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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    FORM 10-K

(Mark One)

[X]      Annual Report Pursuant to Section 13 or 15(d) of the Securities
         Exchange Act of 1934 For the fiscal year ended December 31, 1997

                                       Or

[ ]      Transition Report Pursuant to Section 13 OR 15 (d) Of the Securities
         Exchange Act of 1934

                         Commission File Number 0-20634

                     INFORMATION RESOURCE ENGINEERING, INC.

             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                                                             <C>
                    DELAWARE                                                               52-1287752
                    --------                                                               ----------
        (State or other jurisdiction of                                         (IRS Employer Identification No.)
         incorporation or organization)

              8029 Corporate Drive
              BALTIMORE, MARYLAND                                                             21236
              -------------------                                                             -----
    (Address of principal executive offices)                                               (Zip Code)
</TABLE>

        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:

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<S>                                                                             <C>
                                                                                    Name of each exchange on
              Title of each class                                                       which registered
              -------------------                                                       ----------------
         Common Stock, $.01 par value                                                Nasdaq National Market
</TABLE>

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X  No
                                      ---   ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Revenues for the most recent fiscal year were $16.0 million.

The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 20, 1998, based upon the closing price on that date, on
the Nasdaq National Market, was approximately $30.0 million.

The number of shares of the registrant's Common Stock outstanding as of March
20, 1998 was 5,463,727.

                       DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates information by reference from the registrant's proxy
statement for the Annual Meeting of Shareholders, which proxy statement in
definitive form will be filed no later than 120 days after the close of the
registrant's fiscal year ended December 31, 1997.


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                                     PART I

ITEM 1 - BUSINESS

Except for historical information contained herein, the statements in this Item
are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others, risks
associated with the receipt and timing of future customer orders, price
pressures, other competitive factors leading to a decrease in anticipated
revenues, achieving technical and product development milestones, the ability to
manufacture product in a timely manner to meet market demand, market acceptance
of products, the ability to negotiate favorable purchase and sale agreements,
and sufficient cash flow for future liquidity and capital resource needs. Gross
margins can vary from quarter to quarter based on product and channel mix, and
current gross margin levels may not be indicative of future results.

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

These factors, among others, could cause results to differ materially from those
in the forward looking statements.

     See "Glossary of Technical Terms" on page 12 for explanation of certain
technical terms used herein.

GENERAL

     Information Resource Engineering, Inc. (the "Company") designs,
manufactures and markets enterprise network communications systems secured by
encryption technology. The Company's products are used in Virtual Private
Network ("VPN") applications, and electronic commerce applications by financial
institutions, government agencies and large corporations to secure data
transmissions on private and public computer networks, such as the Internet.
GRETACODER Data Systems AG ("Gretacoder"), a subsidiary of the Company,
manufactures and markets cryptographic equipment primarily in Switzerland and
Europe.

     Encryption technologies are utilized by the Company to provide selective
access to computer networks, prevent electronic eavesdropping or alteration
during electronic data transmission; to provide message authentication
confirming that messages are received in unaltered form; and to enable user
authentication and digital signatures verifying the identity of the message
sender and limiting computer access to authorized users. The Company offers a
choice of encryption algorithms to provide the level of network security
appropriate for each client application.

     The Company's clients include seven of the largest banks in the U.S., Union
Bank of Switzerland, the Society for Worldwide Interbank Financial
Telecommunications ("SWIFT") an international financial clearing house, The
Euroclear System ("Euroclear"), TRW Inc., major federal, state and international
law enforcement agencies and the U.S. Department of Treasury. While the network
security market has traditionally been limited to financial institutions and
government agencies, the Company believes that emerging electronic commerce
applications, particularly business-to-bank and business-to-business, provide
new market opportunities.

     In the second half of 1996, the Company introduced
"SafeNet/Enterprise(TM)", a comprehensive, centrally managed VPN security system
that enables secure use of public networks, such as the Internet, for private
business transactions. In 1997 software and smartcard based product members were
added to the SafeNet product family.


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This product introduction substantially increased unit sales and expanded the
market for SafeNet products by lowering significantly the cost per client
device.

     The Company was originally incorporated in Maryland on April 7, 1983 under
the name "Industrial Resource Engineering, Inc." The Company reincorporated
under its present name in Delaware by merging with its subsidiary in March 1989.
The Company's executive offices are located at 8029 Corporate Drive, Baltimore,
Maryland 21236, and its telephone number is (410) 931-7500.

The Market for Enterprise Network Security Solutions

     Virtual Private Networks allow corporations to use public networks for
their communications backbone. This is achieved by protecting the data traffic
with data communications security technology such as: encryption, message
authentication, user authentication, and firewall technology. Since public
networks are much cheaper than private leased lines and Frame Relay networks
corporations can generally achieve substantial cost savings by using VPNs.

     Management believes that the market for security systems and products
providing VPN solutions has grown over the last several years due to an increase
in the use of the Internet for business communications. Remote access to
computers has increased substantially due to the use of remote databases,
work-at-home arrangements or telecommuting, electronic mail, satellite offices
connected to a central computer, electronic funds transfer, electronic data
interchange with clients, suppliers and business partners and numerous other
arrangements. With the increasing use of public and private communications
networks and the ability of different types of computers to communicate with
each other, data integrity and security have gained increased importance.

     Unsecured data transmitted over public networks, such as the Internet, is
subject to interception, electronic vandalism or terrorism, and alteration. The
increased use of networked computers also increases risk, both by multiplying
the number of access points to valuable data and the number of personal
computers which can be utilized to obtain unauthorized information. The Company
believes that the use of computer networks such as the Internet, will continue
to expand and that, as the reliance on these networks grows, organizations will
become more dependent on the integrity and security of the network.

BUSINESS STRATEGY

     The Company's objective is to be a leading provider of secure network
systems, services and products to the growing market for Virtual Private
Networks. The key elements of the Company's strategy are as follows:

     Provide Clients with a Broad Range of Enterprise Network Security Solutions

     The Company has historically grown by applying its technological competence
to the development of network security systems and products for use in the
complex computer networks of financial, corporate and government clients. The
Company's focus on technology has led to a family of products which have reduced
the complexity and cost associated with applying encryption technology to
computer networks. The SafeNet/Enterprise(TM) product line includes firewalls,
encryption and user identification tokens in a comprehensive, centrally managed
system. The Company believes that this focus on technology is vital for its
future growth and will continue to invest its resources accordingly.

     Develop an Original Equipment Manufacturer Business

     The Company believes that, due to the fact that security is a major concern
among network users, manufacturers of computer and communications products are
seeking to add security capabilities to their products. Consequently, the
Company is developing a family of products which can be incorporated into
computers and communications products manufactured by others. Such products
include smart card readers, a secure communications chip and a line of products
designed around the chip.


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     Develop a Transaction Services Business

     The Company is leveraging its network security expertise to develop a
transaction services business since it believes that the recurring revenue
stream and strategic relationships generated from such business will be
instrumental to its future growth. In the second half of 1996, the Company
established the SafeNet/Trusted Services facility at Company headquarters to
provide security management services such as subscriber enrollment, product
configuration, digital certificates, and key management services to Internet
access providers and directly to end users. The Company expects to receive both
monthly fixed and fee per transaction revenue for providing such services.

     Establish Key Strategic Relationships

     The Company seeks to establish domestic and international relationships
with organizations that have the ability to expand the use of encryption
technology. Relationships currently exist with the following:

         Analog Devices Inc. ("ADI"), a leading manufacturer of high-performance
integrated circuits, is assisting the Company in the design, manufacture and
marketing of the Company's new secure communications chip. The new chip will
provide organizations with a highly secure, inexpensive solution to conducting
business over computer networks.

         CyberGuard Corporation, a leading provider of network security
solutions, has entered into a joint product development and marketing agreement
aimed at providing a comprehensive security solution for Internet business
communications.

         Financial Services Technology Consortium is a group of leading
financial institutions whose goal is to utilize emerging technologies to enhance
the competitiveness of the financial services industry. The Company is a member
of a multiple industry team formed to design and implement an electronic check
for use on the Internet by consumers and businesses.

PRODUCT DESIGN STANDARDS

     Encryption technologies are utilized by the Company to provide selective
access to computer networks, prevent electronic eavesdropping or alteration
during electronic data transmission; to provide message authentication
confirming that messages are received in unaltered form; and to enable user
authentication and digital signatures verifying the identity of the message
sender and limiting computer access to authorized users. The Company offers a
choice of encryption algorithms to provide the level of network security
appropriate for each client application.

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

     Standards Compliance

     The Company's policy is to offer products based upon encryption algorithms
that have been approved as industry and government standards. This provides the
Company's clients assurance that they are using interoperable products which
meet commercial reasonability tests as applied by both government regulation and
courts of law.

     Network Compatibility

     The Company's systems and products contain sufficient intelligence to
accommodate the specific communication protocols employed by complex computer
networks. Appropriate models of each product type are provided to support Frame
Relay, Dial Asynchronous, leased line, X.25, Bisync and Internet protocol-based
networks. This network compatibility results in security systems that are
completely independent of the computer


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hardware systems and software application programs used by clients. No
modifications to hardware or application software are required to implement the
Company's systems and products.

     Ease of Use

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

     Ease of Administration

     The Company has extended its ease of use concept to the central management
of a secure network with a product known as the SafeNet/Security Center(TM)
("SSC"). The SSC provides central management and tracking capability for the
entire encrypted network thus reducing the cost of implementing security for
client organizations. For organizations aiming to defer capital and personnel
investment, the Company's SafeNet/Trusted Services facility provides
comprehensive security management as an optional service performed at the
Company's headquarters.

     Price Performance Criteria

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

ENCRYPTION ALGORITHMS

         At present, the Company's products employ a variety of encryption
algorithms including the U.S. Government Data Encryption Standard, ("DES"), RSA
Data Security Inc. Encryption Standard, ("RSA") and Gretacoder Data Systems
Encryption Standard, ("GDS"). DES, as described in American National Standards
Institute ("ANSI") Standard X3.92, has been certified by the National Institute
of Standards and Technology ("NIST") and is the accepted encryption algorithm
for commercial and non-classified government applications in the U.S. as well as
financial applications worldwide. The Company has received export approval from
the U.S. Commerce Department to export its products with the DES algorithm.

         The Company holds a license to use RSA; a leading public key based
encryption algorithm. RSA is used in Company products to generate and verify
digital signatures as well as for key management purposes.

         GDS is a strong algorithm employing encryption keys which are much
longer than keys in algorithms that are exportable from the United States. GDS
is used by security conscious European organizations including banks and
governments.

         New encryption algorithms are periodically proposed as industry
standards. The Company's policy is to adopt and offer its clients new algorithms
for various applications as they become certified by standards organizations
such as ANSI, NIST and the Internet Engineering Task Force. The Company is
currently developing products which include Triple DES, a longer key length
version of DES.

CURRENT NETWORK SECURITY PRODUCTS AND SYSTEMS

     The Company's principal network security systems and products secure
information transmissions on public and private networks.


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Public Network/Internet Products

     SAFENET/ENTERPRISE(TM). In the second half of 1996, the Company introduced
SafeNet/Enterprise(TM), a comprehensive, centrally managed security system that
enables secure use of public networks, such as the Internet, for private
business transactions. By providing a high level of security,
SafeNet/Enterprise(TM) will allow organizations to reduce their networking costs
by using the Internet instead of costly private networks.

The product line includes:

          -   SafeNet/Smartcard(TM) is a credit card user token that stores user
              identification and encryption keys in an advanced computer chip,

          -   SafeNet/Soft(TM) is a Windows compatible software package that
              provides continuous user authentication, one-time password
              generation and data encryption,

          -   SafeNet/LAN(TM) Encrypting Firewall which provides security for
              LAN connections to the Internet, as well as packet filtering,

          -   SafeNet/Firewall(TM) is a highly secure proxy firewall based on
              the CyberGuard Firewall,

          -   SafeNet/Dial(TM), a secure pocket modem operating at 28.8 bps for
              secure dial access to the Internet by remote users such as
              traveling professionals and telecommuters,

          -   SafeNet/Dial-R(TM) provides security identical to the
              SafeNet/Dial(TM), without the integral modem,

          -   SafeNet/Security Center(TM), a high performance workstation which
              automatically manages the entire suite of SafeNet/Enterprise(TM)
              products,

          -   SafeNet/Trusted Services(TM) provides central management of VPN
              security as a service 24 hours a day, 365 days a year.

Private Network Products

     SECURE MODEMS. In 1994, the Company introduced its AX400 Secure Modem. The
AX400 is a portable device that fits in the palm of a user's hand, weighs just a
few ounces and uses power from the remote computer. It contains an internal
modem that delivers a 14.4K bps data rate while in secure operation using
standards compliant encryption technology. The AX400 also generates a random
password for each communications session when a user enters the appropriate
personal identification number. Due to its small size, user authentication and
data protection capabilities, the AX400 is convenient for mobile or remote
users.

     SECURE DIAL ACCESS SYSTEMS. These products are designed to protect data
communications when remote users access host computers via the voice telephone
network and are most commonly employed when personal computers are communicating
with central computer sites, such as company headquarters. Since computer
communications are taking place over normal, unsecured telephone lines, some
type of security is frequently required in these applications.

     GRETACODER FRAME RELAY ENCRYPTORS. The GDS Frame Relay encryptor combines
the advantages of circuit and packet switched services: small delays over the
network and lower transmission cost. The properties of Frame Relay make it
especially suitable for LAN interconnections where bursty traffic has to be
transmitted.

     X.25 SECURITY SYSTEMS. Complex computer networks such as X.25 networks
break down the data stream sent from computers into smaller, more manageable
pieces called, "packets" which contain address and routing information as well
as user data. The X.25 Security System selectively applies encryption technology
only to the users data while leaving address and routing information intact,
thus assuring proper delivery of user data in secure form at minimal expense.
The Company markets X.25 Security Systems under both the IRE and GDS names.


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     LINK SECURITY SYSTEMS. While dedicated links are inherently more secure
than dial networks, the nature of the data that is frequently transmitted over
dedicated lines (the connections to bank branch offices, for instance) often
requires a high level of security. IRE's products are designed to protect
synchronous or asynchronous communications at speeds up to 64K bps over
dedicated telephone lines. GDS products are designed to protect synchronous or
asynchronous communications at speeds up to 2M bps over dedicated telephone
lines. The Link Security Systems are protocol transparent and supports
asynchronous, bisynchronous, SDLC and HDLC communications protocols.

NEW PRODUCT DEVELOPMENT

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

     New products, capable of a high level of security on the Internet, were
introduced under the SafeNet/Enterprise(TM) brand name in the second half of
1996. The Company intends to continue to develop new versions of the
SafeNet/Enterprise(TM) products to support growth of both its product and
service businesses.

     New encryption algorithms such as the digital signature standard, escrowed
encryption and RSA utilize a technology generally known as public key
encryption. The Company believes that this new technology has potential
widespread demand, and is therefore developing products that utilize this new
technology to manage the security of large computer networks.

     In January 1997, the Company announced that it is developing a low-cost
secure communications chip with ADI. The new chip can combine encryption and
communications functions, such as modems and LAN adapters, on a single
integrated circuit. The chip supports current and future security standards and
can be software personalized for communications applications such as LAN, ADSL,
ISDN and cable modems. The initial secure communications chip will be aimed at
environments which require encrypted communications at high speed.

     Gretacoder is also developing a high performance encryption chip which will
employ the Triple DES Encryption algorithm. Since this chip was entirely
developed and manufactured outside the United States, the Company believes that
it is not subject to U.S. Government export controls.

     The Company is currently devoting significant resources toward the
foregoing product development activities. There can be no assurance that the
Company will successfully complete the development of these products in a timely
fashion or that the Company's current or planned products will satisfy the needs
of the computer and network security market.

PRINCIPAL CLIENTS

     The Company focuses its marketing efforts on both commercial and U.S.
government sales.

     The Company's largest clients vary from year to year and the Company has
experienced shifts in sales patterns with large clients in the past.
Accordingly, the complete loss of any large client or substantial reduction of
sales to such clients could have a material adverse effect on the Company.
Principal commercial clients of the Company, which accounted for more than 10%
of total revenues, by year and percentage of revenue were Lockheed Martin with
15%, in 1997, and MCI with 27% and 13% of revenues in 1996 and 1995,
respectively. For the year ended December 31, 1995, the percentage of revenues
from sales to agencies of the U.S. government was 26%.

Commercial Clients

     Sales to financial institutions are a central part of the Company's
business. Banks use the Company's network security systems and products to
protect corporate cash management applications. In these systems, financial


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officers located at corporations use personal computers to dial into the bank's
computing facility in order to transfer funds electronically.

     In the past year the Company received orders from TRW Inc., the prime
contractor for the development and maintenance of the Treasury Communications
System (TCS) of the U.S. Department of Treasury. The Company's AX Family and
SafeNet/Enterprise(TM) products are being used to protect communications between
Treasury departments and offices nationwide. The Company's automated key
management center was also purchased by TRW for user identification and
authentication, real-time security monitoring, audit services and electronic key
delivery. In addition to TRW Inc., several other customers placed orders for the
Company's SafeNet/Enterprise(TM) products including Credit Management Solutions,
Inc. ("CMSI"), a provider of consumer credit applications on the Internet; State
of Maryland Motor Vehicle Administration, a provider of on-line applications
including electronic vehicle registration; and Interbanking S.A., a financial
institution providing Internet protocol based communications with 3,000
corporate customers in Argentina.

     Euroclear is the world's largest provider of security clearinghouse
services to over 1,400 large international banks and brokerage firms. Euroclear
is owned by a consortium of 120 international financial institutions. The
Company's network security systems and products are used to protect the money
transfer service available to Euroclear participants. When the participant
authorizes a wire transfer for payment, the transfer is protected by the
Company's network security systems and products. Participants who wish to use
the wire transfer service are required to purchase the Company's remote security
devices which provide message authentication, user authentication and data
encryption for the participant's funds transfers communications.

     GDS has also recognized the emerging information security needs of
commercial clients, primarily transactions between banks. GDS products are
utilized commercially in several countries to protect financial transactions
from wiretapping and fraudulent data manipulation. Several Swiss banks and other
financial institutions use GDS units to protect their electronically transmitted
transactions, including Union Bank of Switzerland, Swiss Interbank Clearing,
SWIFT, European Payment Systems Services, Societa Interbancaria per
l'Automazione S.p.A., and Swiss Securities Clearing Operation.

Government Clients

     The U.S. Department of Treasury uses the Company's network security systems
and products to protect the electronic payment of the government's bills for
civilian agencies, securing approximately 750 million payment requests each
year, with an annual value of more than $700 billion. In the electronic
certification system provided to the U.S. Department of Treasury, the Company's
products verify the integrity of electronic payment orders using message and
user authentication.

     The U.S. Department of Energy uses a large installation of the Company's
Link Security System in a communications network that is part of a premises
security system at a highly classified location. The Department of Energy has
deployed the Company's Link Security System at an additional installation.

     Other government agencies deploying the Company's systems and products
include the Federal Bureau of Investigation, National Crime Information Network,
U.S. Drug Enforcement Agency and U.S. Customs Service. The Company's security
systems and products are utilized by these law enforcement agencies to protect
sensitive information traveling across telephone and computer networks.

CLIENT SUPPORT AND PRODUCT WARRANTIES

     The Company provides support for clients through a staff of support
engineers knowledgeable in both the Company's network security systems and
products and complex computer networks. In addition to supporting clients, this
group of engineers performs system level quality assurance testing of new
products and product enhancements.


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     The Company provides client telephone support, including 24 hour a day "hot
line" support. In addition, the Company offers on-site training, installation
and trouble-shooting services, generally on a fee basis.

     The Company provides limited warranties on its products for one year from
acceptance of a product. After warranty expiration, clients may purchase an
extended warranty support contract. This contract extends warranty service for
an additional one year period, providing repair or replacement of defective
products, telephone support, software and firmware support, regular maintenance
releases for products and early access to major product enhancements. The
Company also offers support on a time and materials basis.

SALES AND MARKETING

Sales

     In 1997, the Company continued to transition to indirect distribution
channels in order to expand worldwide sales coverage. In North America, IRE
sells its products through a direct sales force and selected distributors which
include Value Added Resellers and Internet Service Providers. In Switzerland,
GDS sells its products through a direct sales force reporting to a sales manager
at GDS. Outside of such territories, the Company and GDS sell their products
through distributors of communication or information security products. Support
for these distributors is provided by a sales force headed by a Vice President
of International Sales.

Marketing

     In 1997, the Company's marketing program emphasized continued trade show
participation to generate sales leads resulting in increased coverage of the
Company's products in leading trade publications. In addition, the Company has
upgraded the quality of its sales materials, equipping each sales employee with
the capability to make live demonstrations illustrating the value and efficacy
of secure communications to prospective clients.

INVENTORY, SUPPLIES AND MANUFACTURING

     Components for the Company's products are purchased from a limited number
of electronic parts manufacturers and distributors. Electronic assembly firms
are used to mount components onto printed circuit boards according to designs
and instructions provided by the Company's engineers. Since the components are
readily available from other suppliers and since there are several electronic
assembly firms available, a change in suppliers would not have a material effect
on the Company's operations. However, while the Company has not experienced any
significant supply problems in the past, it is possible that in the future the
Company may encounter shortages in parts, components, or other elements vital to
the manufacture, production and sale of its products.

     GDS operations are quality certified according to ISO 9001 and EN 29001.
This is meant to ensure that quality control procedures satisfying the
requirements of these standards are maintained in all processes performed by
GDS. Actual compliance and control are checked by semi-annual third party
audits. In addition to manufacturing, such certifications also extend to
marketing, sales and administration.

     The Company anticipates that it will continue to utilize qualified
suppliers and electronic assembly firms to produce sub-assemblies. The Company
presently performs system integration, final assembly and testing which consists
of assembling the cases containing the product components; attaching integrated
circuits, which contain the specific computer instructions and algorithms, to
printed circuit boards; labeling; adding serial numbers; testing; packaging and
shipping. The Company has and will continue to utilize contract manufacturers
for products requiring high volume production.

COMPETITION

     The network security market is relatively new, highly competitive and
subject to rapid technological changes. The Company believes that competition in
this market is likely to intensify as a result of increasing demand for network
security products. There are several companies in this field that have been
established longer than the


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Company, and have greater financial, research, service support and marketing
resources than those of the Company. There are also a number of other data
encryption methods on the market, both hardware and software, which compete with
the Company's products.

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

     If the network security market continues to develop, it will likely be
characterized by rapid advances in technology and the continuing introduction of
new products which could render the existing technology upon which the Company's
products are based obsolete or non-competitive. This risk will increase to the
extent that the Company's competitors include manufacturers of computer
equipment and modems to which the Company's products relate, since such
manufacturers may be in a better position than the Company to develop security
products in anticipation of developments in their computer equipment.

INTELLECTUAL PROPERTY

     In September 1996, the Company was awarded a United States Patent covering
portable encrypting and authenticating network interface devices such as modems.
The new patent provides the Company with ownership rights to a technology that
the Company believes will be applicable to the growth of computer networks, such
as the Internet. The patent covers various forms of pocket-sized devices
including PCMCIA and Smartcard-based secure tokens and is adaptable to modems
and newer network technologies including ISDN, ADSL and cable modems. The
Company's products covered by the patent include the SafeNet/Dial(TM) and the
AX400. Two additional U.S. patent applications and an international (PCT) patent
application, which cover the same products and technology, are pending.

     The Company has acquired a worldwide license under a United States Patent
for a self authenticating fingerprint identification card for certain computer
security and financial applications from CardGuard International, Inc.

     The Company has filed ten (10) provisional applications related to its
chip development activities.

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

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

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


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EMPLOYEES

    As of March 20, 1998, the Company had approximately 129 full time employees,
of whom 17 are engaged in assembly and quality control, 15 in administration and
financial control, 53 in engineering, development and client support, and 44 in
marketing and sales. The Company employs 99 full time employees in the U.S. and
30 persons are in Switzerland.


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<PAGE>   12


                           GLOSSARY OF TECHNICAL TERMS

ALGORITHM A process or procedure, generally expressed as a set of instructions
 for carrying out a particular task.

ASYNCHRONOUS Data transmission that takes place one character (of 5 to 8 bits)
 at a time, with each character preceded by a start code and followed by a stop
 code of set duration.

BISYNCHRONOUS (BISYNC) A type of synchronous communication protocol
 characterized by bi-directional transmission of character-oriented data.

DEDICATED LINK A type of network wherein telecommunications lines are dedicated
 to particular clients along predetermined routes.

DIAL ASYNCHRONOUS A type of network wherein remote computers access a host
 computer through dial telephone lines and the clocks need not be synchronous.

DIGITAL SIGNATURE A mechanism that allows the recipient of information stored in
 digital form to prove that the information originated from the claimed source.

DIGITAL SIGNATURE STANDARD A U.S. Government standard for digital signatures
 using the Digital Signature Algorithm, proposed by NIST.

ENCRYPT, ENCRYPTION TECHNOLOGY The protection of data employing cryptographic
 procedures to convert it to a form that is unintelligible until it is converted
 back to its original form.

FIREWALL Hardware or software devices which screen data traffic at Internet
 access points in order to assure that only authorized data and users can reach
 computers that are connected to the network.

FRAME RELAY A data communication technology that is used to provide higher speed
 for Internet connections. Its usual application is in connecting work groups
 rather than individuals.

HDLC High Level Data Link Control. A well-known family of data link layer
 protocols defined by the International Standards Organization.

INTERNET A global collection of interconnected computer networks which use
 TCP/IP, a common communications protocol.

INTRANET A network within an organization which provides similar services to the
 Internet but is not necessarily connected to it.

ISDN A collection of telecommunications protocols and standards for high-speed,
 error-minimized, digital data and voice transmission at speeds up to 128 Kbps
 worldwide.

KEY, CRYPTOGRAPHIC KEY A sequence of letters/numbers/bits which is used by a
 cryptographic algorithm to transform data from plaintext to ciphertext or vice
 versa. DES uses a key which is 56 bits long.

KEY MANAGEMENT SYSTEM OR CENTER The physical place or workstation running
 specialized programs that are responsible for generating, disseminating,
 distributing, changing, replacing, storing, checking, and destroying
 cryptographic keys.


                                       12
<PAGE>   13


LAN Local-Area Network. An interconnected set of systems and devices--such as
 PCs, mainframes, workstations, minicomputers, file servers, terminals,
 printers, and other communications and computing devices--within a localized
 environment.

LINK ENCRYPTION The use of encryption at the beginning, and decryption at the
 end, of each link in a communications chain.

MESSAGE AUTHENTICATION A system in which a cryptographic checksum/checkfunction
 is created for a message, and the result added to the message. The recipient
 performs the same procedure on the message and compares the computed result to
 that appended to the original message to verify that it is complete and has not
 been modified in any way.

PACKET A collection of data and control characters in a specified format that
 are transferred as a whole.

PRIVATE KEY One of the two keys in a public-key cryptographic system--normally
 the key used for decryption--which is kept secret.

PROTOCOL A set of rules and conventions for communications, especially those in
 a network, that include specifications of syntax, semantics, and timing.

PUBLIC KEY One of the two keys in a public-key cryptographic system, normally
 made public or distributed to others for their use in encrypting messages to a
 particular recipient.

PUBLIC-KEY CRYPTOGRAPHY A cryptographic system employing separate keys for
 encryption and decryption. One of the keys can be made public, thus enabling a
 message to be encrypted for transmission to a particular recipient, preserving
 its confidentiality because no one without the private key can decipher the
 message.

SDLC Synchronous Data Link Control. A bit-oriented IBM version of HDLC protocol,
 as used in IBM's Systems Network Architecture.

SMARTCARD A plastic card resembling a credit card containing one or more
 computer chips and logic for identification, special-purpose processing, and
 data storage and distribution.

SYNCHRONOUS DATA Transmission that takes place with predictable, exact departure
 or arrival times regulated by clocking data.

TCP/IP Transmission Control Protocol/Internet Protocol. A suite of network
 protocols that allow computers with different architectures and operating
 system software to communicate with other computers on the Internet.

USER AUTHENTICATION Generally, a means of verifying the claimed identity of an
 individual computer user or terminal so as to properly determine what access
 rights are to be given.

VPN Virtual Private Network. A virtual network created by using encryption to
 create a secure "tunnel" through a public network, thereby allowing companies
 to use the lowest cost network infrastructure for their business
 communications.

X.25 A widely used protocol standard for telecommunications between a computer
and a packet-switched data network; it encompasses layers 2 and 3 of the OSI
model.

                                       13
<PAGE>   14



ITEM 2 - PROPERTIES

     The Company maintains its corporate and administrative facilities at 8029
Corporate Drive, Baltimore, Maryland. The building, constructed in 1988, has
approximately 25,000 square feet and is also used for the Company's executive
headquarters, United States production and SafeNet Trusted Services facilities.
The lease, which expires in June 2003, requires the Company to pay real estate
taxes, insurance and maintenance. The lease, which provides for annual increases
in rentals during each year of the lease, requires the Company to pay
approximately $170,000 in 1998.

     GDS leases approximately 20,000 square feet for its administrative and
production facilities in Regensdorf, Switzerland. The lease, which expires on
December 31, 2002, calls for an annual rental of approximately $268,000.

     The Company also leases office space in Danvers, Massachusetts, Bethesda,
Maryland, Princeton, New Jersey, and Dallas, Texas.

ITEM 3 - LEGAL PROCEEDINGS

     The Company knows of no litigation or proceeding, pending or threatened, to
which the Company is or may become a party.

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

     There were no matters submitted to the vote of Security Holders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
fiscal year covered by this report.

                                     PART II

ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED MATTERS

     The following table sets forth the range of high and low sales prices for
the Company's Common Stock, as reported by the Nasdaq National Market under the
symbol IREG.

<TABLE>
<CAPTION>
                                                                     HIGH         LOW
                                                                     ----         ---
                  <S>                                                <C>         <C>
                  1998:
                    First Quarter (through March 20, 1998)           $7.38       $5.88
                  1997:
                    Fourth Quarter                                   11.38        6.00
                    Third Quarter                                    15.75       10.63
                    Second Quarter                                   14.50        6.25
                    First Quarter                                    10.75        6.88
                  1996:
                    Fourth Quarter                                   20.25        8.75
                    Third Quarter                                    24.75       10.50
                    Second Quarter                                   29.50       17.75
                    First Quarter                                    25.50       16.00
</TABLE>


                                       14
<PAGE>   15


     On March 20, 1998, the last reported sale price of the Company's Common
Stock was $7.25, as reported by the Nasdaq National Market. As of that date,
there were approximately 198 holders of record of the Common Stock and 4,000
beneficial holders of the Common Stock. The Company has not paid dividends on
its Common Stock and intends for the foreseeable future to retain earnings, if
any, to finance the expansion and development of its business.

ITEM 6 - SELECTED FINANCIAL DATA

The selected financial data set forth below as of and for each of the five-years
ended December 31, 1997 are derived from the Consolidated Financial Statements
of the Company, which financial statements have been audited by KPMG Peat
Marwick LLP. The Consolidated Financial Statements as of December 31, 1996 and
1997 and for each of the years in the three year period ended December 31,
1997 are included elsewhere herein. The selected financial data is qualified by
and should be read in conjunction with the Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included elsewhere herein.

<TABLE>
<CAPTION>
                                                                                Year ended December 31,
                                                  -------------  ------------- -------------  ------------  ------------
                                                      1993           1994          1995          1996          1997
                                                  -------------  ------------- -------------  ------------  ------------
<S>                                               <C>            <C>           <C>            <C>           <C>
STATEMENT OF OPERATIONS DATA

Revenues                                               $ 2,631        $ 3,424       $ 8,149      $ 14,317      $ 16,007
Cost of Revenues                                           871          1,233         3,318         7,672         6,971
                                                  -------------  ------------- -------------  ------------  ------------
        Gross Profit                                     1,760          2,191         4,831         6,645         9,036
Operating expenses
Research and development expenses                          627            906         1,299         3,840         3,756
Sales and marketing expenses                               665          1,083         1,979         4,692         6,720
General and administrative expenses                        541            705         1,331         2,976         2,570
Amortization of acquired intangible assets                   -            410           631           733           122
Write-off of unamortized acquired intangible
        assets from the Connective Strategies,
        Inc. acquisition                                     -              -             -         2,216             -
                                                  -------------  ------------- -------------  ------------  ------------
        Operating loss                                     (73)          (913)         (409)       (7,812)       (4,132)

Interest income (expense), net                             117             24           (96)          728           494
                                                  -------------  ------------- -------------  ------------  ------------
        Earnings (loss) before income taxes                 44           (889)         (505)       (7,084)       (3,638)
Income tax expense (benefit)                               (15)          (173)          190             -             -
                                                  -------------  ------------- -------------  ------------  ------------
        Net earnings (loss)                                 59           (716)         (695)       (7,084)       (3,638)
Preferred stock dividends                                  128             85            82             -             -
                                                  -------------  ------------- -------------  ------------  ------------
        Net loss attributable to
        common stock                                   $   (69)       $  (801)      $  (777)     $ (7,084)     $ (3,638)
                                                  =============  ============= =============  ============  ============

Loss per common share-basic and diluted                $ (0.02)       $ (0.25)      $ (0.20)     $  (1.34)     $  (0.67)
                                                  =============  ============= =============  ============  ============
</TABLE>


                                       15
<PAGE>   16

<TABLE>
<CAPTION>
                                                                                  Year ended December 31,
                                                    ------------   ------------  ------------   ------------  ------------
                                                       1993           1994          1995           1996          1997
                                                    ------------   ------------  ------------   ------------  ------------
<C>                                                 <C>            <C>           <C>            <C>           <C>
BALANCE SHEET DATA

Working Capital                                         $ 3,536         $  671       $ 2,186        $16,664       $12,499
Intangible Assets                                           384          3,974         4,927          3,223         3,503
Total Assets                                              4,812          7,724        15,472         24,653        21,531
Long-term debt                                                -            116            47             17             -
Stockholders' equity                                      4,236          5,405         8,216         21,861        17,980
</TABLE>

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

     Except for historical information contained herein, the statements in this
Item are forward-looking statements that are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the Company's actual results in future periods to differ
materially from forecasted results. Those risks include, among others, risks
associated with the receipt and timing of future customer orders, price
pressures, other competitive factors leading to a decrease in anticipated
revenues, achieving technical and product development milestones, the ability to
manufacture product in a timely manner to meet market demand, market acceptance
of products, the ability to negotiate favorable purchase and sale agreements,
and sufficient cash flow for future liquidity and capital resource needs. Gross
margins can vary from quarter to quarter based on product and channel mix, and
current gross margin levels may not be indicative of future results.

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

     These factors, among others, could cause results to differ materially from
those in the forward looking statements.

OVERVIEW

     The Company designs, manufactures and markets enterprise network security
solutions using encryption technology. The Company's products are used in
electronic commerce applications by financial institutions, government agencies
and large corporations to secure data transmissions on private and public
computer networks, such as the Internet. In order to expand its product
offerings, the Company acquired GDS in October 1995. GDS designs, manufactures
and markets cryptographic equipment primarily in Switzerland and Europe.

     While Management is committed to the long-term profitability of the
Company, the recent growth of the computer security industry has made it
important that market share be obtained. The Company has undertaken various
strategies in order to increase its revenues and improve its future operating
results, including the GDS


                                       16
<PAGE>   17


acquisition and new product offerings such as its SafeNet/Enterprise(TM)
products for the Internet and the SafeNet/Security Center(TM), a high
performance workstation which automatically manages SafeNet/Enterprise(TM)
products. Management believes that growth in the market for products that
provide secure remote access to computer networks requires the Company to
increase its investment in development, sales and marketing activities to allow
the Company to take advantage of this market opportunity and to achieve
long-term profitability thereby maximizing shareholder value. However, there can
be no assurance that these strategies will be successful.

RESULTS OF OPERATIONS OF THE COMPANY

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

<TABLE>
<CAPTION>
                                                                       1995             1996             1997
                                                                    ------------    -------------    -------------
<S>                                                                 <C>             <C>              <C>
Revenues ................................................              100  %           100  %           100  %
Cost of Revenues ........................................               41               54               44
                                                                    ------------    -------------    -------------
       Gross profit .....................................               59               46               56      
Operating Expenses                                                                                                
Research and development expenses .......................               16               27               23      
Sales and marketing expenses ............................               25               32               43      
General and administrative expenses .....................               16               21               16      
Amortization of acquired intangible assets ..............                7                5                1      
Write-off of unamortized acquired intangible assets .....                                                         
       from the CSI acquisition .........................                -               15                -      
                                                                    ------------    -------------    -------------
       Operating loss ...................................               (5)             (54)             (27)     
Interest income (expense), net ..........................               (1)               5                3      
                                                                    ------------    -------------    -------------
       Loss before income tax expense ...................               (6)             (49)             (24)     
Income tax expense ......................................                2                -                -      
                                                                    ============    =============    =============
Net loss ................................................               (8) %           (49) %           (24)%    
                                                                    ============    =============    =============
</TABLE>


Year ended December 31, 1997, Compared to Year ended December 31, 1996

     Revenues increased 12%, or $1.7 million, to $16.0 million for the year
ended December 31, 1997, from $14.3 million in 1996. During 1997, the Company
was able to generate revenues from new and existing clients that more than
offset the loss of revenue due to the termination of the product agreement with
MCI Telecommunications Corporation ("MCI"), and lower revenues from GDS. The
revenue increase in 1997 was primarily a result of the increased level of
product development services provided by the engineering group in Danvers, MA.

     Gross margin increased to 56% for the year ended December 31, 1997, from
46% for 1996. During 1996, the Company realized a lower gross margin on the
SafeNet dial access products sold to MCI. In 1997, the shift towards sales of
higher gross margin products, the decrease in sales of low margin products to
MCI, and the shift in the product mix towards software-based products,
contributed to the increased margin.

     Sales and marketing expenses accounted for more than the entire increase in
expenses, with a total of $6.7 million in 1997 compared to $4.7 million in 1996,
an increase of $2.0 million, or 43%. The increase in sales and marketing expense
was primarily a result of increased spending on personnel, mostly in the North
American territory, and increased focus on marketing efforts.


                                       17
<PAGE>   18


     Research and development expenses were at the same level in 1997 compared
to 1996, with expenses totaling approximately $3.8 million.

     General and administrative expense decreased by 14% to $2.6 million in
1997, compared to $3.0 million in 1996 which included start up expenses
associated with SafeNet Trusted Services facility.

     The Company had a net operating loss of $4.1 million for the year ended
December 31, 1997, compared to $7.8 million in 1996. The 1996 operating loss
includes charges for amortization of acquired intangible assets from the
acquisitions of CSI and GDS of approximately $0.7 million. The 1996 loss also
includes a one-time charge of $2.2 million for the write-off of unamortized
acquired intangible assets from the Connective Strategies, Inc. acquisition.

     Net interest income totaled $0.5 million in 1997, compared to $0.7 million
in 1996, due to the lower level of investable funds.

     The Company had a net loss of $3.6 million for the year ended December 31,
1997, compared to a net loss of $7.1 million in 1996. The loss per common share
- basic and diluted, was $0.67 for the year ended December 31, 1997, compared to
a loss of $1.34 per share in 1996.

Year ended December 31, 1996, Compared to Year ended December 31, 1995

         Revenues increased 76%, or $6.2 million, to $14.3 million for the year
ended December 31, 1996, from $8.1 million in 1995. Of the increase, $2.2
million is attributable to network security systems and products, mainly the
SafeNet/Dial(TM) products. The remainder of the increase, $3.9 million, is
attributable to the inclusion of GDS revenues for twelve months in 1996 but only
for two months in 1995. Revenues for 1995 on a pro forma basis, which includes
GDS, were $13.2 million.

         The Company concluded discussions with MCI in the fourth quarter of
1996 to terminate a previous product agreement under which MCI was obligated to
purchase $7.0 million of SafeNet/ Enterprise(TM) products during the twelve
month period ending September 30, 1997. As a result, the Company experienced
only a nominal increase in network security systems and products when the
revenues for the last six months of 1996 are compared to revenues for the same
period in 1995 and revenues from MCI are removed from both periods.

         Gross margin decreased to 46% for the year ended December 31, 1996,
from 59% in 1995. On a pro forma basis, which includes GDS, the gross margin was
61% in 1995. The decrease was caused by higher costs associated with the
production of SafeNet/Dial(TM) products, changes in the GDS product mix and a
favorable profit margin on a large purchase order in 1995. The Company realized
a lower gross profit on the SafeNet/Dial(TM) products sold to MCI in 1996 in
order to obtain market share.

         Research and development expenses increased 196%, or $2.5 million, to
$3.8 million for the year ended December 31, 1996, from $1.3 million for 1995.
The inclusion of GDS for the entire year in 1996 accounted for $1.4 million of
the increase. The remainder of the increase was primarily due to higher
personnel related costs associated with the expansion of the engineering staff.

         Sales and marketing expenses increased by 138%, or $2.7 million, to
$4.7 million for the year ended December 31, 1996, from $2.0 million in 1995.
The inclusion of GDS for the entire year accounted for $1.1 million of the
increase. The remainder of the increase was primarily due to higher personnel
related costs associated with the expansion of the sales and marketing staffs
and from increased sales and marketing activities.

         General and administrative expenses increased by 124%, or $1.6 million,
to $3.0 million for the year ended December 31, 1996, from $1.3 million in 1995.
The inclusion of GDS for the entire year accounted for $0.5 million of the
increase. The remainder of the increase was primarily due to start-up costs
associated with the Safe/Net Trusted Services facility and the establishment of
a management information function.


                                       18
<PAGE>   19


         The Company had an operating loss of $7.8 million for the year ended
December 31, 1996, compared to $0.4 in 1995. The 1996 operating loss includes
charges for amortization of acquired intangible assets from the acquisitions of
Connective Strategies, Inc. ("CSI") and GDS of $0.7 million, compared to $0.6
million in 1995. The 1996 loss also includes a one-time charge of $2.2 million
for the write-off of unamortized acquired intangible from the CSI acquisition.

         Net interest income for the year ended December 31, 1996 was $0.7
million compared to net interest expense of $0.1 million for 1995. The increase
resulted from the temporary investment of surplus cash that resulted mainly from
the Company's public offering of common stock in 1996.

         The Company had no income tax expense for the year ended December 31,
1996, compared to $0.2 million for 1995. A valuation allowance has been
established since the Company's ability to fully use the net operating loss is
dependent upon future taxable income.

         The Company had a net loss of $7.1 million for the year ended December
31, 1996 compared to a net loss of $0.7 million in 1995. The loss per common
share was $1.34 for the year ended December 31, 1996, of which $0.42 is due to
the one-time charge, compared to a net loss of $0.20 per common share in 1995.
On a pro forma basis, which includes GDS, the net loss per common share was
$0.30 in 1995

LIQUIDITY AND FINANCIAL POSITION OF THE COMPANY

     The Company believes that its current cash resources, together with the
cash flows from operations, will be sufficient to meet its needs for its 1998
fiscal year. As of December 31, 1997, the Company had cash and short-term
investments of $9.6 million, and working capital of $12.5 million.

     Significant uses of the Company's financial resources in 1997 include $3.5
million in operating activities, and $1.0 million in investing activities.
Accounts receivable increased $1.7 million in the year, primarily a result of a
large volume of shipments at the end of the fourth quarter. Inventories
decreased by approximately $629,000.

     In August 1996, the Company signed a two year Joint Development and
Marketing Agreement with CyberGuard. The companies have developed and intend to
market a product that combines the Company's SafeNet/Enterprise(TM) products and
CyberGuard's Firewall product. In connection therewith, the Company has prepaid
a refundable $1.0 million license fee to CyberGuard. As of December 31, 1997,
the Company has utilized $27,500 in credits against the prepaid license fee. The
agreement provides that in the event that it is terminated prior to such credit
aggregating $1.0 million, then Cyberguard shall repay to the Company the balance
of the $1.0 million prepaid license fee within one year of the termination with
interest at the prime rate.

     In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a full set
of general purpose financial statements. It does not, however, specify when to
recognize or how to measure items that make up comprehensive income.

     SFAS No. 130 is effective for both interim and annual periods beginning
December 15, 1997. Earlier application is permitted. Comparative financial
statements provided for earlier periods are required to be reclassified to
reflect the provisions of this statement.

     In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to report
selected information about operating segments in interim financial statements
issued to shareholders.

     SFAS No. 131 is effective for financial statements for periods beginning
after December 15, 1997. Management intends to adopt its provisions during 1998.


                                       19
<PAGE>   20


     Management has initiated a program to prepare the Company's computer
systems and applications for the year 2000. The Company expects to incur
internal staff costs as well as other expenses related to infrastructure and
facilities enhancements necessary to prepare the systems for the year 2000. A
significant proportion of these costs are not likely to be incremental costs to
the Company, but rather will represent the redeployment of existing information
technology resourses. The costs incurred to date and future costs are not
expected to be material to the financial statements.

INFLATION AND SEASONALITY

     The Company does not anticipate that inflation will significantly impact
its business. The Company does not believe its business is seasonal, however,
because the Company recognizes revenues upon shipment of finished products, such
recognition may be irregular and uneven, thereby disparately impacting quarterly
operating results and balance sheet comparisons.


                                       20
<PAGE>   21


ITEM 8 - FINANCIAL STATEMENTS

                          INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                          PAGE
                                                                                                          ----
<S>                                                                                                       <C>
Independent Auditors' Report                                                                                22

Consolidated Balance Sheets as of December 31, 1996 and 1997                                                23

Consolidated Statements of Operations for the years ended December 31, 1995, 1996 and 1997                  24

Consolidated Statements of Stockholders' Equity for the years ended December 31, 1995, 1996 and 1997        25

Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997                  26

Notes to Consolidated Financial Statements                                                                  28
</TABLE>


                                       21
<PAGE>   22
INDEPENDENT AUDITORS' REPORT



The Board of Directors
Information Resource Engineering, Inc.:


We have audited the accompanying consolidated balance sheets of Information
Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1997.  These consolidated financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Information
Resource Engineering, Inc. and subsidiaries as of December 31, 1996 and 1997,
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1997 in conformity with generally
accepted accounting principles.


                                                          KPMG PEAT MARWICK LLP

Baltimore, Maryland
March 13, 1998


                                      22
<PAGE>   23
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 1996 and 1997

<TABLE>
<CAPTION>
=======================================================================================================================
                                                                                                  1996            1997
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                                      <C>               <C>
ASSETS
Current assets:
      Cash and cash equivalents                                                          $  11,916,991       7,222,069
      Short-term investments                                                                 2,311,980       2,339,408
      Accounts receivable, net of allowance for doubtful
           accounts of $60,276 for 1997 (note 4)                                             1,564,381       3,216,542
      Inventories (note 5)                                                                   3,543,995       2,915,331
      Prepaid expenses                                                                         101,843         356,735
-----------------------------------------------------------------------------------------------------------------------
Total current assets                                                                        19,439,190      16,050,085

Equipment and leasehold improvements, net (notes 6 and 8)                                    1,842,725       1,575,777
Computer software development costs, net of accumulated
      amortization of $336,525 and $498,430                                                  1,142,352       1,407,076
Goodwill, net of accumulated amortization of $142,662 and $264,986                           1,080,568         958,244
Prepaid license fees (note 14)                                                               1,000,000       1,137,500
Other assets                                                                                   148,406         402,337
-----------------------------------------------------------------------------------------------------------------------
                                                                                         $  24,653,241      21,531,019
=======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
      Current maturities of long-term debt (note 8)                                      $      18,480          16,710
      Accounts payable                                                                       1,288,929       1,034,667
      Accrued expenses (note 7)                                                              1,317,389       1,736,963
      Deferred revenue                                                                         150,498         762,579
-----------------------------------------------------------------------------------------------------------------------
Total current liabilities                                                                    2,775,296       3,550,919

Long-term debt, less current maturities (note 8)                                                16,710               -
-----------------------------------------------------------------------------------------------------------------------
Total liabilities                                                                            2,792,006       3,550,919
-----------------------------------------------------------------------------------------------------------------------
Stockholders' equity (notes 9 and 13):
      Preferred stock, $.01 par value per share.  Authorized 500,000 shares                          -               -
      Common stock, $.01 par value per share.  Authorized 15,000,000 shares, issued
           and outstanding 5,458,127 shares in 1996 and 5,462,727 shares in 1997                54,581          54,627
      Additional paid-in capital                                                            30,917,584      30,929,277
      Deficit                                                                               (8,597,003)    (12,234,705)
      Cumulative foreign currency translation adjustment                                      (513,927)       (769,099)
-----------------------------------------------------------------------------------------------------------------------
Net stockholders' equity                                                                    21,861,235      17,980,100

Commitments (notes 11 and 14)                                                                                        -
-----------------------------------------------------------------------------------------------------------------------
                                                                                         $  24,653,241      21,531,019
=======================================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.





                                      23
<PAGE>   24
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Consolidated Statements of Operations

Years ended December 31, 1995, 1996 and 1997

<TABLE>
<CAPTION>
=============================================================================================================
                                                                      1995             1996             1997
-------------------------------------------------------------------------------------------------------------

<S>                                                           <C>                <C>              <C>
Revenues (note 4)                                             $  8,149,224       14,317,423       16,006,998
Cost of revenues                                                 3,318,605        7,671,957        6,971,144
-------------------------------------------------------------------------------------------------------------
Gross profit                                                     4,830,619        6,645,466        9,035,854

Research and development expenses                                1,298,808        3,840,475        3,755,766
Sales and marketing expenses                                     1,979,356        4,692,556        6,720,075
General and administrative expenses                              1,331,194        2,976,273        2,570,200
Amortization of acquired intangible assets (note 3)                630,658          732,644          122,324
Write-off of unamortized acquired intangible assets from
      the Connective Strategies, Inc. acquisition                        -        2,216,200                -
-------------------------------------------------------------------------------------------------------------
Operating loss                                                    (409,397)      (7,812,682)      (4,132,511)

Interest income (expense), net                                     (95,854)         728,132          494,809
-------------------------------------------------------------------------------------------------------------
Loss before income tax expense                                    (505,251)      (7,084,550)      (3,637,702)

Income tax expense (note 10)                                       190,000                -                -
-------------------------------------------------------------------------------------------------------------
Net loss                                                          (695,251)      (7,084,550)      (3,637,702)

Preferred stock dividends                                          (82,270)               -                -
-------------------------------------------------------------------------------------------------------------
Net loss attributable to common stockholders                  $   (777,521)      (7,084,550)      (3,637,702)
=============================================================================================================
Loss per common share - basic and diluted                     $       (.20)           (1.34)            (.67)
=============================================================================================================
Weighted average number of common shares outstanding             3,826,831        5,304,984        5,461,611
=============================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.





                                      24
<PAGE>   25
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

Years ended December 31, 1995, 1996 and 1997

<TABLE>
<CAPTION>
===============================================================================================================================
                                                                             9% Convertible            9% Convertible
                                                                         redeemable cumulative      redeemable cumulative
                                                                            preferred stock            preferred stock
                                                                     ---------------------------  -------------------------
                                                                         Shares         Amount      Shares          Amount
-------------------------------------------------------------------------------------------------------------------------------


<S>                                                                    <C>         <C>                <C>     <C>        
Balance at December 31, 1994                                             75,086     $      751          65     $         1

       Sale of common stock, net of offering expenses                         -              -           -               -
       Stock options exercised                                                -              -           -               -
       Conversion of preferred stock                                    (74,586)          (746)        (65)             (1)
       Redemption of preferred stock                                       (500)            (5)          -               -
       Issuance of common stock upon exercise of warrants,
           net of registration expense                                        -              -           -               -
       Preferred stock dividends declared                                     -              -           -               -
       Net loss for 1995                                                      -              -           -               -
       Foreign currency translation adjustment                                -              -           -               -
-------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995                                                  -              -           -               -

       Sale of common stock, net of offering expenses                         -              -           -               -
       Stock options exercised                                                -              -           -               -
       Net loss for 1996                                                      -              -           -               -
       Foreign currency translation adjustment                                -              -           -               -
-------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996                                                  -              -           -               -

       Stock options exercised                                                -              -           -               -
       Net loss for 1997                                                      -              -           -               -
       Foreign currency translation adjustment                                -              -           -               -
-------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                                                  -     $        -           -     $         -
===============================================================================================================================
</TABLE>


<TABLE>
<CAPTION>
==============================================================================================================================


                                                                           Common stock          Additional
                                                                  ---------------------------       paid-in
                                                                      Shares          Amount        capital         Deficit
------------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>           <C>             <C>            <C>
Balance at December 31, 1994                                       3,638,063     $    36,380      6,103,099        (734,932)

       Sale of common stock, net of offering expenses                300,000           3,000      3,331,036               -
       Stock options exercised                                           300               3          1,478               -
       Conversion of preferred stock                                 240,464           2,405         (1,924)              -
       Redemption of preferred stock                                       -               -         (5,495)              -
       Issuance of common stock upon exercise of warrants,
           net of registration expense                                66,000             660        284,583               -
       Preferred stock dividends declared                                  -               -              -         (82,270)
       Net loss for 1995                                                   -               -              -        (695,251)
       Foreign currency translation adjustment                             -               -              -               -
------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995                                       4,244,827          42,448      9,712,777      (1,512,453)

       Sale of common stock, net of offering expenses              1,172,500          11,725     21,023,046               -
       Stock options exercised                                        40,800             408        181,761               -
       Net loss for 1996                                                   -               -              -      (7,084,550)
       Foreign currency translation adjustment                             -               -              -               -
------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996                                       5,458,127          54,581     30,917,584      (8,597,003)

       Stock options exercised                                         4,600              46         11,693               -
       Net loss for 1997                                                   -               -              -      (3,637,702)
       Foreign currency translation adjustment                             -               -              -               -
------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                                       5,462,727     $    54,627     30,929,277     (12,234,705)
===============================================================================================================================
</TABLE>


<TABLE>
<CAPTION>
==================================================================================================

                                                                      Cumulative
                                                                foreign currency              Net
                                                                     translation    stockholders'
                                                                      adjustment           equity
--------------------------------------------------------------------------------------------------
<S>                                                                    <C>           <C>
Balance at December 31, 1994                                                   -        5,405,299

       Sale of common stock, net of offering expenses                          -        3,334,036
       Stock options exercised                                                 -            1,481
       Conversion of preferred stock                                           -             (266)
       Redemption of preferred stock                                           -           (5,500)
       Issuance of common stock upon exercise of warrants,
           net of registration expense                                         -          285,243
       Preferred stock dividends declared                                      -          (82,270)
       Net loss for 1995                                                       -         (695,251)
       Foreign currency translation adjustment                           (26,310)         (26,310)
--------------------------------------------------------------------------------------------------
Balance at December 31, 1995                                             (26,310)       8,216,462

       Sale of common stock, net of offering expenses                          -       21,034,771
       Stock options exercised                                                 -          182,169
       Net loss for 1996                                                       -       (7,084,550)
       Foreign currency translation adjustment                          (487,617)        (487,617)
--------------------------------------------------------------------------------------------------
Balance at December 31, 1996                                            (513,927)      21,861,235

       Stock options exercised                                                 -           11,739
       Net loss for 1997                                                       -       (3,637,702)
       Foreign currency translation adjustment                          (255,172)        (255,172)
--------------------------------------------------------------------------------------------------
Balance at December 31, 1997                                            (769,099)      17,980,100
==================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.





                                      25
<PAGE>   26
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 1995, 1996 and 1997

<TABLE>
<CAPTION>
===================================================================================================================
                                                                               1995            1996           1997
-------------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>               <C>            <C>
Cash flows from operating activities:
     Net loss                                                          $   (695,251)     (7,084,550)    (3,637,702)
     Adjustments to reconcile net loss to net cash provided by
          (used in) operating activities:
              Depreciation and amortization                                 515,647         659,792        840,499
              Amortization of acquired intangible assets                    630,658         732,644        122,324
              Write-off of unamortized acquired intangible assets
                   from the Connective Strategies, Inc. acquisition               -       2,216,200              -
              Deferred income taxes                                         215,300               -              -
              Changes in operating assets and liabilities:
                   (Increase) decrease in accounts receivable            (2,040,764)      2,608,430     (1,707,438)
                   Decrease in costs and estimated earnings in
                       excess of billing on uncompleted contracts           248,700               -              -
                   (Increase) decrease in inventories                       677,587      (1,425,750)       511,506
                   Decrease in recoverable income taxes                     184,872          32,369              -
                   Increase (decrease) in accounts payable                  136,106         (53,635)      (208,882)
                   Increase (decrease) in accrued expenses                  384,301        (112,880)       468,364
                   Decrease in billings in excess of costs and
                       estimated earnings on uncompleted contracts         (199,225)              -              -
                   Increase (decrease) in deferred revenue                   64,759         (41,290)       616,561
                   Other                                                     45,152        (137,878)      (549,383)
-------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities                         167,842      (2,606,548)    (3,544,151)
-------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
     Acquisition of GRETACODER Data Systems AG,
          net of cash acquired of $131,798                                 (439,602)              -              -
     Maturities of short-term investments                                   399,409               -      7,054,000
     Purchase of short-term investments                                        (902)     (2,311,980)    (7,081,428)
     Equipment expenditures                                                (154,862)     (1,274,770)      (307,258)
     Additions to computer software development costs                      (538,200)       (440,568)      (506,042)
     Prepaid license fees                                                         -      (1,000,000)      (137,500)
-------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                  $   (734,157)     (5,027,318)      (978,228)
-------------------------------------------------------------------------------------------------------------------
</TABLE>




                                                                     (Continued)
                                      26
<PAGE>   27
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows, Continued

Years ended December 31, 1995, 1996 and 1997

<TABLE>
<CAPTION>
====================================================================================================
                                                                 1995           1996           1997
----------------------------------------------------------------------------------------------------
<S>                                                      <C>              <C>            <C>
Cash flows from financing activities:
     Proceeds from notes payable                         $    589,000              -
     Payments of notes payable                             (1,081,351)    (4,053,416)             -
     Proceeds from issuance of common stock, net of
         offering expense                                   3,619,279     21,034,771              -
     Redemption of preferred stock                             (5,766)             -              -
     Payment of preferred stock dividends                    (127,118)             -              -
     Payments of long-term debt                               (67,345)       (80,979)       (18,480)
     Stock options exercised                                    1,481        182,169         11,739
----------------------------------------------------------------------------------------------------
Net cash provided by (used in ) financing activities        2,928,180     17,082,545         (6,741)
----------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash                         3,266       (188,182)      (165,802)
----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents        2,365,131      9,260,497     (4,694,922)

Cash and cash equivalents at beginning of year                291,363      2,656,494     11,916,991
----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                 $  2,656,494     11,916,991      7,222,069
====================================================================================================
Cash paid for:
     Interest expense                                    $     66,481        159,509         11,520
====================================================================================================
     Income taxes                                        $        800              -              -
====================================================================================================
</TABLE>

See accompanying notes to consolidated financial statements.


                                      27
<PAGE>   28
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Years ended December 31, 1996 and 1997

================================================================================


 (1)  BUSINESS

      Information Resource Engineering, Inc. (the Company) is engaged in the
      business of designing, manufacturing and marketing a line of products
      which secure data transmissions on computer networks through the use of
      encryption technology.

      During 1994, the Company acquired Connective Strategies, Inc. (CSI), which
      designs, manufactures and markets communications equipment enabling data
      and voice connectivity via the Integrated Services Digital Network (ISDN).
      In 1996, the Company invested in the development of a new secure
      communications chip. Due to this new superseding technology, which does
      not utilize CSI's ISDN product, the Company no longer markets its CSI
      products to new customers. Consequently, the Company has taken a one-time
      charge in 1996 of $2,216,200 related to the write-off of the unamortized
      acquired intangible assets from this acquisition. Future CSI ISDN product
      sales are not expected to be significant since the products will only be
      sold pursuant to commitments to existing customers.

      On October 31, 1995, the Company acquired all of the issued and
      outstanding stock of GRETACODER Data Systems AG (formerly Gretag Data
      Systems AG) (GDS), a company which designs, manufactures and markets
      cryptographic equipment. Results of operations for GDS are included in the
      accompanying consolidated statement of operations for the period after
      October 31, 1995.


 (2)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      PRINCIPLES OF CONSOLIDATION

      The consolidated financial statements include the accounts of the Company
      and its wholly-owned subsidiaries. All significant intercompany balances
      have been eliminated in consolidation.

      CASH EQUIVALENTS

      The Company considers investments purchased with maturities, at date of
      purchase, of three months or less to be cash equivalents.

      SHORT-TERM INVESTMENTS

      Short-term investments, which consist of commercial paper and corporate
      bonds which mature within one year, are stated at the lower of cost or
      market.

                                                                     (Continued)


                                       28
<PAGE>   29


INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (2)  CONTINUED

      REVENUES

      Revenue is recognized from sales when the product is shipped. Unearned
      income on maintenance contracts is amortized by the straight-line method
      over the terms of the contracts. Revenues from engineering services are
      recognized as the services are provided. There was no material accounts
      receivable related to unbilled engineering services at December 31, 1996
      and 1997.

      INVENTORIES

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

      EQUIPMENT AND LEASEHOLD IMPROVEMENTS

      Equipment and leasehold improvements are stated at cost less accumulated
      depreciation. Depreciation of equipment is determined using the
      straight-line method over the estimated useful life of five years.
      Leasehold improvements are amortized over the life of the lease.

      COMPUTER SOFTWARE DEVELOPMENT COSTS

      Computer software development costs are capitalized subsequent to the
      establishment of technological feasibility for each software product which
      is evidenced by a detailed program design. Capitalization of costs ceases
      when the product is available for general release to customers. Such costs
      are amortized using the straight-line method over a three to five year
      period beginning on product release dates. The Company assesses the
      recoverability of this intangible asset by comparing the unamortized
      balance to the net realizable value.

      GOODWILL

      The excess of acquisition costs over the fair value of net assets acquired
      is amortized on a straight-line basis over ten years. The Company assesses
      the recoverability of this intangible asset by determining whether the
      amortization of the goodwill balance over its remaining life can be
      recovered through undiscounted future operating cash flows of the acquired
      operation. The amount of goodwill impairment, if any, is measured based on
      projected discounted future operating cash flows.


                                                                     (Continued)
                                       29
<PAGE>   30
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (2)  CONTINUED

      IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF

      The Company adopted the provisions of Statement of Financial Accounting
      Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived
      Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996.
      This Statement requires that long-lived assets and certain identifiable
      intangibles be reviewed for impairment whenever events or changes in
      circumstances indicate that the carrying amount of an asset may not be
      recoverable. Recoverability of assets to be held and used is measured by a
      comparison of the carrying amount of an asset to future net cash flows
      expected to be generated by the asset. If such assets are considered to be
      impaired, the impairment to be recognized is measured by the amount by
      which the carrying amount of assets exceed the fair value of the assets.
      Assets to be disposed of are reported at the lower of the carrying amount
      or fair value less costs to sell.

      PRODUCT WARRANTIES

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

      TRANSLATION OF FOREIGN CURRENCIES

      Assets and liabilities of the foreign subsidiary are translated at the
      exchange rates as of the balance sheet dates; equity accounts are
      translated at historical exchange rates. Revenues and expenses are
      translated at the average exchange rates for the periods presented.
      Translation gains and losses are included in stockholders' equity.

      INCOME TAXES

      Deferred tax assets and liabilities are recognized for the future tax
      consequences attributable to differences between the financial statement
      carrying amounts of existing assets and liabilities and their respective
      tax bases and operating loss and tax credit carryforwards. Deferred tax
      assets and liabilities are measured using enacted tax rates expected to
      apply to taxable income in the years in which those temporary differences
      are expected to be recovered or settled. The effect on deferred tax assets
      and liabilities of a change in tax rates is recognized in income in the
      period that includes the enactment date.

      STOCK OPTIONS

      On January 1, 1996, the Company adopted Statement of Financial Accounting
      Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, and has
      elected to continue to



                                                                     (Continued)
                                       30
<PAGE>   31


INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (2)  CONTINUED

      apply the intrinsic value method under Accounting Principles Board (APB)
      No. 25, Accounting for Stock Issued to Employees to account for
      stock-based employee compensation. Under this method, compensation cost is
      recognized for awards of shares of common stock to employees under
      compensatory plans only if the quoted market price of the stock at the
      grant date (or other measurement date, if later) is greater than the
      amount the employee must pay to acquire the stock. SFAS No. 123 permits
      companies to adopt a new fair value based method to account for
      stock-based employee compensation plans or to continue using the intrinsic
      value method. If the intrinsic value method is used, information
      concerning the pro forma effects on net earnings and earnings per share of
      adopting the fair value based method for stock-based employee compensation
      grants made in 1995 and subsequent years is required to be presented in
      the notes to the financial statements. The pro forma disclosures are
      presented in note 13 to the consolidated financial statements.

      LOSS PER COMMON SHARE

      The Company adopted SFAS No. 128, Earnings Per Share, during the year
      ended December 31, 1997. Statement 128 establishes revised standards for
      computing and presenting earnings per share (EPS) data. It requires dual
      presentation of "basic" and "diluted" EPS on the face of the statements of
      income and reconciliation of the numerators and denominators used in the
      basic and diluted EPS calculations. As required by SFAS No. 128, EPS data
      for prior periods presented have been restated to conform to the new
      standard.


                                                                     (Continued)
                                       31
<PAGE>   32
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (2)  CONTINUED

      Basic EPS is calculated by dividing net loss by the weighted-average
      number of common shares outstanding for the applicable period. Diluted EPS
      is calculated after adjusting the numerator and the denominator of the
      basic EPS calculation for the effect of all dilutive potential common
      shares outstanding during the period. Information related to the
      calculation of net loss per share of common stock is summarized as follows
      for the years ended December 31:


<TABLE>
<CAPTION>
                                      1995                       1996                     1997
                             ----------------------    ----------------------   -----------------------
                                  Basic     Diluted         Basic     Diluted        Basic     Diluted
-------------------------------------------------------------------------------------------------------

<S>                         <C>           <C>          <C>         <C>          <C>         <C>
Net loss                    $  (695,251)   (695,251)   (7,084,550) (7,084,550)  (3,637,702) (3,637,702)
Accrued dividends
     on preferred stock         (82,270)    (82,270)          -           -            -           -
-------------------------------------------------------------------------------------------------------

Net loss
     attributable
     to common
     stockholders           $  (777,521)   (777,521)   (7,084,550) (7,084,550)  (3,637,702) (3,637,702)
-------------------------------------------------------------------------------------------------------

Weighted-average
     shares
     outstanding              3,826,831   3,826,831     5,304,984   5,304,984    5,461,611   5,461,611
Dilutive securities
     options                        -           -             -           -            -           -
-------------------------------------------------------------------------------------------------------

Adjusted weighted-
     average shares
     used in EPS
     computation              3,826,831   3,826,831     5,304,984   5,304,984    5,461,611   5,461,611
-------------------------------------------------------------------------------------------------------
</TABLE>


      NEW ACCOUNTING PRONOUNCEMENTS

      In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
      No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes
      standards for reporting and display of comprehensive income and its
      components in a full set of general purpose financial statements. It does
      not, however, specify when to recognize or how to measure items that make
      up comprehensive income.

      SFAS No. 130 is effective for both interim and annual periods beginning
      after December 15, 1997. Earlier application is permitted. Comparative
      financial statements provided for earlier periods are required to be
      reclassified to reflect the provisions of this statement.


                                                                     (Continued)
                                       32
<PAGE>   33
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (2)  CONTINUED

      In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
      an Enterprise and Related Information. SFAS No. 131 establishes standards
      for the way public business enterprises are to report information about
      operating segments in annual financial statements and requires those
      enterprises to report selected information about operating segments in
      interim financial reports issued to shareholders.

      SFAS No. 131 is effective for financial statements for periods beginning
      after December 15, 1997. Management intends to adopt its provision during
      1998.

      USE OF ESTIMATES

      Management of the Company has made a number of estimates and assumptions
      that affect the reported amounts of assets and liabilities as of the date
      of the balance sheet and revenues and expenses for the period to prepare
      these financial statements in conformity with generally accepted
      accounting principles. Actual results could differ significantly from
      those estimates.

      FAIR VALUE OF FINANCIAL INSTRUMENTS

      The following methods and assumptions were used by the Company in
      estimating fair value disclosures for financial instruments:

      The carrying value of cash and cash equivalents, short-term investments,
      accounts receivable, accounts payable and accrued expenses approximates
      fair value due to the short maturity of these instruments.

      The Company evaluates the fair value of fixed-rate debt based upon rates
      currently available for similar types of borrowing arrangements. The book
      value approximates fair value of these instruments.

      SUPPLEMENTARY STATEMENT OF CASH FLOWS INFORMATION

      As described in note 3, during 1995 the Company purchased GDS for cash and
      the issuance of two promissory notes aggregating $3,853,416.

      RECLASSIFICATIONS

      Certain amounts for 1995 and 1996 have been reclassified to conform to the
      1997 presentation.


                                                                     (Continued)
                                       33
<PAGE>   34
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (3)  ACQUISITIONS

      GRETACODER DATA SYSTEMS AG

      On October 31, 1995, the Company acquired all of the issued and
      outstanding stock of GDS. The Stock Purchase Agreement provided for an
      initial cash payment of $431,850 and two promissory notes aggregating
      $3,853,416. Such amount is net of a $400,000 payment discount that the
      Company received upon payment of the notes in February 1996. This
      transaction effectively transferred all ownership of GDS to the Company
      and was accounted for under the purchase accounting method.

      The aggregate net purchase price for GDS was determined as follows:

<TABLE>
<S>                                                <C>
Cash purchase price                                $     431,850
Notes payable                                          3,853,416
Transaction costs                                        139,550
-----------------------------------------------------------------
Net purchase price                                 $   4,424,816
=================================================================
</TABLE>

      The net purchase price was allocated to the acquired tangible and
      intangible net assets based upon the relative fair values as follows:

<TABLE>
<S>                                                <C>
Cash                                               $     131,798
Inventory                                              2,346,416
Other current assets                                   1,484,883
Equipment and leasehold improvements                     412,986
Deferred tax assets                                      194,000
Current liabilities                                   (1,368,497)
Goodwill                                               1,223,230
-----------------------------------------------------------------
Net purchase price                                 $   4,424,816
=================================================================
</TABLE>

      The Company allocated $474,000 of the purchase price to inventory in
      excess of the carrying cost of GDS. Of this amount, $238,000 and $236,000
      was charged to cost of revenues in 1995 and 1996, respectively.


 (4)  REVENUES AND ACCOUNTS RECEIVABLE

      During the three years ended December 31, 1997, revenues from two
      commercial clients accounted for greater than 10% of annual revenues as
      follows: one client accounted for 13% of 1995 revenues and 27% of 1996
      revenues and one client accounted for 15% of 1997 revenues. During the
      three years ended December 31, 1997, revenues from non-U.S. clients were
      34%, 47% and 44%, respectively. The majority of these revenues were
      derived from European distributors and financial institutions.


                                                                     (Continued)
                                       34
<PAGE>   35

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (4)  CONTINUED

      The Company grants credit to clients. Sales terms with clients, including
      distributors, generally do not provide for right of return privileges for
      credit, refund or other products. The Company's clients, which include
      both commercial companies and governmental agencies, are in various
      industries, including banking, security, communications and distributors
      of electronic products.


 (5)  INVENTORIES

      Inventories consist of the following:

<TABLE>
<CAPTION>
                                                    1996            1997
-------------------------------------------------------------------------
<S>                                         <C>                <C>
Raw materials                               $  1,451,142       1,208,439
Finished goods                                 2,092,853       1,706,892
-------------------------------------------------------------------------
                                            $  3,543,995       2,915,331
=========================================================================
</TABLE>

 (6)  EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET

      Equipment and leasehold improvements consist of the following:

<TABLE>
<CAPTION>
                                                       1996            1997
----------------------------------------------------------------------------
<S>                                             <C>               <C>
Equipment                                       $ 1,973,584       2,191,109
Automobiles                                          87,636          87,180
Leasehold improvements                              629,252         630,953
----------------------------------------------------------------------------
                                                  2,690,472       2,909,242

Less accumulated depreciation and amortization      847,747       1,333,465
----------------------------------------------------------------------------
                                                $ 1,842,725       1,575,777
============================================================================
</TABLE>

 (7)  ACCRUED EXPENSES

      Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                     1996        1997
----------------------------------------------------------------------
<S>                                           <C>           <C>
Accrued salaries and commissions              $   694,412   1,016,970
Other                                             622,977     719,993
----------------------------------------------------------------------
                                              $ 1,317,389   1,736,963
======================================================================
</TABLE>

                                                                     (Continued)
                                       35
<PAGE>   36

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

 (8)  LONG-TERM DEBT

      Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                            1996            1997
-----------------------------------------------------------------------------------------------------------------

<S>                                                                                  <C>                  <C>
Note payable to finance company bearing interest at 8.95% and requiring
    monthly payments of principal and interest of $1,740 through October 1998        $    35,190          16,710
-----------------------------------------------------------------------------------------------------------------
                                                                                          35,190          16,710

Less current maturities                                                                   18,480          16,710
-----------------------------------------------------------------------------------------------------------------
                                                                                     $    16,710               -
=================================================================================================================
</TABLE>

      The notes payable are secured by an automobile having a net carrying value
      of $59,558 and $49,126 at December 31, 1996 and 1997, respectively.


(9)   STOCKHOLDERS' EQUITY

      The 9% convertible redeemable cumulative preferred stock (9% preferred
      stock) required cumulative dividends of $.90 per share payable
      semiannually. Holders of the 9% preferred stock converted 74,586 shares of
      such stock into common stock of the Company during the year ended December
      31, 1995. The remaining 500 shares of 9% preferred stock were redeemed for
      cash on June 30, 1995.

      In connection with the offering of the 9% preferred stock, the Company
      issued the underwriter warrants to purchase 66,000 shares of common stock
      at $4.675 per share. The warrants were exercised in June 1995. The Company
      received proceeds from the exercise of $285,243, net of offering expenses.

      In connection with the acquisition of CSI (note 1), the Company issued 65
      shares of Series A Convertible Redeemable Cumulative Preferred Stock
      (Series A preferred stock) valued at $10,000 per share. The Series A
      preferred stock required cumulative dividends payable semiannually at an
      annual rate of 8.75%. On December 5, 1995, the 65 shares of the Series A
      preferred stock were converted for 65,000 shares of common stock.

      In February 1996, the Company completed a public offering of 1,172,500
      shares of common stock at a per share price of $20.00. The net proceeds of
      the Company from the offering were approximately $21,035,000 after
      deducting offering expenses.



                                                                     (Continued)
                                       36
<PAGE>   37
INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(10)  INCOME TAXES

      Income tax expense (benefit) consists of the following:

<TABLE>
<CAPTION>
                                               1995     1996     1997
----------------------------------------------------------------------
Current:
<S>                                 <C>                  <C>       <C>
    Federal                         $       (29,000)     -        -
    State                                    (5,300)     -        -
    Foreign                                   9,000      -        -
----------------------------------------------------------------------
                                            (25,300)     -        -

Deferred:
    Federal                                  19,700      -        -
    State                                     1,600      -        -
    Foreign                                 194,000      -        -
----------------------------------------------------------------------
                                            215,300      -        -
----------------------------------------------------------------------
                                    $       190,000      -        -
======================================================================
</TABLE>

      The income tax expense (benefit) differed from the amount computed by
      applying the Federal income tax rate of 34% to loss before income tax
      expense as a result of the following:

<TABLE>
<CAPTION>
                                                                             1995                1996                 1997
---------------------------------------------------------------------------------------------------------------------------
<S>                                                                   <C>                   <C>                 <C>
Computed "expected" tax benefit                                       $  (171,785)         (2,408,747)          (1,236,819)
Increase (reduction) in income taxes resulting from:
    State and local income taxes,                                    
              net of Federal income tax benefit                            (2,442)           (190,026)            (173,387)
    Amortization of acquired intangible assets,                      
              not deductible for tax purposes                             214,423             249,099               41,590
    Write-off of unamortized acquired intangible assets              
              from the Connective Strategies, Inc. acquisition       
              not deductible for tax purposes                                 -               753,508                  -
    Foreign income taxes at rates less than 34%                           (72,950)                -                    -
    Change in valuation allowance                                         169,500           1,774,500            1,635,000
    Other, net                                                             53,254            (178,334)            (266,384)
---------------------------------------------------------------------------------------------------------------------------
                                                                      $   190,000                 -                    -
===========================================================================================================================
</TABLE>



                                                                     (Continued)
                                       37
<PAGE>   38

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

================================================================================

(10)  CONTINUED

      The tax effects of temporary differences that give rise to significant
      portions of the deferred tax assets are presented below at December 31:

<TABLE>
<CAPTION>
                                                                            1996               1997
----------------------------------------------------------------------------------------------------
<S>                                                                  <C>                    <C>
Deferred tax assets:
   Inventories, due to additional costs inventoried for tax      
           purposes pursuant to the Tax Reform Act of 1986           $    67,000            241,000
   Net operating loss carryforward                                     1,906,000          3,358,000
   Other                                                                  18,000             99,000
----------------------------------------------------------------------------------------------------
                                                                       1,991,000          3,698,000
----------------------------------------------------------------------------------------------------
Deferred tax liabilities:
   Equipment, due to differences in depreciation                         (22,000)           (88,000)
   Other                                                                 (25,000)           (31,000)
----------------------------------------------------------------------------------------------------
                                                                         (47,000)          (119,000)
----------------------------------------------------------------------------------------------------

Net deferred tax asset                                                 1,944,000          3,579,000
Less valuation allowance                                              (1,944,000)        (3,579,000)
----------------------------------------------------------------------------------------------------
                                                                     $       -                  -
====================================================================================================
</TABLE>

      The Company has net operating loss carryforwards for United States income
      tax purposes of approximately $8,700,000 which are available to reduce
      future taxable income through 2012. In addition, the Company has a net
      operating loss of $1,754,000 which is attributable to CSI's preacquisition
      period and is available to reduce future taxable income of CSI at the rate
      of approximately $124,000 per year and expires in various amounts through
      2008.

      In assessing the realizability of deferred tax assets, management
      considers whether it is more likely than not that some portion or all of
      the deferred tax assets will not be realized. The ultimate realization of
      the deferred tax assets is dependent on the generation of future taxable
      income during the periods in which temporary differences are deductible
      and net operating losses are allowable. Based on consideration of the
      above factors management established a valuation allowance for which the
      balance was $1,944,000 and $3,579,000 at December 31, 1996 and 1997,
      respectively.

      The Company has not provided any additional U.S. income taxes on the GDS
      taxable income since management does not expect to repatriate such
      earnings.


                                                                     (Continued)

                                       38
<PAGE>   39

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(11)  LEASES

      The Company leases office facilities and equipment under operating leases
      expiring at various dates through 2003. The leases require the Company to
      pay real estate taxes, insurance and maintenance. The Company recognizes
      rent expense on a straight-line basis. The annual minimum rentals under
      the leases as of December 31, 1997 are as follows:

<TABLE>
<C>                                                <C>
1998                                               $    549,387
1999                                                    549,593
2000                                                    464,478
2001                                                    468,639
2002                                                    481,621
Thereafter                                              115,296
================================================================
</TABLE>

      Rent expense for the years ended December 31, 1995, 1996 and 1997 was
      $184,224, $518,177 and $616,465, respectively.


(12)  PENSION PLAN

      The Company has a defined contribution pension plan for employees who have
      completed three months of service with the Company. The Plan permits
      pre-tax contributions to the Plan by participants pursuant to Section
      401(k) of the Internal Revenue Code (the Code) of 3% to 10% of base
      compensation up to the maximum allowable contributions as determined by
      the Code. The Company matches participants' contributions on a
      discretionary basis. The Company may also make additional discretionary
      contributions. The Company made no contributions to the plan during the
      three years ended December 31, 1997.


(13)  STOCK OPTIONS AND WARRANTS

      The Company has an incentive stock option plan which provides for the
      granting of stock options to officers, directors, consultants and key
      employees of the Company. Options issued pursuant to the plan are
      exercisable at the fair market value of the common stock on the date of
      the issuance of the option. Either incentive stock options or qualified
      stock options may be granted under the plan. The vesting and exercise
      periods are determined by the Board of Directors not to exceed ten years.
      Options issued to date generally vest 20% per year commencing with dates
      of employment or dates of grant and expire seven years from date of grant.


                                                                     (Continued)
                                       39
<PAGE>   40

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(13)  CONTINUED

      Option transactions during 1995, 1996 and 1997 were as follows:

<TABLE>
<CAPTION>
                                       Number            Range of    Weighted average
                                    of shares     exercise prices      exercise price
--------------------------------------------------------------------------------------
<S>                                  <C>         <C>                       <C>
Outstanding at December 31, 1994      112,600    $ 0.10 to $ 5.25             $  3.22
    Granted                           151,000    $ 7.25 to $17.00               14.06
    Canceled                           (9,700)   $ 4.50 to $13.50                7.48
    Exercised                            (300)   $           4.94                4.94
--------------------------------------------------------------------------------------
Outstanding at December 31, 1995      253,600    $ 0.10 to $17.00                9.54
    Granted                           393,000    $ 9.88 to $28.63               18.45
    Canceled                          (37,200)   $ 1.30 to $17.00               12.85
    Exercised                         (40,800)   $ 0.10 to $13.50                4.46
--------------------------------------------------------------------------------------
Outstanding at December 31, 1996      568,600    $ 1.30 to $28.63               15.92
    Granted                           931,250    $ 6.38 to $20.00               10.39
    Canceled                         (500,867)   $ 4.50 to $28.63               16.68
    Exercised                          (4,600)   $ 1.30 to $ 4.50                2.55
--------------------------------------------------------------------------------------
Outstanding at December 31, 1997      994,383    $ 1.30 to $20.00             $ 10.45
======================================================================================
Exercisable at December 31, 1997      151,599    $ 1.30 to $17.00             $  9.33
======================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                1996
                         ------------------------------------------------------------------------------------------------
                                             Options Outstanding                             Options Exercisable
                         -------------------------------------------------------        ---------------------------------
                                         Weighted average
Range of                      Number            remaining      Weighted average              Number     Weighted average
exercise prices            of shares     contractual life        exercise price           of shares       exercise price
-------------------------------------------------------------------------------------------------------------------------
<C>                          <C>               <C>                  <C>                     <C>            <C>
$1.30 to $9.88               105,300           4.97 years            $     5.90              35,100         $       3.54
$10.00 to $20.00             285,300           5.88 years                 14.55              43,700                14.14
$20.38 to $28.63             178,000           6.32 years                 24.02                 -                    -
-------------------------------------------------------------------------------------------------------------------------

                             568,600           5.85 years            $    15.92              78,800         $       9.42
=========================================================================================================================
</TABLE>



                                                                     (Continued)
                                       40
<PAGE>   41

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(13)  CONTINUED

<TABLE>
<CAPTION>
                                                               1997
                         --------------------------------------------------------------------------------------------

                                            Options Outstanding                           Options Exercisable
                         ------------------------------------------------------     ---------------------------------
                                        Weighted average
Range of                     Number            remaining      Weighted average           Number     Weighted average
exercise prices           of shares     contractual life        exercise price        of shares       exercise price
---------------------------------------------------------------------------------------------------------------------

<S>                         <C>               <C>                  <C>                  <C>                <C>
$1.30 to $8.88              210,800           4.49 years            $     6.86           64,100            $    5.24
$9.00 to $9.88              424,083           5.54 years                  9.38           34,999                 9.58
$10.00 to $20.00            359,500           5.73 years                 13.81           52,500                14.15
---------------------------------------------------------------------------------------------------------------------
                            994,383           5.39 years            $    10.45          151,599            $    9.33
=====================================================================================================================
</TABLE>

      The Company applies the intrinsic value method in accounting for its Plan
      and, accordingly, no compensation cost has been recognized for its options
      in the financial statements. Had the Company determined compensation cost
      based on the fair value at the grant date for its stock options under SFAS
      No. 123, the Company's net loss and per share amounts would have been the
      pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                               1995           1996           1997
----------------------------------------------------------------------------------
<S>                                      <C>            <C>            <C>
Net loss                 As reported     $ (695,251)    (7,084,550)    (3,637,702)
                         Pro forma         (760,000)    (7,578,000)    (4,252,000)
Loss per common share -
    basic and diluted    As reported           (.20)         (1.34)          (.67)
                         Pro forma             (.22)         (1.43)          (.78)
==================================================================================
</TABLE>

      Pursuant to SFAS No. 123, pro forma net loss reflects only options granted
      in 1995, 1996 and 1997. Therefore, the full impact of calculating
      compensation cost for stock options under SFAS No. 123 is not reflected in
      the pro forma net loss amounts presented above because compensation cost
      recognized over the option's vesting periods and compensation cost for
      options granted prior to January 1, 1995 is not considered.

      The weighted average fair values of options granted during 1995, 1996 and
      1997 were $806,000, $2,453,000 and $4,128,000, respectively, on the dates
      of grant. The fair values of options granted were calculated using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions used for grants in 1995, 1996 and 1997, respectively:
      risk-free interest rates of 5.83% to 6.76% for 1995, 5.253% to 6.78% for
      1996 and 5.71% to 6.78% for 1997; expected volatility of 32% for 1995 and
      1996 and 63% for 1997; dividend yield and expected dividend growth rate of
      0% in all years; and expected lives of 3 to 5 years and expected
      forfeitures of 0% for all years.


                                                                     (Continued)
                                       41
<PAGE>   42

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(13)  CONTINUED

      In addition, in November 1995, in connection with the private placement of
      300,000 shares of the Company's common stock, the Company issued the
      placement agent warrants to purchase 30,000 shares of common stock at
      $17.00 per share. The warrants are exercisable at any time during a
      four-year period commencing on January 29, 1997. The price and number of
      shares is subject to adjustment in certain circumstances to protect
      against dilution. Holders of the warrants are not entitled to vote,
      receive dividends or exercise any of the rights of holders of shares of
      common stock for any purpose until such warrants are exercised.

      In connection with a financial consulting agreement in February 1997, the
      Company issued warrants to purchase 25,000 shares of common stock at $9.00
      per share and 25,000 shares of common stock at $20.00 per share. The
      warrants are exercisable at any time during a three-year period commencing
      in February 1997.

      At December 31, 1997, the Company had reserved 1,529,300 shares of common
      stock for the stock option plan and conversion of outstanding warrants.


(14)  OTHER COMMITMENTS AND CONTINGENCIES

      In August 1996, the Company signed a two year joint development and
      marketing agreement (agreement) with CyberGuard Corporation (CyberGuard).
      The companies have developed and intend to market a product that combines
      the Company's SafeNet/Enterprise products and CyberGuard's Firewall
      product. In connection therewith, the Company has prepaid a refundable
      $1.0 million license fee to CyberGuard. As of December 31, 1997, the
      Company has utilized $27,500 in credits against the prepaid license fee.
      The agreement provides that in the event that this agreement is terminated
      prior to such credit aggregating $1.0 million, then CyberGuard shall repay
      to the Company the balance of the $1.0 million prepaid license fee within
      one year of the date of such termination with interest at the prime rate.


(15)  OPERATIONS OUTSIDE THE UNITED STATES

      Net income (loss) of the Company's non-U.S. subsidiary was $403,769,
      $(298,872) and $46,182 for 1995, 1996 and 1997, respectively. Net sales
      to unaffiliated customers of the Company's non-U.S. subsidiary were
      $2,295,843, $6,235,987 and $5,474,327 for 1995, 1996 and 1997,
      respectively.


                                                                     (Continued)
                                       42
<PAGE>   43

INFORMATION RESOURCE ENGINEERING, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements


================================================================================

(15)  CONTINUED

      The Company's investment in identifiable assets and liabilities located
      outside the United States was as follows at December 31:

<TABLE>
<CAPTION>
                                                  1996                  1997
-----------------------------------------------------------------------------
<S>                                       <C>                      <C>
Current assets                            $  4,002,221             4,294,819
Property, plant and equipment, net             190,187                73,789
-----------------------------------------------------------------------------
Total assets                                 4,192,408             4,368,608

Current liabilities                          1,257,190             1,579,718
-----------------------------------------------------------------------------
Net assets                                $  2,935,218             2,788,890
=============================================================================
</TABLE>

================================================================================

                                                                     (Continued)
                                       43
<PAGE>   44


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

         None.

                                    PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

    The directors and executive officers of the Company are as follows:

<TABLE>
<CAPTION>
                   NAME                   AGE                      POSITION
           ------------------             ---     ------------------------------------------
<S>                                       <C>     <C>
           Anthony A. Caputo               56     Chairman, Chief Executive Officer and President
           Michael M. Kaplan               53     Senior Vice President, Technology
           Jill Leukhardt                  41     Senior Vice President, Director
           Richard G. Tennant              52     Vice President of Finance and Administration,
                                                  Chief Financial Officer
           Dubhe E. Beinhorn               41     Vice President, International Sales
           Sean Price                      34     Vice President, North American Sales
           Gary L. McGreal                 45     Vice President, Marketing
           John F. Hembrough               48     Vice President, OEM Sales
           Steven Turner                   39     Vice President, Product Support
           Douglas E. Kozlay               58     Principal Engineer, Director
           Ira A. Hunt, Jr                 73     Director
           Bruce R. Thaw                   44     Director
</TABLE>

    All directors hold office until the next annual meeting of shareholders or
until their respective successors are elected and qualify. Executive officers
hold office until their successors are chosen and qualify, subject to earlier
removal by the Board of Directors. Set forth below is a biographical description
of each director and executive officer of the Company based on information
supplied by each of them.

    Anthony A. Caputo, the Chairman, Chief Executive Officer and President of
the Company, invested in the Company in 1986, and became a director in November
1986. In 1982, Mr. Caputo founded another computer security firm, TACT
Technology, as a division of a public company, and after securing outside
funding through a $3.0 million limited partnership in 1984, managed TACT as a
separate company. Mr. Caputo resigned from TACT Technology in November 1986 to
join the Company. Mr. Caputo has over 20 years' experience in the computer
industry, in marketing and management capacities. In June 1993, Mr. Caputo was
named Maryland's High Tech Entrepreneur of the Year, an annual award sponsored
by organizations including Inc. Magazine, Ernst and Young LLP and Merrill Lynch.
He has served as an officer of several publicly traded companies including
International Mobile Machines Inc., and Comshare, Inc., as well as Value
Software, now part of Computer Associates, Inc. Currently, Mr. Caputo is also a
director of CardGuard International, Inc., a privately held company focused on
developing fingerprint identification technology..

Michael M. Kaplan joined the Company in February 1996 as Senior Vice President,
Technology. Formerly the Director of Secure Technologies at AT&T Bell
Laboratories, Mr. Kaplan led the design, development and support of AT&T's
security products for voice, data, fax and video applications. Mr. Kaplan was
employed at AT&T Bell Labs for twenty-seven years and holds a Master of Science
in Mathematics from Adelphi University and a Bachelor of Arts in Mathematics
from Queens College. Mr. Kaplan holds four patents for various aspects of
telephone security devices and associated services and there are two additional
patents pending.

    Jill Leukhardt has been a Senior Vice President of the Company since June
1995. She served as the Vice President of Sales and Marketing of the Company
from 1989 to 1995. She was appointed a director of the Company in December,
1990. Ms. Leukhardt possesses a graduate level degree in Electrical Engineering.
From 1980 to 1986,


                                       44
<PAGE>   45


Ms. Leukhardt was a Marketing Manager at Intel Corporation where she managed
several projects including the planning, specification and initial marketing of
the 80386 microprocessor. Prior to joining the Company, from 1986 to 1989, she
served as Vice President-Marketing for Micro Wholesalers, Inc., a microcomputer
distributor. She has also served as a Trustee of Johns Hopkins University since
July 1992.

     Richard G. Tennant has been Vice President of Finance and Administration
and Chief Financial Officer since July 1997. Prior to joining the Company, Mr.
Tennant served as Vice President of Finance and Administration and Chief
Financial Officer of Netrix Corporation, a wide-area networking corporation,
since 1987.

     Dubhe E. Beinhorn has been Vice President, International Sales since
October 1996. Ms. Beinhorn's principal responsibilities include the
identification and development of distribution channels, partnerships, strategic
alliances and direct customer relationships outside North America. Prior to
joining the Company, Ms. Beinhorn served as Vice President, International Sales
for Netrix Corporation, and National Account Manager, Federal Operations at
Network Equipment Technologies.

     Sean Price joined the Company in April 1997 as Vice President, North
America Sales. His primary responsibility is managing and expanding the
Company's domestic distribution channels, more specifically Value Added
Resellers, systems integrators, and network service providers. Prior to joining
IRE, Mr. Price was Vice President of Worldwide Sales for Nuera Communications,
where he managed direct sales to carriers and end users as well as indirect
sales through Value Added Resellers.

     Gary L. McGreal joined the Company in October 1994 in connection with the
Company's acquisition of Connective Strategies, Inc., and became Director of
Product Planning. In 1996 he became IRE's Director of Planning, and in 1997 he
was made Vice President, Marketing. From 1985 to 1994 he was Executive Vice
President and Chief Operating Officer of Connective Strategies, Inc.

     John F. Hembrough joined the Company in September 1997 as Vice President,
OEM Sales. Mr. Hembrough is responsible for building sales channels and managing
the Company's OEM division through sales of Safenet technology to major
computer, communications, and software manufacturers. Prior to joining IRE, he
was the Vice President/General Manager of European Operations for Raptor
Systems, a software security company.

     Steven Turner has been with the Company since March 1988 serving as
Technician, Engineer, Production Manager, and Director, Product Support. Mr.
Turner has been the Vice President of Product Support since July 1994 where he
is the senior manager for the manufacturing, client support, Safenet Trusted
Services, and MIS groups. Prior to joining the Company, he held various
positions at the U.S. Naval Research Lab, E-Systems, and the U.S. Air Force.

     Douglas E. Kozlay is the co-founder, and was President, of the Company from
1983 until March 1993. Mr. Kozlay's principal responsibilities include serving
as the Company's chief technical officer providing guidance and advice on
product architecture to the Chief Executive Officer and performing engineering
functions as required. Mr. Kozlay has been a director of the Company since its
inception. From 1979 to 1982 Mr. Kozlay served as President of EMAX, Inc., a
company which designed and marketed data acquisition and control systems.
Previously, Mr. Kozlay has served as a manager of a research and development
laboratory for the U.S. National Security Agency and design engineer for IBM
Corporation. In 1982 Mr. Kozlay was Director of Industrial Automation for EMC
Controls. He currently teaches graduate level courses in robotics at Loyola
College of Baltimore.

     Ira A. Hunt, Jr. has been a director of the Company since December 1990.
Mr. Hunt is a graduate of the U.S. Military Academy, West Point, New York. He
served 33 years in various command and staff positions in the U.S. Army,
retiring from active military service as a Major General in 1978. Subsequently
he was President of Pacific Architects and Engineers in Los Angeles, California
and a Vice President of Frank E. Basil, Inc. in Washington, D.C. Mr. Hunt has a
Masters of Science degree in civil engineering from the Massachusetts Institute
of Technology; an MBA from the University of Detroit; a Doctor of the University
degree from the University of Grenoble, France; and a Doctor of Business
Administration degree from George Washington University.


                                       45
<PAGE>   46


    Bruce R. Thaw has been a director of the Company since December 1990. From
1987 to the present, Mr. Thaw has served as general counsel to the Company. Mr.
Thaw was admitted to the bar of the State of New York in 1978 and the California
State Bar in 1983. Mr. Thaw is also a director of Amtech Systems, Inc., a
publicly traded company engaged in the semiconductor industry, and Nastech
Pharmaceutical Company, Inc., a publicly traded company engaged in drug delivery
technology.

    The Company's By-Laws provide for the election of directors at the annual
meeting of shareholders, such directors to hold office until the next annual
meeting and until their successors are duly elected and qualified. The By-Laws
also provide that the annual meeting of shareholders be held each year at such
time, date and place as the Board of Directors shall determine by resolution.
Directors may be removed at any time for cause by the Board of Directors and
with or without cause by a majority of the votes cast by the shareholders
entitled to vote for the election of directors.

    Officers will normally be elected at the annual meeting of the Board of
Directors held immediately following the annual meeting of shareholders, to hold
office for the term for which elected and until their successors are duly
elected and qualified. Officers may be removed by the Board of Directors at any
time with or without cause.

    In January 1997, the Company announced the formation of an advisory board
chaired by former United States Treasury Secretary William E. Simon. Developed
to assist in building shareholder value by managing and maintaining Company
expansion, the Company expects to add additional high-caliber executives to its
board. Subsequently, the Company announced the addition of Dr. Vinton G. Cerf,
MCI's Senior Vice President of Internet Architecture and Daniel L. Mosley, a
partner in the law firm of Cravath, Swaine & Moore, to the board.

    The Company's Certificate of Incorporation contains provisions indemnifying
its officers, directors, employees and agents against certain liabilities.

ITEM 11 - EXECUTIVE COMPENSATION

    The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

    The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The information required by this item is incorporated herein by reference to
the definitive Proxy Statement the Company will be filed with the Securities and
Exchange Commission, no later than 120 days after the close of the Company's
fiscal year ended December 31, 1997.


                                       46
<PAGE>   47


                                     PART IV

ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

<TABLE>
<S>                                                                                                         <C>
(a)    1. The financial statements filed as part of this report are listed
          separately on the Index To Financial Statements on page 19 of this
          Form.
       2. Financial Statement Schedules:  None
(b)    Reports on Form 8-K:  None
(c)    Exhibits required by Item 601 of Regulation S-K:
       3A      Articles of Incorporation of Registrant, as filed with the Secretary of State of
               Delaware on November 1, 1988, as amended on March 6, 1989, May 19, 1989,
               September 22, 1992, June 30, 1995 and October 4, 1995                                        1/B/R(1)
       3B      By-laws of Registrant                                                                        1/B/R(2)
       4       Specimen of Common Stock Certificate of Registrant                                           1/B/R(2)
       10A     Sublease dated November 2, 1993 for facility at 8029 Corporate Drive, Baltimore, Md.         1/B/R(3)
       10B     Stock Option Plan                                                                            1/B/R(4)
       10C     Employment Agreement with Douglas Kozlay                                                     1/B/R(2)
       10D     Form Employee Non-Disclosure Agreement                                                       1/B/R(2)
       10E     Award Contract with United States Department of the Treasury                                 1/B/R(4)
       10F     Agreement with GTE Government Systems Corporation                                            1/B/R(5)
       10G     Agreement and Plan of Merger dated September 30, 1995 with Connective Strategies, Inc.       1/B/R(6)
       10H     Employment Agreement with Charles D. Brown                                                   1/B/R(7)
       10I     Agreement between the Registrant and AT&T International, Inc. for the acquisition of
               Gretag Data Systems AG                                                                       1/B/R(8)
       10J     Agreement between the Registrant and MCI Telecommunications Corporation                      1/B/R(9)
       10K     Employment Agreement between GDS and Dr. Kurt H. Mueller                                     1/B/R(1)
       10L     Placement Agent Warrant                                                                      1/B/R(1)
       10M     Alliance and Joint Marketing Agreement between the Registrant and MCI Telecommunications
               Corporation                                                                                  1/B/R(11)
       10N     Joint Development and Marketing Agreement between the Registrant and CyberGuard
               Corporation                                                                                  1/B/R(11)
       10O     Employment Agreement with Anthony Caputo                                                     1/B/R(11)
       10P     Agreement between the Registrant Lockheed Martin Corporation Information Systems &           1/B/R(11)
               Technologies
       10Q     Agreement between IRE Secure Solutions, Inc. (wholly-owned subsidiary of the Registrant)     1/B/R(10)
               and Analog Devices, Inc.
       21      Subsidiaries of Registrant
       27      Financial Data Schedule
</TABLE>

--------------

(1)  Filed as an exhibit to the Registration Statement on Form SB-2 (File No.
     33-80161) of the Registrant and incorporated herein by reference.

(2)  Filed as an exhibit to the Registration Statement on Form S-18 (File No.
     33-28673) of the Registrant and incorporated herein by reference.

(3)  Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
     1993 and incorporated herein by reference.

(4)  Filed as an exhibit to the Registration Statement on Form S-1 (File No.
     33-52066) of the Registrant and incorporated herein by reference.

(5)  Filed as an exhibit to Form 10-KSB for the fiscal year ended December 31,
     1995 and incorporated herein by reference.

(6)  Filed as an exhibit to Form 8-K, dated October 24, 1995 and incorporated
     herein by reference.

(7)  Filed as an exhibit to Form 10-QSB for the quarterly period ended June 30,
     1995 and incorporated herein by reference.


                                       47
<PAGE>   48


(8)  Filed as an exhibit to Form 8-K dated October 31, 1995 and incorporated
     herein by reference.

(9)  Filed as an exhibit to Form 10-QSB for the quarterly period ended September
     30, 1995 and incorporated herein by reference.

(10) Filed as an exhibit to Form 10-Q for the quarterly period ended September
     30,1996 and incorporated herein by reference.

(11) Filed as an exhibit to Form 10-K for the fiscal year ended December 31,
     1996 and incorporated herein by reference.

                                       48
<PAGE>   49


                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
behalf of the undersigned, thereunto duly authorized.

                              INFORMATION RESOURCE ENGINEERING, INC.

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

    Date:  March 27, 1998

    Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
                 SIGNATURE                                       TITLE                           DATE
                 ---------                                       -----                           ----
<S>                                            <C>                                               <C>
           /s/ ANTHONY A. CAPUTO               Chairman, Chief Executive Officer                 March 27, 1998
--------------------------------------------   and President
             Anthony A. Caputo

                                               Senior Vice President, Director                   March 27, 1998
--------------------------------------------
             Jill L. Leukhardt

          /s/ RICHARD G. TENNANT               Vice President of Finance and                     March 27, 1998
--------------------------------------------   Administration, Chief Financial Officer
            Richard G. Tennant                 (Principal Financial and Accounting Officer)

           /s/ DOUGLAS E. KOZLAY               Director                                          March 27, 1998
--------------------------------------------
             Douglas E. Kozlay

           /s/ IRA A. HUNT, JR.                Director                                          March 27, 1998
--------------------------------------------
             Ira A. Hunt, Jr.

             /s/ BRUCE R. THAW                 Director                                          March 27, 1998
--------------------------------------------
               Bruce R. Thaw
</TABLE>


                                       49