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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

(Mark One)

|[X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- |  | ------------------------------------------------------------------------------------

For the fiscal year ended December 31, 2002

OR

|     |  |                                                                                          
|---- |  | -----------------------------------------------------------------------------------------
|[  ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number 0-20634

SAFENET, INC.


(Exact name of registrant as specified in its charter)


|                                                                                  |  |                                             
|--------------------------------------------------------------------------------- |  | --------------------------------------------
|Delaware
(State or other jurisdiction of
incorporation or organization)           |  | 52-1287752
(IRS Employer
Identification No.)
|                                                                                  |  |                                             
|8029 Corporate Drive
Baltimore, Maryland
(Address of principal executive offices) |  | 21236
(Zip Code)                            

Registrants telephone number, including area code: (410) 931-7500

Securities registered under Section 12 (b) of the Exchange Act: NONE

Securities registered under Section 12 (g) of the Exchange Act:

|                             |  |                             
|---------------------------- |  | ----------------------------
|                             |  | Name of each                
|Title of each class          |  | exchange on which registered
|                             |  |                             
|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. [  ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Rule 12b-2). Yes [x] No [  ]

The aggregate market value of the Common Stock issued and outstanding and held
by non-affiliates of the Registrant, based upon the closing price for the
Common Stock on the Nasdaq National Market on June 30, 2002 was approximately
$97,000,000. All executive officers and directors of the registrant have been
deemed, solely for the purpose of this calculation, to be affiliates of the
registrant. This determination of the affiliate status is not necessarily
conclusive.

The number of shares of the registrants Common Stock outstanding as of March
28, 2002 was 9,993,907.

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, 2002.





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INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, the exhibits hereto and the information
incorporated by reference herein contain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements usually contain the words estimate, anticipate, expect, or
similar expressions. All forward-looking statements are inherently uncertain as
they are based on various expectations and assumptions concerning future events
and they are subject to numerous known and unknown risks and uncertainties.
These uncertainties could cause actual results to differ materially from those
expected for the reasons set forth below under Risk Factors. Readers are
cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. SafeNet, Inc. undertakes no obligation
to publicly release any revisions to forward looking statements to reflect
events or circumstances after the date that this report is filed with the
Securities and Exchange Commission or to reflect the occurrence of anticipated
events.

PART 1

ITEM 1. BUSINESS

COMPANY

SafeNet, Inc. (SafeNet or the Company), was originally incorporated in
Maryland on April 7, 1983 under the name Industrial Resource Engineering,
Inc. SafeNet reincorporated under the name Information Resource Engineering in
Delaware by merging with its subsidiary in March 1989. The Company completed
its initial offering in October of 1989 and a secondary offering in October of
1992. On November 1, 2000, the corporate name was changed by a vote of the
stockholders to SafeNet, Inc. SafeNets executive offices are located at 8029
Corporate Drive, Baltimore, MD 21236. The main telephone line is (410)
931-7500 and website address is www.safenet-inc.com.

The Company has two reportable security business units: hardware, chips,
software, and intellectual property designed and manufactured in the United
States and Europe for sale to companies that will embed SafeNets products into
their products for ultimate sale to end-users (Embedded Security Division),
and hardware, software, and network security systems designed and manufactured
in the United States for direct sales to end-users (Enterprise Security
Division).

In February 2003, SafeNet completed its acquisition of Cylink Corporation
(Cylink), a California Corporation which developed, manufactured, marketed,
and supported a comprehensive portfolio of hardware and software security
products for mission-critical private networks and business communication over
the Internet and private networks. Operations of Cylink were
integrated into the Enterprise Security Division of SafeNet and function as
part of that business unit. This acquisition will have a significant impact on
the Companys business operations going forward. As the transaction closed
subsequent to December 31, 2002, the Cylink acquisition has not been considered
in the Companys discussion of its business as of and for the year ended
December 31, 2002. However, due to its significance to the Companys business,
a discussion of the Cylink acquisition and its anticipated impact is included
at the end of Item 1. Business.

Also in February 2003, SafeNet acquired substantially all the assets of Raqia
Networks, Inc. ("Raqia"), a development stage company, consisting primarily of
technology-related intangible assets. Total consideration paid by SafeNet was
389,640 shares of SafeNet common stock with an estimated value of $6.7 million
plus $805,000 in cash. SafeNet had previously invested $1.0 million in Raqia. The Company will obtain an independent valuation of the acquired
assets, in order to allocate the purchase price during the first quarter of
2003.

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In January 2002, SafeNet acquired Pijnenburg Securealink, Inc. (Securealink),
a Delaware Corporation primarily engaged in the manufacture of security chips
for e-commerce transactions through its European subsidiary. Securealink
develops, markets and sells security chips and intellectual property, primarily
in Europe and Asia. As a result of the acquisition, SafeNet has broadened its
market with the addition of new technologies and a larger presence in Europe.
The operations of Securealink were integrated into SafeNets Embedded Security
division.

GENERAL

Overview

SafeNet delivers a widely deployed Virtual Private Network (VPN) technology for
secure business communications over the Internet, offering both Original
Equipment Manufacturer (OEM) technology and end-user products for VPN and
e-commerce applications. SafeNet security solutions offer competitive
advantages to SafeNet customers by lowering the cost of deploying and managing
secure, reliable private networks, while enabling use of VPNs over the Internet
for trusted transactions with business partners, customers, and staff.

A VPN is a communications system that uses strong encryption and authentication
to create private tunnels through the Internet or other shared, public
networks, allowing businesses to take advantage of the lowest cost network
without exposing their business communications. VPN technology has been a core
competency of SafeNet for over a decade and remains a principal focus of the
Company.

Since it began business in 1983, SafeNet has been providing network security
solutions worldwide for financial, enterprise, telecommunications, and
government use. SafeNets SecureIP TechnologyTM has enjoyed broad market
acceptance through both the enterprise and OEM VPN markets. Organizations that
depend on robust security for all communications have been enabled with SafeNet
technology for years. Through customer engagements with organizations such as
the U.S. Department of Defense, the U.S. Department of State, Internal Revenue
Service, the U.S. Department of the Treasury, the Federal Reserve Bank, the
U.S. Social Security Administration, and Citibank, SafeNet has gained over 19
years of direct experience developing, deploying, and managing network security
systems for Fortune 500 companies and government organizations around the
world.

SafeNet has positioned its VPN technology as a provider of choice for leading
Internet infrastructure manufacturers, semiconductor developers, service
providers, and security vendors, licensing its de facto standard remote access
software to thirty-five leading OEM manufacturers including four of the six
leading VPN appliance manufacturers. Customers include Microsoft, Cisco
Systems, Texas Instruments, ARM, Samsung, NETGEAR, NEC Corporation, Nokia, ZyXEL, Watchguard, Sonicwall and Netscreen. With SafeNet
securing the infrastructure of todays e-business communications, the Company
is opening new markets for interoperable, secure, and deployable VPN
communications.

SafeNet has taken its visionto offer a simple, cost-effective approach to
Internet securityand become an innovator in the Internet security marketplace,
using its expertise to identify and develop emerging security technologies. In
1995, SafeNet introduced the first Internet VPN and has sought to educate the
market and develop leading-edge technology to bring VPNs into the mainstream
and make security on the Internet a reality for business.

VPNs have become one of the most sought after sectors in the networking
communications industry. The tremendous growth of the Internet and the
applications surrounding this pervasive public network has increased the need
for VPN products and technology around the world. SafeNet is continuing its
trend of delivering security solutions for existing

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markets while remaining competitive by creating innovative products and
technology for new and emerging markets, such as broadband and wireless
technologies.

At the same time, after the incidents of September 11th, the need to provide
the U.S. Government and infrastructure organizations with an even higher level
of security has created yet another challenge for SafeNet. The Company has
developed new technologies such as Federal Information Processing Standards
(FIPS) certification and the Advanced Encryption Standard (AES algorithm),
aimed at supporting the nations homeland security efforts. In todays
corporate environment, it is imperative that organizations have options to
protect their businesses through high assurance security technology and at the
same time follow the U.S. guidelines through its homeland security directives.

SOFTWARE HIGHLIGHTS

During this past fiscal year, SafeNet was awarded a contract to provide a
government-specific version of SafeNets new high assurance software,
HighAssurance Remote, making it available for any U.S. Government department,
agency, or command to use for remote access and secure communications through a
SafeNet-hosted website exclusively for government employees to download the
software. SafeNet announced the availability of this
HighAssuranceTM Remote
access VPN client in November 2002. HighAssuranceTM Remote is based on
SafeNets de facto standard VPN software product, SoftRemote, licensed to
thirty-five leading OEM manufacturers.

SafeNet announced the availability of
SoftRemotePDA for the Pocket PC 2002.
Compatible with any portable, handheld device using Pocket PC 2002, such as the
Compaq iPAQ and Casio Cassiopeia®, SoftRemotePDA for the Pocket PC 2002 secures
end-to-end connections between Pocket PC handheld devices and the corporate
network.

NEC Solutions America licensed SafeNets leading VPN remote access client,
SoftRemote®. NEC Solutions America will resell SoftRemote to its customers for
wireless LAN (WLAN), 802.11, and handheld security applications.

The Company licensed a new version of SafeNets SoftRemote® VPN software to
Microsoft Corporation. This new version of SafeNet VPN client software will
support the IETF standard L2TP/IPSec VPN protocol for users of Microsoft
Windows 98, Windows Millennium Edition, and Windows NT Workstation desktop
operating systems.

During fiscal year 2002, the newest version of SafeNets de facto standard VPN
client software SoftRemote® was introduced. SoftRemote 8.0, with Microsoft®
Windows® XP compatibility and support for Network Address Translation (NAT)
Traversal, becomes the only VPN client on the market today that offers
compatibility with all Microsoft Windows operating systems along with other
advanced features and extensive interoperability.

SILICON HIGHLIGHTS

During the Companys fiscal year 2002, SafeNet introduced a new product,
SafeXcel-1141. A next generation step from the SafeXcel-1140, the
SafeXcel-1141, now offering DES, Triple DES, and AES algorithms, is a highly
integrated VPN security co-processor optimized for a variety of products such
as routers, gateways, DSL/Cable modems, wireless access points, and firewalls.
SafeNet believes the SafeXcel-1141 is poised for a leading position among
security processors, because it provides the optimum price versus performance
point for broadband and wireless applications. SnapGear, Inc., a leading
manufacturer of VPN firewall appliances for the small to medium enterprise
market, selected SafeNets Momentum
Series SafeXcelTM-1141 chip for its new VPN
appliances. These appliances are intended for larger enterprise use with
throughputs up to 10 Mbps.

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ZyXEL Communications, the worlds leading xDSL Router Manufacturer (Gartner
Dataquest, July 2001) selected the SafeXcel-1140 chip for its ZyWALL 50
security gateway, used for the small-office-home-office (SOHO) market.

During the fiscal year 2002, SafeNet introduced a new silicon product, the
SafeXcel-1741. The SafeXcel-1741 offers high performance Triple DES and AES
algorithms in a highly integrated VPN security co-processor. Ideal for
broadband applications including routers, gateways, DSL/cable modems, wireless
access points, and firewalls for remote or branch offices, the SafeXcel-1741
improves performance up to 260 Mbps IPSec packet throughput for ESP packets
(AES and SHA-1).

NETGEAR chose the Companys
SafeXcelTM-1741 security co-processor to provide
security to its new Wireless Firewall Router devicea router device that
establishes IPSec-based VPN tunnels over the wireless LAN and multiple tunnels
over the WAN connection, so that small businesses can have a completely secure
and cost-effective network solution. During the same time, NEC Corporation also
chose the SafeXcelTM-1741 to secure its FTTH connections, deploying the chip in
its IX2010 access router for corporate networks.

SafeNet also announced the availability of its VPN InterOp Toolkit, making
SafeNet the only security vendor that can offer one complete security solution.
The VPN InterOp Toolkit allows IPSec, Internet Key Exchange (IKE), and Public
Key Infrastructure (PKI) functionality to be quickly integrated in networking
appliances such as gateways, DSL/Cable modems, routers, wireless access
devices, storage devices, and SOHO boxes.

Early in fiscal year 2002, SafeNet announced the availability of the
SafeXcel-810 chip for secure smart card readers. The SafeXcel-810 chip is an
integrated circuit (IC), which was originally developed by Securealink,
designed for stand-alone smart card readers and keyboards with built-in
readers. This chip has been selected by multiple customers who are actively integrating it into their own product lines.

INTELLECTUAL PROPERTY HIGHLIGHTS

During SafeNets fiscal year 2002, the Company continued selling its technology
to semiconductor manufacturers in the form of intellectual property called
EmbeddedIP. The result of this development led to licensing contracts to
leading companies including ARM Limited. ARM licensed the cryptographic
acceleration offered by the SafeNet EIP-25 together with its ARM core to its
technology partners for use in a variety of applications, including wireless
chipsets and smart cards.

PARTNERSHIP HIGHLIGHTS AND ACQUISITIONS

In January 2002, SafeNet acquired Securealink, which is engaged in the
manufacture of security chips for e-commerce transactions through its European
subsidiary. Securealink develops, markets and sells security chips and
intellectual property, primarily in Europe and Asia. As a result of the
acquisition, SafeNet has broadened its market with the addition of new
technologies and a larger presence in Europe.

During fiscal year 2002, SafeNet entered into a joint development and marketing
agreement with Raqia. Under the agreement, SafeNet also made a
minority investment in Raqia. In February 2003, SafeNet acquired substantially
all of the assets of Raqia, a development stage enterprise, for a purchase
price of 389,640 shares of SafeNet common stock valued at approximately $6.7
million and $805,000 in cash. SafeNet intends to integrate the assets
purchased from Raqia to create what SafeNet believes to be the industrys most
secure and comprehensive systems-on-chip, co-processors, and accelerator cards.

SafeNet announced a strategic alliance with Phoenix Technologies Ltd. (Nasdaq:
PTEC), a global leader in device-authenticated software products for connected
digital devices. Under the agreement, SafeNet and Phoenix will link

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together their market leading products to seek to create what SafeNet believes
to be the industrys most secure VPN software and services.

PalmSource, Inc. selected SafeNet as a VPN security partner in 2002. SafeNet
and PalmSource have been collaborating in recent months on VPN security for
wireless devices, including a license agreement for PalmSource to distribute an
evaluation version of SoftRemotePDA for the Palm OS® 5 platform to licensees.
Licensees will then be able to license the VPN client from SafeNet for
distribution with their Palm Powered products.

SafeNet believes the acquisition of Cylink, which closed in February 2003,
strengthens SafeNets current activities, adds an impressive base of new
government customers, and further expands the scope of the Companys product
line. The Cylink organization is experienced in providing encryption appliances
to major government and financial organizations seeking to add strong security
to their products and looking for an easy, cost effective migration from costly
WAN technology to more cost effective VPN technology. Cylink is being
integrated under the SafeNet brand and will continue to focus on its core area
of expertise in order to better serve SafeNets government and financial
enterprise customers.

INDUSTRY BACKGROUND

The VPN Market

A VPN is a communications system using strong encryption that creates a private
tunnel through the Internet and other communications systems, assuring
authentication of users and privacy of information. This allows businesses to
use the lowest cost network without exposing their business communications. A
VPN can allow an organizations employees to access company-confidential
information over an Intranet or Extranet, or allow trading partners access to a
company Extranet for secure business-to-business electronic commerce
applications. A leading market research firm predicts that by the year 2008 the
sales of VPN products and services will reach $1.8 billion.

VPNs also allow organizations to use public networks for their communications
backbone. This is achieved by protecting the data traffic with data
communications security technology such as: encryption, message authentication,
user authentication, and firewall technology. Because public networks are much
cheaper than private leased lines and dedicated frame relay networks,
corporations can generally achieve substantial cost savings by using VPNs while
taking advantage of the global availability and access to the Internet.

With the increasing use of public and private communications networks and the
ability of different types of computers to communicate with each other, data
integrity and security have gained increased importance. Secure VPNs have three
key uses: secure remote access, secure site-to-site connections, and secure
Extranet connections.

SafeNet management believes that the market for security systems and products
providing VPN solutions has grown over the last several years due to an
increase in the use of the Internet for business communications and electronic
commerce applications such as work-at-home arrangements or telecommuting,
electronic mail, satellite offices connected to a central computer, electronic
funds transfer, electronic data interchange with clients, suppliers, and
business customers, and numerous other arrangements. The popularity and
associated usage of the Internet has increased the requirements for VPN
technology and products to ensure secure intra and inter company
communications.

VPNs are facilitating the growth of e-business and business-to-business online
applications. Growth in this area has been significant and SafeNet management
believes it will continue to grow in the future.

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PRODUCTS

SafeNets VPN technology and product offerings include software and hardware
products, dedicated solutions, and embedded technology for the OEM market.

SecureIP Technology

SecureIP Technologyis the core technology that is at the heart of
all SafeNet solutions and products. Delivered in the form of computer chips,
plug-in boards, software modules, and intellectual property, SecureIP
Technology provides the building blocks for security implementation
that enable organizations to use the Internet and other shared networks for
secure communications. SecureIP Technology is sold in the following
packages:



| |  |  | EmbeddedIP                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | EmbeddedIP is the streamlined delivery of SafeNet SecureIP
Technology for availability to OEM developers, semiconductor
developers, and technology integrators. EmbeddedIP is available for
license in IP cores or blocks whereby selected elements of the VPN encryption
technology can be adapted in single or multiple implementations. This allows
OEMs to incorporate selective blocks in their own ASICs or processors to allow
for very cost-effective, high throughput, low power-consuming designs.
EmbeddedIP can be licensed in the following implementations:



| |  |  | Encryption Engines: DES/3DES, AES;                    
| | - |  | ------------------------------------------------------
|
| |  |  | Hash Engines: SHA-1, MD5;                             
|
| |  |  | Packet Engines: IPSec, MPPE;                          
|
| |  |  | Public Key Accelerators: RSA, DSA, and Diffie-Hellman;
|
| |  |  | Entropy based True Random Number Generator (RNG).     



| |  |  | SafeXcel                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | SafeXcelis SafeNets silicon product line for OEM developers
looking for embedded, accelerated security. SafeXcel chips are separated into
the Momentum Series (up to 100 Mbps), the Velocity Series (100 Mbps to 1 Gbps),
and the Reliance Series (1 Gbps and higher). The SafeNet silicon product line
includes high-performance ICs and privacy products for both IPSec and SSL
encryption. Announced SafeXcel chips include the following: SafeXcel-1140,
SafeXcel-1141, SafeXcel-1741, SafeXcel-2010, SafeXcel-2141, SafeXcel-ISES,
SafeXcel-306, SafeXcel-317, SafeXcel-318, and SafeXcel-810.
|
| |  |  | SafeXcel Cards                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  |  | SafeXcelCards are plug-in PCI boards that provide cryptographic
throughput and acceleration for operations such as encryption, hashing, public
key computations, key negotiation, signatures, and random number generation.
Announced SafeXcel Cards include SafeXcel 140-PCI, SafeXcel 141-PCI, SafeXcel
171-PCI, and SafeXcel 241-PCI.                                                                                                                                                                                                                                                            
|
| |  |  | SoftIP                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  |  | SoftIPis the SafeNet software product line that includes the
remote access client, SoftRemote®, and the latest version,
HighAssuranceRemote. Other software products include SoftRemoteLT
for 802.11 applications, SoftRemotePDA for the Palm OS and SoftRemotePDA for
the Pocket PC 2002 for handheld portable devices, and SoftRemote®
Policy Manager, for complete deployment and management of SoftRemote clients.                                                                                                                                                                             

CGX Security Platform

The CGX Security Platform is a next-generation, integrated, security
environment providing a single, easy solution for building encryption-based
security systems. The CGX Security Platform, the embodiment of over 19 years of
encryption expertise, is a complete environment in which OEMs can build any
type of encryption product. SafeNet believes Platform brings a significant
advantage to OEM developers by accelerating time to market, reducing
development costs, and providing a system-level implementation of encryption
technology. With its flexibility, standalone software, and security hardware,
entire security systems can be easily developed.

SafeEnterprise

SafeEnterpriseis SafeNets enterprise product line that integrates
the full range of Internet security needs, such as access control, encryption,
user authentication, message authentication, and policy management.
SafeEnterprise is

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intended for large government and financial institutions that require a high
level of strong and proven security technology. During fiscal year 2002,
SafeNet introduced a high assurance security product line within the
SafeEnterprise product category, which includes its HighAssurance Remote access
client software, and the HighAssurance 2000 Gateway, a rebranding of the
NetHawk VPN Gateway acquired through Cylink. The SafeEnterprise system consists
of two client products (SafeNet Soft/Smart and SafeNet SoftRemote®) for remote
access, a high performance gateway (SafeNet Speed), and a centralized security
management system, providing comprehensive security in an easy-to-use,
scaleable solution (SafeNet Security Center). SafeNet Security Center includes
three levels of management systems and can also be utilized through a Managed
VPN Service program.

Along with these products, SafeNet added three encryptor products through the
Cylink acquisition, for leased line encryption. The SafeEnterprise Frame
Encryptor, the SafeEnterprise ATM Encryptor, and the SafeEnterprise Link
Encryptor are technology for enterprise-wide LAN-to-LAN, data sharing and
client-server applications. They combine the advantages of circuit and packet
switched services with low latency.

Finally, with the acquisition of Cylink, SafeNet has added PrivaCy Manager, to
be enhanced and rebranded SafeEnterprise Security Management Center (SMC), to
its line of management tools. This management center will allow SafeNet
customers to manage all aspects of their WAN and VPN networks and will allow
for easy migration from WAN to VPN technology.

PRODUCT DEVELOPMENT

SafeNet conducts product development activities to increase the size of its
available market through broader product offerings and to reduce the cost of
its products, resulting in more competitive pricing and/or better operating
margins.

The VPN market, in its growth period, will be continually looking for products
that offer the strongest encryption and the fastest throughput. The Company
will continue to devote resources to the latest VPN technology to meet the
increasing demands of the market.

PRODUCT DESIGN STANDARDS

VPN security technologies are utilized by SafeNet to provide secure
communication over public networks, including the Internet. This security
technology provides selective access to computer networks, prevents electronic
eavesdropping or alteration during electronic data transmission, provides
message authentication confirming that messages are received in unaltered form,
and enables user authentication and digital signatures verifying the identity
of the message sender and limiting computer access to authorized users. SafeNet
offers a choice of encryption algorithms to provide the level of network
security appropriate for each client application.

All of SafeNets network security systems and products comply with the
following general product
design standards:

Standards Compliance

SafeNets policy is to offer products based upon encryption algorithms that
have been approved as industry and government standards, providing SafeNets
clients assurance that they are using products that meet commercial
reasonability tests. This includes FIPS certification as well as a move to
Common Criteria.

Network Compatibility

SafeNets systems and products contain sufficient intelligence to accommodate
the specific communication protocols employed by complex computer networks,
including support for Frame Relay, Dial Asynchronous, leased line, X.25, Bisync
and Internet protocol-based networks.

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Interoperability

SafeNet management believes the market opportunity for VPN technology and
products increases when vendors product offerings become interoperable.
SafeNets commitment to the IPSec standard and multi-vendor interoperability is
utilized in existing and planned product offerings.

Ease of Use

SafeNet believes that users of its products, while concerned that their data is
secure, do not wish to be required to take specific actions to achieve secure
status. Therefore, our products are designed to function without user
involvement, thus offering an extremely high level of ease of use.

Ease of Management and Administration

SafeNet has extended its ease of use concept to the policy management of its
most widely deployed client, SafeNet SoftRemote®. The SoftRemote® Policy
Manager is a Windows-based application that simplifies deployment of all
versions of SafeNet SoftRemote® and enables centralized management of security
policies.

Price Performance Criteria

SafeNet believes that in order for clients to invest in encryption technology,
its products must be implemented cost effectively. As such, our development
staff follows a design approach similar to that used with consumer electronics
products that are designed for low manufacturing cost.

Encryption Algorithms

At present, SafeNets products employ a variety of encryption algorithms
including the Advanced Encryption Standard (AES), U.S. Government Triple Data
Encryption Standard (TDES), Single DES, RSA Data Security Inc. Encryption
Standard (RSA).

SALES AND MARKETING

Sales

SafeNet has continued to sell through both direct sales and indirect
distribution channels in order to expand worldwide sales coverage. In North
America, in addition to direct sales, the Company sells products primarily
through Value Added Resellers (VAR) and Original Equipment Manufacturers. With
the acquisition of Cylink, the VAR partner program expanded to
include channel partners in South America, Asia, Europe, the Middle East, and
Africa. In Europe, SafeNet products are sold through a direct sales force,
which expanded with the acquisition of Cylink to include an office in the UK
and Singapore. Outside of such territories, SafeNet products are sold through
distributors of communication or information security products. A global sales
organization provides support for these distribution channels. OEM sales
efforts are sold through partners and direct sales.

As a result of the acquisition of Cylink, the Enterprise Security Division
expanded its sales concentration into financial and other commercial markets,
while continuing to concentrate on U.S. Government and Homeland Security
efforts. This was accomplished through the addition of several domestic offices
in Virginia and New Jersey.

Marketing

SafeNet continued its initiative of branding the company in Europe and Asia and
strengthening its leadership position with a strong marketing presence.

SafeNet began the year 2002 continuing as a leader in the VPN market. Through a
presence at large tradeshow events like RSA Security Conference in San Jose,
California, and E-Gov in Washington, DC, SafeNet continued
to show its strong security brand. With exhibitions at shows like CEBIT 2002 in
Hanover, Germany, SafeNet began to expand its brand awareness to the large
European markets. During 2002, SafeNet increased it corporate
web presence and e-commerce capabilities, which resulted in an over 150%
increase in the web sales of its software client.

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Beginning in January 2002, SafeNet continued to broaden its brand with the
acquisition and rebranding of Securealink B.V. (SafeNet, B.V.), a fabless
semiconductor company in the Netherlands, and the opening of a new sales office
in Switzerland, operating as SafeNet AG. Efforts were made to gain brand
awareness in Europe through leveraging the reputation and product offerings of
the new Holland operations in Vught, the Netherlands.

SafeNets marketing program also continued lead generation and increased
coverage of SafeNets technology and products in leading trade publications.
The Company increased emphasis on developing awareness of the SafeNet brand
through public relations efforts and joint marketing arrangements with our
strategic partners. SafeNet also increased its use of direct marketing programs
through email, direct mail, and web-based promotions. The Company instituted
processes to ascertain the requirements of existing and prospective end-user
and OEM customers. The Companys success in embedding its technology in leading
networking vendors products has helped gain market awareness. SafeNet will
continue its endeavor to co-brand SafeNet technology with industry leaders to
increase market awareness.

CLIENT SUPPORT AND PRODUCT WARRANTIES

SafeNet provides support for clients through a staff of support engineers
knowledgeable in both SafeNets network security systems and products, and
complex computer networks. In addition to supporting clients, this group of
engineers performs system level quality assurance testing of new products and
product enhancements. SafeNet provides client telephone support, including 24
hour a day hot line support. In addition, the Company offers on-site
training, installation, and trouble-shooting services, generally on a fee
basis.

SafeNet provides limited warranties on its hardware products for one year upon
delivery of the product. After warranty expiration, clients may purchase an
extended warranty support contract. This contract extends warranty service for
an additional one-year period, providing repair or replacement of defective
products and telephone support. SafeNet also offers support on a time and
materials basis.

MANUFACTURING AND INVENTORY

SafeNets inventory and current
manufacturing operations are performed by a contract manufacturer, EIT, Inc., working under SafeNet's direction.  The outsource operations include engineering prototypes, pre-production runs, full turnkey boxbuilds, and product drop shipments.  SafeNet designs and develops all key components of our products; printed circuit boards, software, and our proprietary ASICs (Application Specific
Integrated Circuit), which are fabricated by contract foundries.  SafeNet also designs, specifies and monitors all the testing required to meet our internal and external quality control guidelines. SafeNet's legacy products and product lines are handled by other contract manufacturers with the appropriate product knowledge base.  Outsourcing allows SafeNet to reduce fixed overhead and personnel costs and provides greater flexibility to match product
and market demands.

In January 2003, Cylink transferred substantially all of its inventory and manufacturing operations to EIT, Inc.

COMPETITION

The VPN market is highly competitive and subject to rapid technological
changes. SafeNet believes that competition in this market is likely to
intensify as a result of increasing demand for Internet security technology and
products. There are several companies in this field that have been established
longer than SafeNet, and have greater financial,

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research, service support, and marketing resources than those of SafeNet. There
are also a number of other hardware and software data encryption methods and
security technologies on the market which compete with our products.

SafeNet management believes that the principal competitive factors affecting
the VPN market include standards compliance, quality/reliability, technical
features, network compatibility, ease of use, client service and support,
distribution and price. Although SafeNet believes its technology and products
currently compete favorably with respect to such factors, there can be no
assurance that SafeNet can maintain its competitive position against current
and potential competitors.

If the VPN market continues to develop, it will likely be characterized by
rapid advances in technology and new products that could render the existing
technology upon which SafeNets technology and products are based less
competitive. However, the Company believes that its core technology will be the
basis for future product offerings in the years to come. This risk will
increase to the extent that our competitors include manufacturers of computer
equipment and Internet appliances to which our products relate, since such
manufacturers may be in a better position than SafeNet to develop security
products in anticipation of developments in their computer equipment.

PATENTS AND INTELLECTUAL PROPERTIES

Between 1996 and 2002, SafeNet was awarded seven United States Patents covering
cryptographic key management, kernel mode protection, key recovery schemes,
portable encrypting and authenticating network interface devices, such as
modems. The patents provide SafeNet with ownership rights to a technology that
SafeNet believes will be critical to the growth of computer networks, such as
the Internet. The patents cover our SafeXcel chips, CGX Security Platform,
SafeNet Dial and the AX400. Additional domestic and foreign patent
applications, which cover the same products and technology, as well as
additional EmbeddedIP product offerings, are pending.

SafeNet has acquired the rights to license a United States Patent for a
self-authenticating fingerprint identification card for certain computer
security and financial applications. Under the license agreement, SafeNet pays
to the licensor a royalty on each sale or license of products that contain the
patented technology.

The computer software source codes, which are essential elements of SafeNets
products, are the proprietary trade secrets of and are copyrighted by SafeNet.
The protection of proprietary technology and information developed by the
Company will be limited to such protection as it may be able to secure pursuant
to trade secret or copyright laws or under any confidentiality agreements into
which SafeNet may enter. SafeNet owns federally registered trademarks for the
SafeNet name and for certain of its products; however, there is no assurance as
to the validity, enforceability, or lack of infringement of such trademarks.

At present, SafeNet is a party to confidentiality agreements with its officers,
directors, and employees. There can be no assurance that the scope of any such
protection SafeNet is able to secure will be adequate to protect its
proprietary information, or that SafeNet will have the financial resources to
engage in litigation against parties who may infringe such proprietary
technology or copyrights. In addition, there can be no assurance that others
will not develop similar technology independent of SafeNet.

SafeNet believes that its products do not infringe the proprietary rights of
third parties. There can be no assurance, however, that third parties will not
assert infringement claims in the future.

EMPLOYEES

As of March 3, 2003, SafeNet had 215 employees, of whom 17 are engaged in
production and quality control, 25 in administration and financial control, 112
in engineering, development, and client support, and 61 in marketing and sales.
SafeNet employs 165 employees in the United States, 39 employees in the
Netherlands, 8 employees in

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United Kingdom, and 3 employees in Singapore. Approximately 65 of those
employees are from the acquisition of Cylink.

RISK FACTORS

SafeNet operates in a rapidly changing environment that involves numerous
risks, some of which are beyond our control. The following discussion
highlights some of the possible risks.

SafeNet has a History of Losses And May Incur Future Losses

The Company has experienced substantial net losses in four of the last five
years, including 2002. As of December 31, 2002, SafeNet had an accumulated
deficit of $20,225,000. Although our revenues are subject to fluctuation,
SafeNet intends to maintain or increase our expenditures in all areas in order
to execute the Companys business plan. As a result, the Company may incur
substantial additional losses. The likelihood of SafeNets success must be
considered in light of the problems, expenses and delays frequently encountered
in connection with new technologies utilized with the transition to an Internet
VPN business and the competitive environment in which SafeNet operates.
Investors should not consider the Companys historical results indicative of
future revenue levels or operating results. SafeNet can neither give assurance
that it will operate profitably in the future nor that the Company may sustain
profitability if it is achieved.

Risk of Integrating Recent Acquisitions or Other Future Acquisitions

On February 6, 2003, SafeNet acquired Cylink, a manufacturer of security
appliances and software for securing the Internet and private network
communications. SafeNet expects this acquisition to facilitate the Companys
growth in the enterprise systems aspects of the business through access to a
broader range of government and commercial enterprise customer accounts, a
broader and more complete product offering, and the fortified support of
SafeNets key government and financial customers.

Also, on February 27, 2003, SafeNet acquired substantially all the assets of
Raqia, a development stage company, consisting primarily of
technology-related intangible assets. In addition, the Company may from time
to time pursue other acquisitions of businesses that it believes compliments or
expands its existing business, including acquisitions that could be material in
size and scope.

The acquisitions of Cylink and Raqia and other future acquisitions involve
various risks, including:



| |  |  | Difficulties in integrating the operations, technologies, and products of the acquired company;                                                           
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The risk of diverting managements attention from normal daily operations of the business;                                                                
|
| |  |  | Potential difficulties in completing projects associated with in-process research and development;                                                        
|
| |  |  | Risks of entering markets in which SafeNet has no or limited direct
prior experience and where competitors in such markets have stronger
market positions;
|
| |  |  | Initial dependence on unfamiliar supply chains or relatively small supply partners;                                                                       
|
| |  |  | Insufficient revenues to offset increased expenses associated with the acquisition;                                                                       
|
| |  |  | The potential loss of key employees of the acquired company.                                                                                              

There can be no assurance that the Companys acquisitions of Cylink and Raqia,
or other businesses, will be successful and will not materially adversely
affect SafeNets business, operating results, or financial condition. The
acquisition of Cylink in particular will have a significant impact on the
Companys business operations going forward and failure to integrate this
acquisition effectively could have a material adverse effect on the Companys
business and operating results. SafeNet must also manage any growth resulting
from such acquisitions effectively. Failure to manage such growth effectively
and successfully integrate the acquired companys operations could have a
material adverse effect on SafeNets business and operating results.

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Quarterly Operating Results May Fluctuate and Future Revenues and Profitability
Are Uncertain

SafeNet has experienced significant fluctuations in its quarterly operating
results and anticipates continued substantial fluctuations in its future
operating results. A number of factors have contributed to these quarterly
fluctuations including:



| |  |  | Market acceptance and demand for SafeNet products;                                                                     
| | - |  | -----------------------------------------------------------------------------------------------------------------------
|
| |  |  | Length of sales cycle including the size, timing, cancellation, or delay of customer orders;                           
|
| |  |  | Introduction of new products and product enhancements by SafeNet or its competitors;                                   
|
| |  |  | Market acceptance of new products introduced by SafeNet or its competitors;                                            
|
| |  |  | Budgeting cycles of customers;                                                                                         
|
| |  |  | The timing and execution of individual contracts;                                                                      
|
| |  |  | The product mix sold in a given quarter;                                                                               
|
| |  |  | Changes in the percentage of revenues attributable to OEM license fees and royalties;                                  
|
| |  |  | Length of time required by OEMs to embed SafeNet products into their
products which generate royalties to the Company;
|
| |  |  | The percentage of products sold through the SafeNet direct sales force and its indirect
distribution channels;         
|
| |  |  | Product development expenses;                                                                                          
|
| |  |  | Business combinations and asset acquisitions as well as business disposals                                             
|
| |  |  | Competitive conditions in the industry;                                                                                
|
| |  |  | Changes in general economic conditions.                                                                                

The Companys expenses are based, in part, on its expectations regarding future
revenues, and are largely fixed in nature, particularly in the short-term.
SafeNet may be unable to predict future revenues accurately or to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall.
Accordingly, any significant shortfall of revenues in relation to expectations
could cause significant declines in quarterly operating results.

Due to all of the foregoing factors, SafeNets quarterly revenues and operating
results are difficult to forecast. Therefore, management believes that
period-to-period comparisons of the Companys operating results will not
necessarily be meaningful, and investors should not rely upon them as an
indication of future performance. Also,
it is likely that operating results will fall below expectations and the
expectations of securities analysts or investors in some future quarter. In
such event, the market price of SafeNet common stock could be materially
adversely affected.

Risks of Changes in Technology and Industry Standards

The network security industry is characterized by rapid changes, including
evolving industry standards, frequent new product introductions, continuing
advances in technology, and changes in customer requirements and preferences.
SafeNet expects technological developments to continue at a rapid pace in the
computer and communications industries, and there can be no assurance that
technological developments will not cause the Companys technology to be
rendered obsolete or non-competitive.

Future SafeNet products may not keep pace with technological changes
implemented by competitors, developers of operating systems or networking
systems, or persons seeking to breach network security. The introduction of new
technologies could also require the Company to invest in research and
development at much higher rates with no assurance of developing competitive
products. Changes in technologies or customer requirements may also cause the
development cycle for new products to be significantly longer than the
Companys historical product development cycle, resulting in higher development
costs or a loss in market share. SafeNet products may not satisfy evolving
preferences of customers and prospects. Failure to develop and introduce new
products and improve current products in a timely fashion could adversely
affect the Company. Because of the complexity of SafeNet products, which
operate on or utilize multiple platforms and communications protocols, the
Company has from time to time experienced delays in introducing new products
and product enhancements primarily due to development difficulties or shortages
of development personnel. There can be no assurance that the Company will not
experience longer

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delays or other difficulties that could delay or prevent the successful
development, introduction, or marketing of new products or product
enhancements.

The loss of a commercial customer that accounted for a significant portion of
SafeNets revenues during 2002 could have a material adverse effect on
SafeNets business and results of operations.

SafeNet has one commercial client that accounted for 41% of its consolidated
revenues for the year ended December 31, 2002. A loss of this customer or
significant cutback in its orders for SafeNets products would have
a material adverse effect on SafeNets business and results of operations. In
2003, this customer announced the selection of a different vendor to supply
some of its next generation chip technology, for which SafeNet had previously
been the sole provider. SafeNets business continues to evolve in an effort to
reduce to significant customer exposure through the introduction of new
customers and more products. This customer continues to be a major revenue
source for SafeNet.

Restrictions on the Export of Some SafeNet Products.

Currently SafeNet sells products internationally and intends to continue to
expand relationships with international distributors and resellers.
International sales and operations could be subject to the following risks:



| |  |  | The imposition of governmental controls;          
| | - |  | --------------------------------------------------
|
| |  |  | Export license requirements;                      
|
| |  |  | Restrictions on the export of critical technology;
|
| |  |  | Trade restrictions;                               
|
| |  |  | Changes in tariffs.                               

Some SafeNet network security products are cryptographic devices and are
subject to the export restrictions administered by the Bureau of Export
Control, U.S. Department of Commerce. These restrictions permit the export of
encryption products based on country, algorithm, and class of end-user. They
prohibit the export of encryption products to a number of countries and to
business entities that are not included in a range of end-users. There is no
assurance, however, that the applicable regulations or policies concerning the
export of such technology will not become more restrictive. SafeNet foreign
distributors may also be required to secure licenses or formal permission
before encryption products can be imported.

Facing Intense Competition

The security industry is relatively new, highly competitive, and subject to
rapid technological changes. SafeNets success will depend, in large part, on
its ability to establish and maintain an advantageous market position. The
Company currently competes with companies that have substantially greater
financial resources, sales and marketing organizations, market penetration, and
research and development capabilities, as well as broader product offerings and
greater market presence and name recognition. SafeNet management expects to
face increasing competitive pressures from current competitors and new market
entrants. This competitive risk will increase to the extent that competitors
begin to include software vendors, network providers, and manufacturers of
networking and computer equipment and communication devices. These
manufacturers and network providers may be in a better position to develop
security products in anticipation of developments in their products and
networks. Competitive factors in the VPN market include:



| |  |  | Standards compliance;              
| | - |  | -----------------------------------
|
| |  |  | Product quality and reliability;   
|
| |  |  | Technical features;                
|
| |  |  | Product ease of use;               
|
| |  |  | Network compatibility;             
|
| |  |  | Client service and product support;
|
| |  |  | Distribution;                      
|
| |  |  | Price.                             

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There can be no assurance that the Company can continue to compete successfully
against new or existing competitors.

Market Consolidation May Create More Formidable Competitors

There has been substantial consolidation in the information security industry,
and SafeNet expects that there will be significant additional consolidation in
the near future. As a result of that increasing consolidation, the Company
expects that it will increasingly compete with larger firms that have broader
product offerings and greater financial resources. SafeNet management believes
that such competition may have a significant negative effect on current and
developing collaborative, marketing, distribution and reselling relationships,
product pricing and product development budget and capabilities. Any of those
negative effects could significantly impair the Companys financial condition
and results of operations.

Risk of Inadequate Protection for SafeNet Proprietary Technologies

SafeNets success and ability to compete is dependent, in part, upon the
Companys ability to maintain the proprietary nature of its technologies.
SafeNet relies on a combination of patent, trade secret, copyright and
trademark law, and nondisclosure agreements to protect its proprietary
technology. Although SafeNet holds several patents and has several pending
patent applications that cover certain aspects of the Companys technology,
such patents, and patent applications do not protect some of SafeNets security
products. Current and future patent applications may not be granted.
Additionally, current patents may not be broad enough to protect the core
technology critical to SafeNet security products.

Confidentiality agreements and other methods on which SafeNet relies to protect
its trade secrets and proprietary information and rights may not be adequate to
protect all proprietary rights. Litigation to defend and enforce the Companys
intellectual property rights could result in substantial costs and diversion of
resources and could have a material adverse effect on financial conditions and
results of operations regardless of the final outcome of such litigation.
Despite SafeNets efforts to safeguard and maintain its proprietary rights, it
may not be successful in doing so or the steps taken by the Company in this
regard may not be adequate to deter misappropriation or independent third-party
development of SafeNet technology or prevent an unauthorized third party from
copying or otherwise obtaining and using SafeNet products, technology, or other
information that the Company regards as proprietary. SafeNet trade secrets or
non-disclosure agreements may not provide meaningful protection of its
proprietary information. Also, others may independently develop similar
technologies or duplicate any technology developed by SafeNet. The Companys
inability to protect its proprietary rights would have a material adverse
effect on its financial condition and results of operations.

Further, as the number of network security products in the industry increases
and the functionality of these products further overlaps, SafeNet may become
subject to claims of infringement or misappropriation of the intellectual
property or proprietary rights of others. Third parties could assert
infringement or misappropriation claims against the Company in the future with
respect to current or future products. SafeNet may also be subject to
additional risks as the Company enters into transactions in countries where
intellectual property laws are not well developed or are poorly enforced. Legal
protections of its rights may be ineffective in such countries, and technology
developed in such countries may not be protected in jurisdictions where
protection is ordinarily available. Any claims or litigation, with or without
merit, could be costly and could result in a diversion of managements
attention, which could have a material adverse effect on its financial
condition and results of operations. Adverse determinations in such claims or
litigation could also have a material adverse effect on the Companys financial
condition and results of operations.

Risks Relating to Evolving Distribution Channels

SafeNet relies on both our direct sales force and an indirect channel
distribution strategy for the sale and marketing of its products. The Companys
sales and marketing organization may be unable to successfully compete against
the more extensive and well-funded sales and marketing operations of certain of
its current and future competitors. SafeNet may also be unable to continue to
attract integrators and resellers that can market its legacy products
effectively and provide timely and cost-effective customer support and service.
Additionally, the Companys distributors, integrators, and resellers may carry
competing lines of network security solutions. The loss of important sales
personnel, distributors, integrators, or resellers could adversely affect
SafeNet.

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Risk of Product Development Delays

SafeNet may experience schedule overruns in product development triggered by
factors such as insufficient staffing or the unavailability of
development-related software, hardware, or technologies. Further, when
developing new network security products, development schedules may be altered
as a result of the discovery of software bugs, performance problems or changes
to the product specification in response to customer requirements, technology
market developments or self-initiated changes. All of these factors can cause a
product to enter the market behind schedule, which may adversely affect market
acceptance of the product or place it at a disadvantage to a competitors
product that has already gained market share or market acceptance during the
delay.

Product Liability Risk

The sale and installation of SafeNets network security systems and products
within the computer networks of its customers and the operation of its SafeNet
facility entails a risk of product failure, product liability or other claims.
An actual or perceived breach of network or computer security, regardless of
whether such breach is attributable to the Companys products, could adversely
affect its reputation and financial condition or results of operations. The
complex nature of SafeNet products can make the detection of errors or failures
difficult when products are introduced. If errors or failures are subsequently
discovered, this may result in delays and lost revenues during the correction
process. A malfunction or the inadequate design of SafeNet products could
result in product liability claims. Management attempts to reduce the risk of
such losses through warranty disclaimers and liability limitation clauses.
However, SafeNet may not have obtained adequate contractual protection in all
instances or where otherwise required under agreements it has entered into with
others.

SafeNet currently maintains product liability insurance. However, the insurance
coverage may not be adequate and any product liability claim for damages
resulting from security breaches could be substantial. In the event of product
liability litigation, insufficient insurance coverage could have a material
adverse effect on SafeNets financial condition and results of operations.
Further, certain customers and potential customers may require minimum product
liability insurance coverage as a condition precedent to purchasing SafeNet
products. Failure to satisfy such insurance requirements could impede the
Companys ability to achieve product sales, which would have a material adverse
effect on its financial condition and results of operations. There is no
assurance that such insurance will be available at a reasonable cost or will be
sufficient to cover all possible liabilities.

Dependence upon Third Party Suppliers and Contractors

SafeNet relies upon third party contractors for the manufacture of components
and sub-assemblies for SafeNet products. There is no assurance that the Company
will be able to obtain and/or maintain satisfactory contractual relations with
qualified vendors or suppliers. The unavailability of such third parties may
substantially decrease SafeNets control of the cost, quality and timeliness of
the manufacturing process. At present, the Company is not a party to any
exclusive supply contracts with third party contractors for its legacy
products. All purchases of components or parts for SafeNet products are
accomplished by the use of purchase orders issued in the ordinary course of
business. While SafeNet has not experienced any significant supply problems in
the past, and there have been no materially late deliveries of components or
parts, 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 SafeNet products. The Companys business would suffer if the supply of
such components were interrupted.

Dependence upon Key Personnel

The network security industry is highly specialized and the competition for
qualified employees is intense. SafeNet expects this to remain so for the near
future. The Company believes its success depends significantly upon a number of
key technical and management employees, and upon its ability to retain and hire
additional key personnel. The loss of the services of key personnel or the
inability to attract additional qualified personnel could materially and
adversely affect results of operations and product development efforts. SafeNet
may be unable to achieve its revenue and operating performance objectives
unless it can attract and retain technically qualified and highly skilled
engineers, sales, technical, marketing, and management personnel. Such
personnel are particularly important to research and development efforts, where
SafeNet employs a large number of technical personnel holding advanced degrees.
Further, additions of new and departures of existing personnel, particularly in
key positions, can be

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disruptive and can result in further departures of SafeNet personnel, which
could in turn harm the business and results of operation.

In 2002, SafeNet entered into a five-year employment agreement with Anthony A.
Caputo, its Chairman, Chief Executive Officer, and President. However, the
Company has not historically provided such types of employment agreements other
employees. This may adversely affect the Companys ability to attract and
retain the necessary technical, management, and other key personnel.

SafeNets stock price has been and could continue to be volatile.

Market prices for SafeNets common stock and the securities of other network
security companies have been volatile. Factors such as announcements of
technological innovations or new products by SafeNet or by its competitors and
market conditions for network security company and other technology stocks in
general can have a significant impact on the market for SafeNets common stock,
which could reduce SafeNets stock price regardless of its operating
performance.

SafeNet periodically reviews and considers possible acquisitions of companies
that it believes will contribute to its long-term objectives. In addition,
depending on market conditions, liquidity requirements and other factors,
SafeNet considers, from time to time, accessing the capital markets. Such
events may also affect the market prices for SafeNets common stock and reduce
such prices regardless of operating performance.

Anti-takeover provisions in SafeNets charter documents and Delaware law could
prevent or delay a change in control.

SafeNets certificate of incorporation and bylaws may discourage, delay or
prevent a merger or acquisition that a stockholder may consider favorable by
authorizing the issuance of blank check preferred stock. In addition,
certain provisions of Delaware law may also discourage, delay or prevent a
third party from acquiring or merging with SafeNet, even if such action were
beneficial to some, or even a majority, of SafeNets stockholders.

SafeNet Does Not Pay Dividends

The Company has never paid nor declared any cash or other dividends on its
common stock since its inception and does not presently anticipate that
dividends will be paid on its common stock in the foreseeable future.

SIGNIFICANT BUSINESS ACQUISITION SUBSEQUENT TO DECEMBER 31, 2002

In February 2003, SafeNet completed its acquisition of Cylink.
Operations of Cylink were integrated into the Enterprise Security Division of SafeNet
and function as part of that business unit.  This acquisition will have a significant impact on the
Company's business operations going forward.

Cylink developed, manufactured, marketed and supported a comprehensive portfolio of hardware and software security products for mission-critical private networks and business communications over the Internet. Cylink's solutions enabled its customers to merge their operations and transactions onto existing networks, maximize network use, reduce the costs of operations and expand their businesses. Cylink's customers included leading Fortune 500 companies, multinational corporations, financial institutions and numerous agencies within the United States Government.

Cylink's solutions offered competitive advantages to its customers by lowering the cost of deploying and managing secure, reliable private networks, while enabling its customers' use of the Internet for trusted transactions with their business partners. Cylink offered "drop-in" hardware encryption products that are easily deployed within its customers' existing high-speed data networks known as Local Area Networks, LANs, and Wide Area Networks, WANs, including VPNs, that use the Internet.

Cylink's products were centrally managed by a proprietary software management system. This system allowed Cylink's customers' network security managers to remotely configure and operate all of Cylink's products without risk of tampering by other network operations personnel. In addition, Cylink's public key-based solutions included the NetHawk, which creates a secure VPN for transmitting high-value information. Cylink also offered a unified management platform for all of its security appliances to authenticate these devices, configure their use and centrally manage their operation. Such solutions included Cylink's public key infrastructure, or PKI, for managing the digital identities and privileges of all correspondents on the customer's network. Cylink's products created trust in its customers' networks by securing the access, privacy and integrity of its customers' important information when such information is transmitted over their LANs, WANs, and the Internet.

These products, along Cylink's commitment and focus to customer service and support, will be integrated as a part of SafeNet's industry leading product offerings as well as world class standards of customer service and support.  These products will work to build and improve SafeNet's base product mix as well as improve certain technology and software offerings from the SafeNet product family.  SafeNet believes that these products provide SafeNet a bridge to the next generation of security solutions.  Specifically, Cylink's Nethawk technology is a critical piece of SafeNet's High Assurance Gateway technology line.  Cylink's PrivaCy Manager is a critical piece of SafeNet's Security Management Center technology product package bridging WAN and related technology infrastructures to the VPN and Internet environment with minimal costs and maximum benefits.

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See Note 16 in the Notes to the Consolidated Financial Statements for further
discussion.

PART II

ITEM 2  PROPERTIES

SafeNet maintains its leased corporate and administrative facilities at 8029
Corporate Drive, Baltimore, Maryland. The building, constructed in 1988, has
approximately 25,000 square feet and is also used for SafeNets executive
headquarters, United States production, and SafeNet Trusted Services facility.
The lease, which expires in December 2003, provides for annual increases in rentals
during each year of the lease and will require the Company to pay approximately
$115,000 in 2003.

Cylink leases approximately 47,000 square feet in Santa Clara, California. The
lease, which expires in August 2009, requires annual rental of $1,346,000.
SafeNet also holds the lease to the former Cylink ATM Center, comprising
approximately 10,000 square feet in Raleigh, North Carolina, which expires in
June 2003. We also lease facilities for sales offices in New Jersey, Virginia,
North Carolina, Belgium, the United Kingdom and Singapore. We believe that our
current facilities are well maintained and are adequate for the foreseeable
future.

SafeNet leases approximately 20,000 square feet related to its abandoned
administrative and production facilities in Regensdorf, Switzerland. The lease,
which expires on December 31, 2003, calls for an annual rental of approximately
$348,000.

SafeNet BV leases approximately 13,700 square feet for its operations in Vught,
The Netherlands. The lease, which expires on March 31, 2007, requires annual
rental of approximately $180,000.

SafeNet also leases office space in Danvers, Massachusetts with annual rent of
approximately $99,000.

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ITEM 3  LEGAL PROCEEDINGS

SafeNet is not aware of any material litigation or proceeding, pending or
threatened, to which it is or may become
a party.

In 1998, Cylink filed amended Quarterly Reports on Form 10-Q for the first and
third quarters of 1998 and an amended Annual Report on Form 10-K for the 1997
fiscal year, reflecting restated financial results for those quarters, and for
the fourth quarter of 1997. Between November 6, 1998 and December 14, 1998
several securities class action complaints were filed against Cylink and
certain of its current and former Directors and officers in federal courts in
California. These complaints alleged, among other things, that Cylinks
previously issued financial statements were materially false and misleading and
that the defendants knew or should have known that these financial statements
caused Cylinks common stock price to rise artificially. The actions variously
alleged violations of Section 10(b) of the Securities Exchange Act of 1934, as
amended, and SEC Rule 10b-5 promulgated thereunder, and Section 20 of the
Exchange Act. The securities class action lawsuits were ordered consolidated
into a single action pending in the United States District Court for the
Northern District of California, captioned In Re Cylink Securities Litigation,
No. C98-4292 (VRW). On October 16, 2002, Cylink entered into an agreement with
all plaintiffs in the securities class action lawsuit to settle all claims in
the class action for $6.2 million. The settlement amount will be paid entirely
from insurance proceeds under insurance policies held by Cylink. The settlement
agreement is subject to approval by the United States District Court for the
Northern District of California. The court preliminarily approved the
settlement agreement on November 12, 2002. A motion by the plantiffs was filed
on Feb 24, 2003 and was heard on March 6, 2003. The court requested additional
information from Cylinks litigation expert. The information was provided to
the court on March 20, 2003.

ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

A Special Meeting of Stockholders was held on February 5, 2003, to consider and
vote upon the merger of Cylink with a wholly-owned subsidiary of
SafeNet pursuant to an agreement and plan of reorganization dated October 30,
2002, the issuance of shares of SafeNet common stock pursuant to the merger and
related transactions (collectively, the Merger Proposal). At the meeting,
the stockholders approved the Merger Proposal. There were 4,941,305 shares
cast in favor of the Merger Proposal, 65,137 shares cast against the Merger
Proposal, and 6,817 shares abstained.

ITEM 5  MARKET FOR COMMON EQUITY AND RELATED MATTERS

SafeNets Common Stock is listed on the Nasdaq National Market under the symbol
SFNT. The following table sets forth the quarterly range of per share high and
low bid prices for SafeNets Common Stock as reported by the Nasdaq National
Market for the periods indicated.

|      |                |  |      |       |     |  |   |       | 
|----- | -------------- |  | ---- | ----- | --- |  | - | ----- | 
|      |                |  | High |       | Low
|      |                |  |      |       |    
|2002: |                |  |      |       |     |  |   |      
|      | Fourth Quarter |  | $    | 29.10 |     |  | $ | 13.05 | 
|      | Third Quarter  |  |      | 21.65 |     |  |   | 13.32 | 
|      | Second Quarter |  |      | 16.50 |     |  |   | 10.37 | 
|      | First Quarter  |  |      | 19.41 |     |  |   | 9.70  | 
|2001: |                |  |      |       |     |  |   |      
|      | Fourth Quarter |  |      | 19.71 |     |  |   | 5.81  | 
|      | Third Quarter  |  |      | 10.10 |     |  |   | 5.81  | 
|      | Second Quarter |  |      | 17.55 |     |  |   | 7.10  | 
|      | First Quarter  |  |      | 64.69 |     |  |   | 10.75 | 

On March 28, 2003, the last reported per share sale price of SafeNets Common
Stock on the Nasdaq National Market was $20.89. As of that date, there were
approximately 217 holders of record of the Common Stock and
approximately 4,000 beneficial
holders of the Common Stock. We have not paid dividends on our Common Stock and
intend for the near future to retain earnings, if any, to finance the expansion
and development of our business.

19



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##### 



ITEM 6  SELECTED FINANCIAL DATA

The selected financial data set forth below as of and for each of the five
years ended December 31, 2002 is derived from our audited financial statements.
The selected financial data is qualified by and should be read in conjunction
with the Consolidated Financial Statements and Managements Discussion and
Analysis of Financial Condition and Results of Operations included elsewhere
herein.

The accompanying financial data has been restated to reflect the net assets of
the disposed operations of GretaCoder Data Systems (GDS) as current assets,
non-current assets, and current liabilities of discontinued operations. The
following data should be read in conjunction with Note 3 to the Consolidated
Financial Statements.

|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |        |  
|--------------------------------------------------------- | ------------------------------------------------------------ | ----------------------- | ------ | ------ | ---- | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | - | - | ------ | ------ | -
|(Amounts in thousands, except per share data)             |                                                              | Year Ended December 31,
|                                                          |                                                              |                        
|                                                          |                                                              |                         | 2002   |        | 2001 |   | 2000   |        | 1999 |   | 1998  
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |       
|Revenues                                                  |                                                              | $                       | 32,235 |        |      | $ | 16,462 |        |      | $ | 25,278 |        |  | $ | 10,565 |        |   | $ | 11,624 |       
|Cost of revenues                                          |                                                              |                         | 8,963  |        |      |   | 4,525  |        |      |   | 5,834  |        |  |   | 4,352  |        |   |   | 5,527  |       
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Gross profit                                                 |                         |        | 23,272 |      |   |        | 11,937 |      |   |        | 19,444 |  |   |        | 6,213  |   |   |        | 6,097  |  
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|Research and development expenses                         |                                                              |                         | 8,504  |        |      |   | 6,118  |        |      |   | 6,342  |        |  |   | 4,580  |        |   |   | 3,446  |       
|Sales and marketing expenses                              |                                                              |                         | 7,341  |        |      |   | 5,061  |        |      |   | 4,756  |        |  |   | 5,251  |        |   |   | 5,889  |       
|General and administrative expenses                       |                                                              |                         | 4,108  |        |      |   | 2,203  |        |      |   | 2,681  |        |  |   | 2,227  |        |   |   | 2,292  |       
|Write-off in in-process research and development          |                                                              |                         | 3,375  |        |      |   |       |        |      |   |       |        |  |   |       |        |   |   |       |       
|Amortization of intangibles                               |                                                              |                         | 1,488  |        |      |   |       |        |      |   |       |        |  |   |       |        |   |   |       |       
|(Recovery of) reserve for Cyberguard advance              |                                                              |                         |       |        |      |   |       |        |      |   | (275   | )      |  |   | (375   | )      |   |   | 772    |       
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Total operating expenses                                     |                         |        | 24,816 |      |   |        | 13,382 |      |   |        | 13,504 |  |   |        | 11,683 |   |   |        | 12,399 |  
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Operating (loss) income                                      |                         |        | (1,544 | )    |   |        | (1,445 | )    |   |        | 5,940  |  |   |        | (5,470 | ) |   |        | (6,302 | )
|Investment income and other expenses, net                 |                                                              |                         | 669    |        |      |   | 1,336  |        |      |   | 1,320  |        |  |   | 95     |        |   |   | 232    |       
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | (Loss) income from continuing
operations before income taxes |                         |        | (875   | )    |   |        | (109   | )    |   |        | 7,260  |  |   |        | (5,375 | ) |   |        | (6,070 | )
|Income tax benefit, net                                   |                                                              |                         | (90    | )      |      |   |       |        |      |   |       |        |  |   |       |        |   |   |       |       
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | (Loss) income from continuing operations                     |                         | $      | (785   | )    |   | $      | (109   | )    |   | $      | 7,260  |  |   | $      | (5,375 | ) |   | $      | (6,070 | )
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|(Loss) income from continuing operations per common share |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Basic                                                        |                         | $      | (0.10  | )    |   | $      | (0.01  | )    |   | $      | 1.08   |  |   | $      | (0.98  | ) |   | $      | (1.12  | )
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Diluted                                                      |                         | $      | (0.10  | )    |   | $      | (0.01  | )    |   | $      | 1.01   |  |   | $      | (0.98  | ) |   | $      | (1.12  | )
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|Shares used in computation                                |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Basic                                                        |                         |        | 7,730  |      |   |        | 7,057  |      |   |        | 6,751  |  |   |        | 5,504  |   |   |        | 5,409  |  
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       
|                                                          | Diluted                                                      |                         |        | 7,730  |      |   |        | 7,057  |      |   |        | 7,195  |  |   |        | 5,504  |   |   |        | 5,409  |  
|                                                          |                                                              |                         |        |        |      |   |        |        |      |   |        |        |  |   |        |        |   |   |        |       

|                     |  |                 |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|-------------------- |  | --------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                     |  | At December 31,
|                     |  |                
|                     |  | 2002            |        | 2001 |  | 2000 |        | 1999 |  | 1998
|                     |  |                 |        |      |  |      |        |      |  |     
|Balance Sheet Data:  |  |                 |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|Working capital      |  | $               | 31,987 |      |  | $    | 32,385 |      |  | $    | 33,695 |  |  | $ | 23,035 |  |  | $ | 11,081 | 
|Intangible assets    |  |                 | 13,900 |      |  |      | 727    |      |  |      | 1,516  |  |  |   | 2,107  |  |  |   | 1,527  | 
|Total assets         |  |                 | 55,319 |      |  |      | 39,877 |      |  |      | 43,106 |  |  |   | 31,896 |  |  |   | 18,940 | 
|Stockholders equity |  |                 | 48,378 |      |  |      | 35,459 |      |  |      | 37,723 |  |  |   | 27,636 |  |  |   | 15,400 | 

20



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##### 



QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the quarterly results of operations for the years
ended December 3l, 2002 and 2001. All periods results have been restated to
separately disclose discontinued operations.

(Unaudited  Amounts in thousands, except per share data):



|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |       | 
|------------------------------------------ | ------------------------------------------ | - | ------------------ | ----- | ------- | - | -------- | ----- | ------- | - | ----- | ----- |  | - | ----- | ----- | 
|                                           |                                            |   | 2002 Quarter Ended
|                                           |                                            |   |                   
|                                           |                                            |   | March 31           |       | June 30 |   | Sept. 30 |       | Dec. 31
|                                           |                                            |   |                    |       |         |   |          |       |        
|Revenues                                   |                                            | $ | 6,154              |       |         | $ | 7,428    |       |         | $ | 8,827 |       |  | $ | 9,826 |      
|Cost of revenues                           |                                            |   | 1,953              |       |         |   | 2,061    |       |         |   | 2,580 |       |  |   | 2,369 |      
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | Gross profit                               |   |                    | 4,201 |         |   |          | 5,367 |         |   |       | 6,247 |  |   |       | 7,457 | 
|Operating (loss) income                    |                                            |   | (4,016             | )     |         |   | 222      |       |         |   | 754   |       |  |   | 1,496 |      
|(Loss) income from continuing operations   |                                            |   | (3,742             | )     |         |   | 246      |       |         |   | 877   |       |  |   | 1,834 |      
|(Loss) income from discontinued operations |                                            |   | (3,784             | )     |         |   | (398     | )     |         |   | 116   |       |  |   | 112   |      
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|Net (loss) income                          |                                            | $ | (7,526             | )     |         | $ | (152     | )     |         | $ | 993   |       |  | $ | 1,946 |      
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|(Loss) Earnings Per Share, Basic:          |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | (Loss) income from continuing operations   |   | $                  | (0.49 | )       |   | $        | 0.03  |         |   | $     | 0.12  |  |   | $     | 0.24  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | (Loss) income from discontinued
operations |   | $                  | (0.49 | )       |   | $        | (0.05 | )       |   | $     | 0.01  |  |   | $     | 0.01  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | Net (loss) income                          |   | $                  | (0.98 | )       |   | $        | (0.02 | )       |   | $     | 0.13  |  |   | $     | 0.25  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|(Loss) Earnings Per Share, Diluted:        |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | (Loss) income from continuing operations   |   | $                  | (0.49 | )       |   | $        | 0.03  |         |   | $     | 0.11  |  |   | $     | 0.22  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | (Loss) income from discontinued
operations |   | $                  | (0.49 | )       |   | $        | (0.05 | )       |   | $     | 0.01  |  |   | $     | 0.01  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | Net (loss) income                          |   | $                  | (0.98 | )       |   | $        | (0.02 | )       |   | $     | 0.12  |  |   | $     | 0.23  | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|Shares used in computation                 |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | Basic                                      |   |                    | 7,677 |         |   |          | 7,689 |         |   |       | 7,736 |  |   |       | 7,824 | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      
|                                           | Diluted                                    |   |                    | 7,677 |         |   |          | 7,932 |         |   |       | 8,062 |  |   |       | 8,625 | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |       |  
|------------------------------------------ | ------------------------------------------ | - | ------------------ | ----- | ------- | - | -------- | ----- | ------- | - | ----- | ----- | - | - | ----- | ----- | -
|                                           |                                            |   | 2001 Quarter Ended
|                                           |                                            |   |                   
|                                           |                                            |   | March 31           |       | June 30 |   | Sept. 30 |       | Dec. 31
|                                           |                                            |   |                    |       |         |   |          |       |        
|Revenues                                   |                                            | $ | 5,641              |       |         | $ | 3,134    |       |         | $ | 3,602 |       |   | $ | 4,085 |      
|Cost of revenues                           |                                            |   | 1,489              |       |         |   | 1,444    |       |         |   | 874   |       |   |   | 718   |      
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | Gross profit                               |   |                    | 4,152 |         |   |          | 1,690 |         |   |       | 2,728 |   |   |       | 3,367 |  
|Operating (loss) income                    |                                            |   | 648                |       |         |   | (1,845   | )     |         |   | (448  | )     |   |   | 200   |      
|(Loss) income from continuing operations   |                                            |   | 1,066              |       |         |   | (1,497   | )     |         |   | (167  | )     |   |   | 489   |      
|(Loss) income from discontinued operations |                                            |   | (635               | )     |         |   | (1,278   | )     |         |   | (550  | )     |   |   | (990  | )    
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|Net (loss) income                          |                                            | $ | 431                |       |         | $ | (2,775   | )     |         | $ | (717  | )     |   | $ | (501  | )    
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|(Loss) Earnings Per Share, Basic:          |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | (Loss) income from continuing operations   |   | $                  | 0.15  |         |   | $        | (0.21 | )       |   | $     | (0.02 | ) |   | $     | 0.07  |  
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | (Loss) income from discontinued
operations |   | $                  | (0.09 | )       |   | $        | (0.18 | )       |   | $     | (0.08 | ) |   | $     | (0.13 | )
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | Net (loss) income                          |   | $                  | 0.06  |         |   | $        | (0.39 | )       |   | $     | (0.10 | ) |   | $     | (0.06 | )
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|(Loss) Earnings Per Share, Diluted:        |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | (Loss) income from continuing operations   |   | $                  | 0.15  |         |   | $        | (0.21 | )       |   | $     | (0.02 | ) |   | $     | 0.07  |  
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | (Loss) income from discontinued
operations |   | $                  | (0.09 | )       |   | $        | (0.18 | )       |   | $     | (0.08 | ) |   | $     | (0.14 | )
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | Net (loss) income                          |   | $                  | 0.06  |         |   | $        | (0.39 | )       |   | $     | (0.10 | ) |   | $     | (0.07 | )
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|Shares used in computation                 |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | Basic                                      |   |                    | 6,999 |         |   |          | 7,059 |         |   |       | 7,079 |   |   |       | 7,092 |  
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      
|                                           | Diluted                                    |   |                    | 7,465 |         |   |          | 7,059 |         |   |       | 7,079 |   |   |       | 7,092 |  
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      

During the quarter ended March 31, 2002, the Company recorded a charge of
$3,375,000 related to the write-off of in process research and development
assets acquired in connection with the purchase of Securealink on January 2,
2002. During that quarter, the Company also recorded a charge of $3,506,000
related to the loss on the disposal of the GDS business.

21



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##### 



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 SafeNets actual results in future periods to differ materially
from forecasted results. Those risks include, among others, risks associated
with the receipt and timing of future customer orders, price pressures,
achieving technical and product development milestones, the ability to
negotiate favorable strategic OEM agreements, sufficient cash flow to support
SafeNets liquidity requirements, other competitive factors leading to a
decrease in anticipated revenues and gross profit margins and product
development expenses.

OVERVIEW

SafeNet designs, manufactures and markets enterprise network security solutions
using encryption technology. Our products are used in electronic commerce
applications by financial institutions, government agencies and large
corporations to secure data transmissions on private and public computer
networks, such as the Internet.

In January 2002, we acquired Securealink. Securealink develops, markets and
sells security chips and intellectual property, primarily in Europe and Asia.

In February 2002, management decided to discontinue our Swiss operations at
GDS, which was formerly our European operations segment (see note 3 to the
audited financial statements). The operating results of the discontinued
businesses has been reported in the discontinued operations section of the
consolidated statement of operations. The following comparisons of operating
results focuses on the continuing operations of the Company.

SafeNets historical operating results have been dependent on a variety of
factors including, but not limited to, the length of the sales cycle, the
timing of orders from and shipments to clients, product development expenses
and the timing of development and introduction of new products. Our expense
levels are based, in part, on expectations of future revenues. The size and
timing of our historical revenues have varied substantially from quarter to
quarter and year to year. Accordingly, the results of a particular period, or
period-to-period comparisons of recorded sales and profits may not be
indicative of future operating results.

While management is committed to the long-term profitability of SafeNet, the
recent growth of the computer security industry has made it important that
market share be obtained. We have undertaken various strategies in order to
increase our revenues and improve our future operating results, including new
product offerings such as our SafeNet EmbeddedIP and SafeNet Soft Remote.
Management believes that growth in the market for products that provide secure
remote access to computer networks requires SafeNet to increase its investment
in development, sales and marketing activities to allow SafeNet to take
advantage of this market opportunity and to achieve long-term profitability,
thereby maximizing shareholder value. However, there can be no assurance that
these strategies will be successful.

22



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##### 



RESULTS OF OPERATIONS OF SAFENET

The following table sets forth certain Consolidated Statement of Operations
data of SafeNet as a percentage of revenues for the years ended December 31.

|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|------------------------------------------------------------ |  | ---- | --- | - | - |  |  | ---- |  |  | --- | - | - | ---- |  |  |  |  | --- | - | - |  |  | 
|                                                             |  | 2002 |     |   |   |  |  | 2001 |  |  |     |   |   | 2000 |  |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  | 
|Revenues                                                     |  |      | 100 |   | % |  |  |      |  |  | 100 |   | % |      |  |  |  |  | 100 |   | % |  |  | 
|Cost of revenues                                             |  |      | 28  |   |   |  |  |      |  |  | 27  |   |   |      |  |  |  |  | 23  |   |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|Gross profit                                                 |  |      | 72  |   |   |  |  |      |  |  | 73  |   |   |      |  |  |  |  | 77  |   |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|Research and development expenses                            |  |      | 26  |   |   |  |  |      |  |  | 37  |   |   |      |  |  |  |  | 25  |   |   |  |  | 
|Sales and marketing expenses                                 |  |      | 23  |   |   |  |  |      |  |  | 31  |   |   |      |  |  |  |  | 19  |   |   |  |  | 
|General and administrative expenses                          |  |      | 13  |   |   |  |  |      |  |  | 13  |   |   |      |  |  |  |  | 11  |   |   |  |  | 
|Write-off in in-process research and development             |  |      | 10  |   |   |  |  |      |  |  |    |   |   |      |  |  |  |  |    |   |   |  |  | 
|Amortization of intangibles                                  |  |      | 5   |   |   |  |  |      |  |  |    |   |   |      |  |  |  |  |    |   |   |  |  | 
|Recovery of CyberGuard advance                               |  |      |    |   |   |  |  |      |  |  |    |   |   |      |  |  |  |  | (1  | ) |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|Total operating expenses                                     |  |      | 77  |   |   |  |  |      |  |  | 81  |   |   |      |  |  |  |  | 54  |   |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|Operating (loss) income                                      |  |      | (5  | ) |   |  |  |      |  |  | (8  | ) |   |      |  |  |  |  | 23  |   |   |  |  | 
|Investment income and other expenses, net                    |  |      | 2   |   |   |  |  |      |  |  | 8   |   |   |      |  |  |  |  | 5   |   |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|(Loss) income from continuing operations before income taxes |  |      | (3  | ) |   |  |  |      |  |  |    |   |   |      |  |  |  |  | 28  |   |   |  |  | 
|Income tax benefit                                           |  |      | (0  | ) |   |  |  |      |  |  |    |   |   |      |  |  |  |  |    |   |   |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 
|(Loss) income from continuing operations                     |  |      | (3  | ) | % |  |  |      |  |  |    |   | % |      |  |  |  |  | 28  |   | % |  |  | 
|                                                             |  |      |     |   |   |  |  |      |  |  |     |   |   |      |  |  |  |  |     |   |   |  |  | 

The Company has two reportable segments: products, chips and software designed
and manufactured for sale to companies that will embed the Companys products
into their products for ultimate sale to end-users (Embedded Security
Division), and network security products designed and manufactured for direct
sales to end-users and remote access software sold to OEMs (Enterprise
Security Division). The segments are strategic business units that offer
different products. The segments are managed separately because each segment
requires different technology and marketing strategies (see note 13 to the
audited consolidated financial statements).

The acquisition of Cylink in February 2003, is expected to have a significant
impact on the Companys results of operations and financial condition. Since
the transaction closed subsequent to December 31, 2002, the Cylink acquisition
has not been considered in the Companys discussion of its results of
operations and financial condition as of and for the year ended December 31,
2002. However, due to its significance to the Companys business, a discussion
of the Cylink acquisition and its anticipated impact is included at the end of
Item 7: Managements Discussion and Analysis.

Year ended December 31, 2002 Compared to Year ended December 31, 2001

Revenues increased 96%, or $15,773,000, to $32,235,000 for the period ended
December 31, 2002, from $16,462,000 in 2001. The Embedded Security Division
revenues increased 234% or $12,815,000 due to the full year presence of the
Securealink acquisition for 2002 as well as increased revenue from our largest
commercial customer. The Enterprise Security Division segment increased 27% or
$2,958,000 due to revenues earned under additional long-term government
contracts. These contracts are the result of the governments approach to
internet and communication security in light of the Homeland Security
Initiative.

Gross margin remained consistent, 72% for the period ended December 31, 2002,
from 73% in 2001. Gross margins in the Embedded Security Division decreased to
72% in 2002 from 77% in 2001, due to the change in product mix with the
addition of Securealink delivering lower margin products. Enterprise Security
Division margins increased to 74% in 2002 from 71% in 2001 based on increased
customer base of higher margin customers as well changes in product mix with
higher volumes in higher margin products such as license revenue.

Research and development expenses increased 39%, or $2,386,000 to $8,504,000
for the period ended December 31, 2002, from $6,118,000 in 2001. The increase
is primarily related to the addition of the Securealink business, with the main
cost of that business being research and development costs. Research and
development expenses for the

23



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Embedded Security Division were focused on the next generation products
(chips), designed to be a very cost-effective, high throughput, low
power-consuming chips in the tradition of SafeNets other silicon products.
Research and development expenses for the Enterprise Security Division were
focused on SafeNets High Assurance product line, including gateways, software,
and other appliances. Some of these products were made available in 2002 with
the remaining products coming to market in 2003.

Sales and marketing expenses increased 45%, or $2,280,000 to $7,341,000 for the
period ended December 31, 2002, from $5,061,000 in 2001. The additional
expense reflects increased headcount, higher commissions from higher revenues,
as well as additional promotional dollars spent on the branding of the
Securealink products and name. As a percentage of revenues, the expenses were
23% and 31% in 2002 and 2001, respectively.

General and administrative expenses increased 86%, or $1,905,000, to $4,108,000
for the period ended December 31, 2002, from $2,203,000 in 2001. The increase
is due to the additional office space obtained with the Securealink
acquisition, additional corporate employees, increased bonus expenses, and
additional professional fees incurred related to new corporate governance
requirements. As a percentage of revenues, the expenses were 13% in
2002 and 2001.

The write-off of acquired in-process research and development assets, which
totaled $3,375,000 for the year ended December 31, 2002, relates to the January
2002 acquisition of Securealink. This represents the estimated fair value of
the in-process research and development projects that had not yet reached
technological feasibility at the acquisition date, and had no alternative
future use. Accordingly, this amount was immediately expensed at the
acquisition date. The value assigned to the acquired in-process technology
relates entirely to the development of a new application specific integrated
circuit. The estimated fair value of this project was determined by the use of
a discounted cash flow model, using a discount rate that took into account the
stage of completion and the risks surrounding the successful development and
commercialization of the technology. Subsequent to the acquisition, the
Company incurred approximately $750,000 in additional research and development
charges to complete the development of the technology, which was licensed to a
customer during fiscal year 2002.

Amortization of intangible assets, which totaled $1,488,000 for the year ended
December 31, 2002, also relates to the January 2002 acquisition of Securealink.
Intangible assets, which consist primarily of developed technology and
patents, are amortized over estimated useful lives ranging from one to five
years.

Investment income and other expenses decreased by $667,000, to $669,000 for the
period ended December 31, 2002, from $1,336,000 in 2001.
Investment income and
other expenses decreased primarily due to lower interest rates throughout 2002
as compared to 2001.

For the year ended December 31, 2002, the Company incurred operating losses,
however, the Company also experienced an income tax benefit related to the
amortization of acquired intangibles from the Securealink acquisition. For the
year ended December 31, 2001, the Company incurred operating losses and
therefore, did not record income tax expense. The Companys income tax benefit
related to these losses has been offset by a valuation allowance for the full
amount of the net deferred tax assets since the Companys ability to use the
remaining net operating loss carryforward is dependent upon future taxable
income.

The Company had a loss from continuing operations of $785,000 for the year
ended December 31, 2002 compared to a loss from continuing operations of
$109,000 for the same period in 2001. The loss from continuing operations per
common share was $0.10 in 2002 compared to loss from continuing per common
share of $0.01 in 2001.

Year ended December 31, 2001 Compared to Year ended December 31, 2000

Revenues decreased 35%, or $8,816,000, to $16,462,000 for the period ended
December 31, 2001, from $25,278,000 in 2000. The Embedded Security Division
revenues decreased 15% or $941,000 due to the adverse impact of the economic

24



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slowdown on customers, causing them to delay purchases of software licenses and
upgrades, and accelerator boards. The Enterprise Security Division segment
decreased 42% or $7,875,000 primarily due to delayed purchases of SafeNets VPN
products from government customers in the wake of the
September 11th tragedy.

Gross margin decreased to 73% for the period ended December 31, 2001, from 77%
in 2000. The Company recorded additional inventory reserves related primarily
to legacy products with diminishing future demand. These additional reserves
aggregated $173,000 in the second quarter of 2001 and negatively impacted gross
margins by 1%. For the year, the additional inventory reserves affected the
Embedded and Enterprise segments by $58,000, and $115,000, respectively,
impacting gross margins by 0%, and 1%, respectively. Gross margins in the
Embedded Security Division increased to 77% in 2001 from 68% in 2000, due to
increased royalty revenues earned on chip sales and license fees associated
with intellectual property sales. Enterprise Security Division margins
decreased to 71% from 80% based primarily on the change in product mix to
include a lesser amount of higher margin software sales.

Research and development expenses decreased 4%, or $224,000 to $6,118,000 for
the period ended December 31, 2001, from $6,342,000 in 2000. The decrease is
primary related to lower external development costs of chip fabrication.

Sales and marketing expenses increased 6%, or $305,000 to $5,061,000 for the
period ended December 31, 2001, from $4,756,000 in 2000. The additional
expense reflects managements focus on increasing sales and marketing resources
in new markets. Additional expenses include the costs associated with new
employees and expanded marketing programs such as the SafeNet Secure Tour and
two trade shows. As a percentage of revenues, the expenses were 31% and 19% in
2001 and 2000, respectively.

General and administrative expenses decreased 18%, or $478,000, to $2,203,000
for the period ended December 31, 2001, from $2,681,000 in 2000. The decrease
is due to cost saving measures including staff reductions, reductions in
performance-based compensation, travel expenses, and professional fees. As a
percentage of revenues, the expenses were 13% and 11% of revenues in 2001 and
2000, respectively.

Interest income and other expenses increased by $16,000, to $1,336,000 for the
period ended December 31, 2001, from $1,320,000 in 2000. Interest income
remained steady despite declining interest rates in 2001 due to larger average
cash and short-term investment holdings throughout 2001 compared to 2000.

For the year ended December 31, 2001, the Company has incurred operating losses
and therefore, did not record income tax expense. The Companys income tax
benefit related to these losses has been offset by a valuation allowance for
the full amount of the net deferred tax assets since the Companys ability to
use the remaining net operating loss carryforward is dependent upon future
taxable income. For the year ended December 31, 2000, the Company did not
recognize income tax expense due to the reversal of the valuation allowance on
net operating loss carryforwards available to offset earnings.

The Company had a loss from continuing operations of $109,000 for the year
ended December 31, 2001 compared
to income from continuing operations of $7,260,000 for the same period in 2000.
The loss from continuing operations per common share was $0.01 in 2001
compared to diluted income from continuing per common share of $1.01
in 2000.

Liquidity and Capital Resources

SafeNet believes that its current cash resources will be sufficient to meet its
needs for the next year. As of December 31, 2002, SafeNet had working capital
of $31,987,000 including cash and short-term investments of $32,162,000.

In January 2002, as partial consideration for the acquisition of Securealink,
SafeNet paid $2,000,000 in cash and issued contingent convertible promissory
notes, which were paid in May 2002, in the aggregate amount of $1,618,000.

25



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Additionally, after closing of the acquisition in January 2002, SafeNet
advanced to Securealink approximately $1,484,000 in order to repay
Securealinks line of credit.

As discussed in Note 3 to the consolidated financial statements, in February
2002, SafeNet management decided to discontinue operations at GDS based on the
amount of GDS operating and cash losses during 2000 and 2001 as well as a
significant downturn in future business prospects. GDS suffered cash losses of
$2,284,000 and $756,000 during the years ended December 31, 2001 and 2000,
respectively. Managements decision to discontinue operations at GDS
positively impacted cash flows in 2002.

In 2002, cash and short-term investments increased $1,478,000. The increase
was mainly attributable to cash provided by operating activities of $5,933,000.
Cash used in investing activities during 2002 included investments
in computer software development costs and equipment totaling $833,000 and cash
paid for Securealink was $3,769,000, net of cash required. Cash provided by
financing activities in 2002 included $2,187,000 from the exercise of stock
options.

SafeNet has expended and will continue to expend portions of its operating cash
for acquisition and integration costs related to acquisitions. The Cylink
acquisition expended $386,000 for acquisition costs in 2002 and $255,000 for
integration costs in 2002. We expect the cash outflow to be significant in
2003 as we integrate Cylink throughout the majority of 2003. Actual cash
outflows for the Cylink integration and acquisition for 2003 through February
2003 were $1,126,000. The Raqia acquisition will also require cash outflows,
including $1,305,000 through February 2003. There will also be additional
investments made into the acquired technology from the Raqia acquisition in
2003. We estimated the integration costs for Cylink and Raqia during 2003 to
be $4,000,000 and $250,000, respectively. We estimate the acquisition costs for Cylink and Raqia during 2003 to be
$4,600,000 and $200,000, respectively. SafeNet believes that its current
cash resources will be sufficient to meet its needs for the next year.

Inflation and Seasonality

SafeNet does not believe that inflation will significantly impact its business.
We do not believe our business is seasonal. However, because we generally
recognize product revenues upon shipment and software revenues upon
establishing fair value of undelivered elements, recognition may be irregular
and uneven, thereby disparately impacting quarterly operating results and
balance sheet comparisons.

Effect of Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board issued Statement No.
146, Accounting for Costs Associated with Exit or Disposal Activities, which
addresses accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring).Statement No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
at fair value when the liability is incurred rather than at the date of a
commitment to an exit plan. Costs covered by Statement No. 146 include
one-time termination benefits and certain contract termination costs, including
operating lease termination costs that are associated with an exit or disposal
activity. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002.

Critical Accounting Policies

The Companys accounting policies are more fully described in Note 2 of the
Notes to Consolidated Financial Statements. As discussed in this note, the
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
about future events that affect the amounts reported in the financial
statements and accompanying notes. Future events and their effects cannot be
determined with absolute certainty; therefore, the determination of estimates
requires the exercise of judgment. Actual results inevitably will differ from
those estimates, and such differences may be material to the financial
statements.

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SafeNet believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. SafeNet Senior Management has discussed each of these
critical accounting policies with the Companys audit committee.

Allowance for doubtful accounts

SafeNet maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company calculates its allowance based on a specific analysis of past due
balances and also considers historical trends of write-offs. If the financial
condition of SafeNets customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.

Inventory

SafeNet provides for its estimated inventory obsolescence or unmarketable
inventory equal to the difference between the cost of the inventory and the
estimated market value based upon assumptions about future demand and market
conditions. The Company utilizes projected sales by product to determine the
net realizable value of the inventory. If actual market conditions are less
favorable than those projected by management, additional inventory write-downs
may be required.

Software Development Costs

SafeNet calculates amortization of its capitalized software development costs
based on the greater of the amount computed using the ratio that current gross
revenues for a product bear to the total of current and anticipated future
gross revenues for that product or the straight-line method over the remaining
estimated economic life of the product including the period being reported on.
In addition, SafeNet assesses the recoverability of software development costs
by comparing the unamortized balance to the net realizable value of the asset
and writes off the amount by which the unamortized capitalized costs exceed the
net realizable value.

These calculations require management to make assumptions about future demand
for its products, future revenues to be generated from the sale of its
products, as well as the estimated useful lives of developed technology. If
actual market conditions or product demand is different from those assumptions,
or if changes in technology limit the useful life of SafeNets core technology,
additional amortization or write-downs may be required.

Goodwill and Other Intangible Assets

SafeNet accounts for acquired businesses using the purchase method of
accounting. A portion of the purchase prices for these businesses is allocated
to identifiable tangible and intangible assets and assumed liabilities based on
estimated fair values at the dates of acquisitions. Any excess purchase price
is allocated to goodwill.

The identified intangible assets include patents, developed technology,
purchase orders, contract backlog
and acquired in-process research and development assets. Research and
development assets are written off at the date of acquisition in accordance
with Financial Accounting Standards Board (FASB) Interpretation No. 4,
Applicability of FASB Statement No. 2 to Business Combinations Accounted for by
the Purchase Method. The fair values were determined by management, generally
based upon information supplied by the management of the acquired entities and
valuations prepared by independent valuation experts. The valuations have been
based primarily upon future cash flow projections for the acquired assets,
discounted to present value using a risk-adjusted discount rate. For certain
classes of intangible assets, the valuations have been based upon estimated
cost of replacement. The assigned useful lives, which range from one to five
years, are based upon periods of estimated cash flows and other factors. If
SafeNet used different assumptions and estimates in the calculation of the fair
value of identified intangible assets and the estimation of the related useful
lives, the amounts allocated
to these assets, as well as the related amortization expense, would have been
significantly different than the amounts recorded.

Effective January 1, 2002, SafeNet adopted the provisions of FASB Statement No.
142, Goodwill and Other Intangible Assets. Under Statement 142, goodwill is no
longer amortized but is reviewed annually for impairment, or

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more frequently if impairment indicators exist. Impairment exists when the
carrying amount of goodwill exceeds its implied fair value using impairment
testing methodology in Statement 142. Indicators of potential impairment
include operating losses, loss of a significant customer and adverse industry
developments.
The first annual impairment test for goodwill, all of which was assigned to the
Embedded Security division,
was performed on October 1, 2002. The impairment test was based upon a
comparison of the estimated fair
value of the Embedded Security division to the sum of the carrying value of the
assets and liabilities allocated
to that division. The fair values used in this evaluation were estimated based
upon discounted future cash flow projections for the division as well as
comparable revenue and earnings multiples. In order to project future cash
flows, management made a number of assumptions concerning such things as future
sales volume levels, future price levels, and rates of increase in operating
expenses. Since the estimated fair value of the division exceeded the carrying
value of the recorded net assets, no impairment was identified or recorded.
However, if SafeNet used different assumptions and estimates in the calculation
of the fair value of the division, an impairment of goodwill could have been
identified.

Revenue Recognition

SafeNet derives revenue from software and technology licenses, product sales,
maintenance and other services. Software and technology licenses contain
multiple elements, including the product license, maintenance and/or other
services. The recognition of revenue under these arrangements requires
management to make judgments about the likelihood of granting future
concessions and the ultimate collectibility of fees.

Revenues that are earned under long-term contracts to develop high assurance
encryption technology are recognized using contract accounting. Under contract
accounting, revenue from these arrangements is recognized using the
percentage-of-completion method. Progress to completion is measured using
contract milestones. Accounting for these contracts requires the estimation of
the cost, scope and duration of each milestone and each contract. If the
Company does not accurately estimate the resources required or the scope of
work to be performed, or does not manage its projects properly within the
planned periods of time or satisfy its obligations under the contracts, then
future margins may be significantly and negatively affected or losses on
existing contracts may need to be recognized. Any such resulting reductions in
margins or contract losses could be material to the Companys results of
operations.

Significant Business Acquisition Subsequent to December 31, 2002

In February 2003, SafeNet completed its acquisition of Cylink.
Operations of Cylink were integrated into the Enterprise Security Division of
SafeNet and function as part of that business unit.  This acquisition will have a significant
impact on the Companys business operations going forward.  See Item 1 - Business - Significant
Business Acquisition Subsequent to December 31, 2002.

The results of Cylinks business operations will be included in the Companys
Consolidated Financial Statements from February 6, 2003 forward.

The aggregate purchase price for
Cylink was approximately $35.1 million, consisting primarily of
1,648,000 shares of common stock valued at $31.2 million, 194,000
options and warrants assumed with an aggregate value of $1.7 million,
and estimated direct costs of the acquisition of $2.2 million.
The Company is in the process of obtaining third-party valuations on
this acquisition and the assets included.

On February 11, 2003, the Company filed a
Form 8-K related to the acquisition of Cylink.  The Company will
file an 8-K/A on or about April 21, 2003 that will include historical audited
financial statements of the acquired company and unaudited pro forma financial
information.

See Footnote 16 in Notes to Consolidated Financial Statements.

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ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the risk of loss to future earnings, to fair values or to future
cash flows that may result from changes in the price of financial instruments.
SafeNet is exposed to financial market risks, primarily related to changes in
foreign currency exchange rates. SafeNet currently does not have any
derivative financial instruments to protect against adverse currency movements.
SafeNet manages its exposure to market risks related to operations through
regular operating and financing activities. All of the potential impacts noted
below are based on a sensitivity analysis performed as of December 31, 2002.
Actual results may differ materially

SafeNet derives approximately 10% of its revenues from customers outside of the
U.S. This business is transacted primarily through a wholly owned subsidiary
located in the Netherlands that operates using the Euro as the functional
currency. Expenses are also incurred in Euros to match the subsidiarys
revenues and minimize exposure of operating margins to exchange rate
fluctuations. A hypothetical 10% adverse change in the average Euro exchange
rate would have decreased net operating income in 2002 by approximately
$353,000. SafeNet views the investment in this subsidiary as long-term. The
effect of a change in the Euro exchange rate on the net investment in the
foreign subsidiary is reflected in other comprehensive income (loss). A 10%
depreciation in the Euro relative to the U.S. dollar would result in a decrease
in consolidated stockholders equity at December 31, 2002 of approximately
$363,000.

At December 31, 2002 and 2001, SafeNet did not have any interest bearing
obligations. In addition, SafeNet does not hold any derivative instruments and
does not have any commodity market risk.

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SAFENET, INC
AND SUBSIDIARIES

ITEM 8  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

|                                                                                                                                                                                                                                       |  |      |    | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                                                                                                                                                       |  | PAGE
|                                                                                                                                                                                                                                       |  |     
|Report of Independent Auditors                                                                                                                                                                                                         |  |      | 31 | 
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                                                                                                                           |  |      | 32 | 
|Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000                                                                                                                                             |  |      | 33 | 
|Consolidated Statements of Comprehensive (Loss) Income for the years ended December 31, 2002,
2001 and 2000                                                                                                                            |  |      | 34 | 
|Consolidated Statements of Stockholders Equity for the years ended December 31, 2002,
2001 and 2000                                                                                                                                   |  |      | 35 | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000                                                                                                                                            |  |      | 36 | 
|Notes to Consolidated Financial Statements                                                                                                                                                                                             |  |      | 38 | 
|The following consolidated financial statement schedule of SafeNet, Inc. and subsidiaries is
included in this item:                                                                                                                    |  |      |    | 
|Schedule II Valuation and Qualifying Accounts                                                                                                                                                                                          |  |      | 58 | 
|All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted. |  |      |    | 

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors
SafeNet, Inc.

We have audited the accompanying consolidated balance sheets of SafeNet, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of operations, comprehensive income (loss), stockholders equity,
and cash flows for each of the three years in the period ended December 31,
2002. Our audits also included the financial statement schedule listed in the
Index at Item 14(a). These financial statements and schedule are the
responsibility of the Companys management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of SafeNet, Inc. and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for the each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.

As discussed in Note 7 to the financial statements, in 2002 the Company changed
its method of accounting
for goodwill.

|                                    |                      
|----------------------------------- | ---------------------
|                                    | /s/ Ernst & Young LLP
|Baltimore,
MarylandFebruary 6, 2003 |                      



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SAFENET, INC.
AND SUBSIDIARIESConsolidated Balance Sheets
(Amounts in thousands, except per share data)

|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |         |  
|------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------- | - | ------------ | ------- | ---- | - | ------ | ------- | -
|                                                                                                        |                                                                                                                                    |   | December 31,
|                                                                                                        |                                                                                                                                    |   | 2002         |         | 2001
|                                                                                                        |                                                                                                                                    |   |              |         |     
|Assets                                                                                                  |                                                                                                                                    |   |              |         |      |   |        |        
|Current assets:                                                                                         |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Cash and cash equivalents                                                                                                          |   | $            | 3,399   |      |   | $      | 14,819  |  
|                                                                                                        | Held-to-maturity securities                                                                                                        |   |              | 28,763  |      |   |        | 15,865  |  
|                                                                                                        | Accounts receivable, less allowance of $244 in 2002 and $150 in 2001                                                               |   |              | 4,534   |      |   |        | 3,225   |  
|                                                                                                        | Inventories, less reserve of $958 in 2002 and $482 in 2001                                                                         |   |              | 1,008   |      |   |        | 1,260   |  
|                                                                                                        | Prepaid expenses                                                                                                                   |   |              | 1,002   |      |   |        | 850     |  
|                                                                                                        | Current assets of discontinued operations                                                                                          |   |              | 93      |      |   |        | 784     |  
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Total current assets                                                                                                               |   |              | 38,799  |      |   |        | 36,803  |  
|Property and equipment, net                                                                             |                                                                                                                                    |   | 1,246        |         |      |   | 969    |        
|Computer software development costs, less accumulated amortization of $1,513 in 2002 and $3,113 in 2001 |                                                                                                                                    |   | 479          |         |      |   | 727    |        
|Goodwill                                                                                                |                                                                                                                                    |   | 12,826       |         |      |   |       |        
|Intangible assets, less accumulated amortization of $1,640 in 2002                                      |                                                                                                                                    |   | 595          |         |      |   |       |        
|Non-current assets of discontinued operations                                                           |                                                                                                                                    |   |             |         |      |   | 537    |        
|Other assets                                                                                            |                                                                                                                                    |   | 1,374        |         |      |   | 841    |        
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|Total assets                                                                                            |                                                                                                                                    | $ | 55,319       |         |      | $ | 39,877 |        
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|Liabilities and Stockholders Equity                                                                    |                                                                                                                                    |   |              |         |      |   |        |        
|Current liabilities:                                                                                    |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Accounts payable                                                                                                                   |   | $            | 1,456   |      |   | $      | 988     |  
|                                                                                                        | Accrued compensation and related expenses                                                                                          |   |              | 2,162   |      |   |        | 713     |  
|                                                                                                        | Other accrued expenses                                                                                                             |   |              | 1,424   |      |   |        | 577     |  
|                                                                                                        | Advance payments and deferred revenue                                                                                              |   |              | 1,393   |      |   |        | 1,918   |  
|                                                                                                        | Current liabilities of discontinued operations                                                                                     |   |              | 377     |      |   |        | 222     |  
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Total current liabilities                                                                                                          |   |              | 6,812   |      |   |        | 4,418   |  
|                                                                                                        | Deferred income taxes                                                                                                              |   |              | 129     |      |   |        |        |  
|                                                                                                        | Commitments and contingencies                                                                                                      |   |              |        |      |   |        |        |  
|Stockholders equity:                                                                                   |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Preferred stock, $.01 par value per share. Authorized 500 shares,
no shares issued and outstanding                                 |   |              |        |      |   |        |        |  
|                                                                                                        | Common stock, $.01 par value per share. Authorized 50,000 shares,
issued and outstanding shares of 7,894 in 2002 and 7,108 in 2001 |   |              | 79      |      |   |        | 71      |  
|                                                                                                        | Additional paid-in capital                                                                                                         |   |              | 65,665  |      |   |        | 52,400  |  
|                                                                                                        | Accumulated deficit                                                                                                                |   |              | (20,225 | )    |   |        | (15,486 | )
|                                                                                                        | Accumulated other comprehensive income (loss)                                                                                      |   |              | 2,859   |      |   |        | (1,526  | )
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Total stockholders equity                                                                                                         |   |              | 48,378  |      |   |        | 35,459  |  
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        
|                                                                                                        | Total liabilities and stockholders equity                                                                                         |   | $            | 55,319  |      |   | $      | 39,877  |  
|                                                                                                        |                                                                                                                                    |   |              |         |      |   |        |        

See notes to consolidated financial statements.

32



---



##### 



SAFENET, INC.
AND SUBSIDIARIESConsolidated Statements of Operations
(Amounts in thousands, except per share data)

|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |        |  
|------------------------------------------------------------------------------------------------ | --------------------------------------------------------- | - | ---------------------- | ------ | ---- | - | ------ | ----- | - | - | ------ | ------ | -
|                                                                                                 |                                                           |   | Year ended December 31
|                                                                                                 |                                                           |   | 2002                   |        | 2001 |   | 2000  
|                                                                                                 |                                                           |   |                        |        |      |   |       
|Revenues:                                                                                        |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Licenses and royalties                                    |   | $                      | 7,398  |      |   | $      | 4,031 |   |   | $      | 15,223 |  
|                                                                                                 | Products                                                  |   |                        | 21,588 |      |   |        | 9,732 |   |   |        | 7,901  |  
|                                                                                                 | Service and maintenance                                   |   |                        | 3,249  |      |   |        | 2,699 |   |   |        | 2,154  |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Total revenues                                                                                   |                                                           |   | 32,235                 |        |      |   | 16,462 |       |   |   | 25,278 |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Cost of revenues:                                                                                |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Licenses and royalties                                    |   |                        | 811    |      |   |        | 644   |   |   |        | 2,637  |  
|                                                                                                 | Products                                                  |   |                        | 7,699  |      |   |        | 3,423 |   |   |        | 2,810  |  
|                                                                                                 | Service and maintenance                                   |   |                        | 453    |      |   |        | 458   |   |   |        | 387    |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Total cost of revenues                                                                           |                                                           |   | 8,963                  |        |      |   | 4,525  |       |   |   | 5,834  |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Gross profit                                                                                     |                                                           |   | 23,272                 |        |      |   | 11,937 |       |   |   | 19,444 |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Operating expenses:                                                                              |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Research and development expenses                         |   |                        | 8,504  |      |   |        | 6,118 |   |   |        | 6,342  |  
|                                                                                                 | Sales and marketing expenses                              |   |                        | 7,341  |      |   |        | 5,061 |   |   |        | 4,756  |  
|                                                                                                 | General and administrative expenses                       |   |                        | 4,108  |      |   |        | 2,203 |   |   |        | 2,681  |  
|                                                                                                 | Write-off of acquired in-process research and development |   |                        | 3,375  |      |   |        |      |   |   |        |       |  
|                                                                                                 | Amortization of acquired intangible assets                |   |                        | 1,488  |      |   |        |      |   |   |        |       |  
|                                                                                                 | Other                                                     |   |                        |       |      |   |        |      |   |   |        | (275   | )
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Total operating expenses                                                                         |                                                           |   | 24,816                 |        |      |   | 13,382 |       |   |   | 13,504 |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Operating (loss) income                                                                          |                                                           |   | (1,544                 | )      |      |   | (1,445 | )     |   |   | 5,940  |       
|Other income (expense):                                                                          |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Investment income                                         |   |                        | 539    |      |   |        | 1,337 |   |   |        | 1,321  |  
|                                                                                                 | Other expense, net                                        |   |                        | 130    |      |   |        | (1    | ) |   |        | (1     | )
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|(Loss) income from continuing operations before income taxes                                     |                                                           |   | (875                   | )      |      |   | (109   | )     |   |   | 7,260  |       
|Income tax benefit                                                                               |                                                           |   | (90                    | )      |      |   |       |       |   |   |       |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|(Loss) income from continuing operations                                                         |                                                           |   | (785                   | )      |      |   | (109   | )     |   |   | 7,260  |       
|Loss from operations of discontinued GDS business (including loss
on disposal of $3,506 in 2002) |                                                           |   | (3,954                 | )      |      |   | (3,453 | )     |   |   | (1,503 | )     
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Net (loss) income                                                                                |                                                           | $ | (4,739                 | )      |      | $ | (3,562 | )     |   | $ | 5,757  |       
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|(Loss) income from continuing operations per common share                                        |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Basic                                                     |   | $                      | (0.10  | )    |   | $      | (0.01 | ) |   | $      | 1.08   |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Diluted                                                   |   | $                      | (0.10  | )    |   | $      | (0.01 | ) |   | $      | 1.01   |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Loss from operations of discontinued GDS business per common share                               |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Basic                                                     |   | $                      | (0.51  | )    |   | $      | (0.49 | ) |   | $      | (0.23  | )
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Diluted                                                   |   | $                      | (0.51  | )    |   | $      | (0.49 | ) |   | $      | (0.21  | )
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|Net (loss) income per common share                                                               |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Basic                                                     |   | $                      | (0.61  | )    |   | $      | (0.50 | ) |   | $      | 0.85   |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       
|                                                                                                 | Diluted                                                   |   | $                      | (0.61  | )    |   | $      | (0.50 | ) |   | $      | 0.80   |  
|                                                                                                 |                                                           |   |                        |        |      |   |        |       |   |   |        |       

See notes to consolidated financial statements.

33



---



##### 



SAFENET, INC.
AND SUBSIDIARIESConsolidated Statements of Comprehensive (Loss) Income
(Amounts in thousands)

|                                    |                                                                                                                    |   |                        |       |      |   |        |      |   |   |       |      |  
|----------------------------------- | ------------------------------------------------------------------------------------------------------------------ | - | ---------------------- | ----- | ---- | - | ------ | ---- | - | - | ----- | ---- | -
|                                    |                                                                                                                    |   | Year ended December 31
|                                    |                                                                                                                    |   | 2002                   |       | 2001 |   | 2000  
|                                    |                                                                                                                    |   |                        |       |      |   |       
|Net (loss) income                   |                                                                                                                    | $ | (4,739                 | )     |      | $ | (3,562 | )    |   | $ | 5,757 |     
|Other comprehensive income (loss)  |                                                                                                                    |   |                        |       |      |   |        |      |   |   |       |     
|                                    | Foreign currency translation adjustment                                                                            |   |                        | 2,904 |      |   |        | (165 | ) |   |       | (112 | )
|                                    | Reclassification
adjustment  realization
of foreign currency translation adjustment
upon disposal of GDS business |   |                        | 1,526 |      |   |        |     |   |   |       |     |  
|                                    | Other                                                                                                              |   |                        | (46   | )    |   |        | (84  | ) |   |       | 130  |  
|                                    |                                                                                                                    |   |                        |       |      |   |        |      |   |   |       |     
|Comprehensive (loss) income         |                                                                                                                    | $ | (355                   | )     |      | $ | (3,811 | )    |   | $ | 5,775 |     
|                                    |                                                                                                                    |   |                        |       |      |   |        |      |   |   |       |     

See notes to consolidated financial statements.

34



---



##### 



SAFENET, INC.
AND SUBSIDIARIES

Consolidated Statements of Stockholders Equity
(Amounts in thousands)

|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  |             |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------ |  | ------------ | ----- | ---------- |  | ----------- | -- | ------- |  | ------------- | ------ | ------ |  | - | ------- | - |  | ----------- | ------ | - |  | - | ------ | -
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  | Accumulated |        |   |  |  
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  | Other       |        |   |  |  
|                                                                                                                   |  | Common stock |       | Additional |  |             |    |         |  | Comprehensive |        | Total 
|                                                                                                                   |  |              |       | Paid-in    |  | Accumulated |    | (Loss)  |  | Stockholders
|                                                                                                                   |  | Shares       |       | Amount     |  | Capital     |    | Deficit |  | Income        |        | Equity
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |       
|Balance at January 1, 2000                                                                                         |  |              | 6,542 |            |  | $           | 65 |         |  | $             | 46,547 |        |  | $ | (17,681 | ) |  | $           | (1,295 | ) |  | $ | 27,636 |  
|Stock options exercised                                                                                            |  |              | 392   |            |  |             | 4  |         |  |               | 4,082  |        |  |   |        |   |  |             |       |   |  |   | 4,086  |  
|Stock warrants exercised                                                                                           |  |              | 7     |            |  |             |   |         |  |               | 118    |        |  |   |        |   |  |             |       |   |  |   | 118    |  
|Stock option compensation                                                                                          |  |              |      |            |  |             |   |         |  |               | 128    |        |  |   |        |   |  |             |       |   |  |   | 128    |  
|Net income                                                                                                         |  |              |      |            |  |             |   |         |  |               |       |        |  |   | 5,757   |   |  |             |       |   |  |   | 5,757  |  
|Foreign currency translation adjustment                                                                            |  |              |      |            |  |             |   |         |  |               |       |        |  |   |        |   |  |             | (112   | ) |  |   | (112   | )
|Other                                                                                                              |  |              |      |            |  |             |   |         |  |               | (20    | )      |  |   |        |   |  |             | 130    |   |  |   | 110    |  
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  |             |        |   |  |   |        |  
|Balance at December 31, 2000                                                                                       |  |              | 6,941 |            |  |             | 69 |         |  |               | 50,855 |        |  |   | (11,924 | ) |  |             | (1,277 | ) |  |   | 37,723 |  
|Stock options exercised                                                                                            |  |              | 167   |            |  |             | 2  |         |  |               | 1,547  |        |  |   |        |   |  |             |       |   |  |   | 1,549  |  
|Net loss                                                                                                           |  |              |      |            |  |             |   |         |  |               |       |        |  |   | (3,562  | ) |  |             |       |   |  |   | (3,562 | )
|Foreign currency translation adjustment                                                                            |  |              |      |            |  |             |   |         |  |               |       |        |  |   |        |   |  |             | (165   | ) |  |   | (165   | )
|Other                                                                                                              |  |              |      |            |  |             |   |         |  |               | (2     | )      |  |   |        |   |  |             | (84    | ) |  |   | (86    | )
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  |             |        |   |  |   |        |  
|Balance at December 31, 2001                                                                                       |  |              | 7,108 |            |  |             | 71 |         |  |               | 52,400 |        |  |   | (15,486 | ) |  |             | (1,526 | ) |  |   | 35,459 |  
|Issuance of stock in connection with the
acquisition of Securealink                                                |  |              | 575   |            |  |             | 6  |         |  |               | 10,630 |        |  |   |        |   |  |             |       |   |  |   | 10,636 |  
|Issuance of stock under Employee Stock Purchase Plan                                                               |  |              | 6     |            |  |             |   |         |  |               | 217    |        |  |   |        |   |  |             |       |   |  |   | 217    |  
|Stock options exercised                                                                                            |  |              | 205   |            |  |             | 2  |         |  |               | 1,968  |        |  |   |        |   |  |             |       |   |  |   | 1,970  |  
|Income tax benefit related to stock option exercises                                                               |  |              |      |            |  |             |   |         |  |               | 450    |        |  |   |        |   |  |             |       |   |  |   | 450    |  
|Net loss                                                                                                           |  |              |      |            |  |             |   |         |  |               |       |        |  |   | (4,739  | ) |  |             |       |   |  |   | (4,739 | )
|Reclassification adjustment - realization of
foreign currency translation adjustment upon
disposal of GDS business |  |              |      |            |  |             |   |         |  |               |       |        |  |   |        |   |  |             | 1,526  |   |  |   | 1,526  |  
|Foreign currency translation adjustment                                                                            |  |              |      |            |  |             |   |         |  |               |       |        |  |   |        |   |  |             | 2,904  |   |  |   | 2,904  |  
|Other                                                                                                              |  |              |      |            |  |             |   |         |  |               |       |        |  |   |        |   |  |             | (45    | ) |  |   | (45    | )
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  |             |        |   |  |   |        |  
|Balance at December 31, 2002                                                                                       |  |              | 7,894 |            |  | $           | 79 |         |  | $             | 65,665 |        |  | $ | (20,225 | ) |  | $           | 2,859  |   |  | $ | 48,378 |  
|                                                                                                                   |  |              |       |            |  |             |    |         |  |               |        |        |  |   |         |   |  |             |        |   |  |   |        |  

See notes to consolidated financial statements.

35



---



##### 



SAFENET, INC.
AND SUBSIDIARIESConsolidated Statements of Cash Flows
(Amounts in thousands)

|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |        |       |        |  
|---------------------------------------------- | -------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- | ---------------------------------------------------- | ------- | ---------------------- | ------- | ------ | ------- | ---- | ------- | ------ | ------ | ----- | ------ | -
|                                               |                                                                                                    |                                                                  |                                                      |         | Year ended December 31
|                                               |                                                                                                    |                                                                  |                                                      |         | 2002                   |         | 2001   |         | 2000
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |     
|Cash flows from operating activities:          |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               | Net (loss) income                                                                                  |                                                                  | $                                                    | (4,739  | )                      |         | $      | (3,562  | )    |         | $      | 5,757  |      
|                                               | Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities: |                                                                  |                                                      |         |                        |         |        |         |      |         |        |        |      
|                                               |                                                                                                    | Write-off of acquired in-process research and development        |                                                      |         | 3,375                  |         |        |         |     |         |        |        |      |       
|                                               |                                                                                                    | Loss on disposal of discontinued GDS business, less cash
portion |                                                      |         | 2,687                  |         |        |         |     |         |        |        |      |       
|                                               |                                                                                                    | Depreciation                                                     |                                                      |         | 975                    |         |        |         | 662  |         |        |        | 680   |       
|                                               |                                                                                                    | Amortization of computer software development costs              |                                                      |         | 574                    |         |        |         | 954  |         |        |        | 1,150 |       
|                                               |                                                                                                    | Amortization of acquired intangible assets                       |                                                      |         | 1,488                  |         |        |         | 85   |         |        |        | 85    |       
|                                               |                                                                                                    | Income tax benefit from stock option exercises                   |                                                      |         | 450                    |         |        |         |     |         |        |        |      |       
|                                               |                                                                                                    | Stock compensation                                               |                                                      |         |                       |         |        |         |     |         |        |        | 128   |       
|                                               |                                                                                                    | Other non-cash charges                                           |                                                      |         | 501                    |         |        |         |     |         |        |        |      |       
|                                               |                                                                                                    | Changes in operating assets and liabilities:                     |                                                      |         |                        |         |        |         |      |         |        |        |       |       
|                                               |                                                                                                    |                                                                  | Accounts receivable, net                             |         |                        | (551    | )      |         |      | 167     |        |        |       | 125    |  
|                                               |                                                                                                    |                                                                  | Inventories, net                                     |         |                        | 270     |        |         |      | 1,369   |        |        |       | 19     |  
|                                               |                                                                                                    |                                                                  | Accounts payable                                     |         |                        | (257    | )      |         |      | (778    | )      |        |       | 615    |  
|                                               |                                                                                                    |                                                                  | Accrued compensation and related costs               |         |                        | 977     |        |         |      | (937    | )      |        |       | 492    |  
|                                               |                                                                                                    |                                                                  | Other accrued expenses                               |         |                        | 329     |        |         |      | (8      | )      |        |       | 540    |  
|                                               |                                                                                                    |                                                                  | Advance payments and deferred revenue                |         |                        | (529    | )      |         |      | 959     |        |        |       | (511   | )
|                                               |                                                                                                    |                                                                  | Other                                                |         |                        | 383     |        |         |      | (621    | )      |        |       | 92     |  
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               |                                                                                                    |                                                                  | Net cash provided by (used in) operating activities  |         |                        | 5,933   |        |         |      | (1,710  | )      |        |       | 9,172  |  
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|Cash flows from investing activities:          |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               | Maturities of short-term investments                                                               |                                                                  |                                                      | 25,378  |                        |         |        | 8,433   |      |         |        | 501    |      
|                                               | Purchases of short-term investments                                                                |                                                                  |                                                      | (38,277 | )                      |         |        | (17,966 | )    |         |        | (6,332 | )    
|                                               | Purchases of property and equipment                                                                |                                                                  |                                                      | (507    | )                      |         |        | (399    | )    |         |        | (607   | )    
|                                               | Expenditures for computer software development                                                     |                                                                  |                                                      | (326    | )                      |         |        | (167    | )    |         |        | (631   | )    
|                                               | Cash paid for Securealink, net of cash acquired                                                    |                                                                  |                                                      | (3,769  | )                      |         |        |        |      |         |        |       |      
|                                               | Deferred acquisition costs                                                                         |                                                                  |                                                      | (625    | )                      |         |        |        |      |         |        |       |      
|                                               | Other investments                                                                                  |                                                                  |                                                      | (565    | )                      |         |        |        |      |         |        |       |      
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               |                                                                                                    |                                                                  | Net cash used in investing activities                |         |                        | (18,691 | )      |         |      | (10,099 | )      |        |       | (7,069 | )
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|Cash flows from financing activities:          |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               | Proceeds from stock options exercised and shares issued under
employee stock purchase plan         |                                                                  |                                                      | 2,187   |                        |         |        | 1,549   |      |         |        | 4,086  |      
|                                               | Proceeds from stock warrants exercised                                                             |                                                                  |                                                      |        |                        |         |        |        |      |         |        | 118    |      
|                                               | Repayment of Securealink line of credit                                                            |                                                                  |                                                      | (1,484  | )                      |         |        |        |      |         |        |       |      
|                                               | Other                                                                                              |                                                                  |                                                      |        |                        |         |        |        |      |         |        | (20    | )    
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               |                                                                                                    |                                                                  | Net cash provided by financing activities            |         |                        | 703     |        |         |      | 1,549   |        |        |       | 4,184  |  
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|Effect of exchange rate changes on cash        |                                                                                                    |                                                                  | 460                                                  |         |                        |         | (115   | )       |      |         | (79    | )     
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|                                               |                                                                                                    |                                                                  | Net (decrease) increase in cash and cash equivalents |         |                        | (11,595 | )      |         |      | (10,375 | )      |        |       | 6,208  |  
|Cash and cash equivalents at beginning of year |                                                                                                    |                                                                  | 14,994                                               |         |                        |         | 25,369 |         |      |         | 19,161 |       
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       
|Cash and cash equivalents at end of year       |                                                                                                    | $                                                                | 3,399                                                |         |                        | $       | 14,994 |         |      | $       | 25,369 |       
|                                               |                                                                                                    |                                                                  |                                                      |         |                        |         |        |         |      |         |        |       

36



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##### 



SAFENET, INC.
AND SUBSIDIARIESConsolidated Statements of Cash Flows (continued)
(Amounts in thousands)

|                                          |                         |   |                        |       |      |   |        |        |  |   |        |        | 
|----------------------------------------- | ----------------------- | - | ---------------------- | ----- | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                                          |                         |   | Year ended December 31
|                                          |                         |   | 2002                   |       | 2001 |   | 2000  
|                                          |                         |   |                        |       |      |   |       
|Cash and cash equivalents at end of year: |                         |   |                        |       |      |   |        |        |  |   |        |       
|                                          | Continuing operations   |   | $                      | 3,399 |      |   | $      | 14,819 |  |   | $      | 22,796 | 
|                                          | Discontinued operations |   |                        |      |      |   |        | 175    |  |   |        | 2,573  | 
|                                          |                         |   |                        |       |      |   |        |        |  |   |        |       
|                                          |                         | $ | 3,399                  |       |      | $ | 14,994 |        |  | $ | 25,369 |       
|                                          |                         |   |                        |       |      |   |        |        |  |   |        |       
|Cash paid for income taxes                |                         | $ |                       |       |      | $ | 73     |        |  | $ | 5      |       
|                                          |                         |   |                        |       |      |   |        |        |  |   |        |       

See notes to consolidated financial statements.

37



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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Amounts in Thousands)

(1) BUSINESS

SafeNet, Inc. (SafeNet or the Company) delivers a widely deployed Virtual
Private Network, or VPN, technology for secure business communications over the
Internet, offering both Original Equipment Manufacturer (OEM) technology and
end-user products for VPN and e-commerce applications. The Company provides
its network security solutions worldwide for financial, enterprise,
telecommunications, and government use. The Companys technology is sold and
licensed in various formats, including software, hardware, silicon chips, and
intellectual property.

In January 2002, the Company acquired Pijnenburg Securealink, Inc.
(Securealink), a European manufacturer of security chips for e-commerce
transactions (see Note 4). In February 2003, the Company acquired Cylink, Inc.
(Cylink). Cylink develops, markets, and supports a comprehensive portfolio
of hardware and software security products for mission-critical private
networks and business communications over the Internet (see Note 16).

As discussed in Note 3, in February 2002, the Company made a decision to
discontinue the operations of its Swiss subsidiary, GretaCoder Data Systems
(GDS). The financial position and results of operations of GDS have been
disclosed as discontinued operations in the accompanying consolidated financial
statements.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect reported amounts
reported in the consolidated financial statements and the accompanying notes.
Actual results could differ from those estimates.

Cash Equivalents

The Company considers all highly liquid investments with maturities of three
months or less when purchased to be cash equivalents. The Company had
approximately $3,399 and $14,819 of cash equivalents at December 31, 2002 and
2001, respectively, consisting primarily of overnight repurchase agreements,
short-term money market funds and commercial paper.

Held-to-Maturity Securities

Management determines the appropriate classification of debt securities at the
time of purchase and reevaluates such designation as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost, adjusted for
amortization of premiums and accretion of discounts to maturity computed under
the effective interest method. Such amortization is included in investment
income. Interest on securities classified as held-to-maturity is included in
investment income. The Company had $28,763 and $15,865 of held-to-maturity
securities at December 31, 2002 and 2001, respectively, consisting primarily of
corporate debt instruments. As of December 31, 2002, substantially all of the
held-to-maturity securities are due in one year or less.

Accounts Receivable

The Company reports accounts receivable at net realizable value. The Company
maintains an allowance for doubtful accounts for estimated losses resulting
from the inability of its customers to make required payments. The Company

38



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SAFENET, INC.
AND SUBSIDIARIES

calculates its allowance based on a specific analysis of past due balances and
also considers historical trends of write-offs.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined by
the first-in, first-out method.

Property and Equipment

Property and equipment is stated at cost and depreciation is computed using the
straight-line method over estimated useful lives ranging primarily from three
to seven years. Amortization of leasehold improvements is computed using the
straight-line method over the lesser of the useful life of the asset or the
remaining term of the lease.

Computer Software Development Costs

Costs for the development of new software products and substantial enhancements
to existing software products are expensed as research and development costs as
incurred until technological feasibility has been established, at which time
any additional development costs are capitalized until the product is available
for general release to customers. The Company defines the establishment of
technological feasibility as the completion of a working model of the software
product that has been tested to be consistent with the product design
specifications and that is free of any uncertainties related to known high-risk
development issues.

Amortization of software development costs, which is included in cost of
revenues, begins upon general release of the software. These costs are
amortized on a product by-product basis using the greater of: (i) the amount
computed using the ratio that current gross revenues for each product bear to
the total of current and anticipated future revenue for that product, or (ii)
the amount computed using the straight-line method over the estimated economic
useful life of three to five years. Such costs are amortized beginning on
product release dates. The Company assesses the recoverability of computer
software development costs by comparing the unamortized balance to the net
realizable value of the asset and writes off the amount by which the
unamortized capitalized costs exceed the estimated net realizable value.
During the year ended December 31, 2001, the Company wrote off $218 of
capitalized software development costs for which the unamortized balance
exceeded the estimated net realizable value. This write off has been included
as a charge to 2001 research and development expenses.

Goodwill and Other Intangible Assets

Goodwill is initially measured as the excess of the cost of an acquired company
over the sum of the amounts assigned to tangible and intangible assets acquired
less liabilities assumed. The Company does not amortize goodwill, but rather
reviews the carrying value of the asset for impairment at least annually in
accordance with the provisions of FASB Statement No. 142, Goodwill and
Intangible Assets, the provisions of which the Company adopted effective
January 1, 2002. Intangible assets with finite lives are amortized over their
estimated useful lives ranging from one to five years, with a weighted average
useful live of 28 months (see Note 8).

Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of

Long-lived assets, including amortized intangible assets, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be fully recoverable. If an impairment
indicator is present, the Company evaluates whether an impairment exists on the
basis of undiscounted expected future cash flows from the assets over the
remaining amortization period. If impairment exists, the asset is reduced by
the estimated difference between its fair value and its carrying value. Fair
value is usually determined using discounted cash flows. Assets to disposed of
are reported at the lower of carrying value or fair value less costs to sell.

39



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SAFENET, INC.
AND SUBSIDIARIES

Product Warranties

The Company warrants to the original purchaser that each of its hardware
products will be free from defects in materials and workmanship generally for a
period of one year from the date of purchase. Expected future product warranty
expense is recorded when the product is sold.

Revenue Recognition

The Company derives revenue from software and technology licenses, product
sales, maintenance (post contract customer support), and services. Software
and technology licenses typically contain multiple elements, including the
product license, maintenance, and/or other services. The Company allocates the
total arrangement fee among each deliverable based on the fair value of each of
the deliverables determined based on vendor-specific objective evidence.

License and Royalties

License revenue is comprised of perpetual and time-based license fees, which
are derived from arrangements with end-users, original equipment manufacturers
and resellers. For each software license arrangement, the Company defers
revenue recognition until: (a) persuasive evidence of an arrangement exists;
(b) delivery of the software or technology has occurred and there are no
remaining obligations or substantive customer acceptance provisions; (c) the
fee is fixed or determinable; and (d) collection of the fee is probable. For
both perpetual and time-based licenses, once all of these conditions are
satisfied, the Company recognizes license revenue based on the residual method
after all elements other than maintenance have been delivered as prescribed by
SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions. Royalties are recognized as they are earned.

Revenues that are earned under long-term contracts to develop high assurance
encryption technology are recognized using contract accounting. Under contract
accounting, revenue from these arrangements is recognized using the
percentage-of-completion method. Progress to completion is measured using
contract milestones. Management considers contract milestones to be the best
available measure of progress on these contracts since each milestone contains
customer-specified acceptance criteria. Any estimated losses are provided for
in their entirety in the period they are first determined. Actual remaining
costs under fixed price contracts could vary significantly from the Companys
estimates, and such differences could be material to the financial statements.

Products

The Company also sells hardware and related encryption products. For each
product sale, the Company defers revenue recognition until: (a) persuasive
evidence of an arrangement exists; (b) delivery has occurred and there are no
remaining obligations or substantive customer acceptance provisions; (c) the
selling price to the customer is fixed or determinable; and (d) collectibility
of the selling price is reasonably assured.

Maintenance and Other Services

Maintenance revenue is derived from support arrangements. Maintenance
arrangements provide technical customer support and the right to unspecified
upgrades on an if-and-when-available basis. In accordance with SOP 97-2,
Software Revenue Recognition, vendor specific objective evidence of fair value
of maintenance is determined based on the price charged for the maintenance
element when sold separately. The maintenance term is typically one year in
duration and maintenance revenue is recognized ratably over the maintenance
term. Unrecognized maintenance fees are included in deferred revenue.

Other service revenue is comprised of revenue from consulting fees, training,
engineering services and long-term arrangements for custom development of high
assurance encryption devices. Except for services provided under long-term
arrangements, service revenue is recognized when the services are provided to
the customer. The Companys policy is to recognize software license revenue
when these associated services are not essential to the

40



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SAFENET, INC.
AND SUBSIDIARIES

functionality of the
product. To date, these services have not been essential to the functionality
of the product. Vendor specific objective evidence of fair value of these
services is determined by reference to the price that a customer will be
required to pay when the services are sold separately, which is based on the
price history that the Company has developed for separate sales of these
services.

Foreign Currency Translation

The financial statements of foreign subsidiaries for which the local currency
is the functional currency have been translated into U.S. dollars in accordance
with FASB Statement No. 52, Foreign Currency Translation. All balance sheet
accounts have been translated using the exchange rates in effect at the balance
sheet date. Income statement amounts have been translated using the average
exchange rate for the year. The gains and losses resulting from the changes in
exchange rates from year to year have been reported in other comprehensive
income. Transactions of foreign subsidiaries for which the U.S. dollar is the
functional currency have been remeasured into U.S. dollars with any resulting
gain or loss reported as a component of income. The effect on the consolidated
statements of operations of all transaction gains and losses is insignificant
for all years presented.

Income Taxes

The Company uses the liability method in accounting for income taxes. Under
this method, deferred income tax assets and liabilities are determined based on
difference between financial reporting and tax bases of assets and liabilities
and are measured using the enacted tax rates and laws that will be in effect
when the differences are expected to reverse.

Employee Stock-Based Compensation

At December 31, 2002, the Company had five stock-based employee compensation
plans, which are described more fully in Note 12. The Company accounts for
those plans using the intrinsic value method prescribed by APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant.

41



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SAFENET, INC.
AND SUBSIDIARIES

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

|                                                                                                                                            |                     |   |                        |       |      |   |        |       |   |   |        |      | 
|------------------------------------------------------------------------------------------------------------------------------------------- | ------------------- | - | ---------------------- | ----- | ---- | - | ------ | ----- | - | - | ------ | ---- | 
|                                                                                                                                            |                     |   | Year ended December 31
|                                                                                                                                            |                     |   | 2002                   |       | 2001 |   | 2000  
|                                                                                                                                            |                     |   |                        |       |      |   |       
|Net (loss) income, as reported                                                                                                              |                     | $ | (4,739                 | )     |      | $ | (3,562 | )     |   | $ | 5,757  |     
|Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects |                     |   | (3,762                 | )     |      |   | (5,436 | )     |   |   | (4,117 | )   
|                                                                                                                                            |                     |   |                        |       |      |   |        |       |   |   |        |     
|Pro forma net (loss) income                                                                                                                 |                     | $ | (8,501                 | )     |      | $ | (8,998 | )     |   | $ | 1,640  |     
|                                                                                                                                            |                     |   |                        |       |      |   |        |       |   |   |        |     
|Earnings per share:                                                                                                                         |                     |   |                        |       |      |   |        |       |   |   |        |     
|                                                                                                                                            | Basicas reported   |   | $                      | (0.61 | )    |   | $      | (0.50 | ) |   | $      | 0.85 | 
|                                                                                                                                            | Basicpro forma     |   | $                      | (1.10 | )    |   | $      | (1.26 | ) |   | $      | 0.24 | 
|                                                                                                                                            | Dilutedas reported |   | $                      | (0.61 | )    |   | $      | (0.50 | ) |   | $      | 0.80 | 
|                                                                                                                                            | Dilutedpro forma   |   | $                      | (1.10 | )    |   | $      | (1.26 | ) |   | $      | 0.24 | 

Pro forma information regarding net income and earnings per share required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The
weighted-average grant date fair value per share of options granted during
2002, 2001, and 2000 was $8.85, $11.50, and $20.45, respectively. The fair
value for these options was estimated at the dates of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions for 2002, 2001, and 2000, respectively: risk-free interest rates
of 3.88%, 4.42%, and 5.10%; expected volatility of 119%, 139%, and 180%;
dividend yield and expected dividend growth rate of 0% in all years; and
weighted-average expected remaining life of 3 to 7 years in all years. For
purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options vesting period.

Comprehensive (Loss) Income

Comprehensive (loss) income includes all changes in equity that result from
recognized transactions and other economic events of a period other than
transactions with owners in their capacity as owners. Certain non-owner changes
in equity, consisting primarily of foreign currency translation adjustments,
are included in other comprehensive (loss) income. The Company reports
comprehensive (loss) income in the statement of comprehensive (loss) income and
discloses the accumulated total of other comprehensive (loss) income in the
stockholders equity section of the balance sheet.

Fair Value of Financial Instruments

The carrying amount of financial instruments, including cash and cash
equivalents and held-to-maturity securities approximates fair value based on
the short-term nature of these instruments.

Reclassifications

Where appropriate, certain amounts in the prior year consolidated financial
statements have been reclassified to conform to the 2002 presentation.

42



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SAFENET, INC.
AND SUBSIDIARIES

Recent Accounting Pronouncement

In June 2002, the Financial Accounting Standards Board issued Statement No.
146, Accounting for Costs Associated with Exit or Disposal Activities, which
addresses accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring).Statement No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
at fair value when the liability is incurred rather than at the date of a
commitment to an exit plan. Costs covered by Statement No. 146 include
one-time termination benefits and certain contract termination costs, including
operating lease termination costs that are associated with an exit or disposal
activity. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002.

(3) DISCONTINUED OPERATIONS

As discussed further in Note 4, on January 2, 2002, SafeNet acquired 100
percent of the outstanding common shares of Pijnenburg Securealink, Inc.
(Securealink). SafeNets acquisition of Securealink resulted in changes to
SafeNets business initiatives. One of the areas impacted was the Companys
Swiss subsidiary, GDS. Based on the amount of GDS operating and cash losses
during 2000 and 2001, as well as a significant downturn in future business
prospects due to the loss of two substantial contracts in February 2002,
SafeNet management made the decision to discontinue operations at GDS. Certain
employees from GDSs sales and marketing team were transferred to SafeNet to
create a new European sales office focused on selling SafeNets Enterprise
Security products in Europe. All of the operations at GDS, including research
and development, manufacturing and administration were closed and 26 employees
were terminated during the first and second quarters of 2002.

As a result of the discontinued operations, the Company recorded a one-time
charge of $3,506 in the first quarter of 2002 related to the write-off of the
abandoned assets and the accrual of the estimated costs of the closing and
severance and related costs. The disposition of GDS operations represents the
disposal of a business segment under FASB Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. Accordingly, the results of this
operation have been classified as discontinued during all periods presented.
For business segment reporting purposes, GDSs business results were previously
classified as the segment European Operations.

Summarized operating results from the discontinued operation included in the
consolidated statements of operations, excluding the loss on disposal, are as
follows for the years ended December 31:

|                     |  |      |        |      |  |      |        |   |  |   |        |  
|-------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                     |  | 2002 |        | 2001 |  | 2000
|                     |  |      |        |      |  |     
|Revenues             |  | $    | 198    |      |  | $    | 1,655  |   |  | $ | 3,547  |  
|Loss from operations |  |      | (448   | )    |  |      | (3,453 | ) |  |   | (1,503 | )
|Loss on disposal     |  |      | (3,506 | )    |  |      |       |   |  |   |       |  
|                     |  |      |        |      |  |      |        |   |  |   |        |  
|Net (loss) income    |  | $    | (3,954 | )    |  | $    | (3,453 | ) |  | $ | (1,503 | )
|                     |  |      |        |      |  |      |        |   |  |   |        |  

Assets and liabilities of the discontinued operations at December 31 were as
follows:

|                                      |  |      |      |      |  |   |       |  
|------------------------------------- |  | ---- | ---- | ---- |  | - | ----- | -
|                                      |  | 2002 |      | 2001
|                                      |  |      |      |     
|Cash and cash equivalents             |  | $    |     |      |  | $ | 175   |  
|Inventories, net                      |  |      |     |      |  |   | 232   |  
|Other current assets                  |  |      | 93   |      |  |   | 377   |  
|Property and equipment, net           |  |      |     |      |  |   | 221   |  
|Other assets                          |  |      |     |      |  |   | 316   |  
|Current liabilities                   |  |      | (377 | )    |  |   | (222  | )
|                                      |  |      |      |      |  |   |       |  
|Net assets of discontinued operations |  | $    | (284 | )    |  | $ | 1,099 |  
|                                      |  |      |      |      |  |   |       |  

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SAFENET, INC.
AND SUBSIDIARIES

The fair value of assets to be disposed was based on estimated net realizable
value at the time of disposal. The significant components of the loss on
disposal of the GDS operations is as follows:

|                                                        |  |   |       | 
|------------------------------------------------------- |  | - | ----- | 
|Severance costs                                         |  | $ | 697   | 
|Lease termination costs                                 |  |   | 573   | 
|Goodwill                                                |  |   | 316   | 
|Reclassification of foreign currency translation losses |  |   | 1,526 | 
|Other                                                   |  |   | 394   | 
|                                                        |  |   |       | 
|Total                                                   |  | $ | 3,506 | 
|                                                        |  |   |       | 

(4) ACQUISITION OF SECUREALINK

On January 2, 2002, SafeNet acquired 100% of the outstanding common shares of
Securealink in accordance with an Agreement and Plan of Reorganization dated
December 14, 2001. The purchase price the Company paid to the stockholders of
Securealink in connection with the acquisition totaled $14,778 and consisted of
an aggregate of 575 shares of SafeNet, Inc. common stock valued at $10,636,
$2,000 in cash, contingent convertible promissory notes with an aggregate
principal amount of $2,000, the resolution and payment of which were satisfied
on May 16, 2002 in the aggregate amount of $1,617, and direct costs of
acquisition of $525. The fair market value of common shares was based on the
average market price of the shares over the period from three days before to
three days after the closing date. The cash portion of the consideration was
funded with cash on hand.

The amount and type of consideration was determined on the basis of arms
length negotiations between the Company and Securealink. Securealink develops
security chips and sells them in Europe and throughout the world. Securealink
is continuing to operate as a provider of security chips and is now a
subsidiary of SafeNet. As a result of the acquisition, SafeNet has broadened
its market with the addition of new technologies and a larger presence in
Europe. Additionally, Securealink brings over thirty cryptographic experts who
have complimented and strengthened development team. The results of
Securealink have been included in the Companys consolidated results beginning
on the date of acquisition.

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SAFENET, INC.
AND SUBSIDIARIES

The following table summarizes the changes to assets (other than cash) and
liabilities in connection with this acquisition:

|                                                   |  |   |        |  
|-------------------------------------------------- |  | - | ------ | -
|Current assets, excluding cash of $374             |  | $ | 1,271  |  
|Property and equipment                             |  |   | 787    |  
|Goodwill                                           |  |   | 10,859 |  
|Acquired in-process research and development costs |  |   | 3,375  |  
|Intangible assets subject to amortization          |  |   | 1,905  |  
|                                                   |  |   |        |  
|Total assets acquired, excluding cash              |  | $ | 18,197 |  
|                                                   |  |   |        |  
|Short-term borrowings                              |  | $ | (1,484 | )
|Deferred income taxes                              |  |   | (670   | )
|Other current liabilities                          |  |   | (1,639 | )
|                                                   |  |   |        |  
|Total liabilities assumed                          |  |   | (3,793 | )
|                                                   |  |   |        |  
|Purchase price, net of cash received               |  | $ | 14,404 |  
|                                                   |  |   |        |  

All of the assets and liabilities were assigned to the Embedded Security
segment. As noted above, $3,375 of the purchase price represents the estimated
fair value of acquired in-process research and development projects that had
not yet reached technological feasibility and had no alternative future use.
Accordingly, this amount was immediately expensed in the Consolidated Statement
of Operations on the acquisition date. The value assigned to purchased
in-process technology relates entirely to the development of a new application
specific integrated circuit.

The estimated fair value of this project was determined by employment of a
discounted cash flow model. The discount rate used takes into account the stage
of completion and the risks surrounding the successful development and
commercialization of the purchased in-process technology project.

The unaudited pro forma combined historical results, as if Securealink had been
acquired on January 1, 2001, is as follows:

|                                           |  |  |   |        |  
|------------------------------------------ |  |  | - | ------ | -
|Revenues                                   |  |  | $ | 23,345 |  
|Loss from continuing operations            |  |  | $ | (4,373 | )
|Net loss                                   |  |  | $ | (7,825 | )
|Loss per common share  basic and diluted: |  |  |   |        |  
|Loss from continuing operations            |  |  | $ | (0.57  | )
|Net loss                                   |  |  | $ | (1.03  | )

The pro forma results include the estimated amortization of intangibles and
interest expense on the promissory notes used to finance part of the purchase.
As described in Note 2, the Company does not record amortization expense
related to the goodwill. The pro forma results are not necessarily indicative
of the results that would have occurred if the acquisition had actually been
completed on January 1, 2001, nor are they necessarily indicative of future
consolidated results.

45



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##### 



SAFENET, INC.
AND SUBSIDIARIES

(5) INVENTORIES

Inventories related to continuing operations consisted of the following at
December 31:

|                                          |  |      |       |      |  |   |       |  
|----------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|                                          |  | 2002 |       | 2001
|                                          |  |      |       |     
|Raw materials                             |  | $    | 252   |      |  | $ | 222   |  
|Finished goods                            |  |      | 1,714 |      |  |   | 1,520 |  
|                                          |  |      |       |      |  |   |       |  
|                                          |  |      | 1,966 |      |  |   | 1,742 |  
|Reserve for excess and obsolete inventory |  |      | (958  | )    |  |   | (482  | )
|                                          |  |      |       |      |  |   |       |  
|                                          |  | $    | 1,008 |      |  | $ | 1,260 |  
|                                          |  |      |       |      |  |   |       |  

(6) PROPERTY AND EQUIPMENT

Property and equipment related to continuing operations consisted of the
following at December 31:

|                                          |  |      |        |      |  |   |        |  
|----------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                          |  | 2002 |        | 2001
|                                          |  |      |        |     
|Furniture and equipment                   |  | $    | 4,350  |      |  | $ | 3,036  |  
|Computer software                         |  |      | 912    |      |  |   | 521    |  
|Leasehold improvements                    |  |      | 718    |      |  |   | 536    |  
|                                          |  |      |        |      |  |   |        |  
|                                          |  |      | 5,980  |      |  |   | 4,093  |  
|Accumulated depreciation and amortization |  |      | (4,734 | )    |  |   | (3,124 | )
|                                          |  |      |        |      |  |   |        |  
|                                          |  | $    | 1,246  |      |  | $ | 969    |  
|                                          |  |      |        |      |  |   |        |  

(7) GOODWILL

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.
Statement 142 prohibits the amortization of goodwill and intangible assets with
indefinite useful lives. Statement 142 requires that these assets be reviewed
for impairment at least annually. Intangible assets with finite lives will
continue to be amortized over their estimated useful lives. Additionally,
Statement 142 requires that goodwill included in the carrying value of equity
method investments no longer be amortized.

46



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##### 



SAFENET, INC.
AND SUBSIDIARIES

The following table sets forth the Companys net income (loss) for all periods
presented adjusted to exclude amortization expense recognized in those periods
related to goodwill. There was no impact on income (loss) from continuing
operations for all periods presented.

|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|--------------------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ----- | 
|                                  |  | Year ended December 31,
|                                  |  | 2002                    |        | 2001 |  | 2000
|                                  |  |                         |        |      |  |     
|Reported net (loss) income        |  | $                       | (4,739 | )    |  | $    | (3,562 | ) |  | $ | 5,757 | 
|Add back: Goodwill amortization   |  |                         |       |      |  |      | 85     |   |  |   | 85    | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|Adjusted net (loss) income        |  | $                       | (4,739 | )    |  | $    | (3,477 | ) |  | $ | 5,842 | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|Basic (loss) earnings per share   |  |                         |        |      |  |      |        |   |  |   |       | 
|Reported net (loss) income        |  | $                       | (0.61  | )    |  | $    | (0.50  | ) |  | $ | 0.85  | 
|Add back: Goodwill amortization   |  |                         |       |      |  |      | 0.01   |   |  |   | 0.01  | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|Adjusted net (loss) income        |  | $                       | (0.61  | )    |  | $    | (0.49  | ) |  | $ | 0.86  | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|Diluted (loss) earnings per share |  |                         |        |      |  |      |        |   |  |   |       | 
|Reported net (loss) income        |  | $                       | (0.61  | )    |  | $    | (0.50  | ) |  | $ | 0.80  | 
|Add back: Goodwill amortization   |  |                         |       |      |  |      | 0.01   |   |  |   | 0.01  | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 
|Adjusted net (loss) income        |  | $                       | (0.61  | )    |  | $    | (0.49  | ) |  | $ | 0.81  | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 

The changes in the carrying amount of goodwill for the year ended December 31,
2002 consist of goodwill acquired in connection with the acquisition of
Securealink (see Note 4) and the impact of translating the Euro denominated
goodwill into U.S. dollars at the balance sheet date.

(8) ACQUIRED INTANGIBLE ASSETS

Acquired intangible assets consisted of the following at December 31, 2002, all
related to the Embedded Security segment:

|                                     |  |                |       |              |  |   |        |  
|------------------------------------ |  | -------------- | ----- | ------------ |  | - | ------ | -
|                                     |  | Gross Carrying |       | Accumulated 
|                                     |  | Amount         |       | Amortization
|                                     |  |                |       |             
|Patents and related                  |  | $              | 738   |              |  | $ | (143   | )
|Developed technology                 |  |                | 1,336 |              |  |   | (1,336 | )
|Purchase orders and contract backlog |  |                | 161   |              |  |   | (161   | )
|                                     |  |                |       |              |  |   |        |  
|Total                                |  | $              | 2,235 |              |  | $ | (1,640 | )
|                                     |  |                |       |              |  |   |        |  

47



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##### 



SAFENET, INC.
AND SUBSIDIARIES

The amortization expense for the year ended December 31, 2002 was $1,488. The
estimated amortization expense for the years ending December 31 is as follows:

|     |  |  |      | 
|---- |  |  | ---- | 
|2003 |  |  | $149 | 
|2004 |  |  | $149 | 
|2005 |  |  | $149 | 
|2006 |  |  | $148 | 

(9) INCOME TAXES

The Company recorded no provision for income taxes on earnings from continuing
operations for the years ended December 31, 2002 and 2001. Significant
components of the Companys income tax benefit on earnings from continuing
operations for the year ended December 31, 2002 are as follows:

|                    |         |   |      |      |   | 
|------------------- | ------- | - | ---- | ---- | - | 
|Current:            |         |   |      |     
|                    | Federal |   | $    |     |  
|                    | State   |   |      | 179  |  
|                    | Foreign |   |      |     |  
|                    |         |   |      |     
|                    |         |   | 179  |     
|Deferred (benefit): |         |   |      |     
|                    | Federal |   |      | 271  |  
|                    | State   |   |      |     |  
|                    | Foreign |   |      | (540 | )
|                    |         |   |      |     
|                    |         |   | (269 | )   
|                    |         |   |      |     
|Total benefit       |         | $ | (90  | )   
|                    |         |   |      |     

Deferred tax assets and liabilities arising from continuing operations are
comprised of the following at December 31:

|                          |                                        |   |       |        |      |   |       |        |  
|------------------------- | -------------------------------------- | - | ----- | ------ | ---- | - | ----- | ------ | -
|                          |                                        |   | 2002  |        | 2001
|                          |                                        |   |       |        |     
|Deferred tax assets:      |                                        |   |       |        |      |   |       |       
|                          | Inventories                            |   | $     | 272    |      |   | $     | 278    |  
|                          | Net operating loss carryforward        |   |       | 7,191  |      |   |       | 8,428  |  
|                          | Stock option and deferred compensation |   |       | 200    |      |   |       | 142    |  
|                          | Other                                  |   |       | 478    |      |   |       | 336    |  
|                          |                                        |   |       |        |      |   |       |        |  
|                          |                                        |   | 8,141 |        |      |   | 9,184 |       
|                          |                                        |   |       |        |      |   |       |        |  
|Deferred tax liabilities: |                                        |   |       |        |      |   |       |       
|                          | Other                                  |   |       | (129   | )    |   |       | (12    | )
|                          |                                        |   |       |        |      |   |       |        |  
|                          |                                        |   | (129  | )      |      |   | (12   | )     
|                          |                                        |   |       |        |      |   |       |        |  
|                          | Net deferred tax asset                 |   |       | 8,012  |      |   |       | 9,172  |  
|                          | Less valuation allowance               |   |       | (8,141 | )    |   |       | (9,172 | )
|                          |                                        |   |       |        |      |   |       |        |  
|                          |                                        | $ | (129  | )      |      | $ |      |       
|                          |                                        |   |       |        |      |   |       |        |  

The reconciliation of the reported income tax expense (benefit) to the amount
that would result by applying the U.S. federal statutory tax rate of 34% to
income (loss) from continuing operations is as follows:

48



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##### 



SAFENET, INC.
AND SUBSIDIARIES

|                                                                                  |  |      |        |      |  |      |     |   |  |   |        |  
|--------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | --- | - |  | - | ------ | -
|                                                                                  |  | 2002 |        | 2001 |  | 2000
|                                                                                  |  |      |        |      |  |     
|Tax expense (benefit) at U.S. statutory rate                                      |  | $    | (298   | )    |  | $    | (37 | ) |  | $ | 2,468  |  
|Effect of permanent differences                                                   |  |      | 1,182  |      |  |      | 24  |   |  |   | 17     |  
|State income taxes, net of federal benefit                                        |  |      | 179    |      |  |      | (5  | ) |  |   | 335    |  
|Change in valuation allowance, excluding
charge related to stock option exercises |  |      | (1,031 | )    |  |      | 18  |   |  |   | (2,803 | )
|Other, net                                                                        |  |      | (122   | )    |  |      |    |   |  |   | (17    | )
|                                                                                  |  |      |        |      |  |      |     |   |  |   |        |  
|                                                                                  |  | $    | (90    | )    |  | $    |    |   |  | $ |       |  
|                                                                                  |  |      |        |      |  |      |     |   |  |   |        |  

In assessing the realization of deferred tax assets, management considers
whether it is more likely than not that all or some portion of the deferred tax
assets will not be realized. The ultimate realization of the deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which temporary differences are deductible and net operating losses
are utilized. Based on consideration of these factors, the Company has
established a valuation allowance of $8,141 and $9,172 at December 31, 2002 and
2001, respectively.

Prior to the third quarter of fiscal year 2000, the Company followed the
practice of computing its income tax expense using the assumption that current
year stock option deductions were used first to offset its financial statement
taxable income. The remaining net operating loss carryforwards could then be
used to offset any excess of financial statement taxable income over current
year stock option deductions. Because the stock option deductions are not
recognized as an expense for financial reporting purposes, the tax benefit from
stock option deductions must be credited to additional paid-in capital with an
offsetting charge to income tax expense in the statement of operations.

Effective July 1, 2000, the Company changed its method of accounting for income
taxes to recognize the tax benefits from current and prior years stock option
deductions after the utilization of net operating losses from operations (i.e.,
net operating losses determined without deductions for the exercise of
non-qualified stock options and disqualified disposition of incentive stock
options) to reduce income tax expense. The Company believed that this change
was to a preferable method because the Company will not realize any tax benefit
from stock compensation deductions until it has fully utilized its current and
prior net operating loss carryforwards from operations. Thus, this method more
accurately reflects the incremental effect of the Companys stock option
deductions in the appropriate accounting period. Because the Company was
generating net operating losses prior to 2000 rather than utilizing them, this
accounting change had no effect on prior years tax provisions or additional
paid-in capital.

49



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##### 



SAFENET, INC.
AND SUBSIDIARIES

At December 31, 2002, the Company had net operating loss carryforwards related
to its discontinued Swiss subsidiary of approximately $7,111, which expire from
2007 to 2009 and are available to offset future taxable income of that
subsidiary. Also at December 31, 2002, the Company had net operating loss
carryforwards related to its Netherlands subsidiary of approximately $4,132,
which do not expire and are available to offset future taxable income of that
subsidiary. And finally, at December 31, 2002, the Company had net operating
loss carryforwards for U.S. income tax purposes of approximately $14,875, which
expire from 2011 to 2022 and are available to offset future U.S. taxable
income. The exercise of non-qualified stock options and disqualified
disposition of incentive stock options (stock option deductions) have
generated all of the remaining U.S. net operating loss carryforwards. When
these net operating loss carryforwards are utilized, the resulting reduction in
the valuation allowance will be recorded as a direct increase to stockholders
equity. During the year ended December 31, 2002, an increase to stockholders
equity of $450 was recorded related to the tax benefit of stock option
deductions.

(10) LEASES

The Company leases office facilities and equipment under non-cancelable
operating leases expiring at various dates through 2007. The leases require the
Company to pay a proportionate share of real estate taxes, insurance and
maintenance. The Company recognizes rent expense on a straight-line basis. The
future minimum payments under the leases for the years ending December 31, are
as follows:

|     |  |  |      | 
|---- |  |  | ---- | 
|2003 |  |  | $700 | 
|2004 |  |  | $235 | 
|2005 |  |  | $220 | 
|2006 |  |  | $199 | 
|2007 |  |  | $199 | 

Rent expense under all operating leases related to continuing operations for
the years ended December 31, 2002, 2001, and 2000 was $517, $360, and $334,
respectively.

(11) PENSION PLANS

The Company sponsors a defined contribution pension plan for employees who have
completed three months of service. The Plan permits pre-tax contributions by
participants pursuant to Section 401(k) of the Internal Revenue Code (the Code)
of 3% to 15% of base compensation up to the maximum allowable contributions as
determined by the Code. The Company matches up to 50% of the first 4% of
employee compensation that is contributed to the plan. The Companys matching
contributions vest with the participant over a 5-year period on a pro rata
basis. The Company may also make additional discretionary contributions. The
Company incurred expenses for its matching contributions for the years ended
December 31, 2002, 2001 and 2000 totaling $77, $137 and $73, respectively.

50



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##### 



SAFENET, INC.
AND SUBSIDIARIES

(12) STOCK COMPENSATION PLANS

Stock Option Plans

The Company sponsors four stock option plans that provide for the granting of
stock options to officers, directors, consultants and employees of the Company.
Options have been granted with exercise prices that are equal to the fair
market value of the common stock on the date of grant and, subject to
termination of employment, expire seven years from the date of grant. Either
incentive stock options or non-qualified stock options may be granted under the
plans. The vesting and exercise periods are determined by the Board of
Directors and may not exceed ten years. Options issued to date generally vest
in equal amounts over a vesting period of either three or four years. Option
activity during 2000, 2001 and 2002 was as follows:

|                                 |           |  |           |      |                 |                 |                  |   |       |       |          |  | 
|-------------------------------- | --------- |  | --------- | ---- | --------------- | --------------- | ---------------- | - | ----- | ----- | -------- |  | 
|                                 |           |  |           |      |                 |                 |                  |   |       |       | Weighted
|                                 |           |  |           |      |                 |                 |                  |   |       |       | Average 
|                                 |           |  | Number    |      | Range of        |                 | Exercise        
|                                 |           |  | of Shares |      | Exercise Prices |                 | Price           
|                                 |           |  |           |      |                 |                 |                 
|Outstanding at January 1, 2000   |           |  | 1,199     |      |                 | $3.09 to $31.50 |                  | $ | 10.28 |      
|                                 | Granted   |  |           | 752  |                 |                 | $14.75 to $43.50 |   | $     | 22.66 |         
|                                 | Canceled  |  |           | (217 | )               |                 | $4.50 to $25.63  |   | $     | 11.25 |         
|                                 | Exercised |  |           | (392 | )               |                 | $3.09 to $20.25  |   | $     | 10.42 |         
|                                 |           |  |           |      |                 |                 |                  |   |       |       |          | 
|Outstanding at December 31, 2000 |           |  | 1,342     |      |                 | $3.09 to $43.50 |                  | $ | 17.01 |      
|                                 | Granted   |  |           | 825  |                 |                 | $5.85 to $43.63  |   | $     | 11.79 |         
|                                 | Canceled  |  |           | (117 | )               |                 | $3.25 to $43.50  |   | $     | 25.78 |         
|                                 | Exercised |  |           | (167 | )               |                 | $3.09 to $24.87  |   | $     | 9.41  |         
|                                 |           |  |           |      |                 |                 |                  |   |       |       |          | 
|Outstanding at December 31, 2001 |           |  | 1,883     |      |                 | $4.38 to $43.63 |                  | $ | 14.85 |      
|                                 | Granted   |  |           | 404  |                 |                 | $11.10 to $16.51 |   | $     | 13.09 |         
|                                 | Canceled  |  |           | (106 | )               |                 | $8.53 to $33.63  |   | $     | 17.94 |         
|                                 | Expired   |  |           | (52  | )               |                 | $9.19 to $18.06  |   | $     | 9.47  |         
|                                 | Exercised |  |           | (205 | )               |                 | $5.13 to $24.13  |   | $     | 9.50  |         
|                                 |           |  |           |      |                 |                 |                  |   |       |       |          | 
|Outstanding at December 31, 2002 |           |  | 1,924     |      |                 | $4.38 to $43.63 |                  | $ | 15.08 |      
|                                 |           |  |           |      |                 |                 |                  |   |       |       |          | 
|Exercisable at December 31, 2002 |           |  | 1,121     |      |                 | $4.38 to $43.63 |                  | $ | 14.92 |      
|                                 |           |  |           |      |                 |                 |                  |   |       |       |          | 

51



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##### 



SAFENET, INC.
AND SUBSIDIARIES

The following table summarizes information about stock options outstanding at
December 31, 2002:

|                 |  |                     |       |                     |  |           |  |           |       |          |  |  |       |          |  |   |       |  |  | 
|---------------- |  | ------------------- | ----- | ------------------- |  | --------- |  | --------- | ----- | -------- |  |  | ----- | -------- |  | - | ----- |  |  | 
|                 |  | Options Outstanding |       | Options Exercisable
|                 |  |                     |       |                    
|                 |  |                     |       |                     |  | Weighted  |  | Weighted  |       |          |  |  |       | Weighted
|                 |  |                     |       |                     |  | Average   |  | Average   |       |          |  |  |       | Average 
|Range of         |  | Number              |       | Remaining           |  | Exercise  |  | Number    |       | Exercise
|Exercise Prices  |  | of shares           |       | Contractual Life    |  | Price     |  | of Shares |       | Price   
|                 |  |                     |       |                     |  |           |  |           |       |         
|$4.38 to $8.70   |  |                     | 415   |                     |  | 3.9 years |  | $         | 6.91  |          |  |  | 240   |          |  | $ | 7.00  | 
|$9.19 to $17.56  |  |                     | 1,035 |                     |  | 5.3 years |  | $         | 13.16 |          |  |  | 610   |          |  | $ | 13.23 | 
|$18.13 to $26.00 |  |                     | 359   |                     |  | 3.3 years |  | $         | 22.98 |          |  |  | 207   |          |  | $ | 22.68 | 
|$31.50 to $43.63 |  |                     | 115   |                     |  | 3.3 years |  | $         | 37.30 |          |  |  | 64    |          |  | $ | 35.71 | 
|                 |  |                     |       |                     |  |           |  |           |       |          |  |  |       |          |  |   |       |  |  | 
|                 |  |                     | 1,924 |                     |  | 4.4 years |  | $         | 15.08 |          |  |  | 1,121 |          |  | $ | 20.62 | 
|                 |  |                     |       |                     |  |           |  |           |       |          |  |  |       |          |  |   |       |  |  | 

At December 31, 2002, the Company had reserved 2,313 shares of common stock for
exercise of outstanding stock options and additional stock options authorized
for granting under existing stock option plans.

Employee Stock Purchase Plan

During 2002, the Company adopted the SafeNet, Inc. Employee Stock Purchase
Plan. The plan allows eligible employees to purchase shares of common stock at
85% of the lower of the closing price of the Companys common stock on the
first trading day or the last trading day of each semi-annual offering period.
Employees may authorize the Company to withhold up to 10% of their compensation
during any offering period, subject to certain limitations. During 2002, 7
shares were issued under the plan at a price of $15.06 per share.

(13) SEGMENTS OF THE COMPANY AND RELATED INFORMATION

The Company has two reportable segments related to continuing operations:
products, chips and software designed and manufactured for sale to companies
that will embed the Companys products into their products for ultimate sale to
end-users (Embedded Security Division), and network security products
designed and manufactured for direct sales to end-users and remote access
software sold to OEMs (Enterprise Security Division). The reportable
segments are strategic business units that offer different products. The
segments are managed separately because each segment requires different
technology and marketing strategies. The Embedded Security Division and
Enterprise Security Division include some international sales mainly to South
America, Europe and Asia.

52



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##### 



SAFENET, INC.
AND SUBSIDIARIES

|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|--------------------------------------------------------------------------- | ---------------------------- | - | ----------------------- | ------ | ---- | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                            |                              |   | Year ended December 31,
|                                                                            |                              |   | 2002                    |        | 2001 |   | 2000  
|                                                                            |                              |   |                         |        |      |   |       
|Revenue from external customers:                                            |                              |   |                         |        |      |   |        |        |   |   |        |       
|                                                                            | Embedded security division   |   | $                       | 18,292 |      |   | $      | 5,477  |   |   | $      | 6,418  |  
|                                                                            | Enterprise security division |   |                         | 13,943 |      |   |        | 10,985 |   |   |        | 18,860 |  
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Consolidated revenues                                                       |                              | $ | 32,235                  |        |      | $ | 16,462 |        |   | $ | 25,278 |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Significant non-cash items other than depreciation and amortization expense |                              |   |                         |        |      |   |        |        |   |   |        |       
|                                                                            | Embedded security division   |   | $                       | 3,375  |      |   | $      |       |   |   | $      |       |  
|                                                                            | Enterprise security division |   |                         |       |      |   |        |       |   |   |        |       |  
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Consolidated significant non-cash charges                                   |                              | $ | 3,375                   |        |      | $ |       |        |   | $ |       |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Operating (loss) income:                                                    |                              |   |                         |        |      |   |        |        |   |   |        |       
|                                                                            | Embedded security division   |   | $                       | (4,227 | )    |   | $      | (1,697 | ) |   | $      | (268   | )
|                                                                            | Enterprise security division |   |                         | 2,683  |      |   |        | 252    |   |   |        | 6,208  |  
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Consolidated operating (loss) income                                        |                              | $ | (1,544                  | )      |      | $ | (1,445 | )      |   | $ | 5,940  |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Depreciation and amortization:                                              |                              |   |                         |        |      |   |        |        |   |   |        |       
|                                                                            | Embedded security division   |   | $                       | 2,180  |      |   | $      | 1,163  |   |   | $      | 1,076  |  
|                                                                            | Enterprise security division |   |                         | 857    |      |   |        | 398    |   |   |        | 699    |  
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Consolidated depreciation and amortization                                  |                              | $ | 3,037                   |        |      | $ | 1,561  |        |   | $ | 1,775  |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|(Loss) income from continuing operations
before income taxes:               |                              |   |                         |        |      |   |        |        |   |   |        |       
|                                                                            | Embedded security division   |   | $                       | (3,794 | )    |   | $      | (1,253 | ) |   | $      | 67     |  
|                                                                            | Enterprise security division |   |                         | 2,919  |      |   |        | 1,143  |   |   |        | 7,193  |  
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|Consolidated (loss) income from continuing
operations before income taxes   |                              | $ | (875                    | )      |      | $ | (109   | )      |   | $ | 7,260  |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  

|                                               |  |      |        |      |  |              |        |  |  |   |        | 
|---------------------------------------------- |  | ---- | ------ | ---- |  | ------------ | ------ |  |  | - | ------ | 
|Geographic Information                         |  |      |        |      |  | December 31, |        |  |  |  
|                                               |  | 2002 |        | 2001 |  | 2000        
|                                               |  |      |        |      |  |             
|Revenues:                                      |  |      |        |      |  |              |        |  |  |   |        | 
|United States                                  |  | $    | 28,945 |      |  | $            | 15,134 |  |  | $ | 23,877 | 
|All other countries                            |  |      | 3,290  |      |  |              | 1,328  |  |  |   | 1,401  | 
|                                               |  |      |        |      |  |              |        |  |  |   |        | 
|Consolidated revenues                          |  | $    | 32,235 |      |  | $            | 16,462 |  |  | $ | 25,278 | 
|                                               |  |      |        |      |  |              |        |  |  |   |        | 
|Long-lived assets, from continuing operations: |  |      |        |      |  |              |        |  |  |   |        | 
|United States                                  |  | $    | 1,140  |      |  | $            | 1,696  |  |  | $ | 2,696  | 
|All other countries                            |  |      | 585    |      |  |              |       |  |  |   |       | 
|                                               |  |      |        |      |  |              |        |  |  |   |        | 
|Consolidated long-lived assets                 |  | $    | 1,725  |      |  | $            | 1,696  |  |  | $ | 2,696  | 
|                                               |  |      |        |      |  |              |        |  |  |   |        | 

53



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##### 



SAFENET, INC.
AND SUBSIDIARIES

The Company does not allocate assets to its reportable segments, as assets
generally are not specifically attributable to any particular segment.
Accordingly, asset information by reportable segment is not presented. Where
the underlying assets can be specifically attributed to a segment, the related
depreciation and amortization have been classified accordingly. The remaining
depreciation is allocated based on a percentage of revenue.

(14) SIGNIFICANT CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist primarily of accounts receivable. The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. Sales terms with clients, including distributors, do
not provide for right of return privileges for credit, refund or other
products. The Companys payment terms are generally 30 days from delivery of
products, but could fluctuate depending on the terms of each specific contract.
The Companys clients, who include both commercial companies and governmental
agencies, are in various industries, including banking, security,
communications and distributors of electronic products.

In 2002, one commercial client of the Embedded Security Division accounted for
41% of the Companys consolidated revenues. In 2001, one commercial client of
the Enterprise Security Division accounted for 15% of the Companys
consolidated revenues. In 2000, one commercial client of the Enterprise
Security Division accounted for 11% and one commercial client of the Embedded
Security Division accounted for 18% of the Companys consolidated revenues.

As of December 31, 2002, 4 commercial clients of the Enterprise Security
Division accounted for 11% of accounts receivable and 3 commercial clients of
the Embedded Security Division accounted for a combined 42% of accounts
receivable. As of December 31, 2001, three commercial clients of the
Enterprise Security Division accounted for 37% of accounts receivable and two
commercial clients of the Embedded Security Division accounted for a combined
30% of accounts receivable.

54



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##### 



SAFENET, INC.
AND SUBSIDIARIES

(15) (LOSS) INCOME PER SHARE

The following table sets forth the computation of basic and diluted income
(loss) from continuing operations per common share for the years ended December
31:

|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 
|---------------------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | - |  | - | ----- | 
|                                                                                                           |  | 2002 |       | 2001 |  | 2000
|                                                                                                           |  |      |       |      |  |     
|Numerator:                                                                                                 |  |      |       |      |  |      |       |   |  |   |       | 
|(Loss) income from continuing operations                                                                   |  | $    | (785  | )    |  | $    | (109  | ) |  | $ | 7,260 | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 
|Denominator:                                                                                               |  |      |       |      |  |      |       |   |  |   |       | 
|Denominator for basic (loss) income per
share  weighted average shares                                    |  |      | 7,730 |      |  |      | 7,057 |   |  |   | 6,751 | 
|Effect of employee stock options                                                                           |  |      |      |      |  |      |      |   |  |   | 444   | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 
|Denominator for diluted (loss) income
per share  adjusted weighted-average
shares and assumed conversions |  |      | 7,730 |      |  |      | 7,057 |   |  |   | 7,195 | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 
|Basic (loss) income from continuing
operations per share                                                   |  | $    | (0.10 | )    |  | $    | (0.01 | ) |  | $ | 1.08  | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 
|Diluted (loss) income from continuing
operations per share                                                 |  | $    | (0.10 | )    |  | $    | (0.01 | ) |  | $ | 1.01  | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 

Diluted loss from continuing operations per common share in 2002 and 2001 is
equal to basic loss per common share because if potentially dilutive securities
were included in the computation, the result would be anti-dilutive. These
securities consist of company stock options.

(16) SUBSEQUENT EVENTS

ACQUISITION OF CYLINK CORPORATION

On February 6, 2003, SafeNet acquired 100% of the outstanding common shares of
Cylink Corporation (Cylink) in accordance with an Agreement and Plan of
Reorganization dated as of October 30, 2002. The results of operations of
Cylink will be included in the Companys consolidated results of operations
beginning on February 6, 2003. Cylink, develops, manufactures, markets and
supports a comprehensive portfolio of hardware and software security products
for mission-critical private networks and business communications over the
Internet. Cylinks solutions enable its customers to merge their operations and
transactions onto existing networks, maximize network use, reduce the costs of
operations and expand their businesses. As a result of the acquisition, the
Company believes that it will be able to grow its base of government and
commercial customers, enhance its product line, expand its international sales
and provide broader technology and expertise to its customers. It also expects
to reduce costs through economies of scale.

55



---



##### 



The aggregate purchase price was $35,102 consisting primarily of 1,684 shares
of common stock valued at $31,256, 194 options and warrants assumed with an
aggregate value of $1,691, and estimated direct costs of the acquisition of
$2,156. The value of the common shares issued was determined based on the
average market price of the Companys common shares over the period including
three days before and after the terms of the acquisition were agreed to and
announced.

The following table summarizes the estimated fair values of the assets acquired
and liabilities assumed at the date of acquisition.
The Company is in the process of completing third-party valuations of certain
intangible assets; thus, the allocation of the purchase price is subject to
refinement.

|                                                                                  |  |   |        |  |  | 
|--------------------------------------------------------------------------------- |  | - | ------ |  |  | 
|Current assets                                                                    |  | $ | 17,346 | 
|Property and equipment                                                            |  |   | 786    | 
|Goodwill                                                                          |  |   | 24,997 | 
|Acquired in-process research and development assets                               |  |   | 3,317  | 
|Intangible assets subject to amortization
(2.7 year weighted average useful life) |  |   | 17,432 | 
|Other assets                                                                      |  |   | 728    | 
|                                                                                  |  |   |        | 
|Total assets acquired                                                             |  | $ | 64,606 | 
|                                                                                  |  |   |        | 
|Current liabilities                                                               |  | $ | 20,225 | 
|Deferred income taxes, less current portion                                       |  |   | 4,394  | 
|Other long-term liabilities                                                       |  |   | 4,885  | 
|                                                                                  |  |   |        | 
|Total liabilities assumed                                                         |  | $ | 29,504 | 
|                                                                                  |  |   |        | 
|Net assets acquired                                                               |  | $ | 35,102 | 
|                                                                                  |  |   |        | 

The $3,317 assigned to acquired in-process research and development assets will
be written off at the date of acquisition in accordance with FASB
Interpretation No. 4, Applicability of FASB Statement No. 2 to Business
Combinations Accounted for by the Purchase Method.

The $24,997 of goodwill was assigned to the Enterprise Security segment. Of
that total amount, none is expected to be deductible for tax purposes.

The unaudited pro forma combined historical results, as if Cylink had been
acquired on January 1, 2002, is as follows:

| |                                                               |  |   |         |   | 
| | ------------------------------------------------------------- |  | - | ------- | - | 
| | Revenues                                                      |  | $ | 59,759  |  
| | Loss from continuing operations                               |  | $ | (26,841 | )
| | Net loss                                                      |  | $ | (30,795 | )
| | Loss per share from continuing operations
- basic and diluted |  | $ | (2.85   | )
| | Loss per share  basic and diluted                            |  | $ | (3.27   | )

56



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##### 



SAFENET, INC.
AND SUBSIDIARIES

The pro forma results include the estimated amortization of intangibles. As
described in Note 2, the Company does not record amortization expense related
to the goodwill. The pro forma results are not necessarily indicative of the
results that would have occurred if the acquisition had actually been completed
on January 1, 2002, nor are they necessarily indicative of future consolidated
results.

ASSET ACQUISITION OF RAQIA NETWORKS, INC.

On February 27, 2003, SafeNet acquired substantially all the assets of Raqia
Networks, Inc., a development stage company, consisting primarily of
technology-related intangible assets. Total consideration paid by SafeNet was
389,640 shares of SafeNet common stock with an estimated value of $6,715 plus
$805 in cash. SafeNet had previously invested $1,000 in Raqia Networks. The
Company will obtain an independent valuation of the acquired assets, in order
to allocate the purchase price during the first quarter of 2003.

57



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##### 



SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS
(Amounts in thousands)

|                                                                          |  |            |     |          |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   |  |  |   |     | 
|------------------------------------------------------------------------- |  | ---------- | --- | -------- |  | -------- | --- | ------------- |  | -------- | - | --------- |  | - | -- | ------- |  | - | - |  |  | - | --- | 
|                                                                          |  | Balance at |     | Charged  |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   | 
|                                                                          |  | Beginning  |     | to Costs |  | Charges  |     |               |  |          |   |           |  |   |    | Balance
|                                                                          |  | of         |     | and      |  | to Other |     |               |  |          |   |           |  |   |    | at End 
|                                                                          |  | Period     |     | Expenses |  | Accounts |     | Deductions(a) |  | Recovery |   | of Period
|                                                                          |  |            |     |          |  |          |     |               |  |          |   |          
|Allowance for doubtful accounts:                                          |  |            |     |          |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   |  |  |   |     | 
|Year ended December 31, 2002                                              |  | $          | 150 |          |  | $        | 94  |               |  | $        |  |           |  | $ |   |         |  | $ |  |  |  | $ | 244 | 
|Year ended December 31, 2001                                              |  |            | 196 |          |  |          | 32  |               |  |          |  |           |  |   | 78 |         |  |   |  |  |  |   | 150 | 
|Year ended December 31, 2000                                              |  |            | 215 |          |  |          | 60  |               |  |          |  |           |  |   | 79 |         |  |   |  |  |  |   | 196 | 
|Reserve for obsolete inventory:                                           |  |            |     |          |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   |  |  |   |     | 
|Year ended December 31, 2002                                              |  | $          | 482 |          |  | $        | 477 |               |  | $        |  |           |  | $ |   |         |  | $ |  |  |  | $ | 958 | 
|Year ended December 31, 2001                                              |  |            | 207 |          |  |          | 284 |               |  |          |  |           |  |   | 9  |         |  |   |  |  |  |   | 482 | 
|Year ended December 31, 2000                                              |  |            | 207 |          |  |          |    |               |  |          |  |           |  |   |   |         |  |   |  |  |  |   | 207 | 
|                                                                          |  |            |     |          |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   |  |  |   |     | 
|(a)  Deductions represent
write-offs of specifically
identified accounts |  |            |     |          |  |          |     |               |  |          |   |           |  |   |    |         |  |   |   |  |  |   |     | 

58



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##### 



ITEM 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated herein by reference to
the definitive Proxy Statement of SafeNet, which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of
SafeNets fiscal year ended December 31, 2002.

ITEM 11  EXECUTIVE COMPENSATION

The information required by this item is incorporated herein by reference to
the definitive Proxy Statement of SafeNet, which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of
SafeNets fiscal year ended December 31, 2002.

ITEM 12  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated herein by reference to
the definitive Proxy Statement of SafeNet, which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of
SafeNets fiscal year ended December 31, 2002.

ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated herein by reference to
the definitive Proxy Statement of SafeNet, which will be filed with the
Securities and Exchange Commission no later than 120 days after the close of
SafeNets fiscal year ended December 31, 2002.

ITEM 14  CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | As required by Rule 13a-15 under the Exchange Act, within 90 days
prior to the filing date of this annual report (the Evaluation
Date), the Company carried out an evaluation of the effectiveness of
the design and operation of the Companys disclosure controls and
procedures. This evaluation was carried out under the supervision and
with the participation of the Companys management, including the
Companys chief executive officer and chief financial officer. Based
upon that

59



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##### 





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | evaluation, the Companys chief executive officer and chief financial
officer concluded that the Companys disclosure controls and
procedures are effective. Disclosure controls and procedures are
controls and other procedures that are designed to ensure that
information required to be disclosed in the Companys reports filed or
submitted under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the SECs rules and
forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that
information required to be disclosed in the Companys reports filed
under the Exchange Act is accumulated and communicated to management,
including the Companys chief executive officer and chief financial
officer, as appropriate, to allow timely decisions regarding required
disclosures.

Changes in internal controls.



| |                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There were no significant changes in the Companys internal controls
or in other factors that could significantly affect the Companys
internal controls subsequent to the Evaluation Date, nor any
significant deficiencies or material weaknesses in such internal
controls requiring corrective actions.

PART IV

ITEM 15  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 30 of this       Form 10-K.                                                                                      
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | 2.   Financial Statement Schedules: Schedule II Valuation and Qualifying Accounts                                                                                                                                                              
|   
|    |  | All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable therefore have been omitted              
|   
|(b) |  | Reports on Form 8-K:

The Company filed a Current Report on Form 8-K with the Securities and Exchange Commission on November 1, 2002 in connection with entering into a
definitive agreement and plan of reorganization with Cylink Corporation
|   
|(c) |  | Exhibits required by Item 601 of Regulation S-K:                                                                                                                                                                                               

| |  |     |  |                                                                                                                                            |  |         
| |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------ |  | --------
| |  | 2A  |  | Agreement and Plan of Reorganization dated October 30, 2002 by and among the
Registrant, Sapphire Acquisition Corp. and Cylink Corporation |  | I/B/R(1)
| |  |     |  |                                                                                                                                            |  |         
| |  | 3A  |  | Restated Certificate of Incorporation of Registrant, as filed with the Secretary of
State of Delaware on May 23, 2001                      |  | I/B/R(2)
| |  |     |  |                                                                                                                                            |  |         
| |  | 3B  |  | By-laws of Registrant                                                                                                                      |  | I/B/R(3)
| |  |     |  |                                                                                                                                            |  |         
| |  | 4   |  | Specimen of Common Stock Certificate of Registrant                                                                                         |  | I/B/R(3)
| |  |     |  |                                                                                                                                            |  |         
| |  | 10A |  | Sublease dated November 2, 1993 for facility at 8029 Corporate Drive, Baltimore, MD                                                        |  | I/B/R(4)
| |  |     |  |                                                                                                                                            |  |         
| |  | 10B |  | Stock Option Plan of 1989                                                                                                                  |  | I/B/R(5)
| |  |     |  |                                                                                                                                            |  |         
| |  | 10C |  | Joint Development and Marketing Agreement between the Registrant and CyberGuard
Corporation                                                |  | I/B/R(6)
| |  |     |  |                                                                                                                                            |  |         
| |  | 10D |  | Agreement between SafeNet Secure Solutions, Inc. (wholly-owned subsidiary of the
Registrant) and Analog Devices, Inc.                      |  | I/B/R(7)

60



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##### 

\

| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------
| |  | 10E  |  | 1999 Employee Stock Option Plan                                                                                                                                                                       |  | I/B/R(8) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10F  |  | 1999 Stock Bonus Plan                                                                                                                                                                                 |  | I/B/R(8) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10G  |  | Non-Employee Director Stock Option Plan                                                                                                                                                               |  | I/B/R(8) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10H  |  | 2000 Employee and Directors Stock Option Plan                                                                                                                                                         |  | I/B/R(8) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10I  |  | 2001 Omnibus Stock Option Plan                                                                                                                                                                        |  | I/B/R(9) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10J  |  | Employment Agreement with Anthony Caputo                                                                                                                                                              |  | I/B/R(10)
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10K  |  | Employment Agreement with Cees Jan Koomen                                                                                                                                                             |  | I/B/R(10)
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10L  |  | Employee Stock Purchase Plan                                                                                                                                                                          |  | I/B/R(9) 
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10M  |  | Second Amendment to Lease and Partial Termination Agreement dated October 30, 2002
by and between Cylink Corporation and Orchard Jay Investors, LLC for facilities
located in Santa Clara, California |  | I/B/R(11)
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 10N  |  | Stipulation and Agreement of Settlement filed on November 5, 2002, in the United
States District Court for the Northern District of California, No. C98-4292 (VRW)                                    |  | I/B/R(11)
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 21   |  | Subsidiaries of Registrant                                                                                                                                                                            |  |          
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 23.1 |  | Consent of Ernst & Young LLP, independent auditors                                                                                                                                                    |  |          
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 99.1 |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                |  |          
| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | 99.2 |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002                                                                                |  |          



|(1)  |  | Filed as an exhibit to the Registration Statement on Form S-4 (File No.
333-101577) of the Registrant and incorporated herein by reference.                           
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Filed as an exhibit to the Form 10-Q for the quarterly period ended June
30, 2002 and incorporated herein by reference.                                               
|    
|(3)  |  | Filed as an exhibit to the Registration Statement on Form S-18 (File No.
33-28673) of the Registrant and incorporated herein by reference.                            
|    
|(4)  |  | Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
1993 and incorporated herein by reference.                                                  
|    
|(5)  |  | Filed as an exhibit to the Registration Statement on Form S-1 (File No.
33-52066) of the Registrant and incorporated herein by reference.                             
|    
|(6)  |  | Filed as an exhibit to Form 10-K for the fiscal year ended December 31,
1996 and incorporated herein by reference.                                                    
|    
|(7)  |  | Filed as an exhibit to Form 10-Q for the quarterly period ended September
30, 1996 and incorporated herein by reference.                                              
|    
|(8)  |  | Filed as an exhibit to a Definitive Proxy Statement on Schedule 14A for
the Annual Meeting of Shareholders held on July 28, 1999 and incorporated
herein by reference.
|    
|(9)  |  | Filed as an exhibit to the Registration Statement on Form S-8 (File No.
333-98029) of the Registrant and incorporated herein by reference.                            
|    
|(10) |  | Filed as an exhibit to the Form 10-Q for the quarterly period ended
September 30, 2002 and incorporated herein by reference.                                          
|    
|(11) |  | Filed as an exhibit to the Form 10-Q of Cylink Corporation (File No.
0-27742) for the quarterly period ended September 29,2002 and incorporated
herein by reference.  

61



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##### 



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.

SAFENET, INC.

|    |  |                                                                  
|--- |  | -----------------------------------------------------------------
|By: |  | /s/ Anthony A. Caputo                                            
|    |  |                                                                  
|    |  | Anthony A. Caputo
Chairman, Chief Executive Officer and President

Date: March 31, 2003

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. CaputoAnthony A. Caputo     |  | Chairman, Chief Executive Officer
And President   |  | March 31,  2003
|                                           |  |                                                   |  |                
|                                           |  | Senior Vice President and Chief
Financial Officer |  |                
|/s/ Carole D. ArgoCarole D. Argo           |  | (Principal Financial and Accounting
Officer)      |  | March 31,  2003
|                                           |  |                                                   |  |                
|/s/ Thomas A. BrooksThomas A. Brooks       |  | Director                                          |  | March 31,  2003
|                                           |  |                                                   |  |                
|/s/ Shelley A. HarrisonShelley A. Harrison |  | Director                                          |  | March 31,  2003
|                                           |  |                                                   |  |                
|/s/ Ira A. Hunt, Jr.Ira A. Hunt, Jr.       |  | Director                                          |  | March 31,  2003
|                                           |  |                                                   |  |                
|/s/ Bruce R. ThawBruce R. Thaw             |  | Director                                          |  | March 31,  2003

62



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##### 



CHIEF EXECUTIVE OFFICER CERTIFICATION

I, Anthony A. Caputo, Chairman, President and Chief Executive Officer of
SafeNet, Inc. (the Company), certify that:

1.     I have reviewed this annual report on Form 10-K of the
Company;

2.     Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this annual report;

4.     The Companys other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:



| | a) |  | designed such disclosure controls and procedures
to ensure that material information relating to the Company,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report was being prepared;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the Companys
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the
Evaluation Date); and                                                                                                   
|
| | c) |  | presented in this annual report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;                                                                                                                      

5.     The Companys other certifying officer and I have disclosed, based on
our most recent evaluation, to the Companys auditors and the audit committee
of the Companys board of directors:



| | a) |  | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the Companys ability to record, process, summarize and report
financial data and have identified for the Companys auditors
any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | amy fraud, whether or not material, that involves
management or other employees who have a significant role in
the Companys internal controls; and                                                                                                                                     

6.     The Companys other certifying officer and I have indicated in this
annual report whether or not there were any significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                     |  |                                                                  
|-------------------- |  | -----------------------------------------------------------------
|                     |  | SAFENET, INC.                                                    
|                     |  |                                                                  
|                     |  | /s/ Anthony A. Caputo                                            
|Date: March 31, 2003 |  | ANTHONY A. CAPUTO
Chairman, President and Chief Executive Officer

63



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##### 



CHIEF FINANCIAL OFFICER CERTIFICATION

I, Carole D. Argo, Senior Vice President and Chief Financial Officer of
SafeNet, Inc. (the Company), certify that:

1.     I have reviewed this annual report on Form 10-K of the Company;

2.     Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3.     Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
Company as of, and for, the periods presented in this annual report;

4.     The Companys other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:



| | a) |  | designed such disclosure controls and procedures
to ensure that material information relating to the Company,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report was being prepared;
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the Companys
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the
Evaluation Date); and                                                                                                   
|
| | c) |  | presented in this annual report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;                                                                                                                      

5.     The Companys other certifying officer and I have disclosed, based on
our most recent evaluation, to the Companys auditors and the audit committee
of the Companys board of directors:



| | a) |  | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the Companys ability to record, process, summarize and report
financial data and have identified for the Companys auditors
any material weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in
the Companys internal controls; and                                                                                                                                     

6.     The Companys other certifying officer and I have indicated in this
annual report whether or not there were any significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                     |  |                                                                 
|-------------------- |  | ----------------------------------------------------------------
|                     |  | SAFENET, INC.                                                   
|                     |  |                                                                 
|                     |  | /s/ Carole D. Argo                                              
|Date: March 31, 2003 |  | CAROLE D. ARGO
Senior Vice President and Chief Financial Officer

64