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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K/A




Amendment No. 2




|           |  |                                                                                     
|---------- |  | ------------------------------------------------------------------------------------
|(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

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

Commission File Number 0-20634

SAFENET, INC.

(Exact name of registrant as specified in its charter)





|                                         |  |                    
|---------------------------------------- |  | -------------------
|Delaware                                 |  | 52-1287752         
|(State or other jurisdiction of          |  | (IRS Employer      
|incorporation or organization)           |  | Identification No.)
|                                         |  |                    
|4690 Millennium Drive                    |  |                    
|Belcamp, Maryland                        |  | 21017              
|(Address of principal executive offices) |  | (Zip Code)         




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

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

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

|                             |  |                             
|---------------------------- |  | ----------------------------
|                             |  | Name of each                
|Title of each class          |  | exchange on which registered
|                             |  |                             
|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 o

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. o

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

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
February 9, 2004 was 13,350,400.




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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Explanatory Note

This
amendment to SafeNet, Inc.s Annual Report on Form 10-K for the year
ended December 31, 2002, which was filed with the Securities and Exchange
Commission on March 31, 2003, as amended by Amendment No. 1
on Form 10-K/A, which was filed on April 29, 2003, is being filed
to revise and expand disclosures in
Item 1Business, Item 7Managements Discussion and Analysis of Financial
Condition and Results of Operations, and Item 8Financial Statements and
Supplementary Data. No further changes have been made to the Form 10-K. In
connection with the filing of this amendment and pursuant to Rule 12b-15 under
the Securities Exchange Act of 1934, as amended, SafeNet, Inc. is including
certain currently dated certifications and an updated consent of its
independent auditors. This amendment continues to speak as of the date of the
original filing of the Form 10-K and the Company has not updated the disclosure
in this amendment to speak to any later date.

In this
Annual Report on Form 10-K/A, SafeNet, we, us, and our
refer to SafeNet, Inc. and its subsidiaries, unless the context otherwise
requires.




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

Overview

We develop, market, sell and support a portfolio of hardware and software
network security products and services that enable secure communications and
data services. Our products and services are used to create secure wide area
networks (WANs) and virtual private networks over the Internet (VPNs) to
prevent security breaches that could result in unauthorized access to
confidential data, invasion of privacy and financial loss. Our security
solutions allow our customers to lower the cost of deploying and managing
secure, reliable private networks and enable the use of the Internet for secure
business communications and transactions with customers, suppliers and
employees.

Our products and services address a wide range of customer and market
needs. Through our Enterprise Security Division, we sell high-performance
security solutions to address the needs of our government, financial
institutions and other security-sensitive commercial customers. We also
provide, through our Embedded Security Division, a broad range of security
products, including silicon chips, accelerator cards, licensed intellectual
property and software products, to original equipment manufacturers (OEMs) that
embed them into their own network and wireless products. We believe that our
relationships with both enterprises and OEMs allow us to provide security
products to a broad spectrum of end-users.

Our products are based on industry standard encryption algorithms and
communication protocols that allow for integration into large networks and
interoperability with other network devices and applications. Our solutions
incorporate our security technologies, including our silicon chips, appliances,
client software and management software, to provide a vertically integrated
solution that addresses the stringent security needs of our customers. Our
security products are centrally managed with our management software, which
enables policy management and the secure, scalable monitoring of network
devices, applications, network traffic and security events.

Founded in 1983, we are headquartered in Baltimore, Maryland. We have a
long track record of technology and security innovation and dedication to
continuous product improvement. In 1995, we developed our first Internet VPN
solution for a major financial institution. Through business




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relationships with end-user customers, such as the U.S. Department of
Defense, the Internal Revenue Service, the Immigration and Naturalization
Service and Citigroup, and OEMs, such as Cisco Systems and Texas Instruments,
we have considerable experience developing and deploying network security
solutions.

In February 2003, we completed our 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
our Enterprise Security Division and function as part of that business unit.
This acquisition will have a significant impact on our business operations
going forward. As the transaction closed subsequent to December 31, 2002, the
Cylink acquisition has not been considered in the discussion of our business as
of and for the year ended December 31, 2002. However, due to its significance
to our business, a discussion of the Cylink acquisition and its anticipated
impact is included at the end of Item 1. Business.

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

In January 2002, we acquired Pijnenburg Secuealink, Inc. 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. We integrated the operations of Securealink into our Embedded
Security Division.

Industry Background

Enterprises increasingly require secure and reliable networks to conduct
electronic commerce, collaborate with customers and provide remote access for
employees. The pervasive use of WANs and the Internet is substantially
increasing the volume of electronic communications and transactions and the
demand for network security products and services.

Today, large networks contain numerous points of vulnerability, which can
make passwords, network architecture and other critical information vulnerable
to attack. Communications may pass through dozens of countries, over
satellites, numerous operating systems in computers and routers, and through a
variety of organizations or communications providers and their premises.
Consequently, multiple parties have access, or can acquire access, to
proprietary data within these networks. Because of this exposure, enterprises
must have access to secure paths of communication.

Secure electronic communications and transactions have traditionally
required costly private networks and dedicated leased lines. Over time,
enterprises have invested heavily in WANs (asynchronous transfer
mode, or ATM, frame relay and link) to
conduct secure communications and transactions, resulting in a significant
installed base of these networks. However, there are several limitations that
exist with traditional leased-line WANs. Their proprietary, fixed nature
results in significant costs and reduced flexibility and scalability. The need
for dedicated leased lines and excess capacity to meet peak load requirements
results in networks that are significantly more expensive to maintain and
administer. Additionally, providing network access is made difficult and
expensive by the need to add another dedicated leased-line for each new
location, partner and employee that needs to be connected to the network. In
the future, we expect that most networks will utilize both WANs and the
Internet, but will increasingly depend on the Internet as they expand to
support a much larger number of users. As a result, these enterprises will
require solutions that seamlessly manage both types of network technologies.

The adoption of VPNs and, more recently, the Internet Protocol Security
(IPSec), a widely used industry protocol to enable secure transmissions over
the Internet, has enabled the secure




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transfer of information and data over the Internet. A VPN is a
communications system using encryption technology that creates a private
tunnel through the Internet and other communications systems, assuring
authentication of users and privacy of information. Increased availability of
VPN services has allowed a secure alternative to traditional WANs. VPNs allow
organizations to use public networks for their communications backbone. Because
the Internet is less expensive to use than private networks, enterprises can
generally achieve substantial cost savings by using VPNs while taking advantage
of the global availability and access to the Internet. VPNs have three key
uses:



| |  |  | Remote access VPNs connect teleworkers and mobile workers to the
corporate network;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | Site-to-site VPNs connect the central office of an enterprise
to its various branch and satellite offices; and
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | Extranet VPNs connect an enterprise and its suppliers and
business partners, allowing them to exchange real-time information
such as inventory levels or pricing.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

Some network security products emphasize one or more forms of security
technology other than VPNs, such as firewalls, intrusion detection and
anti-virus. Firewalls use filtering technology to control external access to an
enterprise network. Intrusion detection, or intrusion prevention, is intended
to alert network operators of attempts to penetrate customers networks.
Similarly, anti-virus products address the prevalence of virus attacks that
proliferate through the Internet, and migrate into private networks through
their users computers. We believe that encryption and authentication should be
the first line of defense in the networks security strategy, with firewalls,
intrusion detection and anti-virus solutions providing additional defense for
communications received from remaining, unsecured sources. We further believe
that encryption, by protecting the privacy of the information, ensuring the
integrity of the data and authenticating the source and destination of the
communication, is the foundation technology upon which a secure network can be
built.

The SafeNet Solution

We develop, market, sell and support a portfolio of hardware and software
network security products and services that provide secure communications and
data services over WANs and the Internet. Our products and services address a
wide range of customer and market needs. Through our Enterprise Security
Division, we sell high-performance security solutions to address the high-level
security needs of our government, financial institution and other
security-sensitive commercial customers. By providing a solution that
incorporates our security technologies, including our silicon chips,
appliances, client software and management software, we are able to provide a
vertically integrated solution that addresses the stringent security needs of
these customers. We also provide, through our Embedded Security Division, a
broad range of security solutions, including silicon chips, accelerator cards,
licensed intellectual property and software products, to OEMs that embed them
into their own network and wireless products.

Strategy

Our objective is to be the leading provider of products and services that
enable secure communications and data services over WANs and the Internet. To
achieve this objective, we continue to pursue the following strategies:



| |  |  | Extend our Technology and Introduce New Products.We intend to
leverage our technology and product strength and expertise to further
expand our core product functionality, continue to develop
complementary products, and expand our target market. We will continue
to invest in research and development and expect to announce several
new product and technology offerings during 2003. For example in 2003,
we expect to introduce content inspection chips designed for intrusion
detection and prevention, application firewalls and anti-virus
protection. We have
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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| |  |  | assembled a team of experienced developers and engineers with security
expertise and encourage a corporate culture that fosters continuous
product innovation.
| |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Further Penetrate our Existing Enterprise Customer Base.We have an
established customer base of government, financial institution and
other commercial enterprises. The strategic importance of our products
allows us to develop long-term relationships with the key technology
and security decision-makers within our customer base. The breadth of
our existing enterprise product line allows us to address a wide range
of customer needs. We intend to generate incremental sales from our
existing customer base through the introduction of new and enhanced
products and services. We believe that the acquisition of Cylink
provides us with an opportunity to sell new products and services into
the larger combined customer base, including selling our VPN solutions
to Cylinks customers.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expand Strategic OEM Relationships and Other Distribution Channels.
We intend to continue to focus on our OEM relationships and to expand
distribution channels to develop new markets. We believe that these
relationships allow us to provide our security solutions to the largest
number of end-user customers. We sell a variety of security products to
OEMs, including silicon chips, accelerator cards, licensed intellectual
property and software products. We currently have OEM relationships
with major companies, such as Cisco Systems, Texas Instruments, ARM,
Advanced Micro Devices and Samsung. We offer comprehensive training and
marketing programs to support our OEMs. We intend to further develop
our relationships with system integrators for the government sector and
value added resellers for international markets.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Target the Government and Financial Institution Markets.We
continue to target government agencies and financial institutions. We
believe these markets represent, over the long-term, a significant
growth opportunity for sales of high-end network security products.
Governmental agencies as well as financial institutions have
increasingly focused on enhancing the security of their networks,
especially after the September 11, 2001 terrorist attacks. We intend
to expand our position in these markets and leverage this position to
target new high growth market opportunities as they arise.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Target the Wireless Market.We have recently targeted the
wireless communications market. We are currently in the process of
developing additional security technology that will address the
growing need for secure wireless communication.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pursue Strategic Acquisitions on a Selective Basis.We explore
acquisitions from time to time to acquire businesses, products or
technologies that we believe will enhance and expand our current
product offerings and our customer base.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Products, Services and Technology

Our enterprise products and services are typically sold to government
agencies, financial institutions and other commercial customers. Our embedded
products are typically sold to OEM customers as components, such as silicon
chips, accelerator cards, licensed intellectual property and software.

Enterprise Solutions

SafeEnterpriseSecurity System.Our SafeEnterprise Security System
provides security solutions for government and financial institutions that
require a high level of security to protect their networks from unauthorized
access and to protect sensitive information as it travels over both WANs and
the Internet. This solution, which includes both appliances and software that
can be sold as an integrated turnkey solution or separately as discreet
hardware and software products, consists of network gateways, backbone
encryptors, remote access, client software and our management software. The
SafeEnterprise system provides management functionality, including policy
creation,




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policy enforcement, network monitoring, activity auditing and
troubleshooting. SafeEnterprise provides a secure solution for both WANs (ATM,
frame relay and link) and the Internet.

Appliances.The SafeEnterprise Security System includes HighAssurance
Gateways that employ the U.S. government endorsed Triple Data Encryption
Standard (3DES) and Data Encryption Standard (DES) algorithms and Advanced
Encryption Standard (AES) algorithms. In addition, the SafeEnterprise Security
System also includes ATM, Frame and Link Encryptors that employ 3DES and DES
algorithms.



| |  |  | HighAssurance Gateways:Our HighAssurance Gateway line provides
a portfolio of IPSec VPN gateways covering small, medium and large
network requirements. The gateways are differentiated by the
performance needs of the network and where they are placed in the
network. Our gateways integrate advanced features, such as load
balancing and fail-over, secure multi-casting, firewalls and routing,
and are all IPSec standards-compliant.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HighAssurance Gateways include:
| | - |  | --------------------------------

Product
    
    IPSec Throughput
    
    IPSec Tunnels(1)HighAssurance 500 Gateway
    
    1.5 Mbps
    
    
    500HighAssurance 1000 Gateway
    
    10 Mbps
    
    
    1,000HighAssurance 2000 Gateway
    
    100 Mbps
    
    
    10,000HighAssurance 4000 Gateway
    
    1 Gbps
    
    
    1,024




| | (1) |  | A tunnel is an encrypted link between two devices.
| | --- |  | --------------------------------------------------



| |  |  | ATM Encryptor:The SafeEnterprise ATM Encryptor provides data
privacy and access control for connections over public and private ATM
networks and protects all workstations, servers and other end nodes
connected to a local area network. This product allows the flexibility
to choose desired interface modules across a range of speeds.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Frame Encryptor:SafeEnterprise Frame Encryptor provides security
for frame relay networks at speeds up to 52 Mbps. This product is used
across a wide range of frame relay networks and applications.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Link Encryptor:SafeEnterprise Link Encryptor secures sensitive
data transmitted over high-speed, point-to-point, or dial-up
communication links at speeds up to 52 Mbps. The Link Encryptor is
designed for organizations that rely heavily on close-looped secure
networks for the transport of highly sensitive data.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Software.The SafeEnterprise Security System includes the following
software products:



| |  |  | Security Management Center:Our Security Management Center product
provides security management for our VPN and WAN appliances and
software clients, including authentication, definition and enforcement
of security policy, configuration, monitoring and audit capabilities.
The Security Management Center allows customers to manage all aspects
of their VPN and WAN networks and allows for easy migration from WAN to
VPN technology. The Security Management Center is a Java-based
management platform.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SoftRemote:SoftRemote allows for remote access to corporate
networks. This product provides VPN access capabilities for desktops
and portable computers for all versions of Microsoft® Windows®,
including Windows XP®. The client software provides secure client-
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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| |  |  | to-client or client-to-gateway communications over the Internet, dial-up
connections and wireless local area networks. Key features include
personal firewall capabilities and support for strong two-factor
authentication through industry-standard smart cards. SoftRemote
additionally includes policy protection and support for browser
certificates. We also sell versions of our SoftRemote VPN client software
to OEMs who are able to co-brand the client and offer it as part of their
overall solution.
| |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | HighAssurance Remote:The HighAssurance Remote client is based on
SoftRemote, which contains additional security features for the U.S.
government and other agencies. HighAssurance Remote is federal
information processing standards (FIPS) certified.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SoftRemoteLT-SoftRemoteLT is a streamlined version of SoftRemote
that offers all the features of SoftRemote except for personal firewall
capabilities.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SoftRemotePDA:SoftRemotePDA is based on SoftRemote and designed
specifically to extend VPN access to mobile devices, such as personal
digital assistants, or PDAs. SoftRemotePDA is designed to combat the
vulnerabilities in wireless communications by applying the IPSec
technologies utilized by SoftRemote to handheld portable devices. It
allows PDA users to securely communicate over wireless links to
retrieve email, access corporate information from a network or browse
the Internet. SoftRemotePDA is available for both Palm OS® and Pocket
PC® handheld devices.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Services.The SafeEnterprise Security System includes the following
services:



| |  |  | SafeNet Trusted Services:SafeNet Trusted Services provides a
complete outsourced VPN solution. Our managed services allow
organizations to implement our VPNs without the investment in
equipment, facilities and security expertise. SafeNet Trusted Services
provides system availability in excess of 99.9% and our primary network
operations center, located in Baltimore, Maryland, has been approved by
several U.S. government security organizations. Qualified security
specialists perform around-the-clock functions necessary to maintain
VPN security, including providing help desk services and other
maintenance functions. SafeNet Trusted Services specialists work
closely with the customer to define and implement its security policy.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Embedded Solutions.

Hardware Solutions.We provide OEMs with the following portfolio of
silicon chips and accelerator cards:



| |  |  | SafeXcel:SafeXcel is our line of silicon chips
that addresses the needs of OEMs for embedded, accelerated
security. This product line includes high-performance integrated
circuits and privacy products for both IPSec and Secured Socket
Layer, or SSL, encryption. Our SafeXcel product line includes
the following series:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SafeXcel Momentum Series.The
SafeXcel Momentum Series of silicon chips is developed
for the consumer and small office/home office, or SOHO,
markets. These chips are designed for low cost
applications, such as broadband access, SOHO routers,
wireless access devices, VPN gateways and firewalls.
The Momentum Series includes the following silicon
chips with the indicated IPSec throughputs:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SafeXcel-1140, 50 Mbps;
| | - |  | -----------------------



| |  |  | SafeXcel-1141, 135 Mbps; and
| | - |  | ----------------------------



| |  |  | SafeXcel-1741, 260 Mbps.
| | - |  | ------------------------




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| |  |  | SafeXcel Velocity Series.The
SafeXcel Velocity Series of silicon chips is designed
for higher performing networking appliances, such as
routers, firewalls, gateways and remote access servers.
The Velocity Series includes the following silicon
chips:
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SafeXcel-2010, which supports 50 Mbps of IPSec throughput; and
| | - |  | --------------------------------------------------------------



| |  |  | SafeXcel-ISES, an SSL accelerator used in SSL appliances.
| | - |  | ---------------------------------------------------------



| |  |  | SafeXcel Transaction Series.The
SafeXcel Transaction Series of silicon chips is
designed for point-of-sale terminals, keyboards and
smart cards, which may be used in e-commerce, financial
and medical transactions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | SafeXcel Cards. SafeXcel Cards are accelerator
cards that provide cryptographic throughput and acceleration for
operations such as encryption, hashing, public key computations,
key negotiation, signatures and random number generation.
SafeXcel Cards include SafeXcel 140-PCI, SafeXcel 141-PCI,
SafeXcel 171-PCI and SafeXcel 241-PCT. Also available is a PCI
card based on SafeXcel-4850.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

EmbeddedIP.EmbeddedIP is the delivery of our technology in a form that
allows OEMs to embed security in their silicon chips, including products
designed specifically for the wireless market. EmbeddedIP is available for
license in intellectual property 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
silicon chips to allow for cost-effective, high throughput, low power-consuming
designs. EmbeddedlP can be licensed in the following blocks:



| |  |  | Encryption Engines;
| | - |  | -------------------



| |  |  | Hash Engines;
| | - |  | -------------



| |  |  | Packet Engines;
| | - |  | ---------------



| |  |  | Public Key Accelerators; and
| | - |  | ----------------------------



| |  |  | Entropy based True Random Number Generator
(RNG).
| | - |  | -------------------------------------------------

We also license our CGX (CryptoGraphic eXtensions) Library, a library of
more than 60 cryptographic commands, which allows OEMs to deploy applications
with reduced development time.

Technology

Our portfolio of VPN security products is based on SecureIP Technology.
SecureIP Technology is the intellectual property underlying the building blocks
of security applications that enable entities to securely use the Internet and
other shared networks. SecureIP Technology is implemented in our CGX Library, a
library of more than 60 cryptographic commands, processes and interfaces that
provides a flexible and secure application that is portable across many
processors and operating systems. The CGX Library is embedded in our chips,
accelerator cards and software clients forming a seamless suite of readily
embeddable products for our OEM customers. In addition, we apply our security
technologies at each layer of the enterprise; not only the embedded
technologies, but also in the designs of the gateways and the systems resulting
in integrated enterprise security systems with high level performance.

Customers and Customer Support

The majority of our customers are U.S. government agencies, financial
institutions and many of the leading OEMs.




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Our significant end-user customers include:



| |  |  | Government:U.S. Department of Defense, U.S. Customs Service,
Internal Revenue Service, U.S. Department of State and Immigration and
Naturalization Service.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Financial Institutions:Citigroup, UBS, JPMorgan Chase, MBNA and
SWIFT.
| | - |  | ----------------------------------------------------------------------

Our significant OEM customers include:



| |  |  | Network Infrastructure:Cisco Systems, Microsoft, WatchGuard,
NetScreen and SonicWall.
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Wireless/Semiconductor:Advanced Micro Devices, Texas
Instruments and ARM.
| | - |  | -------------------------------------------------------------------------

We provide customer support through a staff of support engineers
knowledgeable in both our network security systems and products, and complex
computer networks. In addition to supporting customers, this group of engineers
performs system level quality assurance testing of new products and product
enhancements. We provide customer telephone support, including 24 hour a day
hot line support. In addition, we offer on-site training, installation and
trouble-shooting services, generally on a fee basis.

We provide limited warranties on our 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. We also offer support on a time and materials
basis.

Sales and Marketing

We sell our products and services primarily through direct sales
personnel dedicated to both enterprise and OEM markets and internationally
primarily through value added resellers. The unique requirements of our
customers require us to maintain specialized sales personnel. Our Enterprise
Security Division sales group, which includes a federal sales group and a
commercial sales group, specifically targets government organizations and
worldwide financial entities and utilizes federal systems integrators to
fulfill customer purchase orders as a contract vehicle for our federal
customers. The Embedded Security Division sales organization is responsible
for pursuing and managing sales to OEMs who embed our technology and
products into their own network and wireless products. We have sales offices
in the United States, the United Kingdom, Singapore, Switzerland and the
Netherlands.

Our marketing department is dedicated to marketing communications,
developing sales tools and sales support programs, public relations, product
launch support, events and partner programs. Our marketing efforts focus on
building brand recognition and developing leads for our sales force.

To achieve these objectives, our marketing program includes:



| |  |  | Direct marketing efforts through a Web marketing program and
website, as well as email and direct-mail promotions;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Programs to ascertain the requirements of existing and prospective
end-user and OEM customers;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | Trade-shows and seminars to increase the visibility of our
solutions and generate leads for our sales force, such as the RSA
Security Conference in San Jose, California and E-Gov in Washington,
DC;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | European brand awareness through exhibitions such as CEBIT in
Hanover, Germany and new European sales offices;
| | - |  | --------------------------------------------------------------------------------------------------------------




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| |  |  | Increased coverage of our technology and products in leading trade publications; and
| | - |  | ------------------------------------------------------------------------------------



| |  |  | Public relations efforts and joint marketing and co-branding arrangements with our partners.
| | - |  | --------------------------------------------------------------------------------------------

Some of our network security products contain encryption algorithms that
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 some countries and to business
entities that are not included in a range of end-users.

Product Development

We have assembled a team of engineers with experience in the fields of
computing, network systems design, Internet routing protocols, security
standards and software. Our engineering team has experience in developing and
delivering hardware, software, encryption and authentication technology,
accelerator cards and integrated custom silicon chips.

We believe strong product development capabilities are essential to our
strategy of enhancing our core technology, developing additional product
functionality and maintaining the competitiveness of our products. Our current
initiatives include:



| |  |  | Developing wireless security products;
| | - |  | --------------------------------------



| |  |  | Expanding our products to address the firewall, intrusion detection
and prevention and anti-virus markets through the release of a content
inspection product; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Further incorporating in our product lines high assurance security
techniques derived from joint development initiatives with U.S.
government agencies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

We will continue to devote resources to the latest security technology and
to meet the increasing demands of our customers and the market.

Backlog

Orders for our products are usually placed by customers on an as-needed
basis and we typically ship products within five days to 10 weeks of receipt of
a customers firm purchase order. Our backlog consists of all orders received,
where the anticipated shipping date is typically within six months. Because of
the possibility of customer changes in delivery schedules or cancellations of
orders, our backlog as of any particular date may not be indicative of sales in
any future period. We seldom maintain long-term contracts with our customers
that require them to purchase our products.

Contract Manufacturing

We design and develop all key components of our appliances, software and
silicon chips, which are fabricated by contract foundries. Our silicon chips
are primarily manufactured by Analog Devices and Samsung. We outsource the
manufacturing of our other products primarily to a small privately-held
manufacturer. The outsourced operations include engineering prototypes,
pre-production runs, full turnkey boxbuilds and product drop shipments. We also
design, specify and monitor all the testing required to meet our internal and
external quality control guidelines. Outsourcing allows us to reduce fixed
overhead and personnel costs and provides greater flexibility to match product
and market demands. However, the unavailability of the contract manufacturers
and foundries we utilize could substantially decrease our control of the cost,
quality and timeliness of the manufacturing process.




10



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Competition

The network security market is highly competitive and subject to rapid
technological changes. We expect to face increasing competitive pressures from
competitors as network security becomes more prevalent. We currently compete
against 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. There are also a number of other hardware and software
data encryption methods and security technologies on the market that compete
with our products.

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

We face numerous competitors. Our key OEM competitive threat comes from
potential customers electing to develop internal capabilities similar to those
provided by our products rather than buying solutions from us or another
outside vendor. The key enterprise competitive threat is that customers select
vendors with greater financial, research and marketing resources.

Patents and Intellectual Property

Our success and ability to compete is dependent, in part, upon our ability
to maintain the proprietary nature of our technologies. We rely on a
combination of patent, trade secret, copyright and trademark law and
nondisclosure agreements to protect our intellectual property. We own 21 United
States and foreign patents and have additional pending foreign and domestic
patent applications. These patents cover our SafeXcel chips, CGX Security
Platform, SafeNet Dial and the AX400.

We seek to protect the source codes to our computer software programs,
which are essential elements of our products, by means of copyright and trade
secrets laws. The protection of our intellectual property and information we
develop will be limited to such protection as we may be able to secure pursuant
to trade secret or copyright laws or under any confidentiality agreements into
which we may enter. We own federally registered trademarks for the SafeNet name
and for certain of our products. However, we cannot assure you as to the
validity, enforceability or lack of infringement of these trademarks.

At present, we have confidentiality agreements with our officers,
directors and employees. There can be no assurance that the scope of any such
protection we are able to secure will be adequate to protect our intellectual
property or that we will have the financial resources to engage in litigation
against parties who may infringe such intellectual property. In addition, we
cannot assure you that others will not develop similar technology independent
of us.

We believe that our 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, we 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.
We employ 165 employees in the United States, 39 employees in the
Netherlands, 8 employees in 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

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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.

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;        

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| |  |  | 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 delays

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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,
Cisco Systems, Inc., 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, Cisco Systems 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. Cisco Systems 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;             

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| |  |  | Product ease of use;               
| | - |  | -----------------------------------
|
| |  |  | Network compatibility;             
|
| |  |  | Client service and product support;
|
| |  |  | Distribution;                      
|
| |  |  | Price.                             

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

15



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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.

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

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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 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.

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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.

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.

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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.

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 | 

19



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##### 



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.

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.

|                                                          |                                                              |      |                         |        |   |      |        |        |   |      |        |        |  |   |        |        |   |   |        |        |  
|--------------------------------------------------------- | ------------------------------------------------------------ | ---- | ----------------------- | ------ | - | ---- | ------ | ------ | - | ---- | ------ | ------ |  | - | ------ | ------ | - | - | ------ | ------ | -
|                                                          |                                                              |      | Year Ended December 31,
|                                                          |                                                              |      |                        
|(Amounts
in thousands, except per share data)             |                                                              | 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  |  
|                                                          |                                                              |      |                         |        |   |      |        |        |   |      |        |        |  |   |        |        |   |   |        |       

20



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##### 



|                     |  |                 |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   |        | 
|-------------------- |  | --------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | 
|                     |  | 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 | 

QUARTERLY RESULTS OF OPERATIONS

The following is a summary of the quarterly results of operations for the years
ended December 31, 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 | 
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |  |   |       |      

21



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##### 



|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |       |  
|------------------------------------------ | ------------------------------------------ | - | ------------------ | ----- | ------- | - | -------- | ----- | ------- | - | ----- | ----- | - | - | ----- | ----- | -
|                                           |                                            |   | 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 |  
|                                           |                                            |   |                    |       |         |   |          |       |         |   |       |       |   |   |       |      

22



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##### 



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.

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, the
risks described in Item 1  Business.




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.

23



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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, which resulted in increased
revenues of approximately
$2,217,000, as well as increased revenue from our largest
commercial customer, Cisco Systems, Inc. Cisco Systems accounted for 41% of
our consolidated revenues for the year ended December 31, 2002. The Enterprise
Security Division segment increased 27% or
$2,958,000 due primarily to revenues of approximately
$3,050,000 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

24



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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 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

25



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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
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.

26



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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. SafeNet did not have any material commitments for
capital expenditures in 2002 and does not have any such commitments
for the forseeable future.









Material recurring uses of working
capital include salaries and other compensation, which accounted for
approximately $12,200,000 in 2002, sales and
marketing expenses, which accounted for approximately
$3,700,000 in 2002, and research and development
projects, which accounted for approximately
$2,200,000 in 2002.




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.

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.

27



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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.

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

28



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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 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.

29



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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.

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.

SAFENET, INC.
AND SUBSIDIARIES

ITEM 8  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

Report of Independent Auditors

Consolidated Balance Sheets as of December 31, 2002 and 2001


Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000


Consolidated Statements of Comprehensive (Loss) Income for the years ended December 31,
2002, 2001 and 2000


Consolidated Statements of Stockholders Equity for the years ended December 31, 2002,
2001 and 2000


Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000


Notes to Consolidated Financial Statements


The following consolidated financial statement schedule of SafeNet, Inc. and subsidiaries
is included in this item:


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 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, Maryland |  |                      
|February 6, 2003    |  |                      

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SAFENET, INC.
AND SUBSIDIARIES

Consolidated 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 SUBSIDIARIES

Consolidated 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 SUBSIDIARIES

Consolidated 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.

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.

34



---



##### 



SAFENET, INC.
AND SUBSIDIARIES

Consolidated 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 |       
|                                               |                                                                                                    |                                                      |        |                        |         |      |        |         |         |   |        |       
|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.

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,

35



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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 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.

36



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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. SafeNet 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 SafeNet adopted effective January 1,
2002.

The goodwill impairment test under Statement 142 involves a two-step approach.
Under the first step, SafeNet determines the fair value of each reporting unit
to which goodwill has been assigned. SafeNet then compares the fair value of
the reporting unit to its carrying value, including goodwill. If the fair
value exceeds the carrying value, no impairment loss is recognized. If the
carrying value exceeds the fair value, the goodwill of the reporting unit is
considered potentially impaired and the second step is completed in order to
measure the impairment loss. Under the second step, SafeNet calculates the
implied fair value of goodwill by deducting the fair value of all tangible and
intangible net assets, including any unrecognized intangible assets, of the
reporting unit from the fair value of the reporting unit as determined in the
first step. SafeNet then compares the implied fair value of goodwill to the
carrying value of goodwill. If the implied fair value of goodwill is less than
the carrying value of goodwill, SafeNet recognizes an impairment loss equal to
the difference.

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.

Product Warranties






SafeNet offers a one-year warranty for substantially all of its products. The
specific terms and conditions of those warranties vary depending upon the
product sold and country in which SafeNet does business. SafeNet estimates the
costs that may be incurred under its basic limited warranty and records a
liability in the amount of such costs at the time product revenue is
recognized. Factors that affect SafeNets warranty liability include the
number of installed units, historical and anticipated rates of
warranty claims and cost per claim. SafeNet periodically assesses the adequacy of its
recorded warranty liabilities and adjusts the amounts as necessary. The
balance in SafeNets warranty accrual totaled $50 at December 31, 2002 and
2001.




37



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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 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.

38



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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.

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.

39



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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.

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:

40



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|                     |  |      |        |      |  |      |        |   |  |   |        |  
|-------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                     |  | 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 |  
|                                      |  |      |      |      |  |   |       |  

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.

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

41



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##### 



|                                                   |  |   |        |   |  |  |  | 
|-------------------------------------------------- |  | - | ------ | - |  |  |  | 
|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 using the income approach, which
involves two general steps. The first step is to establish a forecast of the estimated future
net cash flows expected to accrue to SafeNet resulting from ownership of the asset or a
group of assets. The second step involves discounting these estimated future net cash
flows to their present value. In order to estimate future net cash flows, SafeNet employed
a multi-period excess earnings method, under which it prepared a forecast of cash
inflows, cash outflows, and pro-forma charges for economic returns of and on tangible
assets employed and other enabling intangible assets, including patents and core
technologies. The cash inflows included in the forecast were projected to commence in
the third quarter of fiscal year 2002 and continue until the end of fiscal year 2005 and
were based on pricing that was consistent with historical sales of similar application
specific integrated circuit products and technology.

Cash outflows include direct and indirect expenses for costs to complete, cost of sales
based on historical gross margin rates for similar products of approximately 80%, sales,
marketing, general and administrative, and income taxes assuming a 35% effective
income tax rate. The net cash inflows over an estimated economic life of approximately
four years were then discounted to net present value using a risk adjust discount rate of
25%. The discount rate used in this calculation takes into account the stage of
completion and the risks surrounding the successful development and commercialization
of each purchased in-process technology project that was valued.




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.

(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 |  
|                                          |  |      |       |      |  |   |       |  

42



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(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.

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  | 
|                                  |  |                         |        |      |  |      |        |   |  |   |       | 

43



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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 | )
|                                     |  |                |       |              |  |   |        |  

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  | )      |      | $ |      |       
|                          |                                        |   |       |        |      |   |       |       

44



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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:

|                                                                                  |  |      |        |      |  |      |     |   |  |   |        |  
|--------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | ---- | --- | - |  | - | ------ | -
|                                                                                  |  | 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

45



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##### 



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.

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.

(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:

46



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##### 



|                                 |           |  |           |      |                 |                   |                   |   |       |       |          |  | 
|-------------------------------- | --------- |  | --------- | ---- | --------------- | ----------------- | ----------------- | - | ----- | ----- | -------- |  | 
|                                 |           |  |           |      |                 |                   |                   |   |       |       | 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 |      
|                                 |           |  |           |      |                 |                   |                   |   |       |       |          | 

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.

47



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##### 



(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.

|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  
|--------------------------------------------------------------------------- | ---------------------------- | - | ----------------------- | ------ | ---- | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                            |                              |   | 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  |       
|                                                                            |                              |   |                         |        |      |   |        |        |   |   |        |        |  

48



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##### 



|                                               |  |              |        |      |  |      |        |  |  |   |        | 
|---------------------------------------------- |  | ------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                                               |  | December 31,
|                                               |  |             
|Geographic Information                         |  | 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  | 
|                                               |  |              |        |      |  |      |        |  |  |   |        | 

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.

(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 |  | 2002
|                                                                                                           |  |      |       |      |  |     
|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  | 
|                                                                                                           |  |      |       |      |  |      |       |   |  |   |       | 

49



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##### 



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.

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 | 
|                                                                                  |  |   |        | 

50



---



##### 



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                               |  | $ | (20,410 | )
|Net loss                                                      |  | $ | (24,364 | )
|Loss per share from continuing operations - basic and diluted |  | $ | (2.17   | )
|Loss per share  basic and diluted                            |  | $ | (2.59   | )

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.

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

|                                 |  |           |     |          |  |          |     |               |  |          |   |        |  |   |    |        |  |         |   |  |  |   |     | 
|-------------------------------- |  | --------- | --- | -------- |  | -------- | --- | ------------- |  | -------- | - | ------ |  | - | -- | ------ |  | ------- | - |  |  | - | --- | 
|                                 |  | Balance   |     |          |  |          |     |               |  |          |   |        |  |   |    |        |  |         |   |  |  |  
|                                 |  | at        |     | Charged  |  |          |     |               |  |          |   |        |  |   |    |        |  | Balance
|                                 |  | Beginning |     | to Costs |  | Charges  |     |               |  |          |   |        |  |   |    | at End
|                                 |  | of        |     | and      |  | to Other |     |               |  |          |   |        |  |   |    | of    
|                                 |  | Period    |     | Expenses |  | Accounts |     | Deductions(a) |  | Recovery |   | 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
|--- | ---------------------------------------------------------------------

51



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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 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

52



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##### 



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) 
| |  |     |  |                                                                                                                                            |  |          
| |  | 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)

53



---



##### 



| |  |      |  |                                                                                                                                                                                                       |  |          
| |  | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------
| |  | 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                                                                                                                                                    |  |          
| |  |      |  |                                                                                                                                                                                                       |  |          
|
| |  | 31.1 |  | Certification
pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934, as amended.                                                                                                       |  |          
|
| |  |      |  |                                                                                                                                                                                                       |  |          
|
| |  | 31.2 |  | Certification
pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934,
as amended.                                                                                                       |  |          
|
| |  |      |  |                                                                                                                                                                                                       |  |          
|
| |  | 32.1 |  | Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002                                                                                |  |          
|
| |  |      |  |                                                                                                                                                                                                       |  |          
|
| |  | 32.2 |  | Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002                                                                                |  |          
|
| |  |      |  |                                                                                                                                                                                                       |  |          



---

|    
|----
|   
|    
|    
|(1) 
|    
|(2) 
|    
|(3) 
|    
|(4) 
|    
|(5) 
|    
|(6) 
|    
|(7) 
|    
|(8) 
|    
|(9) 
|    
|(10)
|    
|(11)

54



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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: February 10, 2004

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                                                |  | February 10, 2004
|                                          
|/s/ Carole D. ArgoCarole D. Argo           |  | Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer) |  | February 10, 2004
|                                          
|/s/ Thomas A. BrooksThomas A. Brooks       |  | Director                                                                                       |  | February 10, 2004
|                                          
|/s/ Shelley A. HarrisonShelley A. Harrison |  | Director                                                                                       |  | February 10, 2004
|                                          
|/s/ Ira A. Hunt, Jr.Ira A. Hunt, Jr.       |  | Director                                                                                       |  | February 10, 2004
|                                          
|/s/ Bruce R. ThawBruce R. Thaw             |  | Director                                                                                       |  | February 10, 2004




55