled engineering services at December 31, 1996 and 1997. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. EQUIPMENT AND LEASEHOLD IMPROVEMENTS Equipment and leasehold improvements are stated at cost less accumulated depreciation. Depreciation of equipment is determined using the straight-line method over the estimated useful life of five years. Leasehold improvements are amortized over the life of the lease. COMPUTER SOFTWARE DEVELOPMENT COSTS 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. 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 net realizable value. GOODWILL The excess of acquisition costs over the fair value of net assets acquired is amortized on a straight-line basis over 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. (Continued) 29 30 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (2) CONTINUED IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. PRODUCT WARRANTIES The Company warrants to the original purchaser that each of its 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. TRANSLATION OF FOREIGN CURRENCIES Assets and liabilities of the foreign subsidiary are translated at the exchange rates as of the balance sheet dates; equity accounts are translated at historical exchange rates. Revenues and expenses are translated at the average exchange rates for the periods presented. Translation gains and losses are included in stockholders' equity. INCOME TAXES Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. STOCK OPTIONS On January 1, 1996, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, and has elected to continue to (Continued) 30 31 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (2) CONTINUED apply the intrinsic value method under Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees to account for stock-based employee compensation. Under this method, compensation cost is recognized for awards of shares of common stock to employees under compensatory plans only if the quoted market price of the stock at the grant date (or other measurement date, if later) is greater than the amount the employee must pay to acquire the stock. SFAS No. 123 permits companies to adopt a new fair value based method to account for stock-based employee compensation plans or to continue using the intrinsic value method. If the intrinsic value method is used, information concerning the pro forma effects on net earnings and earnings per share of adopting the fair value based method for stock-based employee compensation grants made in 1995 and subsequent years is required to be presented in the notes to the financial statements. The pro forma disclosures are presented in note 13 to the consolidated financial statements. LOSS PER COMMON SHARE The Company adopted SFAS No. 128, Earnings Per Share, during the year ended December 31, 1997. Statement 128 establishes revised standards for computing and presenting earnings per share (EPS) data. It requires dual presentation of "basic" and "diluted" EPS on the face of the statements of income and reconciliation of the numerators and denominators used in the basic and diluted EPS calculations. As required by SFAS No. 128, EPS data for prior periods presented have been restated to conform to the new standard. (Continued) 31 32 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (2) CONTINUED Basic EPS is calculated by dividing net loss by the weighted-average number of common shares outstanding for the applicable period. Diluted EPS is calculated after adjusting the numerator and the denominator of the basic EPS calculation for the effect of all dilutive potential common shares outstanding during the period. Information related to the calculation of net loss per share of common stock is summarized as follows for the years ended December 31:
1995 1996 1997 ---------------------- ---------------------- ----------------------- Basic Diluted Basic Diluted Basic Diluted - ------------------------------------------------------------------------------------------------------- Net loss $ (695,251) (695,251) (7,084,550) (7,084,550) (3,637,702) (3,637,702) Accrued dividends on preferred stock (82,270) (82,270) - - - - - ------------------------------------------------------------------------------------------------------- Net loss attributable to common stockholders $ (777,521) (777,521) (7,084,550) (7,084,550) (3,637,702) (3,637,702) - ------------------------------------------------------------------------------------------------------- Weighted-average shares outstanding 3,826,831 3,826,831 5,304,984 5,304,984 5,461,611 5,461,611 Dilutive securities options - - - - - - - ------------------------------------------------------------------------------------------------------- Adjusted weighted- average shares used in EPS computation 3,826,831 3,826,831 5,304,984 5,304,984 5,461,611 5,461,611 - -------------------------------------------------------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. It does not, however, specify when to recognize or how to measure items that make up comprehensive income. SFAS No. 130 is effective for both interim and annual periods beginning after December 15, 1997. Earlier application is permitted. Comparative financial statements provided for earlier periods are required to be reclassified to reflect the provisions of this statement. (Continued) 32 33 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (2) CONTINUED In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. SFAS No. 131 is effective for financial statements for periods beginning after December 15, 1997. Management intends to adopt its provision during 1998. USE OF ESTIMATES Management of the Company has made a number of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ significantly from those estimates. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments: The carrying value of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximates fair value due to the short maturity of these instruments. The Company evaluates the fair value of fixed-rate debt based upon rates currently available for similar types of borrowing arrangements. The book value approximates fair value of these instruments. SUPPLEMENTARY STATEMENT OF CASH FLOWS INFORMATION As described in note 3, during 1995 the Company purchased GDS for cash and the issuance of two promissory notes aggregating $3,853,416. RECLASSIFICATIONS Certain amounts for 1995 and 1996 have been reclassified to conform to the 1997 presentation. (Continued) 33 34 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (3) ACQUISITIONS GRETACODER DATA SYSTEMS AG On October 31, 1995, the Company acquired all of the issued and outstanding stock of GDS. The Stock Purchase Agreement provided for an initial cash payment of $431,850 and two promissory notes aggregating $3,853,416. Such amount is net of a $400,000 payment discount that the Company received upon payment of the notes in February 1996. This transaction effectively transferred all ownership of GDS to the Company and was accounted for under the purchase accounting method. The aggregate net purchase price for GDS was determined as follows: Cash purchase price $ 431,850 Notes payable 3,853,416 Transaction costs 139,550 - ----------------------------------------------------------------- Net purchase price $ 4,424,816 =================================================================
The net purchase price was allocated to the acquired tangible and intangible net assets based upon the relative fair values as follows: Cash $ 131,798 Inventory 2,346,416 Other current assets 1,484,883 Equipment and leasehold improvements 412,986 Deferred tax assets 194,000 Current liabilities (1,368,497) Goodwill 1,223,230 - ----------------------------------------------------------------- Net purchase price $ 4,424,816 =================================================================
The Company allocated $474,000 of the purchase price to inventory in excess of the carrying cost of GDS. Of this amount, $238,000 and $236,000 was charged to cost of revenues in 1995 and 1996, respectively. (4) REVENUES AND ACCOUNTS RECEIVABLE During the three years ended December 31, 1997, revenues from two commercial clients accounted for greater than 10% of annual revenues as follows: one client accounted for 13% of 1995 revenues and 27% of 1996 revenues and one client accounted for 15% of 1997 revenues. During the three years ended December 31, 1997, revenues from non-U.S. clients were 34%, 47% and 44%, respectively. The majority of these revenues were derived from European distributors and financial institutions. (Continued) 34 35 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (4) CONTINUED The Company grants credit to clients. Sales terms with clients, including distributors, generally do not provide for right of return privileges for credit, refund or other products. The Company's clients, which include both commercial companies and governmental agencies, are in various industries, including banking, security, communications and distributors of electronic products. (5) INVENTORIES Inventories consist of the following:
1996 1997 - ------------------------------------------------------------------------- Raw materials $ 1,451,142 1,208,439 Finished goods 2,092,853 1,706,892 - ------------------------------------------------------------------------- $ 3,543,995 2,915,331 =========================================================================
(6) EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET Equipment and leasehold improvements consist of the following:
1996 1997 - ---------------------------------------------------------------------------- Equipment $ 1,973,584 2,191,109 Automobiles 87,636 87,180 Leasehold improvements 629,252 630,953 - ---------------------------------------------------------------------------- 2,690,472 2,909,242 Less accumulated depreciation and amortization 847,747 1,333,465 - ---------------------------------------------------------------------------- $ 1,842,725 1,575,777 ============================================================================
(7) ACCRUED EXPENSES Accrued expenses consist of the following:
1996 1997 - ---------------------------------------------------------------------- Accrued salaries and commissions $ 694,412 1,016,970 Other 622,977 719,993 - ---------------------------------------------------------------------- $ 1,317,389 1,736,963 ======================================================================
(Continued) 35 36 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (8) LONG-TERM DEBT Long-term debt consists of the following:
1996 1997 - ----------------------------------------------------------------------------------------------------------------- Note payable to finance company bearing interest at 8.95% and requiring monthly payments of principal and interest of $1,740 through October 1998 $ 35,190 16,710 - ----------------------------------------------------------------------------------------------------------------- 35,190 16,710 Less current maturities 18,480 16,710 - ----------------------------------------------------------------------------------------------------------------- $ 16,710 - =================================================================================================================
The notes payable are secured by an automobile having a net carrying value of $59,558 and $49,126 at December 31, 1996 and 1997, respectively. (9) STOCKHOLDERS' EQUITY The 9% convertible redeemable cumulative preferred stock (9% preferred stock) required cumulative dividends of $.90 per share payable semiannually. Holders of the 9% preferred stock converted 74,586 shares of such stock into common stock of the Company during the year ended December 31, 1995. The remaining 500 shares of 9% preferred stock were redeemed for cash on June 30, 1995. In connection with the offering of the 9% preferred stock, the Company issued the underwriter warrants to purchase 66,000 shares of common stock at $4.675 per share. The warrants were exercised in June 1995. The Company received proceeds from the exercise of $285,243, net of offering expenses. In connection with the acquisition of CSI (note 1), the Company issued 65 shares of Series A Convertible Redeemable Cumulative Preferred Stock (Series A preferred stock) valued at $10,000 per share. The Series A preferred stock required cumulative dividends payable semiannually at an annual rate of 8.75%. On December 5, 1995, the 65 shares of the Series A preferred stock were converted for 65,000 shares of common stock. In February 1996, the Company completed a public offering of 1,172,500 shares of common stock at a per share price of $20.00. The net proceeds of the Company from the offering were approximately $21,035,000 after deducting offering expenses. (Continued) 36 37 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (10) INCOME TAXES Income tax expense (benefit) consists of the following:
1995 1996 1997 - ---------------------------------------------------------------------- Current: Federal $ (29,000) - - State (5,300) - - Foreign 9,000 - - - ---------------------------------------------------------------------- (25,300) - - Deferred: Federal 19,700 - - State 1,600 - - Foreign 194,000 - - - ---------------------------------------------------------------------- 215,300 - - - ---------------------------------------------------------------------- $ 190,000 - - ======================================================================
The income tax expense (benefit) differed from the amount computed by applying the Federal income tax rate of 34% to loss before income tax expense as a result of the following:
1995 1996 1997 - --------------------------------------------------------------------------------------------------------------------------- Computed "expected" tax benefit $ (171,785) (2,408,747) (1,236,819) Increase (reduction) in income taxes resulting from: State and local income taxes, net of Federal income tax benefit (2,442) (190,026) (173,387) Amortization of acquired intangible assets, not deductible for tax purposes 214,423 249,099 41,590 Write-off of unamortized acquired intangible assets from the Connective Strategies, Inc. acquisition not deductible for tax purposes - 753,508 - Foreign income taxes at rates less than 34% (72,950) - - Change in valuation allowance 169,500 1,774,500 1,635,000 Other, net 53,254 (178,334) (266,384) - --------------------------------------------------------------------------------------------------------------------------- $ 190,000 - - ===========================================================================================================================
(Continued) 37 38 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (10) CONTINUED The tax effects of temporary differences that give rise to significant portions of the deferred tax assets are presented below at December 31:
1996 1997 - ---------------------------------------------------------------------------------------------------- Deferred tax assets: Inventories, due to additional costs inventoried for tax purposes pursuant to the Tax Reform Act of 1986 $ 67,000 241,000 Net operating loss carryforward 1,906,000 3,358,000 Other 18,000 99,000 - ---------------------------------------------------------------------------------------------------- 1,991,000 3,698,000 - ---------------------------------------------------------------------------------------------------- Deferred tax liabilities: Equipment, due to differences in depreciation (22,000) (88,000) Other (25,000) (31,000) - ---------------------------------------------------------------------------------------------------- (47,000) (119,000) - ---------------------------------------------------------------------------------------------------- Net deferred tax asset 1,944,000 3,579,000 Less valuation allowance (1,944,000) (3,579,000) - ---------------------------------------------------------------------------------------------------- $ - - ====================================================================================================
The Company has net operating loss carryforwards for United States income tax purposes of approximately $8,700,000 which are available to reduce future taxable income through 2012. In addition, the Company has a net operating loss of $1,754,000 which is attributable to CSI's preacquisition period and is available to reduce future taxable income of CSI at the rate of approximately $124,000 per year and expires in various amounts through 2008. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent on the generation of future taxable income during the periods in which temporary differences are deductible and net operating losses are allowable. Based on consideration of the above factors management established a valuation allowance for which the balance was $1,944,000 and $3,579,000 at December 31, 1996 and 1997, respectively. The Company has not provided any additional U.S. income taxes on the GDS taxable income since management does not expect to repatriate such earnings. (Continued) 38 39 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (11) LEASES The Company leases office facilities and equipment under operating leases expiring at various dates through 2003. The leases require the Company to pay real estate taxes, insurance and maintenance. The Company recognizes rent expense on a straight-line basis. The annual minimum rentals under the leases as of December 31, 1997 are as follows: 1998 $ 549,387 1999 549,593 2000 464,478 2001 468,639 2002 481,621 Thereafter 115,296 ================================================================
Rent expense for the years ended December 31, 1995, 1996 and 1997 was $184,224, $518,177 and $616,465, respectively. (12) PENSION PLAN The Company has a defined contribution pension plan for employees who have completed three months of service with the Company. The Plan permits pre-tax contributions to the Plan by participants pursuant to Section 401(k) of the Internal Revenue Code (the Code) of 3% to 10% of base compensation up to the maximum allowable contributions as determined by the Code. The Company matches participants' contributions on a discretionary basis. The Company may also make additional discretionary contributions. The Company made no contributions to the plan during the three years ended December 31, 1997. (13) STOCK OPTIONS AND WARRANTS The Company has an incentive stock option plan which provides for the granting of stock options to officers, directors, consultants and key employees of the Company. Options issued pursuant to the plan are exercisable at the fair market value of the common stock on the date of the issuance of the option. Either incentive stock options or qualified stock options may be granted under the plan. The vesting and exercise periods are determined by the Board of Directors not to exceed ten years. Options issued to date generally vest 20% per year commencing with dates of employment or dates of grant and expire seven years from date of grant. (Continued) 39 40 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (13) CONTINUED Option transactions during 1995, 1996 and 1997 were as follows:
Number Range of Weighted average of shares exercise prices exercise price - -------------------------------------------------------------------------------------- Outstanding at December 31, 1994 112,600 $ 0.10 to $ 5.25 $ 3.22 Granted 151,000 $ 7.25 to $17.00 14.06 Canceled (9,700) $ 4.50 to $13.50 7.48 Exercised (300) $ 4.94 4.94 - -------------------------------------------------------------------------------------- Outstanding at December 31, 1995 253,600 $ 0.10 to $17.00 9.54 Granted 393,000 $ 9.88 to $28.63 18.45 Canceled (37,200) $ 1.30 to $17.00 12.85 Exercised (40,800) $ 0.10 to $13.50 4.46 - -------------------------------------------------------------------------------------- Outstanding at December 31, 1996 568,600 $ 1.30 to $28.63 15.92 Granted 931,250 $ 6.38 to $20.00 10.39 Canceled (500,867) $ 4.50 to $28.63 16.68 Exercised (4,600) $ 1.30 to $ 4.50 2.55 - -------------------------------------------------------------------------------------- Outstanding at December 31, 1997 994,383 $ 1.30 to $20.00 $ 10.45 ====================================================================================== Exercisable at December 31, 1997 151,599 $ 1.30 to $17.00 $ 9.33 ======================================================================================
1996 ------------------------------------------------------------------------------------------------ Options Outstanding Options Exercisable ------------------------------------------------------- --------------------------------- Weighted average Range of Number remaining Weighted average Number Weighted average exercise prices of shares contractual life exercise price of shares exercise price - ------------------------------------------------------------------------------------------------------------------------- $1.30 to $9.88 105,300 4.97 years $ 5.90 35,100 $ 3.54 $10.00 to $20.00 285,300 5.88 years 14.55 43,700 14.14 $20.38 to $28.63 178,000 6.32 years 24.02 - - - ------------------------------------------------------------------------------------------------------------------------- 568,600 5.85 years $ 15.92 78,800 $ 9.42 =========================================================================================================================
(Continued) 40 41 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (13) CONTINUED
1997 -------------------------------------------------------------------------------------------- Options Outstanding Options Exercisable ------------------------------------------------------ --------------------------------- Weighted average Range of Number remaining Weighted average Number Weighted average exercise prices of shares contractual life exercise price of shares exercise price - --------------------------------------------------------------------------------------------------------------------- $1.30 to $8.88 210,800 4.49 years $ 6.86 64,100 $ 5.24 $9.00 to $9.88 424,083 5.54 years 9.38 34,999 9.58 $10.00 to $20.00 359,500 5.73 years 13.81 52,500 14.15 - --------------------------------------------------------------------------------------------------------------------- 994,383 5.39 years $ 10.45 151,599 $ 9.33 =====================================================================================================================
The Company applies the intrinsic value method in accounting for its Plan and, accordingly, no compensation cost has been recognized for its options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss and per share amounts would have been the pro forma amounts indicated below:
1995 1996 1997 - ---------------------------------------------------------------------------------- Net loss As reported $ (695,251) (7,084,550) (3,637,702) Pro forma (760,000) (7,578,000) (4,252,000) Loss per common share - basic and diluted As reported (.20) (1.34) (.67) Pro forma (.22) (1.43) (.78) ==================================================================================
Pursuant to SFAS No. 123, pro forma net loss reflects only options granted in 1995, 1996 and 1997. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net loss amounts presented above because compensation cost recognized over the option's vesting periods and compensation cost for options granted prior to January 1, 1995 is not considered. The weighted average fair values of options granted during 1995, 1996 and 1997 were $806,000, $2,453,000 and $4,128,000, respectively, on the dates of grant. The fair values of options granted were calculated using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1995, 1996 and 1997, respectively: risk-free interest rates of 5.83% to 6.76% for 1995, 5.253% to 6.78% for 1996 and 5.71% to 6.78% for 1997; expected volatility of 32% for 1995 and 1996 and 63% for 1997; dividend yield and expected dividend growth rate of 0% in all years; and expected lives of 3 to 5 years and expected forfeitures of 0% for all years. (Continued) 41 42 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (13) CONTINUED 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. The warrants are exercisable at any time during a four-year period commencing on January 29, 1997. The price and number of shares is subject to adjustment in certain circumstances to protect against dilution. Holders of the warrants are not entitled to vote, receive dividends or exercise any of the rights of holders of shares of common stock for any purpose until such warrants are exercised. In connection with a financial consulting agreement in February 1997, the Company issued warrants to purchase 25,000 shares of common stock at $9.00 per share and 25,000 shares of common stock at $20.00 per share. The warrants are exercisable at any time during a three-year period commencing in February 1997. At December 31, 1997, the Company had reserved 1,529,300 shares of common stock for the stock option plan and conversion of outstanding warrants. (14) OTHER COMMITMENTS AND CONTINGENCIES In August 1996, the Company signed a two year joint development and marketing agreement (agreement) with CyberGuard Corporation (CyberGuard). The companies have developed and intend to market a product that combines the Company's SafeNet/Enterprise products and CyberGuard's Firewall product. In connection therewith, the Company has prepaid a refundable $1.0 million license fee to CyberGuard. As of December 31, 1997, the Company has utilized $27,500 in credits against the prepaid license fee. The agreement provides that in the event that this agreement is terminated prior to such credit aggregating $1.0 million, then CyberGuard shall repay to the Company the balance of the $1.0 million prepaid license fee within one year of the date of such termination with interest at the prime rate. (15) OPERATIONS OUTSIDE THE UNITED STATES Net income (loss) of the Company's non-U.S. subsidiary was $403,769, $(298,872) and $46,182 for 1995, 1996 and 1997, respectively. Net sales to unaffiliated customers of the Company's non-U.S. subsidiary were $2,295,843, $6,235,987 and $5,474,327 for 1995, 1996 and 1997, respectively. (Continued) 42 43 INFORMATION RESOURCE ENGINEERING, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements ================================================================================ (15) CONTINUED The Company's investment in identifiable assets and liabilities located outside the United States was as follows at December 31:
1996 1997 - ----------------------------------------------------------------------------- Current assets $ 4,002,221 4,294,819 Property, plant and equipment, net 190,187 73,789 - ----------------------------------------------------------------------------- Total assets 4,192,408 4,368,608 Current liabilities 1,257,190 1,579,718 - ----------------------------------------------------------------------------- Net assets $ 2,935,218 2,788,890 =============================================================================
================================================================================ (Continued) 43 44 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of the Company are as follows:
NAME AGE POSITION ------------------ --- ------------------------------------------ Anthony A. Caputo 56 Chairman, Chief Executive Officer and President Michael M. Kaplan 53 Senior Vice President, Technology Jill Leukhardt 41 Senior Vice President, Director Richard G. Tennant 52 Vice President of Finance and Administration, Chief Financial Officer Dubhe E. Beinhorn 41 Vice President, International Sales Sean Price 34 Vice President, North American Sales Gary L. McGreal 45 Vice President, Marketing John F. Hembrough 48 Vice President, OEM Sales Steven Turner 39 Vice President, Product Support Douglas E. Kozlay 58 Principal Engineer, Director Ira A. Hunt, Jr 73 Director Bruce R. Thaw 44 Director
All directors hold office until the next annual meeting of shareholders or until their respective successors are elected and qualify. Executive officers hold office until their successors are chosen and qualify, subject to earlier removal by the Board of Directors. Set forth below is a biographical description of each director and executive officer of the Company based on information supplied by each of them. Anthony A. Caputo, the Chairman, Chief Executive Officer and President of the Company, invested in the Company in 1986, and became a director in November 1986. In 1982, Mr. Caputo founded another computer security firm, TACT Technology, as a division of a public company, and after securing outside funding through a $3.0 million limited partnership in 1984, managed TACT as a separate company. Mr. Caputo resigned from TACT Technology in November 1986 to join the Company. Mr. Caputo has over 20 years' experience in the computer industry, in marketing and management capacities. In June 1993, Mr. Caputo was named Maryland's High Tech Entrepreneur of the Year, an annual award sponsored by organizations including Inc. Magazine, Ernst and Young LLP and Merrill Lynch. He has served as an officer of several publicly traded companies including International Mobile Machines Inc., and Comshare, Inc., as well as Value Software, now part of Computer Associates, Inc. Currently, Mr. Caputo is also a director of CardGuard International, Inc., a privately held company focused on developing fingerprint identification technology.. Michael M. Kaplan joined the Company in February 1996 as Senior Vice President, Technology. Formerly the Director of Secure Technologies at AT&T Bell Laboratories, Mr. Kaplan led the design, development and support of AT&T's security products for voice, data, fax and video applications. Mr. Kaplan was employed at AT&T Bell Labs for twenty-seven years and holds a Master of Science in Mathematics from Adelphi University and a Bachelor of Arts in Mathematics from Queens College. Mr. Kaplan holds four patents for various aspects of telephone security devices and associated services and there are two additional patents pending. Jill Leukhardt has been a Senior Vice President of the Company since June 1995. She served as the Vice President of Sales and Marketing of the Company from 1989 to 1995. She was appointed a director of the Company in December, 1990. Ms. Leukhardt possesses a graduate level degree in Electrical Engineering. From 1980 to 1986, 44 45 Ms. Leukhardt was a Marketing Manager at Intel Corporation where she managed several projects including the planning, specification and initial marketing of the 80386 microprocessor. Prior to joining the Company, from 1986 to 1989, she served as Vice President-Marketing for Micro Wholesalers, Inc., a microcomputer distributor. She has also served as a Trustee of Johns Hopkins University since July 1992. Richard G. Tennant has been Vice President of Finance and Administration and Chief Financial Officer since July 1997. Prior to joining the Company, Mr. Tennant served as Vice President of Finance and Administration and Chief Financial Officer of Netrix Corporation, a wide-area networking corporation, since 1987. Dubhe E. Beinhorn has been Vice President, International Sales since October 1996. Ms. Beinhorn's principal responsibilities include the identification and development of distribution channels, partnerships, strategic alliances and direct customer relationships outside North America. Prior to joining the Company, Ms. Beinhorn served as Vice President, International Sales for Netrix Corporation, and National Account Manager, Federal Operations at Network Equipment Technologies. Sean Price joined the Company in April 1997 as Vice President, North America Sales. His primary responsibility is managing and expanding the Company's domestic distribution channels, more specifically Value Added Resellers, systems integrators, and network service providers. Prior to joining IRE, Mr. Price was Vice President of Worldwide Sales for Nuera Communications, where he managed direct sales to carriers and end users as well as indirect sales through Value Added Resellers. Gary L. McGreal joined the Company in October 1994 in connection with the Company's acquisition of Connective Strategies, Inc., and became Director of Product Planning. In 1996 he became IRE's Director of Planning, and in 1997 he was made Vice President, Marketing. From 1985 to 1994 he was Executive Vice President and Chief Operating Officer of Connective Strategies, Inc. John F. Hembrough joined the Company in September 1997 as Vice President, OEM Sales. Mr. Hembrough is responsible for building sales channels and managing the Company's OEM division through sales of Safenet technology to major computer, communications, and software manufacturers. Prior to joining IRE, he was the Vice President/General Manager of European Operations for Raptor Systems, a software security company. Steven Turner has been with the Company since March 1988 serving as Technician, Engineer, Production Manager, and Director, Product Support. Mr. Turner has been the Vice President of Product Support since July 1994 where he is the senior manager for the manufacturing, client support, Safenet Trusted Services, and MIS groups. Prior to joining the Company, he held various positions at the U.S. Naval Research Lab, E-Systems, and the U.S. Air Force. Douglas E. Kozlay is the co-founder, and was President, of the Company from 1983 until March 1993. Mr. Kozlay's principal responsibilities include serving as the Company's chief technical officer providing guidance and advice on product architecture to the Chief Executive Officer and performing engineering functions as required. Mr. Kozlay has been a director of the Company since its inception. From 1979 to 1982 Mr. Kozlay served as President of EMAX, Inc., a company which designed and marketed data acquisition and control systems. Previously, Mr. Kozlay has served as a manager of a research and development laboratory for the U.S. National Security Agency and design engineer for IBM Corporation. In 1982 Mr. Kozlay was Director of Industrial Automation for EMC Controls. He currently teaches graduate level courses in robotics at Loyola College of Baltimore. Ira A. Hunt, Jr. has been a director of the Company since December 1990. Mr. Hunt is a graduate of the U.S. Military Academy, West Point, New York. He served 33 years in various command and staff positions in the U.S. Army, retiring from active military service as a Major General in 1978. Subsequently he was President of Pacific Architects and Engineers in Los Angeles, California and a Vice President of Frank E. Basil, Inc. in Washington, D.C. Mr. Hunt has a Masters of Science degree in civil engineering from the Massachusetts Institute of Technology; an MBA from the University of Detroit; a Doctor of the University degree from the University of Grenoble, France; and a Doctor of Business Administration degree from George Washington University. 45 46 Bruce R. Thaw has been a director of the Company since December 1990. From 1987 to the present, Mr. Thaw has served as general counsel to the Company. Mr. Thaw was admitted to the bar of the State of New York in 1978 and the California State Bar in 1983. Mr. Thaw is also a director of Amtech Systems, Inc., a publicly traded company engaged in the semiconductor industry, and Nastech Pharmaceutical Company, Inc., a publicly traded company engaged in drug delivery technology. The Company's By-Laws provide for the election of directors at the annual meeting of shareholders, such directors to hold office until the next annual meeting and until their successors are duly elected and qualified. The By-Laws also provide that the annual meeting of shareholders be held each year at such time, date and place as the Board of Directors shall determine by resolution. Directors may be removed at any time for cause by the Board of Directors and with or without cause by a majority of the votes cast by the shareholders entitled to vote for the election of directors. Officers will normally be elected at the annual meeting of the Board of Directors held immediately following the annual meeting of shareholders, to hold office for the term for which elected and until their successors are duly elected and qualified. Officers may be removed by the Board of Directors at any time with or without cause. In January 1997, the Company announced the formation of an advisory board chaired by former United States Treasury Secretary William E. Simon. Developed to assist in building shareholder value by managing and maintaining Company expansion, the Company expects to add additional high-caliber executives to its board. Subsequently, the Company announced the addition of Dr. Vinton G. Cerf, MCI's Senior Vice President of Internet Architecture and Daniel L. Mosley, a partner in the law firm of Cravath, Swaine & Moore, to the board. The Company's Certificate of Incorporation contains provisions indemnifying its officers, directors, employees and agents against certain liabilities. ITEM 11 - EXECUTIVE COMPENSATION The information required by this item is incorporated herein by reference to the definitive Proxy Statement the Company will be filed with the Securities and Exchange Commission, no later than 120 days after the close of the Company's fiscal year ended December 31, 1997. 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 the Company will be filed with the Securities and Exchange Commission, no later than 120 days after the close of the Company's fiscal year ended December 31, 1997. ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the definitive Proxy Statement the Company will be filed with the Securities and Exchange Commission, no later than 120 days after the close of the Company's fiscal year ended December 31, 1997. 46 47 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 19 of this Form. 2. Financial Statement Schedules: None (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 and October 4, 1995 1/B/R(1) 3B By-laws of Registrant 1/B/R(2) 4 Specimen of Common Stock Certificate of Registrant 1/B/R(2) 10A Sublease dated November 2, 1993 for facility at 8029 Corporate Drive, Baltimore, Md. 1/B/R(3) 10B Stock Option Plan 1/B/R(4) 10C Employment Agreement with Douglas Kozlay 1/B/R(2) 10D Form Employee Non-Disclosure Agreement 1/B/R(2) 10E Award Contract with United States Department of the Treasury 1/B/R(4) 10F Agreement with GTE Government Systems Corporation 1/B/R(5) 10G Agreement and Plan of Merger dated September 30, 1995 with Connective Strategies, Inc. 1/B/R(6) 10H Employment Agreement with Charles D. Brown 1/B/R(7) 10I Agreement between the Registrant and AT&T International, Inc. for the acquisition of Gretag Data Systems AG 1/B/R(8) 10J Agreement between the Registrant and MCI Telecommunications Corporation 1/B/R(9) 10K Employment Agreement between GDS and Dr. Kurt H. Mueller 1/B/R(1) 10L Placement Agent Warrant 1/B/R(1) 10M Alliance and Joint Marketing Agreement between the Registrant and MCI Telecommunications Corporation 1/B/R(11) 10N Joint Development and Marketing Agreement between the Registrant and CyberGuard Corporation 1/B/R(11) 10O Employment Agreement with Anthony Caputo 1/B/R(11) 10P Agreement between the Registrant Lockheed Martin Corporation Information Systems & 1/B/R(11) Technologies 10Q Agreement between IRE Secure Solutions, Inc. (wholly-owned subsidiary of the Registrant) 1/B/R(10) and Analog Devices, Inc. 21 Subsidiaries of Registrant 27 Financial Data Schedule
- -------------- (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-KSB for the fiscal year ended December 31, 1995 and incorporated herein by reference. (6) Filed as an exhibit to Form 8-K, dated October 24, 1995 and incorporated herein by reference. (7) Filed as an exhibit to Form 10-QSB for the quarterly period ended June 30, 1995 and incorporated herein by reference. 47 48 (8) Filed as an exhibit to Form 8-K dated October 31, 1995 and incorporated herein by reference. (9) Filed as an exhibit to Form 10-QSB for the quarterly period ended September 30, 1995 and incorporated herein by reference. (10) Filed as an exhibit to Form 10-Q for the quarterly period ended September 30,1996 and incorporated herein by reference. (11) Filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1996 and incorporated herein by reference. 48 49 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf of the undersigned, thereunto duly authorized. INFORMATION RESOURCE ENGINEERING, INC. By: /s/ ANTHONY A. CAPUTO ----------------------------------------------- Anthony A. Caputo Chairman, Chief Executive Officer and President Date: March 27, 1998 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 March 27, 1998 - -------------------------------------------- and President Anthony A. Caputo Senior Vice President, Director March 27, 1998 - -------------------------------------------- Jill L. Leukhardt /s/ RICHARD G. TENNANT Vice President of Finance and March 27, 1998 - -------------------------------------------- Administration, Chief Financial Officer Richard G. Tennant (Principal Financial and Accounting Officer) /s/ DOUGLAS E. KOZLAY Director March 27, 1998 - -------------------------------------------- Douglas E. Kozlay /s/ IRA A. HUNT, JR. Director March 27, 1998 - -------------------------------------------- Ira A. Hunt, Jr. /s/ BRUCE R. THAW Director March 27, 1998 - -------------------------------------------- Bruce R. Thaw
49 EX-21 2 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21 SUBSIDIARIES OF REGISTRANT The registrant owns 100% of the capital stock of the following subsidiaries: Connective Strategies, Inc. (A Delaware Corporation) GRETACODER Data Systems AG (A Switzerland Corporation) SafeNet/Trusted Services Corporation (A Delaware Corporation) IRE Secure Solutions, Inc. (A Delaware Corporation) 50 EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 FOR INFORMATION RESOURCE ENGINEERING. YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 7,222,069 2,339,408 3,276,818 60,276 2,915,331 16,050,085 2,909,242 1,333,465 21,531,019 3,550,919 0 0 0 54,627 17,925,473 21,531,019 16,006,998 16,006,998 6,971,144 6,971,144 0 60,276 11,520 (3,637,702) 0 (3,637,702) 0 0 0 (3,637,702) (0.67) (0.67)
-----END PRIVACY-ENHANCED MESSAGE-----