**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 
| **(Mark One)** |   |
|----------------|--------|

 

| **ý** | **ANNUAL REPORT PURSUANT TO SECTION  13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|-------------------------------------------------------------------------------------------|

 

For the fiscal year ended December 31, 2001

 

**OR**

 

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

 

Commission File Number 0-20634

 

**SAFENET,INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                                 |   | **52-1287752**                    |
|------------------------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction of incorporation or organization)          |   | (IRS Employer Identification No.) |
|                                                                         |   |                              |
| **8029 Corporate Drive**                                                     |   |                              |
| **Baltimore, Maryland**                                                      |   | **21236**                         |
| (Address of principal executive offices)                                     |   | (Zip Code)                        |
|                                                                         |   |                              |
| Registrant’s telephone number, including area code: **(410)  931-7500** |

 

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

 

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

 

| **Title of  each class**     |   | **Name of  each  exchange on which registered** |
|------------------------------|--------|------------------------------------------------------|
| Common Stock, $.01 par value |   | Nasdaq National Market                               |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes ý  No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 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 informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  ý

 

The aggregate market value ofthe Common Stock issued and outstanding and held by non-affiliates of the Registrant,based upon the closing price for the Common Stock on the Nasdaq National Marketon March 14, 2002 was approximately $97,000,000. All executive officers anddirectors of the registrant have been deemed, solely for the purpose of thiscalculation, to be “affiliates” of the registrant.  This determination of the affiliate status is not necessarilyconclusive.

 

The number of shares of theregistrant’s Common Stock outstanding as of March 14, 2002 was 7,684,700.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

Part III incorporatesinformation by reference from the registrant’s proxy statement for the AnnualMeeting of Shareholders, which proxy statement in definitive form will be filedno later than 120 days after the close of the registrant’s fiscal year endedDecember 31, 2001.

 

 

 

**INFORMATIONREGARDING FORWARD-LOOKING STATEMENTS**

 

This Annual Report on Form10-K, the exhibits hereto and the information incorporated by reference hereincontain “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended. Forward-looking statements usually contain the words “estimate,”“anticipate,” “expect” or similar expressions. All forward-looking statements are inherently uncertain as they arebased on various expectations and assumptions concerning future events and theyare subject to numerous known and unknown risks and uncertainties.  These uncertainties could cause actual resultsto differ materially from those expected for the reasons set forth below underRisk Factors.  Readers are cautioned notto place undue reliance on these forward-looking statements, which speak onlyas of the date hereof.  SafeNet, Inc.undertakes no obligation to publicly release any revisions to “forward lookingstatements” to reflect events or circumstances after the date that this reportis filed with the Securities and Exchange Commission or to reflect theoccurrence of anticipated events.

 

**Part1**

 

**ITEM1. BUSINESS**

 

**COMPANY**

 

SafeNet, Inc. (“SafeNet” or the“Company”), was originally incorporated in Maryland on April 7, 1983 under thename “Industrial Resource Engineering, Inc.” SafeNet reincorporated under Information Resource Engineering in Delawareby merging with its subsidiary in March 1989. We completed our initial offering in October of 1989 and our secondaryoffering in October of 1992.  OnNovember 1, 2000, the Corporate name was changed by a vote of the stockholdersto SafeNet, Inc.  SafeNet’s executiveoffices are located at 8029 Corporate Drive, Baltimore, MD  21236. Our main telephone line is 410.931.7500 and website address iswww.safenet-inc.com.

 

In January 2002, SafeNetcompleted its acquisition of Pijnenburg Securealink, Inc. (“Securealink”), aDelaware Corporation primarily engaged in the manufacture of security chips fore-commerce transactions through its European subsidiary.  Operations of Securealink are beingconducted through SafeNet BV (formerly Securealink BV) in the Netherlands (seenote 13 to the audited consolidated financial statements).

 

In February 2002, managementdecided to discontinue operations of SafeNet’s Swiss subsidiary, GRETACODERData Systems AG (“GDS”) (see note 14 to the audited consolidated financialstatements).

 

The Company has three reportablesegments: products, chips and software designed and manufactured in the UnitedStates for sale to companies that will embed the Company’s products into theirproducts for ultimate sale to end-users (“Technology Operations”), networksecurity products designed and manufactured in the United States for directsales to end-users (“Product Operations”), and network security productsdesigned and manufactured outside the United States (“European Operations”)(see Item 7, Management’s Discussion and Analysis of Financial Condition andResults of Operation and Note 10 to the audited consolidated financialstatements).

 

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**GENERAL**

 

**Overview**

SafeNet delivers a widelydeployed Virtual Private Network (VPN) technology for secure businesscommunications over the Internet, offering both Original Equipment Manufacturer(OEM) technology and end-user products for VPN and e-commerce applications.

 

A VPN is a communicationssystem that uses strong encryption and authentication to create private“tunnels” through the Internet or other shared networks, allowing businesses totake advantage of the lowest cost network without exposing their businesscommunications. VPN technology has been a core competency of SafeNet for over adecade and remains a principal focus of SafeNet.

 

Since our inception in 1983,SafeNet has been providing network security solutions worldwide for financial,enterprise, telecommunications, and government use.  SafeNet’s SecureIP TechnologyTM has enjoyed broad marketacceptance through both the end-user and OEM VPN markets.  Organizations that depend on robust securityfor all communications have been enabled with our technology for years. Throughcustomer engagements with organizations such as the U.S. Department of State,Internal Revenue Service, U.S. Treasury, Federal Reserve Bank, and Citibank, wehave gained over 18 years of direct experience developing, deploying, andmanaging network security systems for Fortune 500 companies and governmentorganizations around the world.

 

SafeNet has positioned its VPNtechnology as a provider of choice for leading Internet infrastructuremanufacturers, semiconductor developers, service providers, and securityvendors.  Customers include CiscoSystems, Texas Instruments, Centillium, Samsung, RSA Security, Nokia, andNetscreen. With SafeNet securing the infrastructure of today’s e-businesscommunications, we are opening new markets for interoperable, secure, anddeployable VPN communications.

 

SafeNet has taken the vision—tooffer a simple, cost-effective approach to Internet security—and become aninnovator in the Internet marketplace, using its expertise to identify anddevelop emerging security technologies. In 1995, SafeNet introduced the first Internet VPN.  We have sought to educate the market anddevelop leading-edge technology to bring VPNs into the mainstream and makesecurity on the Internet a reality for business.

 

VPNs have become one of themost sought after sectors in the networking communications industry.  The tremendous growth of the Internet andthe applications surrounding this pervasive public network has increased theneed for VPN products and technology around the world.   SafeNet is continuing its trend of deliveringsecurity solutions for existing markets while remaining competitive by creatinginnovative products and technology for new and emerging markets, such asbroadband and wireless technologies.

 

During SafeNet’s fiscal year2001, the Company began selling its technology to semiconductor manufacturers inthe form of intellectual property called EmbeddedIPTM.  The result of this development led to licensing contracts toleading companies including Centillium Communications, Texas Instruments, andSamsung. SafeNet’s EmbeddedIPTM technology is being combined with TexasInstruments OMAPTM family of processors designed for 2.5G and 3G networks.Together, SafeNet and Texas Instruments are enabling the strongest security fornext generation wireless devices including PDAs, cell phones, and pagers.

 

In September 2001 SafeNetintroduced the CGX Security Platform. The CGX Security Platform is anext-generation, integrated, security environment providing a single, easysolution for building encryption-based security systems. The first announcedcustomer of this product was Corrent Corporation, a manufacturer of high-speedsecurity semiconductors.

 

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In February 2001, SafeNetannounced its next generation remote access client for the enterprise network,offering extended features to remote access users connecting to a corporateVPN.  SoftRemoteTM is the next generationof our VPN client, Soft-PKTM—extended to include Personal Firewallcapabilities and support User Authentication through industry-standard SmartCards.  New customers for SoftRemoteTMinclude Adtran, RSA, and Watchguard.

 

During 2001, we continued tobroaden our market focus to include developing security technology for thebroadband and wireless markets.  Newaccess technologies, such as DSL, cable modems, and wireless technologies arebecoming an increasingly popular way to access the enterprise network forremote, mobile, and at-home workers. These emerging access technologies mayalso be more vulnerable to Internet-borne security threats.  SafeNet’s boards, chips, EmbeddedIPTM,and software are securing communications in all these types of markets.

 

The Company responded to theexplosion of wireless devices by announcing a strategic partnership with RSASecurity to create wireless VPN clients for the mobile marketplace based on RSASecurity technology.  As a result ofthis relationship, SafeNet recently announced SoftRemotePDATM, a VPN productoffering secure client-to-gateway communication over wireless networks for PalmPoweredTM handhelds.

 

SafeNet’s VPN products andmanaged services saw continued interest from government agencies and financialinstitutions during 2001.  Onedevelopment includes a signed reseller agreement with a majortelecommunications and network provider. The IRS Secure Dial-In program (SDI),being secured by SafeNet products, has increased its enrollment to over 20,000users and continues to grow.

 

In conjunction with LockheedMartin Corporation, SafeNet’s Enterprise VPN system has been deployed at U.S.Military bases throughout the world under a Department of Defense programcalled Theatre Battle Management Control System (TBMCS).

 

The acquisition of Securealinkprovides us with an experienced and competitive cryptographic development teamand access to a full fabless semiconductor business model with in-house designand customer fulfillment.  TheSecurealink organization is experienced in providing security chip products tomajor European OEM manufacturers seeking to add strong security to theirproducts. Each of these groups will conduct business under the SafeNet brandand continue to focus on its core area of expertise in order to better serveour European customers.

 

**INDUSTRYBACKGROUND**

** **

**TheVPN Market**

A VPN is a communications system using strongencryption that creates a private “tunnel” through the Internet and othercommunications systems, assuring authentication of users and privacy ofinformation. This allows businesses to use the lowest cost network withoutexposing their business communications. A VPN can allow an organization’s employees to accesscompany-confidential information over an intranet, or allow trading partnersaccess to a company extranet for secure business-to-business electroniccommerce applications.  A leading marketresearch firm predicts that by the year 2004 the VPN product and services willreach $39.8 billion dollars.

 

VPNs also allow organizations to use publicnetworks for their communications backbone. This is achieved by protecting thedata traffic with data communications security technology such as: encryption,message authentication, user authentication, and firewall technology.  Because public networks are much cheaperthan private leased lines and dedicated frame relay networks,

 

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corporations can generally achievesubstantial cost savings by using VPNs while taking advantage of the globalavailability and access to the Internet.

 

With the increasing use of public and privatecommunications networks and the ability of different types of computers tocommunicate with each other, data integrity and security have gained increasedimportance.  Secure VPNs have three keyuses: secure remote access, secure site-to-site connections and secure extranetconnections.

 

Management believes that the market forsecurity systems and products providing VPN solutions has grown over the lastseveral years due to an increase in the use of the Internet for businesscommunications and electronic commerce applications such as work-at-homearrangements or telecommuting, electronic mail, satellite offices connected toa central computer, electronic funds transfer, electronic data interchange withclients, suppliers and business customers and numerous other arrangements.  The popularity and associated usage of theInternet has increased the requirements for VPN technology and products toensure secure “intra” and “inter” company communications.

 

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

** **

** **

**PRODUCTS**

 

SafeNet’s VPN technology and productofferings include software and hardware products, dedicated solutions, andembedded technology for the OEM market.

 

**SecureIPTechnologyTM**

SecureIP TechnologyTM is thecore technology that is at the heart of all SafeNet solutions andproducts.  Delivered in the form ofcomputer chips, plug-in boards, software modules, and intellectual property,SecureIP Technology provides the building blocks for security implementationthat enable organizations to use the Internet and other shared networks forsecure communications.  SecureIPTechnology is sold in the following form factors:

 

**EmbeddedIPTM**

EmbeddedIPTM is thestreamlined delivery of SafeNet SecureIP TechnologyTM foravailability to OEM developers, semiconductor developers, and technologyintegrators. EmbeddedIPTM is available for license in IP modules orblocks — whereby selected elements of the VPN encryption technology can beadapted in single or multiple implementations. This allows OEMs to incorporateselective blocks in their own ASICs or processors to allow for verycost-effective, high throughput, low power designs.  EmbeddedIP can be licensed in the following implementations:

•        EncryptionEngines: DES/3DES, RC4, Rijndael (AES)

•        HashEngines: SHA-1, MD5, RIPEMD-128/160

•        PacketEngines: IPSec, SSL, TLS, WTLS, IPcomp

•        PublicKey Accelerator

•        Entropybased True Random Number Generator (RNG)

•        DeflateCompression Engine

 

**SafeXcelTM**

SafeXcelTM is SafeNet’s siliconproduct line for OEM developers looking for embedded, acceleratedsecurity.  SafeXcel chips are separatedinto the Momentum Series (up to 100 Mbps), the Velocity Series (100 Mbps to 1Gbps), and the Gigabit Series. With the acquisition of Securealink, the SafeNet

 

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silicon product line includeshigh-performance ICs and privacy products for both IPSec and SSL encryption.  Announced SafeXcel chips include thefollowing:  SafeXcel-1140,SafeXcel-2141, SafeXcel-2142, SafeXcel-2020, SafeXcel-ISES, SafeXcel-306,SafeXcel-317, SafeXcel-318, SafeXcel-807, and SafeXcel-810.

 

**SafeXcelTMCards**

SafeXcelTM Cards are plug-in PCI boards thatprovide cryptographic throughput and acceleration for operations such asencryption, hashing, public key computations, key negotiation, signatures, andrandom number generation.  AnnouncedSafeXcel Cards include SafeXcel 241-PCI and SafeXcel 140-PCI.

 

**SoftIPTM**

SoftIPTM is the SafeNet software product linethat includes the remote access client, SoftRemoteTM.  Other software products include SoftRemoteLTTM for 802.11applications, SoftRemotePDATM for handheld portable devices, and SoftRemotePolicy Manager, for complete deployment and management of SoftRemote clients.

 

**CGXSecurity Platform**

The CGX Security Platform is anext-generation, integrated, security environment providing a single, easysolution for building encryption-based security systems. The Security Platform,the embodiment of over 18 years of encryption expertise, is a completeenvironment in which OEMs can build any type of encryption product.  The Platform brings a significant advantageto OEM developers by accelerating time to market, reducing development costs,and providing a system-level implementation of encryption technology.  With its flexibility, standalone software,and security hardware, entire security systems can be easily developed.

 

**SafeEnterpriseTM**

SafeEnterpriseTM is SafeNet’s enterpriseproduct line that integrates the full range of Internet security needs such asaccess control, encryption, user authentication, message authentication, andpolicy management.  SafeEnterprise isintended for large government and financial institutions that require a highlevel of strong and proven security technology.  The SafeEnterprise system consists of two client products(SafeNet SoftTM and SafeNet SmartTM) for remote access, a high performance gateway(SafeNet SpeedTM), and a centralized security management system, providingcomprehensive security in an easy-to-use, scaleable solution (SafeNet SecurityCenter).  SafeNet Security Centerincludes 3 levels of management systems and can also be utilized through aManaged VPN Service program.

 

Along with these products,SafeNet adds two encryptor products for leased line encryption. The SafeNetFrame Encryptor is the technology for enterprise-wide LAN-to-LAN, data sharingand client-server applications. It combines the advantages of circuit andpacket switched services with low latency. These properties make itparticularly suitable for LAN interconnections with bursty traffic with datarates up to 8 Mbps. It can handle a mix of clear and encrypted logical connectionssimultaneously.

 

The SafeNet Advanced Link Encryptor offershigh-end link encryption for data rates 9.6 kbps up to 45 Mbps, with a varietyof interfaces available. SafeNet algorithms and key management are designed forthe highest security, with up to true 256 bit key size.

 

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**PRODUCT DEVELOPMENT**

 

SafeNet conducts product developmentactivities to increase the size of its available market through broader productofferings and to reduce the cost of its products, resulting in more competitivepricing and/or better operating margins.

 

The VPN market, in its growth period, will becontinually looking for products that offer the strongest encryption and thefastest throughput.  We will continue todevote resources to the latest VPN technology to meet the increasing demands ofthe market.

 

**PRODUCT DESIGNSTANDARDS**

 

VPN security technologies are utilized bySafeNet to provide secure communication over public networks including theInternet.  This security technologyprovides selective access to computer networks, prevents electroniceavesdropping or alteration during electronic data transmission, providesmessage authentication confirming that messages are received in unaltered form,and enables user authentication and digital signatures verifying the identityof the message sender and limiting computer access to authorized users. Weoffer a choice of encryption algorithms to provide the level of networksecurity appropriate for each client application.

 

All of SafeNet’s network security systems andproducts comply with the following general product design standards:

 

**StandardsCompliance**

SafeNet’s policy is to offer products basedupon encryption algorithms that have been approved as industry and government standards,providing SafeNet’s clients assurance that they are using products that meetcommercial reasonability tests.

 

**NetworkCompatibility**

SafeNet’s systems and products containsufficient intelligence to accommodate the specific communication protocolsemployed by complex computer networks, including support for Frame Relay, DialAsynchronous, leased line, X.25, Bisync and Internet protocol-based networks.

 

**Interoperability**

Management believes the market opportunityfor VPN technology and products increases when vendors’ product offeringsbecome interoperable.  Our commitment tothe IPSec standard and multi-vendor interoperability is utilized in existingand planned product offerings.

 

**Ease of Use**

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

 

**Ease ofMangement and Administration**

SafeNet has extended its ease of use conceptto the policy management of its most widely deployed client, SafeNetSoftRemote.  The SoftRemote PolicyManager is a Windows-based application that simplifies deployment of allversions of SafeNet SoftRemote and enables centralized management of securitypolicies.

 

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**PricePerformance Criteria**

SafeNet believes that in order for clients toinvest in encryption technology, its products must be implemented costeffectively. As such, our development staff follows a design approach similarto that used with consumer electronics products that are designed for lowmanufacturing cost.

 

**EncryptionAlgorithms**

At present, SafeNet’s products employ a varietyof encryption algorithms including the Advanced Encryption Standard (AES), U.S.Government Triple Data Encryption Standard, (“TDES”) and Single DES, RSA DataSecurity Inc. Encryption Standard, (“RSA”).

 

**CUSTOMERS**

 

During 2001, SafeNet announced relationshipswith the following Customers:

 

**Adtran**

In November 2001, Adtran licensed SafeNetSoftRemoteTM.  Adtran is using SoftRemoteas the NetVanta VPN Client, rounding out its VPN solution to provide a remoteaccess client product that will serve the company’s enterprise customers.

 

**Samsung**

Samsung licensed EmbeddedIPTM, SafeNet’slicense-ready intellectual property. Samsung is incorporating EmbeddedIPTM in its products including customASICs, System-on-Chip (SOCs), ARM-based cores, networking products, wireless products,and smart cards.

 

**Watchguard**

In May 2001, SafeNet announced thatWatchguard is integrating SafeNet’s SafeXcel 140-PCI Card for its Firebox 4500for hardware acceleration.

 

**Corrent**

Corrent is using SafeNet’s CGX SecurityPlatform, a next-generation, integrated, security environment, to assist in thedevelopment of high-speed processors for the security market.

 

**TexasInstruments**

In May 2001, SafeNet announced that it hasbeen chosen to partner with Texas Instruments (“TI”) to provide a new wirelesssecurity library for next generation (2.5 and 3G) wireless devices. SafeNet’sencryption technology, combined with TI’s DSP-based OMAPTM family of processors,will enable the strongest security for next generation wireless devicesincluding personal digital assistants, cell phones, and pagers.

 

**WorldCom(UUNet)**

In April 2001, SafeNet announced that UUNethad licensed SafeNet’s VPN client for use with the new UUSecure Dial-UpService, offering remote access users a way to connect securely over theInternet.

 

**CentilliumCommunications**

In January 2001, Centillium licensedSafeNet’s EmbeddedIPTM to provide a next-generation DSL encryptionsolution for manufacturers of telecommunications equipment. EmbeddedIPTMis enabling Centillium to integrate market-leading security with its broadbandnetworking products.  Centillium iscurrently shipping DSL chips with SafeNet’s EmbeddedIPTM.

 

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**IRS**

In January 2001, SafeNet announced that theInternal Revenue Service (IRS) had enrolled its 15,000th employee using SafeNet’sVPN technology to protect its Secure Dial-In (SDI) program, an enterprise-widecommunications system that supports virtually every division within theagency.  The program is currently over20,000 enrolled users.

 

**NetMAX:**

On January 8, 2001 NetMAXTM, a division ofCybernet Systems Corporation, licensed SafeNet’s VPN client to provide theircustomers with a best-of-class remote access solution that featuresease-of-use, robust security functionality, and compatibility with all WindowsTMoperating systems.

 

In 2001, one commercial client of the ProductGroup accounted for 11% of the Company’s consolidated revenue (see Note 11 tothe audited consolidated financial statements).

 

**SALES AND MARKETING**

 

**Sales**

SafeNet has continued to sell through both directsales and indirect distribution channels in order to expand worldwide salescoverage.  In North America, in additionto direct sales, we sell our products primarily through Value Added Resellersand Original Equipment Manufacturers. In Europe, we sell our products through a direct sales force. Outside ofsuch territories, we sell our products through distributors of communication orinformation security products. A global sales organization provides support forthese distribution channels. OEM sales efforts are sold through partners anddirect sales.

 

**Marketing**

SafeNet continued itsinitiative of branding the company and strengthening its leadership positionwith a strong marketing presence.

 

SafeNet began the year 2001 asa leading player in the VPN market and launched the Secure Tour to establishSecureIP TechnologyTM as a leading brand for secure e-businesscommunications.  The Secure Tour was ahigh profile national tour dedicated to educating the public about security andpromoting the Company’s leading software and silicon technology. During 2001,SafeNet increased it corporate web presence and e-commerce capabilities, whichresulted in an over 250% increase in the web sales of its software client.

 

Beginning in January 2002,SafeNet continued to broaden its brand with the acquisition and rebranding ofSecurealink and the opening of a new sales office in Switzerland, operating asSafeNet AG.

 

SafeNet’s marketing program also continuedlead generation and increased coverage of SafeNet’s technology and products inleading trade publications. We increased our emphasis on developing awarenessof the SafeNet brand through our public relations efforts and joint marketingarrangements with our strategic partners. SafeNet also increased its use of direct marketing programs throughemail, direct mail, and web-based promotions. We instituted processes to ascertain the requirements of our existingand prospective end-user and OEM customers. Our success in embedding our technology in leading networking vendors’products has helped us to gain market awareness.  SafeNet will continue its endeavor to co-brand SafeNet technologywith industry leaders to increase market awareness.

 

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**CLIENT SUPPORT ANDPRODUCT WARRANTIES**

 

SafeNet provides support for clients througha staff of support engineers knowledgeable in both SafeNet’s network securitysystems and products and complex computer networks. In addition to supportingclients, this group of engineers performs system level quality assurancetesting of new products and product enhancements.  SafeNet provides client telephone support, including 24 hour aday “hot line” support. In addition, we offer on-site training, installation andtrouble-shooting services, generally on a fee basis.

 

SafeNet provides limited warranties on itsproducts for one year upon delivery of the product. After warranty expiration,clients may purchase an extended warranty support contract. This contractextends warranty service for an additional one-year period, providing repair orreplacement of defective products and telephone support. We also offer supporton a time and materials basis.

 

**MANUFACTURING ANDINVENTORY**

 

Components for SafeNet’s products arepurchased from a limited number of electronic parts manufacturers anddistributors. Electronic assembly firms are used to mount components ontoprinted circuit boards according to designs and instructions provided bySafeNet’s engineers. Since the components are readily available from other suppliersand since there are several electronic assembly firms available, a change insuppliers or assemblers would not have a material effect on SafeNet’soperations. However, while we have not experienced any significant supplyproblems in the past, it is possible that in the future we may encountershortages in parts, components, or other elements vital to the manufacture,production and sale of products.

 

SafeNet anticipates that it will continue toutilize qualified suppliers and electronic assembly firms to producesub-assemblies. We presently perform system integration, final assembly andtesting which consists of assembling the cases containing the productcomponents, attaching integrated circuits which contain the specific computerinstructions and algorithms to printed circuit boards, labeling, adding serialnumbers, testing, packaging, and shipping. SafeNet has and will continue toutilize contract manufacturers for products requiring high volume production.

 

While SafeNet and Analog Devices, Inc. (“ADI”)jointly developed the SafeNet DSP, ADI will be the manufacturer and point ofprocurement for the chip.  We may seekother partners similar to ADI for future product manufacturing andprocurements.

 

**COMPETITION**

 

The VPN market is highly competitive and subjectto rapid technological changes. SafeNet believes that competition in thismarket is likely to intensify as a result of increasing demand for Internetsecurity technology and products. There are several companies in this fieldthat have been established longer than SafeNet, and have greater financial,research, service support and marketing resources than those of SafeNet. Thereare also a number of other hardware and software data encryption methods andsecurity technologies on the market, which compete with our products.

 

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

 

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If the VPN market continues to develop, itwill likely be characterized by rapid advances in technology and new productsthat could render the existing technology upon which SafeNet’s technology andproducts are based less competitive. However, we believe that our core technology will be the basis forfuture product offerings in the years to come. This risk will increase to theextent that our competitors include manufacturers of computer equipment andInternet appliances to which our products relate, since such manufacturers maybe in a better position than us to develop security products in anticipation ofdevelopments in their computer equipment.

 

**PATENTS ANDINTELLECTUAL PROPERTIES**

 

Between 1996 and 2001, SafeNet was awardedseven United States Patents covering cryptographic key management, kernel modeprotection, key recovery schemes, portable encrypting and authenticatingnetwork interface devices, such as modems. The patents provide SafeNet withownership rights to a technology that SafeNet believes will be critical to thegrowth of computer networks, such as the Internet. The patents cover ourSafeXcel chips, CGX Security Platform, SafeNet Dial and the AX400.  Additional domestic and foreign patentapplications, which cover the same products and technology, as well asadditional EmbeddedIP product offerings are pending.

 

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

 

The computer software source codes, which areessential elements of SafeNet’s products, are the proprietary trade secrets ofand are copyrighted by SafeNet. The protection of proprietary technology andinformation developed by us will be limited to such protection as we may beable to secure pursuant to trade secret or copyright laws or under anyconfidentiality agreements which we may enter. SafeNet owns federallyregistered trademarks for SafeNet name and for certain of its products;however, there is no assurance as to the validity, enforceability or lack ofinfringement of such trademarks.

 

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

 

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

 

**EMPLOYEES**

 

As of March 8, 2002, SafeNet had 139employees, of whom 9 are engaged in assembly and quality control, 19 inadministration and financial control, 75 in engineering, development and clientsupport, and 36 in marketing and sales. SafeNet employs 87 employees in theUnited States, 35 employees in the Netherlands, and 17 employees inSwitzerland.

 

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**RISK FACTORS**

 

We operate in a rapidly changing environmentthat involves numerous risks, some of which are beyond our control.  The following discussion highlights some ofthe risks we face.

 

**We Have aHistory of Losses And May Incur Future Losses**

We have experienced substantial net losses infour of the last five years, including 2001. As of December 31, 2001, we had anaccumulated deficit of $15,486,000. Although our revenues are subject tofluctuation, we intend to maintain or increase our expenditures in all areas inorder to execute our business plan. As a result, we may incur substantialadditional losses. The likelihood of our success must be considered in light ofthe problems, expenses and delays frequently encountered in connection with newtechnologies utilized with the transition to an Internet VPN business and thecompetitive environment in which we operate. You should not consider ourhistorical results indicative of future revenue levels or operatingresults.  We can neither give assurancethat we will operate profitably in the future nor that we may sustainprofitability if it is achieved.

 

**Riskof Integrating Recently Acquired Company**

On January 2, 2002, we acquiredPijnenburg Securealink, Inc. (Securealink), a European manufacturer of securitychips for e-commerce transactions. We expect this acquisition to facilitate ourgrowth in the silicon and intellectual property aspects of our business throughaccess to a full fabless semiconductor business model with in-house design andcustomer fulfillment, and the fortified support of SafeNet’s key Europeanwireless customers.

 

The acquisition of Securealinkinvolves various risks, including:

 

•        Difficulties in integrating theoperations, technologies, and products of Securealink;

•        The risk of diverting management’sattention from normal daily operations of the business;

•        Potential difficulties in completingprojects associated with in-process research and development;

•        Risks of entering markets in which wehave no or limited direct prior experience and where competitors in suchmarkets have stronger market positions;

•        Initial dependence on unfamiliar supplychains or relatively small supply partners;

•        Insufficient revenues to offsetincreased expenses associated with the acquisition;

•        The potential loss of key employees ofSecurealink.

 

There can be no assurance that ouracquisition of Securealink will be successful and will not materially adverselyaffect our business, operating results, or financial condition. We must alsomanage any growth resulting from the acquisition effectively. Failure to managesuch growth effectively and successfully integrate Securealink’s operations couldhave a material adverse effect on our business and operating results.

 

**OurQuartely Operating Results May Fluctuate and Our Future Revenues andProfitability Are Uncertain**

We have experienced significantfluctuations in our quarterly operating results and anticipate continuedsubstantial fluctuations in our future operating results. Anumber of factors have contributed to these quarterly fluctuations including:

 

•        Marketacceptance and demand for our products;

•        Lengthof sales cycle including the size, timing, cancellation or delay of customerorders;

•        Introductionof new products and product enhancements by us or our competitors;

•        Marketacceptance of new products introduced by us or our competitors;

•        Budgetingcycles of customers;

•        Thetiming and execution of individual contracts;

 

12

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•       The product mix sold in a given quarter;

•       Changes in the percentage of revenuesattributable to OEM license fees and royalties;

•       Length of time required by OEM’s to embedour products into their products which generate royalties to the Company;

•       The percentage of products sold throughour direct sales force and our indirect distribution channels;

•       Product development expenses;

•       Competitive conditions in the industry;

•       Changes in general economic conditions.

 

Our expenses are based, inpart, on our expectations regarding future revenues, and are largely fixed innature, particularly in the short-term. We may be unable to predict our futurerevenues accurately or to adjust spending in a timely manner to compensate forany unexpected revenue shortfall. Accordingly, any significant shortfall ofrevenues in relation to our expectations could cause significant declines inour quarterly operating results.

 

Due to all of the foregoingfactors, our quarterly revenues and operating results are difficult toforecast. Therefore, we believe that period-to-period comparisons of ouroperating results will not necessarily be meaningful, and you should not relyupon them as an indication of our future performance.  Also, it is likely that our operating results will fall below ourexpectations and the expectations of securities analysts or investors in somefuture quarter. In such event, the market price of our common stock could bematerially adversely affected.

 

**Risksof Changes in Technology and Industry Standards**

The network security industryis characterized by rapid changes, including evolving industry standards,frequent new product introductions, continuing advances in technology andchanges in customer requirements and preferences. We expect technologicaldevelopments to continue at a rapid pace in the computer and communicationsindustries, and there can be no assurance that technological developments willnot cause our technology to be rendered obsolete or non-competitive.  However, we believe that our core technologywill be the basis for future product offerings in the years to come.

 

Our future products may notkeep pace with technological changes implemented by competitors, developers ofoperating systems or networking systems, or persons seeking to breach networksecurity. The introduction of new technologies could also require us to investin research and development at much higher rates with no assurance ofdeveloping competitive products. Changes in technologies or customerrequirements may also cause the development cycle for our new products to besignificantly longer than our historical product development cycle, resultingin higher development costs or a loss in market share. Our products may notsatisfy evolving preferences of customers and prospects. Failure to develop andintroduce new products and improve current products in a timely fashion couldadversely affect us. Because of the complexity of our products, which operateon or utilize multiple platforms and communications protocols, we have fromtime to time experienced delays in introducing new products and productenhancements primarily due to development difficulties or shortages ofdevelopment personnel. There can be no assurance that we will not experiencelonger delays or other difficulties that could delay or prevent the successfuldevelopment, introduction or marketing of new products or product enhancements.

 

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**Restrictionson the Export of Some of Our Products.**

We currently sell our productsinternationally and intend to continue to expand our relationships withinternational distributors and resellers. Our international sales andoperations could be subject to the following risks:

 

•        Theimposition of governmental controls;

•        Exportlicense requirements;

•        Restrictionson the export of critical technology;

•        Traderestrictions;

•        Changesin tariffs.

 

Some of our network securityproducts are cryptographic devices and are subject to the export restrictionsadministered by the Bureau of Export Control, U.S. Department of Commerce.These restrictions permit the export of encryption products based on country,algorithm and class of end-user. They prohibit the export of encryptionproducts to a number of countries and to business entities that are notincluded in a range of end-users. There is no assurance, however, that theapplicable regulations or policies concerning the export of such technologywill not become more restrictive. Our foreign distributors may also be requiredto secure licenses or formal permission before encryption products can beimported.

 

**WeFace Intense Competition**

Our industry is relatively new, highlycompetitive and subject to rapid technological changes. Our success willdepend, in large part, on our ability to establish and maintain an advantageous market position. Wecurrently compete with companies that have substantially greater financialresources, sales and marketing organizations, market penetration and researchand development capabilities, as well as broader product offerings and greatermarket presence and name recognition. We expect to face increasing competitivepressures from our current competitors and new market entrants. Thiscompetitive risk will increase to the extent that our competitors begin toinclude software vendors, network providers, and manufacturers of networkingand computer equipment and communication devices. These manufacturers andnetwork providers may be in a better position to develop security products inanticipation of developments in their products and networks. Competitivefactors in the VPN market include:

 

•        Standards compliance;

•        Productquality and reliability;

•        Technicalfeatures;

•        Productease of use;

•        Networkcompatibility;

•        Clientservice and product support;

•        Distribution;

•        Price.

 

There can be no assurance thatwe can continue to compete successfully against new or existing competitors.

 

**MarketConsolidation May Create More Formidable Competitors**

There has been substantialconsolidation in the information security industry, and we expect that therewill be significant additional consolidation in the near future. As a result ofthat increasing consolidation, we expect that we will increasingly compete withlarger firms that have broader product offerings and greater financialresources. We believe that such competition may have a significant negativeeffect on our current and developing collaborative, marketing, distribution andreselling relationships, our product pricing and our product development budgetand capabilities. Any of those negative effects can significantly impair ourfinancial condition and our results of operations.

 

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**Riskof Inadequate Protection for Our Proprietary Technologies**

Our success and ability tocompete is dependent, in part, upon our ability to maintain the proprietarynature of our technologies. We rely on a combination of patent, trade secret,copyright and trademark law and nondisclosure agreements to protect ourproprietary technology. Although we hold several patents and have severalpending patent applications that cover certain aspects of our technology, suchpatents and patent applications do not protect some of our security products.Our current and future patent applications may not be granted. Additionally,our patents may not be broad enough to protect the core technology critical toour security products.

 

Confidentiality agreements andother methods on which we rely to protect our trade secrets and proprietaryinformation and rights may not be adequate to protect our proprietary rights.Litigation to defend and enforce our intellectual property rights could resultin substantial costs and diversion of resources and could have a materialadverse effect on our financial condition and results of operations regardlessof the final outcome of such litigation. Despite our efforts to safeguard andmaintain our proprietary rights, we may not be successful in doing so or thesteps taken by us in this regard may not be adequate to deter misappropriationor independent third-party development of our technology or prevent anunauthorized third party from copying or otherwise obtaining and using ourproducts, technology or other information that we regard as proprietary. Ourtrade secrets or non-disclosure agreements may not provide meaningfulprotection of our proprietary information. Also, others may independentlydevelop similar technologies or duplicate any technology developed by us. Ourinability to protect our proprietary rights would have a material adverseeffect on our financial condition and results of operations.

 

Further, as the number ofnetwork security products in the industry increases and the functionality ofthese products further overlaps, we may become subject to claims ofinfringement or misappropriation of the intellectual property or proprietaryrights of others. Third parties could assert infringement or misappropriationclaims against us in the future with respect to current or future products. Wemay also be subject to additional risks as we enter into transactions incountries where intellectual property laws are not well developed or are poorlyenforced. Legal protections of our rights may be ineffective in such countries,and technology developed in such countries may not be protected injurisdictions where protection is ordinarily available. Any claims orlitigation, with or without merit, could be costly and could result in adiversion of management’s attention, which could have a material adverse effecton our financial condition and results of operations. Adverse determinations insuch claims or litigation could also have a material adverse effect on ourfinancial condition and results of operations.

 

**RisksRelating to Evolving Distribution Channels**

We rely on both our directsales force and an indirect channel distribution strategy for the sale andmarketing of our products. Our sales and marketing organization may be unableto successfully compete against the more extensive and well-funded sales andmarketing operations of certain of our current and future competitors.  We may also be unable to continue to attractintegrators and resellers that can market our legacy products effectively andprovide timely and cost-effective customer support and service. Additionally,our distributors, integrators and resellers may carry competing lines ofnetwork security solutions. The loss of important sales personnel,distributors, integrators or resellers could adversely affect us.

 

**Risk ofProduct Development Delays**

We may experience schedule overruns inproduct development triggered by factors such as insufficient staffing or theunavailability of development-related software, hardware or technologies.Further, when developing newnetwork security products, our development schedules may be altered asa result of the discovery of software bugs, performance problems or changes tothe product specification in response to customer requirements, technology marketdevelopments or self-initiated 

 

15

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changes. All of these factors can cause aproduct to enter the market behind schedule, which may adversely affect marketacceptance of the product or place it at a disadvantage to a competitor’sproduct that has already gained market share or market acceptance during thedelay.

 

**ProductLiability Risk**

The sale and installation of our networksecurity systems and products within the computer networks of our customers andthe operation of our SafeNetTM facility entails a risk of product failure,product liability or other claims. An actual or perceived breach of network orcomputer security, regardless of whether such breach is attributable to ourproducts, could adversely affect our reputation and our financial condition orresults of operations. The complex nature of our products can make thedetection of errors or failures difficult when products are introduced. Iferrors or failures are subsequently discovered, this may result in delays andlost revenues during the correction process. A malfunction or the inadequatedesign of our products could result in product liability claims.  We attempt to reduce the risk of such lossesthrough warranty disclaimers and liability limitation clauses. However, we maynot have obtained adequate contractual protection in all instances or whereotherwise required under agreements we have entered into with others.

 

We currently maintain product liabilityinsurance. However, our insurance coverage may not be adequate and any productliability claim for damages resulting from security breaches could besubstantial. In the event of product liability litigation, insufficientinsurance coverage could have a material adverse effect on our financialcondition and results of operations. Further, certain customers and potentialcustomers may require minimum product liability insurance coverage as acondition precedent to purchasing our products. Failure to satisfy suchinsurance requirements could impede our ability to achieve product sales, whichwould have a material adverse effect on our financial condition and results ofoperations. There is no assurance that such insurance will be available at areasonable cost or will be sufficient to cover all possible liabilities.

 

**DependenceUpon Third Party Suppliers and Contractors**

We rely upon third party contractors for themanufacture of components and sub-assemblies for our products. There is noassurance that we will be able to obtain and/or maintain satisfactorycontractual relations with qualified vendors or suppliers. The unavailabilityof such third parties may substantially decrease our control of the cost,quality and timeliness of the manufacturing process. At present, we are not aparty to any exclusive supply contracts with third party contractors for ourlegacy products. All purchases of components or parts for our products areaccomplished by the use of purchase orders issued in the ordinary course ofbusiness. While we have not experienced any significant supply problems in thepast, and there have been no materially late deliveries of components or parts,it is possible that in the future we may encounter shortages in parts,components, or other elements vital to the manufacture, production and sale ofour products. Our business would suffer if the supply of such components wereinterrupted.

 

**We DependUpon Key Personnel**

The network security industry is highlyspecialized and the competition for qualified employees is intense. We expectthis to remain so for the foreseeable future. We believe our success dependssignificantly upon a number of key technical and management employees, and uponour ability to retain and hire additional key personnel.  The loss of the services of key personnel orthe inability to attract additional qualified personnel could materially andadversely affect our results of operations and product development efforts. Wemay be unable to achieve our revenue and operating performance objectivesunless we can attract and retain technically qualified and highly skilledengineers, sales, technical, marketing, and management personnel. Suchpersonnel are particularly important to our research and development efforts,where we employ a large number of technical personnel holding advanced degrees.Further, additions of new and departures of existing personnel, particularly inkey positions, can be disruptive and can result in further departures of ourpersonnel, which could in turn harm our business and results of operation.

 

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In 1997, we entered into a five-yearemployment agreement with Anthony A. Caputo, our Chairman, Chief ExecutiveOfficer and President.  However, we havenot historically provided such types of employment agreements to our otheremployees. This may adversely impact our ability to attract and retain thenecessary technical, management and other key personnel.

 

**We Do NotPay Dividends**

We have never paid nor declared any cash orother dividends on our common stock since our inception and we do not presentlyanticipate that dividends will be paid on our common stock in the foreseeablefuture.

 

**PART II**

** **

**ITEM 2 — PROPERTIES**

 

SafeNet maintains its corporate andadministrative facilities at 8029 Corporate Drive, Baltimore, Maryland. Thebuilding, constructed in 1988, has approximately 25,000 square feet and is alsoused for SafeNet’s executive headquarters, United States production and SafeNetTrusted Services facilities. The lease, which expires in June 2003, providesfor annual increases in rentals during each year of the lease and will requireus to pay approximately $213,000 in 2002.

 

GDS leases approximately 20,000 square feetfor its administrative and production facilities in Regensdorf, Switzerland.The lease, which expires on December 31, 2003, calls for an annual rental ofapproximately $241,000.

 

SafeNet BV leases approximately 4,000 squarefeet for its operations in Vught, The Netherlands.  The lease, which expires on March 31, 2007, requires annualrental of approximately $150,000.

 

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

 

**ITEM 3 — LEGAL PROCEEDINGS**

 

SafeNet knows of no litigationor proceeding, pending or threatened, to which SafeNet is or may become aparty.

 

**ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

There were no matters submittedto the vote of Security Holders, through the solicitation of proxies orotherwise, during the fourth quarter of the fiscal year covered by this report.

 

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**ITEM 5 — MARKET FOR COMMON EQUITY AND RELATEDMATTERS**

 

SafeNet’s Common Stock islisted on the Nasdaq National Market under the symbol SFNT.  The following table sets forth the quarterlyrange of per share high and low bid prices for SafeNet’s Common Stock asreported by the Nasdaq National Market for the periods indicated.

 
|           |   | **High** |   | **Low** |   |
|----------------|--------|----------|--------|---------|--------|
| **2002:**      |   |     |   |    |   |
| First Quarter  |   | $        | 19.41  |    | $      | 9.70 |   |
| **2001:**      |   |     |   |    |   |
| Fourth Quarter |   | 19.71    |   | 5.81    |   |
| Third Quarter  |   | 10.10    |   | 5.81    |   |
| Second Quarter |   | 17.55    |   | 7.10    |   |
| First Quarter  |   | 64.69    |   | 10.75   |   |
| **2000:**      |   |     |   |    |   |
| Fourth Quarter |   | 53.50    |   | 22.31   |   |
| Third Quarter  |   | 39.50    |   | 24.75   |   |
| Second Quarter |   | 36.25    |   | 14.13   |   |
| First Quarter  |   | 44.56    |   | 19.81   |   |
|                |        |          |        |         |        |  |  |

 

On March 14, 2002, the lastreported per share sale price of SafeNet’s Common Stock on the Nasdaq NationalMarket was $12.65.  As of that date,there were approximately 114 holders of record of the Common Stock and 2,500beneficial holders of the Common Stock. We have not paid dividends on ourCommon Stock and intend for the foreseeable future to retain earnings, if any,to finance the expansion and development of our business.

 

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**ITEM6 — SELECTED FINANCIAL DATA**

 

The selected financial data setforth below as of and for each of the five years ended December 31, 2001 isderived from our audited financial statements. The selected financial data is qualified by and should be read inconjunction with the Consolidated Financial Statements and Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded elsewhere herein

 
|                                         |   | **Year Ended December 31,**                  |   |
|----------------------------------------------|--------|----------------------------------------------|--------|
|                                         |   | **2001**                                     |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
|                                         |   | **(In thousands, except per share amounts)** |   |
| Revenues                                     |   | $                                            | 18,127 |   | $ | 28,826 |   | $ | 18,927 |   | $ | 23,242 |   | $ | 16,007 |   |
| Cost of revenues                             |   | 6,482                                        |   | 7,663 |   | 7,228 |   | 9,793 |   | 6,971 |   |
| Gross profit                                 |   | 11,645                                       |   | 21,163 |   | 11,699 |   | 13,449 |   | 9,036 |   |
| Research and development expenses            |   | 7,400                                        |   | 7,381 |   | 5,851 |   | 4,625 |   | 3,756 |   |
| Sales and marketing expenses                 |   | 6,290                                        |   | 5,945 |   | 6,524 |   | 7,312 |   | 6,720 |   |
| General and administrative expenses          |   | 2,789                                        |   | 3,643 |   | 2,730 |   | 2,944 |   | 2,571 |   |
| Amortization of acquired intangible assets   |   | 85                                           |   | 85 |   | 94 |   | 122 |   | 122 |   |
| Reserve for (recovery of) Cyberguard advance |   | —                                       |   | (275 | ) | (375 | ) | 772 |   | — |   |
| Total operating expenses                     |   | 16,564                                       |   | 16,779 |   | 14,824 |   | 15,775 |   | 13,169 |   |
| Operating income (loss)                      |   | (4,919                                       | )      | 4,384 |   | (3,125 | ) | (2,326 | ) | (4,133 | )  |
| Interest income                              |   | 1,357                                        |   | 1,373 |   | 150 |   | 259 |   | 495 |   |
| Income (loss) before income taxes            |   | (3,562                                       | )      | 5,757 |   | (2,975 | ) | (2,067 | ) | (3,638 | )  |
| Income taxes                                 |   | —                                       |   | — |   | 85 |   | 319 |   | — |   |
|                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Net income (loss)                            |   | $                                            | (3,562 | ) | $ | 5,757 |   | $ | (3,060 | ) | $ | (2,386 | ) | $ | (3,638 | )  |
|                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Net income (loss) per common share           |   |                                         |   |   |   |   |   |   |   |   |   |
| Basic                                        |   | $                                            | (0.50  | ) | $ | 0.85 |   | $ | (0.56 | ) | $ | (0.44 | ) | $ | (0.67 | )  |
| Diluted                                      |   | $                                            | (0.50  | ) | $ | 0.80 |   | $ | (0.56 | ) | $ | (0.44 | ) | $ | (0.67 | )  |
|                                         |   |                                         |   |   |   |   |   |   |   |   |   |
| Shares used in computation                   |   |                                         |   |   |   |   |   |   |   |   |   |
| Basic                                        |   | 7,057                                        |   | 6,751 |   | 5,504 |   | 5,409 |   | 5,462 |   |
| Diluted                                      |   | 7,057                                        |   | 7,194 |   | 5,504 |   | 5,409 |   | 5,462 |   |
|                                         |   |                                         |   |   |   |   |   |   |   |   |   |
|                                         |   | **At December 31,**                          |   |
|                                         |   | **2001**                                     |   | **2000** |   | **1999** |   | **1998** |   | **1997** |   |
| Balance Sheet Data:                          |   |                                         |   |   |   |   |   |   |   |   |   |
| Working capital                              |   | $                                            | 32,385 |   | $ | 33,695 |   | $ | 23,035 |   | $ | 11,081 |   | $ | 12,499 |   |
| Intangible assets                            |   | 1,043                                        |   | 1,993 |   | 2,593 |   | 2,159 |   | 2,365 |   |
| Total assets                                 |   | 39,878                                       |   | 43,106 |   | 31,896 |   | 18,940 |   | 21,531 |   |
| Stockholders' equity                         |   | 35,459                                       |   | 37,723 |   | 27,636 |   | 15,400 |   | 17,980 |   |
|                                              |        |                                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**QUARTERLYRESULTS OF OPERATIONS**

 

The following is a summary of the quarterlyresults of operations for the years ended December 3l, 2001 and 2000.  (Unaudited — In thousands, except per shareamounts):

 
|                            |   | **2001 Quarter Ended** |   | **2000 Quarter Ended** |   |
|---------------------------------|--------|------------------------|--------|------------------------|--------|
|                            |   | **March 31**           |   | **June 30**            |   | **Sept. 30** |   | **Dec. 31** |   | **March 31** |   | **June 30** |   | **Sept. 30** |   | **Dec. 31** |   |
| Revenues                        |   | $                      | 6,013  |                   | $      | 3,500 |   | $ | 4,074 |   | $ | 4,540 |   | $ | 5,838 |   | $ | 6,471 |   | $ | 7,633 |   | $ | 8,884 |   |
| Cost of revenues                |   | 1,726                  |   | 2,116                  |   | 1,181 |   | 1,459 |   | 1,700 |   | 1,630 |   | 2,019 |   | 2,314 |   |
| Gross profit                    |   | 4,287                  |   | 1,384                  |   | 2,893 |   | 3,081 |   | 4,138 |   | 4,841 |   | 5,614 |   | 6,570 |   |
| Operating income (loss)         |   | 6                      |   | (3,140                 | )      | (1,003 | ) | (782 | ) | 126 |   | 536 |   | 1,475 |   | 2,247 |   |
| Net income (loss)               |   | $                      | 431    |                   | $      | (2,775 | ) | $ | (717 | ) | $ | (501 | ) | $ | 357 |   | $ | 841 |   | $ | 1,873 |   | $ | 2,686 |   |
| Earnings (Loss)  Per Share |   |                   |   |                   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted                         |   | $                      | 0.06   |                   | $      | (0.39 | ) | $ | (0.10 | ) | $ | (0.07 | ) | $ | 0.05 |   | $ | 0.13 |   | $ | 0.28 |   | $ | 0.39 |   |
| Basic                           |   | $                      | 0.06   |                   | $      | (0.39 | ) | $ | (0.10 | ) | $ | (0.07 | ) | $ | 0.05 |   | $ | 0.12 |   | $ | 0.26 |   | $ | 0.36 |   |
| Shares used in computation      |   |                   |   |                   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                           |   | 6,999                  |   | 7,059                  |   | 7,079 |   | 7,092 |   | 6,611 |   | 6,669 |   | 6,802 |   | 6,909 |   |
| Diluted                         |   | 7,465                  |   | 7,059                  |   | 7,079 |   | 7,092 |   | 7,343 |   | 7,011 |   | 7,249 |   | 7,390 |   |

 

**ITEM 7 — MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Except for historicalinformation contained herein, the statements in this Item are forward-looking statementsthat are made pursuant to the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995. Forward-looking statements involve known andunknown risks and uncertainties, which may cause SafeNet’s actual results infuture periods to differ materially from forecasted results. Those risksinclude, among others, risks associated with the receipt and timing of futurecustomer orders, price pressures, achieving technical and product developmentmilestones, the ability to negotiate favorable strategic OEM agreements,sufficient cash flow to support SafeNet’s liquidity requirements, othercompetitive factors leading to a decrease in anticipated revenues and grossprofit margins and product development expenses.

 

**OVERVIEW**

 

SafeNet designs, manufacturesand markets enterprise network security solutions using encryption technology.Our products are used in electronic commerce applications by financialinstitutions, government agencies and large corporations to secure datatransmissions on private and public computer networks, such as the Internet.Our European operations design, manufacture and market cryptographic equipmentprimarily in Switzerland and Europe.  InFebruary 2002, management decided to discontinue our Swiss operations at GDS, ourEuropean operations segment (see note 14 to the audited financial statements).

 

However, in January 2002, weacquired Securealink, Inc., a Delaware Corporation primarily engaged in themanufacture of security chips for e-commerce transactions through its Europeansubsidiary (see note 13 to the audited financial statements). Securealinkdevelops, markets and sells security chips and intellectual property, primarilyin Europe and Asia.

 

SafeNet’s historical operatingresults have been dependent on a variety of factors including, but not limitedto, the length of the sales cycle, the timing of orders from and shipments toclients, product 

 

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development expenses and thetiming of development and introduction of new products. Our expense levels arebased, in part, on expectations of future revenues. The size and timing of ourhistorical revenues have varied substantially from quarter to quarter and yearto year. Accordingly, the results of a particular period, or period-to-periodcomparisons of recorded sales and profits may not be indicative of futureoperating results.

 

While management is committedto the long-term profitability of SafeNet, the recent growth of the computersecurity industry has made it important that market share be obtained. We haveundertaken various strategies in order to increase our revenues and improve ourfuture operating results, including new product offerings such as our SafeNetEmbeddedIP and SafeNet Soft Remote. Management believes that growth in themarket for products that provide secure remote access to computer networksrequires SafeNet to increase its investment in development, sales and marketingactivities to allow SafeNet to take advantage of this market opportunity and toachieve long-term profitability, thereby maximizing shareholder value. However,there can be no assurance that these strategies will be successful.

 

**RESULTS OFOPERATIONS OF SAFENET**

 

The following table sets forthcertain Consolidated Statement of Operations data of SafeNet as a percentage ofrevenues for the years ended December 31:

 
|                                       |   | **2001** |   | **2000** |   | **1999** |       |
|--------------------------------------------|--------|----------|--------|----------|--------|----------|------------|
| Revenues                                   |   | 100      | %      | 100      | %      | 100      | %          |
| Cost of revenues                           |   | 36       |   | 27       |   | 38       |       |
| Gross profit                               |   | 64       |   | 73       |   | 62       |       |
|                                       |   |     |   |     |   |     |       |
| Research and development expenses          |   | 41       |   | 26       |   | 31       | ** ** |
| Sales and marketing expenses               |   | 35       |   | 21       |   | 34       |       |
| General and administrative expenses        |   | 15       |   | 12       |   | 15       | ** ** |
| Amortization of acquired intangible assets |   | —   |   | —   |   | —   |       |
| Recovery of CyberGuard advance             |   | —   |   | (1       | )      | (2       | )          |
| Total operating expenses                   |   | 91       |   | 58       |   | 78       |       |
| Operating income (loss)                    |   | (27      | )      | 15       |   | (16      | )          |
| Interest income, net                       |   | 7        |   | 5        |   | 1        |       |
| Income (loss) before income taxes          |   | (20      | )      | 20       |   | (15      | )          |
| Income taxes                               |   | —   |   | —   |   | 1        |       |
| Net income (loss)                          |   | (20      | )%     | 20       | %      | (16      | )%         |

 

The Company has threee reportable segments:products, chips and software designed and manufactured in the United States forsale to companies that will embed the Company’s products into their productsfor ultimate sale to end-users ("Technology Operations"), networksecurity products designed and manufactured in the United States for directsales to end-users ("Product Operations"), and network securityproducts designed and manufactured outside the United States ("EuropeanOperations"). The segments are strategic business units that offerdifferent products. The segments are managed separately because each segmentrequires different technology and marketing strategies (see Note 10 to theaudited consolidated financial statements).

 

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

Revenues decreased 37%, or$10,699,000, to $18,127,000 for the period ended December 31, 2001, from$28,826,000 in 2000.  The TechnologyOperations revenues decreased 52% or $8,370,000 due to the adverse impact of theeconomic slowdown on customers, causing them to delay purchases of softwarelicenses and upgrades, and accelerator boards. The Product Operations segment decreased 5% or $447,000 primarily due todelayed purchases of SafeNet’s VPN products from government customers in thewake of the September 11th tragedy.  TheEuropean Operations revenues decreased 53% or $1,882,000 as a result of thereduction in the sale of legacy products in Europe.

 

Gross margindecreased to 64% for the period ended December 31, 2001, from 73% in 2000.  The Company recorded additional inventoryreserves related primarily to legacy products with diminishing future demand..  These additional reserves aggregated$1,083,000 in the second quarter of 2001 and negatively impacted gross marginsby 6%.  For the year, the additionalinventory reserves affected Technology, Product, and European Operations’segments by $58,000, $115,000, and $910,000, respectively, impacting grossmargins by 1%, 2%, and 58%, respectively. Gross margins in the Technology Operations decreased to 77% in 2001 from84% in 2000, due to reduced sales of high margin VPN software products, and theadditional amortization of capitalized software development as a result ofadjustments to the future revenue estimates under the revenue curve method ofcalculating amortization.  ProductOperations’ margins increased to 68% from 66% based primarily on the change inproduct mix to include a greater portion of higher margin software sales.  The gross margin for the European operationsdecreased to (18%) from 49% in 2000 as a result of an increase in inventoryreserves to reflect a reduction in the value of legacy product inventories aswell as less revenue to absorb the fixed portion of cost of revenues.

 

Research anddevelopment expenses remained even on a percentage bases increasing by $19,000to $7,400,000 for the period ended December 31, 2001, from $7,381,000 in2000.  

 

Sales andmarketing expenses increased 6%, or $345,000 to $6,290,000 for the period endedDecember 31, 2001, from $5,945,000 in 2000. The additional expense reflects management’s focus on increasing salesand marketing resources in new markets. Additional expenses include the costs associated with new employees andexpanded marketing programs such as the SafeNet Secure Tour and two tradeshows.  As a percentage of revenues, theexpenses were 35% and 21% in 2001 and 2000, respectively.

 

General andadministrative expenses decreased 23%, or $854,000, to $2,789,000 for theperiod ended December 31, 2001, from $3,643,000 in 2000. The decrease is due tocost saving measures including staff reductions, reductions inperformance-based compensation, travel expenses, and professional fees.  As a percentage of revenues, the expenseswere 15% and 12% of revenues in 2001 and 2000, respectively.

 

Interest incomedecreased by $16,000, to $1,357,000 for the period ended December 31, 2001,from $1,373,000 in 2000.  Interestincome remained steady despite declining interest rates in 2001 due to largeraverage cash and short-term investment holdings throughout 2001 compared to2000. 

 

For the yearended December 31, 2001, the Company has incurred operating losses andtherefore, did not record income tax expense. The Company’s income tax benefit related to these losses has been offsetby a valuation allowance for the full amount of the net deferred tax assetssince the Company's ability to use the remaining net operating losscarryforward is dependent upon future taxable income.  For the year ended December 31, 2000, the Company did not recognizeincome tax expense due to the reversal of the valuation allowance on netoperating loss carryforwards available to offset earnings.

 

The Company hada net loss of $3,562,000 for the period ended December 31, 2001 compared to netincome of $5,757,000 for the same period in 2000.  The loss per common share was $0.50 in 2001 compared to dilutedincome per common share of $0.80 in 2000.

 

22

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**Yearended December 31, 2000 Compared to Year ended December 31, 1999**

Revenues increased 52%, or$9,899,000, to $28,826,000 for the period ended December 31, 2000, from$18,927,000 in 1999.  The TechnologyOperations revenues increased 306% or $12,024,000.  Included in Technology revenues are sales of PCI cards, softwarelicenses and royalties from chip sales. All areas increased significantly over 1999, however the primary productcontributing to the increase was soft PK. Revenues from the Product Operations segment increased $2,690,000primarily due to customer shipments of VPN products to several largeenterprises as well as an overall increase in demand for SafeNet VPNproducts.  The European Operationsrevenues decreased 58% or $4,815,000 as a result of the reduction in the saleof legacy products in Europe.

 

Gross margin increased to 73%for the period ended December 31, 2000, from 62% in 1999.  Margins on sales of software licenses andSafeNet DSP Chips in the Technology Operations segment led the increase with anoverall 84% gross margin compared to a 1999 gross margin of 71% made upprimarily of development project sales. Product Operations’ margins increased to 66% from 52% on strong sales ofhigher margin VPN products versus lower margin legacy products in 1999.  The gross margin for the European operationsdecreased to 49% from 66% in 1999 as a result of lower revenues available torecover fixed costs.

 

Researchand development expenses increased 26%, or $1,530,000, to $7,381,000 for theperiod ended December 31, 2000, from $5,851,000 in 1999.  The increase is primarily attributable toincreased personnel costs during 2000 related to the Company’s software andintegrated circuit development projects in Technology Operations, and thecompletion of several large consulting contracts during 1999 under which $1,042,000of research and development expenses were directly attributable to cost ofgoods sold.  As a percentage ofrevenues, the expenses were 26% and 31% in 2000 and 1999, respectively.

 

Salesand marketing expenses decreased 9%, or $579,000 to $5,945,000 for the periodended December 31, 2000, from $6,524,000 in 1999.  The decrease is due to a reduction in personnel and theirsalaries, telephone, travel and related expenses as well as scaled downparticipation in trade shows versus 1999.  As a percentage of revenues, expenses were 21% and 34% in 2000 and 1999,respectively.  Sales and marketingexpenses did not increase in proportion to the revenue increase becauseSafeNet’s OEM technology is integrated into customer’s products saving the costof direct sales to the end user.

 

Generaland administrative expenses increased 33%, or $913,000, to $3,643,000 for theperiod ended December 31, 2000, from $2,730,000 in 1999. The increase isprimarily due to professional fees incurred to export software developed in theUnited States to the European Operations segment, costs associated withstrengthening the executive management team in both the U.S. and Europe, andprofessional services related to strategic initiative planning.  As a percentage of revenues, the expenseswere 12% and 15% of revenues in 2000 and 1999, respectively.

 

Interestincome increased by $1,223,000, to $1,373,000 for the period ended December 31,2000, from $150,000 in 1999.  Theincrease is due to larger cash and short-term investment holdings in 2000compared to 1999, which is explained below in the “Liquidity and CapitalResources” section.

 

Therewas no income tax expense for the period ended December 31, 2000 due to thereversal of the valuation allowance on net operating loss carryforwards availableto offset current year earnings.  The1999 income tax expense of $85,000 was for taxes on the income of the EuropeanOperations that has no income tax liability in 2000.  The Company has not recorded a United States income tax benefitin either period.  A valuation allowancefor the full amount of the United States net deferred tax assets has beenestablished since the Company’s ability to use the remaining United States net

 

23

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operatingloss carryforward is dependent upon future taxable income.  The Company has also recorded a fullvaluation allowance against the net operating loss of the European Operationsgenerated during 2000.  As discussed inNote 5 to the audited consolidated financial statements, in 2000 the Companychanged its method of accounting for income taxes

 

The Company had net income of $5,757,000 forthe period ended December 31, 2000 compared to a net loss of $3,060,000 for thesame period in 1999.  The diluted incomeper common share was $0.80 in 2000 compared to a $0.56 loss per common share in1999.

 

**Liquidityand Capital Resources**

SafeNetbelieves that its current cash resources will be sufficient to meet its needsfor the next year. As of December 31, 2001, SafeNet had working capital of$32,385,000 including cash and short-term investments of $30,859,000.

 

InJanuary 2002, as partial consideration for the acquisition of Securealink,SafeNet paid $2,000,000 in cash and issued convertible promissory notes in theamount of $2,000,000.  The notes are duewithin three years and have an interest rate of 5%.  Additionally, after closing of the acquisition in January 2002,SafeNet advanced to Securealink approximately $1,140,000 in order to repaySecurealink’s line of credit.

 

Asdiscussed in Note 14 to the consolidated financial statements, in February2002, SafeNet management decided to discontinue operations at GDS on the amountof GDS operating and cash losses during 2000 and 2001 as well as a significantdownturn in future business prospects. GDS has suffered cash losses of $2,284,000 and $756,000 during the yearsended December 31, 2001 and 2000, respectively.  It is estimated that the impact of management’s decision todiscontinue operations at GDS will positively impact cash flows byapproximately $2,500,000 in 2002.

 

In2001, cash and short-term investments decreased $843,000.   The decrease was mainly attributable tocash used in operating activities of $1,709,000.  Cash provided by financing activities in 2001 included $1,549,000from the exercise of stock options. Cash used in investing activities during 2001 included investments incomputer software development costs and equipment totaling $565,000.

 

In2000, cash and short-term investments increased $12,040,000.  The increase was mainly attributable to cashprovided by operating activities of $9,171,000.  Cash provided by financing activities in 2000 included $4,204,000from the exercise of stock options and warrants.  Cash used in investing activities during 2000 included investmentsin computer software development costs and equipment totaling $1,239,000.

** **

**Inflationand Seasonality**

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

 

**Effectof Recent Accounting Pronouncements**

In June 2001, the FinancialAccounting Standards Board issued Statements of Financial Accounting StandardsNo. 141 *Business Combinations,*and No. 142 *Goodwill and Other Intangible*Assets.  Statement 141 requires that the purchasemethod of accounting be used for all business combinations

 

24

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initiated after June 30,2001.  Statement 141 also includesguidance on the initial recognition and measurement of goodwill and otherintangible assets arising from business combinations completed after June 30,2001.  Statement 142 prohibits theamortization of goodwill and intangible assets with indefinite useful lives.  Statement 142 requires that these assets bereviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized overtheir estimated useful lives. Additionally, Statement 142 requires that goodwill included in thecarrying value of equity method investments no longer be amortized.

 

The Company will applyStatement 142 beginning in the first quarter of 2002.  Application of the nonamortization provisions of Statement 142 isnot expected to result in a material change in net income (loss).

 

In August 2001, the Financial AccountingStandards Board issued Statement of Financial Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets and supersedesStatement No. 121, *Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,*and the accounting and reporting provisions of APB Opinion No. 30, *Reporting the Results of Operations* for adisposal of a segment of business. Statement 144 is effective for fiscal years beginning after December 15,2001, with earlier application encouraged. The Company expects to adopt Statement 144 as of January 1, 2002 and itdoes not expect that the adoption of the Statement will have a significantimpact on the Company’s financial position and results of operations.  However, as described in Note 14 to theconsolidated financial statements, during February 2002, the Company approved aplan to dispose of its Swiss subsidiary. The Company will account for this disposal during fiscal year 2002 usingthe provisions of Statement 144.

 

**CriticalAccounting Policies**

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

 

SafeNet believes the following critical accounting policies affect itsmore significant judgments and estimates used in the preparation of itsconsolidated financial statements.

 

*Allowance for doubtful accounts*

 

SafeNet maintains an allowance for doubtful accounts for estimatedlosses resulting from the inability of its customers to make requiredpayments.  The Company calculates itsallowance based on a specific analysis of past due balances and also considershistorical trends of write-offs.  If thefinancial condition of SafeNet’s customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired.

 

*Inventory*

 

SafeNet provides for its estimated inventory obsolescence orunmarketable inventory equal to the difference between the cost of theinventory and the estimated market value based upon assumptions about futuredemand and market conditions.  The Companyutilizes projected sales by product to determine the net realizable value ofthe inventory.  If actual marketconditions are less favorable than those projected by management, additionalinventory write-downs may be required.

 

25

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*Software Development Costs*

 

SafeNet calculates amortization of its capitalized software developmentcosts based on the greater of the amount computed using the ratio that currentgross revenues for a product bear to the total of current and anticipatedfuture gross revenues for that product or the straight-line method over theremaining estimated economic life of the product including the period beingreported on.  In addition, SafeNetassesses the recoverability of software development costs by comparing theunamortized balance to the net realizable value of the asset and writes off theamount by which the unamortized capitalized costs exceed the net realizablevalue.

 

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

 

*Revenue Recognition*

 

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

** **

26

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**ITEM7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

SafeNet’s major market risk isto fluctuations in foreign currency exchange rates, principally related to theSwiss Franc. As of December 31, 2001, our investment in our European operationswas approximately $2,258,000. A 10% change in the average Swiss Franc exchangerate for the year ended December 31, 2001 would have changed our reportedearnings for fiscal year 2001 by approximately $306,000, compared to $64,000 in2000.  A 10% change in the December 31,2001 Swiss Franc exchange rate would have changed SafeNet’s reported currencytranslation adjustment for fiscal year 2001 by approximately $29,000, comparedto $354,000 in 2000.  A 10% change inthe average interest rate for fiscal year 2001 would have changed SafeNet’sreported interest income by approximately $136,000.

 

AtDecember 31, 2001 and 2000, SafeNet did not have any interest bearingobligations. In addition, SafeNet does not hold any derivative instruments anddoes not have any commodity market risk.

 

27

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**SAFENET, INC.AND SUBSIDIARIES**

** **

**ITEM 8 - FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

** **

**INDEX TO FINANCIAL STATEMENTS**

** **
| Reports of Independent  Auditors                                                                             |
|--------------------------------------------------------------------------------------------------------------|
|                                                                                                         |
| Consolidated  Balance Sheets as of December 31, 2001 and 2000                                                |
|                                                                                                         |
| Consolidated  Statements of Operations for the years ended December 31, 2001, 2000 and 1999                  |
|                                                                                                         |
| Consolidated Statements of Comprehensive  Income (Loss) for the years ended December 31, 2001, 2000 and 1999 |
|                                                                                                         |
| Consolidated Statements of Stockholders’  Equity for the years ended December 31, 2001, 2000 and 1999   |
|                                                                                                         |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2001, 2000 and 1999                  |
|                                                                                                         |
| Notes to Consolidated Financial Statements                                                                   |
|                                                                                                         |
| Schedule II Valuation and Qualifying  Accounts                                                               |
|                                                                                                         |

 

28

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**REPORTOF INDEPENDENT AUDITORS**

** **

**TheBoard of Directors**

**SafeNet,Inc.**

** **

Wehave audited the accompanying consolidated balance sheets of SafeNet, Inc. andsubsidiaries as of December 31, 2001 and 2000, and the relatedconsolidated statements of operations, comprehensive income (loss),stockholders’ equity and cash flows for the years then ended.  Our audit also included the financialstatement schedule listed in the Index at Item 14(a) for the years endedDecember 31, 2001 and 2000.  Thesefinancial statements and schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and schedule based on our audits.

 

Weconducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of SafeNet, Inc. andsubsidiaries at December 31, 2001 and 2000, and the consolidated resultsof their operations and their cash flows for the year then ended in conformitywith accounting principles generally accepted in the United States. Also, inour opinion, the related financial statement schedule for the years endedDecember 31, 2001 and 2000, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

 

Asdiscussed in Note 5 to the consolidated financial statements, in 2000 theCompany changed its method of accounting for income taxes.

 

 
|                                             | **/s/ Ernst & Young LLP** |
|--------------------------------------------------|-------------------------------|
|                                             |                          |
| **Baltimore, Maryland**                          |
| **January 25, 2002,**                            |
| **except for Note 14, as to which the  date is** |
| **February 11, 2002**                            |

 

29

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**INDEPENDENT AUDITORS’ REPORT**

** **

**The Board of Directors**

** **

**SafeNet, Inc. (formerly Information ResourceEngineering, Inc.)**

** **

Wehave audited the accompanying consolidated statements of operations,comprehensive income (loss), stockholders’ equity and cash flows of SafeNet,Inc. (formerly Information Resource Engineering, Inc.) and subsidiaries for theyear ended December 31, 1999. In connection with our audit of theconsolidated financial statements, we have also audited the financial statementschedule as listed in the accompanying index as of and for the year endingDecember 31, 1999. These consolidated financial statements and financialstatement schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements and financial statement schedule based on our audits.

 

Weconducted our audit in accordance with auditing standards generally accepted inthe United States of America. Those standards require that we plan and performthe audit to obtain reasonable assurance about whether the consolidatedfinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provide a reasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the results of operations and cash flows of SafeNet, Inc.and subsidiaries for the year ended December 31, 1999 in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, the related financial statement schedule, when considered inrelation to the basic consolidated financial statements taken as a whole,presents fairly, in all material respects, the information set forth therein.

 
| /s/ KPMG LLP         |   |
|----------------------|--------|
|                 |
| Baltimore,  Maryland |
| February 9,  2000    |

 

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**SAFENET, INC.AND SUBSIDIARIES**

** **

ConsolidatedBalance Sheets

** **

December31, 2001 and 2000

 
|                                                                                                                                      |   | **2001**    |       | **2000**    |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|-------------|--------|
| **Assets**                                                                                                                                |   |        |       |        |   |
| Current assets:                                                                                                                           |   |        |       |        |   |
| Cash and cash equivalents                                                                                                                 |   | $           | 14,993,803 |        | $      | 25,369,258 |   |
| Short-term investments                                                                                                                    |   | 15,864,783  |       | 6,332,488   |   |
| Accounts receivable, net of allowance for doubtful accounts of  $155,264 in 2001 and $231,724 in 2000                                     |   | 3,781,770   |       | 4,211,589   |   |
| Inventories, net of reserve of $1,470,117 in 2001, and $400,536 in  2000                                                                  |   | 1,492,219   |       | 2,908,706   |   |
| Prepaid expenses                                                                                                                          |   | 670,632     |       | 255,731     |   |
|                                                                                                                                      |   |        |       |        |   |
| Total current assets                                                                                                                      |   | 36,803,207  |       | 39,077,772  |   |
| Property and equipment, net                                                                                                               |   | 1,189,804   |       | 1,375,216   |   |
| Computer software development costs, net of accumulated amortization  of $3,112,725 in 2001 and $2,376,828 in 2000                        |   | 727,097     |       | 1,591,662   |   |
| Goodwill, net of accumulated amortization of $651,062 in 2001 and  $566,198 in 2000                                                       |   | 316,172     |       | 401,036     |   |
| Other assets                                                                                                                              |   | 841,338     |       | 660,093     |   |
|                                                                                                                                      |   | $           | 39,877,618 |        | $      | 43,105,779 |   |
|                                                                                                                                      |   |        |       |        |   |
| **Liabilities  and Stockholders' Equity**                                                                                                 |   |        |       |        |   |
| Current liabilities:                                                                                                                      |   |        |       |        |   |
| Accounts payable                                                                                                                          |   | $           | 1,016,264  |        | $      | 1,737,464 |   |
| Accrued salaries and commissions                                                                                                          |   | 872,620     |       | 1,829,523   |   |
| Other accrued expenses                                                                                                                    |   | 608,449     |       | 854,063     |   |
| Advance payments and deferred revenue                                                                                                     |   | 1,921,014   |       | 961,958     |   |
| Total current liabilities                                                                                                                 |   | 4,418,347   |       | 5,383,008   |   |
|                                                                                                                                      |   |        |       |        |   |
| Commitments and contingencies                                                                                                             |   | —      |       | —      |   |
|                                                                                                                                      |   |        |       |        |   |
| Stockholders' equity:                                                                                                                     |   |        |       |        |   |
| Preferred stock, $.01 par value per share.                                                                                                |   |        |       |        |   |
| Authorized 500,000 shares, no shares issued and outstanding                                                                               |   | —      |       | —      |   |
| Common stock, $.01 par value per share.  Authorized 50,000,000 shares, issued 7,107,533 shares in 2001  and 6,940,637 shares in 2000 |   | 71,075      |       | 69,406      |   |
| Additional paid-in capital                                                                                                                |   | 52,399,586  |       | 50,854,155  |   |
| Accumulated deficit                                                                                                                       |   | (15,485,582 | )          | (11,924,068 | )      |
| Accumulated other comprehensive loss                                                                                                      |   | (1,525,808  | )          | (1,276,722  | )      |
| Net stockholders' equity                                                                                                                  |   | 35,459,271  |       | 37,722,771  |   |
|                                                                                                                                      |   | $           | 39,877,618 |        | $      | 43,105,779 |   |

 

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**SAFENET, INC.AND SUBSIDIARIES**

 

ConsolidatedStatements of Operations

 

Yearsended December 31, 2001, 2000, and 1999

 
|                                       |   | **2001**   |       | **2000**   |   | **1999**   |   |
|--------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
| Revenues                                   |   |       |       |       |   |       |   |
| Licenses and royalties                     |   | $          | 4,030,857  |       | $      | 15,223,215 |   | $ | 1,559,557 |   |
| Products                                   |   | 10,885,404 |       | 10,848,681 |   | 13,077,640 |   |
| Service and maintenance                    |   | 3,210,746  |       | 2,753,688  |   | 4,289,696  |   |
| Total revenues                             |   | 18,127,007 |       | 28,825,584 |   | 18,926,893 |   |
| Cost of revenues                           |   |       |       |       |   |       |   |
| Licenses and royalties                     |   | 644,010    |       | 2,637,157  |   | 200,034    |   |
| Products                                   |   | 4,779,166  |       | 4,248,361  |   | 4,823,628  |   |
| Service and maintenance                    |   | 1,059,322  |       | 777,120    |   | 2,204,218  |   |
| Total cost of revenues                     |   | 6,482,498  |       | 7,662,638  |   | 7,227,880  |   |
| Gross profit                               |   | 11,644,509 |       | 21,162,946 |   | 11,699,013 |   |
| Research and development expenses          |   | 7,399,540  |       | 7,380,543  |   | 5,851,255  |   |
| Sales and marketing expenses               |   | 6,290,087  |       | 5,945,218  |   | 6,523,441  |   |
| General and administrative expenses        |   | 2,788,796  |       | 3,642,988  |   | 2,730,322  |   |
| Amortization of acquired intangible assets |   | 84,864     |       | 84,864     |   | 94,020     |   |
| Recovery of CyberGuard advance             |   | —     |       | (275,000   | )      | (375,000   | )      |
| Total operating expenses                   |   | 16,563,287 |       | 16,778,613 |   | 14,824,038 |   |
| Operating income (loss)                    |   | (4,918,778 | )          | 4,384,333  |   | (3,125,025 | )      |
| Interest income, net                       |   | 1,357,264  |       | 1,372,811  |   | 149,636    |   |
| Income (loss) before income taxes          |   | (3,561,514 | )          | 5,757,144  |   | (2,975,389 | )      |
| Income taxes                               |   | —     |       | —     |   | 85,133     |   |
| Net income (loss)                          |   | $          | (3,561,514 | )          | $      | 5,757,144  |   | $ | (3,060,522 | ) |
|                                       |   |       |       |       |   |       |   |
| Net income (loss) per common share         |   |       |       |       |   |       |   |
| Basic                                      |   | $          | (0.50      | )          | $      | 0.85       |   | $ | (0.56 | ) |
| Diluted                                    |   | $          | (0.50      | )          | $      | 0.80       |   | $ | (0.56 | ) |

 

See notes to consolidated financialstatements.

 

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**SAFENET, INC.AND SUBSIDIARIES**

 

ConsolidatedStatements of Comprehensive Income (Loss)

 

Yearended December 31, 2001, 2000, and 1999

 
|                                                                              |   | **2001** |       | **2000** |   | **1999**  |   |
|-----------------------------------------------------------------------------------|--------|----------|------------|----------|--------|-----------|--------|
| Net income (loss)                                                                 |   | $        | (3,561,514 | )        | $      | 5,757,144 |   | $ | (3,060,522 | ) |
|                                                                              |   |     |       |     |   |      |   |
| Other comprehensive income (loss) — Foreign currency translation  adjustment |   | (165,036 | )     | (112,057 | )      | (915,038  | )      |
| Other                                                                             |   | (84,050  | )          | 130,248  |   | —    |   |
| Comprehensive income (loss)                                                       |   | $        | (3,810,600 | )        | $      | 5,775,335 |   | $ | (3,975,560 | ) |

 

See notes to consolidated financial statements.

 

33

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** **

**SAFENET, INC.AND SUBSIDIARIES**

 

ConsolidatedStatements of Stockholders Equity

 

Yearsended December 31, 2001, 2000, and 1999

 
|                                                             |   |       |       |               |       | **Additional  Paid-in  Capital** |   | **Accumulated**

**Deficit** |   | **Accumulated  Other  Comprehensive  Income  (Loss)** |        |     |   |       |   | **Total  Stockholders’  Equity** |   |
|------------------------------------------------------------------|--------|------------|------------|--------------------|------------|----------------------------------|--------|------------------------------|--------|-------------------------------------------------------|-------------|----------|--------|------------|--------|---------------------------------------|--------|
|                                                             |   |       |       |               |       |                             |   |                         |   |                                                  |        |     |   |
|                                                             |   |       |       |               |       |                             |   |                         |   |                                                  |        |     |   |
|                                                             |   |       |       |               |       |                             |   |                         |   |
| **Common stock**                                                 |   |       |       | **Treasury Stock** |       |                             |
| **Shares**                                                       |   | **Amount** | **Shares** |               | **Amount** |
| Balance at January 1, 1999                                       |   | 5,466,527  |       | $                  | 54,665     |                             | $      | 31,041,854                   |   | $                                                     | (14,620,690 | )        | $      | (379,875   | )      | 174,000                               |   | $ | (695,853 | ) | $ | 15,400,101 |   |
| Sale of common  stock, net of offering expenses of $968,000 |   | 1,000,000  |       | 10,000             |       | 14,021,812                       |   | —                       |   | —                                                |        | —   |   | —     |   | 14,031,812                            |   |
| Stock options  exercised                                         |   | 51,906     |       | 519                |       | 947,606                          |   | —                       |   | —                                                |        | (174,000 | )      | 695,853    |   | 1,643,978                             |   |
| Stock warrants  exercised                                        |   | 23,050     |       | 231                |       | 391,620                          |   | —                       |   | —                                                |        | —   |   | —     |   | 391,851                               |   |
| Stock option  compensation                                       |   | —     |       | —             |       | 138,255                          |   | —                       |   | —                                                |        | —   |   | —     |   | 138,255                               |   |
| Net loss for 1999                                                |   | —     |       | —             |       | —                           |   | (3,060,522                   | )      | —                                                |        | —   |   | —     |   | (3,060,522                            | )      |
| Foreign currency  translation adjustment                         |   | —     |       | —             |       | —                           |   | —                       |   | (915,038                                              | )           | —   |   | —     |   | (915,038                              | )      |
| Other                                                            |   | —     |       | —             |       | 5,500                            |   | —                       |   | —                                                |        | —   |   | —     |   | 5,500                                 |   |
| Balance at  December 31, 1999                                    |   | 6,541,483  |       | 65,415             |       | 46,546,647                       |   | (17,681,212                  | )      | (1,294,913                                            | )           | —   |   | —     |   | 27,635,937                            |   |
| Stock options exercised                                          |   | 392,204    |       | 3,922              |       | 4,081,936                        |   | —                       |   | —                                                |        | —   |   | —     |   | 4,085,858                             |   |
| Stock warrants  exercised                                        |   | 6,950      |       | 69                 |       | 118,081                          |   | —                       |   | —                                                |        | —   |   | —     |   | 118,150                               |   |
| Stock option  compensation                                       |   | —     |       | —             |       | 127,724                          |   | —                       |   | —                                                |        | —   |   | —     |   | 127,724                               |   |
| Net income for  2000                                             |   | —     |       | —             |       | —                           |   | 5,757,144                    |   | —                                                |        | —   |   | —     |   | 5,757,144                             |   |
| Foreign currency  translation adjustment                         |   | —     |       | —             |       | —                           |   | —                       |   | (112,057                                              | )           | —   |   | —     |   | (112,057                              | )      |
| Other                                                            |   | —     |       | —             |       | (20,233                          | )      | —                       |   | 130,248                                               |        | —   |   | —     |   | 110,015                               |   |
| Balance at  December 31, 2000                                    |   | 6,940,637  |       | 69,406             |       | 50,854,155                       |   | (11,924,068                  | )      | (1,276,722                                            | )           | —   |   | —     |   | 37,722,771                            |   |
| Stock options  exercised                                         |   | 166,896    |       | 1,669              |       | 1,547,369                        |   | —                       |   | —                                                |        | —   |   | —     |   | 1,549,038                             |   |
| Net loss for 2001                                                |   | —     |       | —             |       | —                           |   | (3,561,514                   | )      | —                                                |        | —   |   | —     |   | (3,561,514                            | )      |
| Foreign currency  translation adjustment                         |   | —     |       | —             |       | —                           |   | —                       |   | (165,036                                              | )           | —   |   | —     |   | (165,036                              | )      |
| Other                                                            |   | —     |       | —             |       | (1,938                           | )      | —                       |   | (84,050                                               | )           | —   |   | —     |   | (85,988                               | )      |
| Balance at  December 31, 2001                                    |   | 7,107,533  |       | $                  | 71,075     |                             | $      | 52,399,586                   |   | $                                                     | (15,485,582 | )        | $      | (1,525,808 | )      | —                                |   | $ | — |   | $ | 35,459,271 |   |
|                                                                  |        |            |            |                    |            |                                  |        |                              |        |                                                       |             |          |        |            |        |                                       |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidated financialstatements.

 

34

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**SAFENET, INC.AND SUBSIDIARIES**

** **

Consolidated Statements ofCash Flows

 

Yearsended December 31, 2001, 2000, and 1999

 
|                                                                                                 |   | **2001**    |       | **2000**   |   | **1999**   |   |
|------------------------------------------------------------------------------------------------------|--------|-------------|------------|------------|--------|------------|--------|
| Cash flows from operating activities:                                                                |   |        |       |       |   |       |   |
| Net income (loss)                                                                                    |   | $           | (3,561,514 | )          | $      | 5,757,144  |   | $ | (3,060,522 | ) |
| Adjustments to reconcile net income (loss) to net   cash provided by (used in) operating activities: |   |        |       |       |   |       |   |
| Depreciation                                                                                         |   | 661,659     |       | 679,616    |   | 618,744    |   |
| Amortization of computer software  development costs                                                 |   | 953,600     |       | 1,150,252  |   | 478,498    |   |
| Amortization of acquired intangible assets                                                           |   | 84,864      |       | 84,864     |   | 94,020     |   |
| Stock option compensation                                                                            |   | —      |       | 127,724    |   | 138,255    |   |
| Changes in operating assets and liabilities:                                                         |   |        |       |       |   |       |   |
| Accounts receivable, net                                                                             |   | 471,297     |       | 125,002    |   | 313,966    |   |
| Inventories, net                                                                                     |   | 1,369,395   |       | 18,520     |   | 366,171    |   |
| Accounts payable                                                                                     |   | (777,552    | )          | 615,078    |   | (231,902   | )      |
| Accrued salaries and commissions                                                                     |   | (937,007    | )          | 492,233    |   | 135,721    |   |
| Other accrued expenses                                                                               |   | (312,204    | )          | 540,320    |   | (117,877   | )      |
| Deferred revenue                                                                                     |   | 959,080     |       | (510,563   | )      | 1,157,542  |   |
| Other                                                                                                |   | (621,017    | )          | 90,892     |   | 78,528     |   |
|                                                                                                 |   |        |       |       |   |       |   |
| Net cash provided by (used in)      operating activities                         |   | (1,709,399  | )          | 9,171,082  |   | (28,856    | )      |
|                                                                                                 |   |        |       |       |   |       |   |
| Cash flows from investing activities:                                                                |   |        |       |       |   |       |   |
| Maturities of short-term investments                                                                 |   | 8,433,298   |       | 500,715    |   | —     |   |
| Purchases of short-term investments                                                                  |   | (17,965,593 | )          | (6,332,488 | )      | (500,715   | )      |
| Purchases of property and equipment                                                                  |   | (398,597    | )          | (607,251   | )      | (493,042   | )      |
| Expenditures for computer software development                                                       |   | (167,235    | )          | (631,391   | )      | (1,058,408 | )      |
|                                                                                                 |   |        |       |       |   |       |   |
| Net cash used in investing  activities                                                               |   | (10,098,127 | )          | (7,070,415 | )      | (2,052,165 | )      |
|                                                                                                      |        |             |            |            |        |            |        |  |  |  |

 

35

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|                                                             |   | **2001**    |       | **2000**   |   | **1999**   |   |
|------------------------------------------------------------------|--------|-------------|------------|------------|--------|------------|--------|
| Cash flows from financing activities:                            |   |        |       |       |   |       |   |
| Proceeds from issuance of common stock,  net of offering expense |   | $           | —     |       | $      | —     |   | $ | 14,031,812 |   |
| Proceeds from stock options exercised                            |   | 1,549,038   |       | 4,085,858  |   | 1,643,978  |   |
| Proceeds from stock warrants exercised                           |   | —      |       | 118,150    |   | 391,851    |   |
| Other                                                            |   | —      |       | (20,233    | )      | 5,500      |   |
|                                                             |   |        |       |       |   |       |   |
| Net cash provided by (used in) financing   activities            |   | 1,549,038   |       | 4,183,775  |   | 16,073,141 |   |
|                                                             |   |        |       |       |   |       |   |
| Effect of exchange rate changes on cash                          |   | (116,967    | )          | (76,626    | )      | (696,360   | )      |
|                                                             |   |        |       |       |   |       |   |
| Net increase (decrease) in cash and cash equivalents        |   | (10,375,455 | )          | 6,207,816  |   | 13,295,760 |   |
|                                                             |   |        |       |       |   |       |   |
| Cash and cash equivalents at beginning of year                   |   | 25,369,258  |       | 19,161,442 |   | 5,865,682  |   |
| Cash and cash equivalents at end of year                         |   | $           | 14,993,803 |       | $      | 25,369,258 |   | $ | 19,161,442 |   |
|                                                             |   |        |       |       |   |       |   |
| Cash paid for income taxes                                       |   | $           | 72,556     |       | $      | 56,627     |   | $ | 101,170 |   |

 

See notes to consolidated financialstatements.

 

36

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**SAFENET, INC.AND SUBSIDIARIES**

** **

Notesto Consolidated Financial Statements

 

December31, 2001

 

**(1)           BUSINESS**

 

SafeNet, Inc. (the Company), formerlyInformation Resource Engineering, Inc., is engaged in the business ofdesigning, manufacturing and marketing enterprise network security technologyand systems that enable the deployment of secure Virtual Private Network solutionsover the Internet and other shared public networks.

 

** (2)          SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Principlesof Consolidation**

The consolidated financial statements includethe accounts of the Company and its wholly owned subsidiaries. All significantintercompany transactions have been eliminated in consolidation.

 

**Useof Estimates**

The preparation of consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectreported amounts in the consolidated financial statements and the accompanyingnotes. Actual results could differ from those estimates.

 

**CashEquivalents**

The Company considers all highly liquidinvestments with maturities of three months or less when purchased to be cashequivalents. The Company has approximately $14,954,000 and $22,630,000 of cashequivalents at December 31, 2001 and 2000, respectively, comprised of overnightrepurchase agreements, short-term money market funds and commercial paper.

 

**Short-TermInvestments**

Short-term investments of $15,865,000 and$6,332,000 at December 31, 2001, and 2000, respectively, consist of held-tomaturity corporate debt. Management determines the appropriate classificationof debt securities at the time of purchase and reevaluates such designation asof each balance sheet date. Debt securities are classified as held-to-maturitywhen the Company has the positive intent and ability to hold the securities tomaturity. Held-to-maturity securities are stated at amortized cost, adjustedfor amortization of premiums and accretion of discounts to maturity. Suchamortization is included in interest income. Interest on securities classifiedas held-to-maturity is included in interest income. Short-term investments atDecember 31, 2001 mature between January and December 2002.

 

**Inventories**

Inventories are stated at the lower of costor market. Cost is determined by the first-in, first-out method. Cost isdetermined by the average cost method for the Company’s subsidiary outside theUnited States.

 

**Propertyand equipment**

Property and equipment is stated at cost anddepreciation is computed using the straight-line method over estimated usefullives ranging from three to seven years. Amortization of leasehold 

 

37

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improvements is computed using thestraight-line method over the lesser of the useful life of the asset or theremaining term of the lease.

 

**ComputerSoftware Development Costs**

Costs for the development of new softwareproducts and substantial enhancements to existing software products areexpensed as research and development costs as incurred until technologicalfeasibility has been established, at which time any additional development costsare capitalized until the product is available for general release tocustomers.  The Company defines theestablishment of technological feasibility as the point when product softwarereaches a working model.

 

Computer software development costs are capitalizedsubsequent to the establishment of technological feasibility for each softwareproduct which is evidenced by a detailed program design. Capitalization ofcosts ceases when the product is available for general release to customers.

 

Amortization of software development costs,which is included in cost of revenues, begins upon general release of thesoftware. These costs are amortized on a product by-product basis using thegreater of:  (i) the amount computed usingthe ratio that current gross revenues for each product bear to the total ofcurrent and anticipated future revenue for that product, or (ii) the amountcomputed using the straight-line method over the estimated economic useful lifeof three to five years.  Such costs areamortized beginning on product release dates. The Company assesses therecoverability of computer software development costs by comparing theunamortized balance to the net realizable value of the asset and writes off theamount by which the unamortized capitalized costs exceed the net realizablevalue.  During the year ended December31, 2001, the Company wrote off $218,000 of capitalized software developmentcosts for which the unamortized balance exceeded the net realizable value.  This write off has been included as a chargeto 2001 research and development expenses.

 

**Goodwill**

Goodwill consists of the excess of thepurchase price over the fair value of net assets acquired and is beingamortized on a straight-line basis over the estimated useful life of ten years.The Company assesses the recoverability of this intangible asset by determiningwhether the amortization of the goodwill balance over its remaining life can berecovered through undiscounted future operating cash flows of the acquiredoperation. The amount of goodwill impairment, if any, is measured based onprojected discounted future operating cash flows.  In 1999, the Company realized $52,017 as the benefit of anacquired net operating loss carryforward, which was recorded as a reduction togoodwill. No such benefit was realized in 2001 or 2000.

 

**Impairmentof Long-Lived Assets  and Long-LivedAssets to Be Disposed Of**

Long-lived assets, including intangibleassets, are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be fully recoverable. Ifan impairmentindicatoris present, the Company evaluates whether an impairment exists on the basis ofundiscounted expected future cash flows from operations for the remainingamortization period. If impairment exists, the asset is reduced by theestimated difference between its discounted cash flows and its carrying value.

 

38

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**ProductWarranties**

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

** **

**RevenueRecognition**

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

 

***License andRoyalties***

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

 

***Products***

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

 

***Maintenance andOther Services***

Maintenance revenue isderived from support arrangements. Maintenance arrangements provide technical customer support and theright to unspecified upgrades on an if-and-when-available basis. In accordance with SOP 97-2, *SoftwareRevenue Recognition,*vendor specific objective evidence of fairvalue of maintenance is determined based on the price charged for themaintenance element when sold separately. The maintenance term is typically one year in duration and maintenancerevenue is recognized ratably over the maintenance term.  Unrecognized maintenance fees are includedin deferred revenue.

 

Other service revenue iscomprised of revenue from consulting fees, training and engineeringservices.  This service revenue isrecognized when the services are provided to the customer.  The Company’s policy is to recognizesoftware license revenue when these associated services are not essential tothe functionality of the product.  Todate, these services have not been essential to the functionality of theproduct.  Vendor specific objective evidence of fair value of these services isdetermined by reference to the price that a customer will be required to paywhen the services 

 

39

----

 

are sold separately, whichis based on the price history that the Company has developed for separate salesof these services.

 

 

**ForeignCurrency Translation**

The Company’s Swiss subsidiaryutilizes the Swiss Franc as its functional currency and its financialstatements are translated into U.S. dollars using the current rate method inaccordance with Statement of Financial Accounting Standards No. 52, *Foreign Currency Translation*.  All balance sheet accounts have beentranslated using the exchange rates in effect at the balance sheet date.  Operating and cash flow amounts have beentranslated using average exchange rates. Translation gains or losses, resultingfrom the changes in exchange rates from year to year, have been reported as a componentof other comprehensive income (loss). The effect on the consolidated statementsof operations of transaction gains and losses is insignificant for all yearspresented.

 

**IncomeTaxes**

The Company uses the liabilitymethod in accounting for income taxes. Under this method, deferred income taxassets and liabilities are determined based on difference between financialreporting and tax bases of assets and liabilities and are measured using theenacted tax rates and laws that will be in effect when the differences areexpected to reverse. As discussed in Note 5, in 2000 the Company changed itsmethod of accounting for income taxes.

 

**StockOptions Granted to Employees**

The Company accounts for all stock-basedcompensation plans using the intrinsic value method prescribed by APB Opinion25, *Accounting for Stock Issued to Employees*(“APB 25”). Under APB 25, if the exercise price of the employee stock optionsequals the estimated fair value of the underlying stock on the date of grant,no compensation expense is recognized.

 

The Financial AccountingStandards Board has issued Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation*,(“Statement 123”) which encourages companies to recognize expense forstock-based awards based on their estimated fair value on the date ofgrant.  Statement 123 does not requirecompanies to use fair value accounting for stock-based awards, but if the fairvalue method is not adopted, pro forma income is required to be disclosed in anote to the financial statements. The Company has supplementally disclosed inNote 8 the required pro forma information as if the fair value method had beenadopted.

 

**NetIncome (Loss) Per Common Share**

Basic income (loss) per shareis calculated by dividing net income (loss) by the weighted-average number ofcommon shares outstanding for the period. Diluted income (loss) per share iscalculated after adjusting the numerator and the denominator of the basiccalculation for the dilutive effect, if any, of all stock options, warrants andconvertible securities outstanding during the period.

 

**ComprehensiveIncome (Loss)**

Comprehensive income (loss)includes all changes in equity that result from recognized transactions andother economic events of a period other than transactions with owners in theircapacity as owners. Certain non-owner changes in equity, consisting primarilyof foreign currency translation adjustments, are included in “othercomprehensive income (loss).”  TheCompany reports comprehensive income (loss) in the statement of comprehensiveincome (loss) and discloses the

 

40

----

 

accumulated total of othercomprehensive income (loss) in the stockholders’ equity section of the balancesheet.

 

**NewAccounting Pronouncements**

In June 2001, the FinancialAccounting Standards Board issued Statements of Financial Accounting StandardsNo. 141 *Business Combinations,*and No. 142 *Goodwill and Other Intangible*Assets.  Statement 141 requires that the purchasemethod of accounting be used for all business combinations initiated after June30, 2001.  Statement 141 also includesguidance on the initial recognition and measurement of goodwill and otherintangible assets arising from business combinations completed after June 30,2001.  Statement 142 prohibits theamortization of goodwill and intangible assets with indefinite usefullives.  Statement 142 requires thatthese assets be reviewed for impairment at least annually.  Intangible assets with finite lives willcontinue to be amortized over their estimated useful lives.  Additionally, Statement 142 requires thatgoodwill included in the carrying value of equity method investments no longerbe amortized.

 

The Company will applyStatement 142 beginning in the first quarter of 2002.  Application of the nonamortization provisions of Statement 142 isnot expected to result in a material change in net income (loss).

 

In August 2001, the FinancialAccounting Standards Board issued Statement of Financial Standards No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets and supersedesStatement No. 121, *Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,*and the accounting and reporting provisions of APB Opinion No. 30, *Reporting the Results of Operations* for adisposal of a segment of business. Statement 144 is effective for fiscal years beginning after December 15,2001, with earlier application encouraged. The Company expects to adopt Statement 144 as of January 1, 2002 and itdoes not expect that the adoption of the Statement will have a significantimpact on the Company’s financial position and results of operations.  However, as described in Note 14, duringFebruary 2002, the Company approved a plan to dispose of its Swisssubsidiary.  The Company will accountfor this disposal during fiscal year 2002 using the provisions of Statement 144.

 

**FairValue of Financial Instruments**

The carrying amount offinancial instruments, including cash and cash equivalents, short-terminvestments, accounts receivable, accounts payable and accrued expensesapproximates fair value.

 

 

**(3)           INVENTORIES**

 

Inventories consist of thefollowing at December 31:

 
| Raw materials                                   |   | $          | 436,076   |      | $      | 1,198,163 |   |
|-------------------------------------------------|--------|------------|-----------|-----------|--------|-----------|--------|
| Finished Goods                                  |   | 2,526,260  |      | 2,111,079 |   |
|                                            |   | 2,962,336  |      | 3,309,242 |   |
| Less reserve for excess and obsolete  inventory |   | (1,470,117 | )         | (400,536  | )      |
|                                            |   | $          | 1,492,219 |      | $      | 2,908,706 |   |

 

41

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**(4)           PROPERTY AND EQUIPMENT**

** **

Property and equipment consistsof the following at December 31:

 
|                                           |   | **2001**  |      | **2000**  |   |
|------------------------------------------------|--------|-----------|-----------|-----------|--------|
| Furniture and equipment                        |   | $         | 3,563,798 |      | $      | 3,278,286 |   |
| Computer software                              |   | 538,888   |      | 445,248   |   |
| Leasehold improvements                         |   | 653,303   |      | 649,240   |   |
|                                           |   | 4,755,989 |      | 4,372,774 |   |
| Less accumulated depreciation and amortization |   | 3,566,185 |      | 2,997,558 |   |
|                                           |   | $         | 1,189,804 |      | $      | 1,375,216 |   |

 

**(5)           INCOME TAXES**

** **

The Company recorded noprovision for income taxes for the years ended December 31, 2001 and 2000.Income taxes for the year ended December 31, 1999 of $85,133 consisted ofincome tax expense of the Company’s Swiss subsidiary.

 

Deferred tax assets andliabilities are comprised of the following at December 31:

 
| Deferred tax assets:                   |   |        |    |       |   |
|----------------------------------------|--------|-------------|---------|------------|--------|
|                                   |   |        |    |       |   |
| Inventories                            |   | $           | 278,000 |       | $      | 189,000 |   |
| Net operating loss carryforward        |   | 9,747,000   |    | 7,504,000  |   |
| Stock option and deferred compensation |   | 142,000     |    | 142,000    |   |
| Other                                  |   | 351,000     |    | 151,000    |   |
|                                   |   | 10,518,000  |    | 7,986,000  |   |
| Deferred tax liabilities:              |   |        |    |       |   |
| Other                                  |   | (12,000     | )       | (14,000    | )      |
|                                   |   | (12,000)    |    | (14,000    | )      |
|                                   |   |        |    |       |   |
| Net deferred tax asset                 |   | 10,506,000  |    | 7,972,000  |   |
|                                   |   |        |    |       |   |
| Less valuation allowance               |   | (10,506,000 | )       | (7,972,000 | )      |
|                                   |   | $           | —  |       | $      | — |   |

 

42

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The reconciliation of the reported income taxexpense to the amount that would be result by applying the U.S. federalstatutory tax rate of 34% to net income (loss) is as follows:

 
|                                                                               |   | **2001**  |       | **2000**   |    | **1999**  |   |
|------------------------------------------------------------------------------------|--------|-----------|------------|------------|---------|-----------|--------|
| Tax expense (benefit) at U.S. statutory rate                                       |   | $         | (1,211,000 | )          | $       | 1,914,000 |   | $ | (1,012,000 | ) |
| Effect of permanent differences                                                    |   | 24,000    |       | 17,000     |    | 32,000    |   |
| State income taxes, net of federal benefit                                         |   | (165,000  | )          | 260,000    |    | (149,000  | )      |
| Effect of foreign income taxed at lower rates                                      |   | —    |       | —     |    | (51,000   | )      |
| Change in valuation allowance, excluding charge related to stock  option exercises |   | 1,352,000 |       | (2,173,000 | )       | 1,327,000 |   |
| Other, net                                                                         |   | —    |       | (18,000    | )  | (62,000   | )      |
|                                                                               |   | $         | —     |       | $       | —    |   | $ | 85,000 |   |
|                                                                                    |        |           |            |            |         |           |        |  |  |  |  |  |  |

 

In assessing the realization ofdeferred tax assets, management considers whether it is more likely than notthat all or some portion of the deferred tax assets will not be realized.  The ultimate realization of the deferred taxassets is dependent upon the generation of future taxable income during theperiods in which temporary differences are deductible and net operating lossesare utilized.  Based on consideration ofthese factors, the Company has established a valuation allowance of $10,506,000and $7,972,000 at December 31, 2001 and 2000, respectively.

 

Prior to the third quarter of fiscal year2000, the Company followed the practice of computing its income tax expenseusing the assumption that current year stock option deductions were used firstto offset its financial statement taxable income. The remaining net operatingloss carryforwards could then be used to offset any excess of financialstatement taxable income over current year stock option deductions. Because thestock option deductions are not recognized as an expense for financialreporting purposes, the tax benefit from stock option deductions must becredited to additional paid-in capital with an offsetting charge to income taxexpense in the statement of operations.

 

Effective July 1, 2000, the Company changedits method of accounting for income taxes to recognize the tax benefits fromcurrent and prior years’ stock option deductions after the utilization of netoperating losses from operations (i.e., net operating losses determined withoutdeductions for the exercise of non-qualified stock options and disqualifieddisposition of incentive stock options) to reduce income tax expense. TheCompany believed that this change was to a preferable method because theCompany will not realize any tax benefit from stock compensation deductionsuntil it has fully utilized its current and prior net operating loss carryforwardsfrom operations. Thus, this method more accurately reflects the incrementaleffect of the Company’s stock option deductions in the appropriate accountingperiod. Because the Company was generating net operating losses prior to 2000rather than utilizing them, this accounting change had no effect on prioryears’ tax provisions or additional paid-in capital.

 

At December 31, 2001, the Company had netoperating loss carryforwards related to its Swiss subsidiary of approximately$4,975,000, which expire from 2007 to 2008 and are available to offset futuretaxable income of that subsidiary. At December 31, 2001, the Company had netoperating loss carryforwards for U.S. income tax purposes of approximately$20,264,000, which expire from 2011 to 2021 and are available to offset futureU.S. taxable income. The exercise of non-qualified stock 

 

43

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options and disqualified disposition ofincentive stock options (“stock option deductions”) have generated approximately$13,426,000 of the U.S. net operating loss carryforwards. When these netoperating loss carryforwards are utilized, the resulting reduction in thevaluation allowance will be recorded as a direct increase to stockholders’equity.

 

**(6)           LEASES**

** **

The Company leases officefacilities and equipment under non-cancelable operating leases expiring atvarious dates through 2005. The leases require the Company to pay aproportionate share of real estate taxes, insurance and maintenance. TheCompany recognizes rent expense on a straight-line basis. The future minimumpayments under the leases for the years ending December 31, are asfollows:

 

| 2002   |   | $       | 610,538   |   |
|--------|--------|---------|-----------|--------|
| 2003   |   | 385,578 |      |
| 2004   |   | 25,340  |      |
| 2005   |   | 14,107  |      |
|   |   | $       | 1,035,563 |   |

 

Rent expense under all operatingleases for the years ended December 31, 2001, 2000, and 1999 was $600,189$574,771, and $629,233, respectively.

 

**(7)           PENSION PLANS**

** **

The Company sponsors a definedcontribution pension plan for employees who have completed three months ofservice. The Plan permits pre-tax contributions by participants pursuant toSection 401(k) of the Internal Revenue Code (the Code) of 3% to 15% of basecompensation up to the maximum allowable contributions as determined by theCode. Effective January 1, 2000, the Company matches up to 50% of the first 4%of employee compensation that is contributed to the plan. The company’smatching contributions vest with the participant over a 5-year period on a prorata basis. The Company may also make additional discretionary contributions.The Company incurred expenses for its matching contributions totaling $137,020and $72,777 in 2001 and 2000, respectively. Prior to January 1, 2000, theCompany made no contributions to the Plan.

 

44

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All of the Company’s Swissemployees are participants in a national, compulsory, contributory pensionplan, which is administered by an outside institution. The employees’contributions are defined and calculated according to age group. The employer’scontributions are then equal to the same amount. The pension costs for theSwiss subsidiary during 2001, 2000, and 1999 totaled $240,701, $217,622, and$238,079, respectively.

 

45

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**(8)           STOCK OPTIONS AND WARRANTS**

** **

The Company sponsors stockoption plans that provide for the granting of stock options to officers,directors, consultants and employees of the Company. Options are exercisable atthe fair market value of the common stock on the date of grant and, subject totermination of employment, expire seven years from the date of grant.  Either incentive stock options ornon-qualified stock options may be granted under the plans. The vesting andexercise periods are determined by the Board of Directors and may not exceedten years. Options issued to date generally vest in equal amounts over avesting period of either three or four years. Option activity during 1999, 2000and 2001 was as follows:

** **
|                             |   |                  |   |                          |             | **Weighted  Average  Exercise  Price** |   |
|----------------------------------|--------|-----------------------|--------|-------------------------------|------------------|----------------------------------------|--------|
|                             |   |                  |   |                          |             |                                   |
|                             |   | **Number  of Shares** |   | **Range of  Exercise Prices** |             |                                   |
|                             |   |                  |   |                          |
| Outstanding at January 1, 1999   |   | 1,157,683             |   | $                             | 1.30  to $20.00  |                                   | $      | 8.23 |   |
| Granted                          |   | 362,700               |   | $                             | 9.19  to $31.50  |                                   | 14.91  |   |
| Canceled                         |   | (95,105               | )      | $                             | 5.00  to $23.31  |                                   | 9.93   |   |
| Exercised                        |   | (225,906              | )      | $                             | 1.30  to $13.00  |                                   | 7.35   |   |
|                             |   |                  |   |                          |             |                                   |   |
| Outstanding at December 31, 1999 |   | 1,199,372             |   | $                             | 3.09  to $31.50  |                                   | 10.28  |   |
| Granted                          |   | 751,541               |   | $                             | 14.75  to $43.50 |                                   | 22.66  |   |
| Canceled                         |   | (216,557              | )      | $                             | 4.50  to $25.63  |                                   | 11.25  |   |
| Exercised                        |   | (392,204              | )      | $                             | 3.09  to $20.25  |                                   | 10.42  |   |
|                             |   |                  |   |                          |             |                                   |   |
| Outstanding at December 31, 2000 |   | 1,342,152             |   | $                             | 3.09  to $43.50  |                                   | 17.01  |   |
| Granted                          |   | 825,422               |   | $                             | 5.85  to $43.63  |                                   | 11.79  |   |
| Canceled                         |   | (117,219              | )      | $                             | 3.25  to $43.50  |                                   | 25.78  |   |
| Exercised                        |   | (166,896              | )      | $                             | 3.09  to $24.87  |                                   | 9.41   |   |
|                             |   |                  |   |                          |             |                                   |   |
| Outstanding at December 31, 2001 |   | 1,883,459             |   | $                             | 4.38  to $43.63  |                                   | $      | 14.85 |   |
|                             |   |                  |   |                          |             |                                   |   |
| Exercisable at December 31, 2001 |   | 755,946               |   | $                             | 4.38  to $42.88  |                                   | $      | 13.54 |   |

** **

The following table summarizesinformation about stock options outstanding at December 31, 2001:

 

46

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|                          |   | **Options Outstanding** |   | **Options Exercisable**                            |   |
|-------------------------------|--------|-------------------------|--------|----------------------------------------------------|--------|
|                          |   |                    |   | **Weighted  Average  Remaining  Contractual Life** |   | **Weighted  Average  Exercise  Price** |   |   |   | **Weighted  Average  Exercise  Price** |   |
|                          |   |                    |   |                                               |   |   |   |   |
| **Range of  Exercise Prices** |   | **Number  of shares**   |   |                                               |   | **Number  of Shares** |   |   |
|                          |   |                    |   |                                               |   |
| $ 4.38 to $8.73               |   | 541,789                 |   | 5.6  years                                         |   | $ | 6.99 |   | 221,789 |   | $ | 7.36 |   |
| $ 8.74 to $17.450             |   | 785,180                 |   | 6.9  years                                         |   | $ | 12.56 |   | 361,720 |   | $ | 12.11 |   |
| $ 17.46 to $26.18             |   | 431,822                 |   | 5.2  years                                         |   | $ | 22.48 |   | 134,394 |   | $ | 21.96 |   |
| $ 26.18 to $34.90             |   | 53,168                  |   | 5.7  years                                         |   | $ | 32.59 |   | 27,668 |   | $ | 31.68 |   |
| $ 34.91 to $43.63             |   | 71,500                  |   | 5.1  years                                         |   | $ | 40.29 |   | 10,375 |   | $ | 37.88 |   |
|                          |   | 1,883,459               |   | 6.0  years                                         |   | $ | 14.85 |   | 755,946 |   | $ | 13.54 |   |
|                               |        |                         |        |                                                    |        |  |  |  |  |  |  |  |  |  |

 

The Company applies the intrinsic valuemethod in accounting for options granted to employees and directors and,accordingly, no compensation cost has been recognized for its options in theconsolidated financial statements.  Proforma financial information regarding net income (loss) and income (loss) pershare has been determined as if the Company had accounted for its employeestock options using the fair value method. For purposes of pro forma disclosures, the estimated fair value of theoptions is amortized to expense over the options’ vesting period.  The Company’s pro forma information follows:

 
|                             |   | **2001** |       | **2000** |   | **1999**  |   |
|----------------------------------|--------|----------|------------|----------|--------|-----------|--------|
| Net income (loss)                |   |     |       |     |   |      |   |
| As reported                      |   | $        | (3,561,514 | )        | $      | 5,757,144 |   | $ | (3,060,522 | ) |
| Proforma                         |   | $        | (8,898,000 | )        | $      | 1,640,000 |   | $ | (5,124,000 | ) |
| Earnings (loss) per common share |   |     |       |     |   |      |   |
| As reported                      |   |     |       |     |   |      |   |
| Basic                            |   | $        | (.50       | )        | $      | .85       |   | $ | (.56 | ) |
| Diluted                          |   | $        | (.50       | )        | $      | .80       |   | $ | (.56 | ) |
| Proforma                         |   |     |       |     |   |      |   |
| Basic                            |   | $        | (1.26      | )        | $      | .24       |   | $ | (.93 | ) |
| Diluted                          |   | $        | (1.26      | )        | $      | .24       |   | $ | (.93 | ) |

 

The weighted-average fair value per share ofoptions granted during 2001, 2000, and 1999 was $11.50, $20.45, and $11.43,respectively, on the dates of grant. The fair values of options granted wasestimated using the Black-Scholes option-pricing model with the followingweighted average assumptions for grants in 2001, 2000, and 1999, respectively:  risk-free interest rates of 4.42%, 5.10%,and 6.44%; expected volatility of 139%, 180%, and 143%; dividend yield andexpected dividend growth rate of 0% in all years; and weighted-average expectedlife of 3 to 5 years.

 

In addition, in November 1995, in connectionwith the private placement of 300,000 shares of the Company’s common stock, theCompany issued the placement agent warrants to purchase 30,000

 

47

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shares of common stock at $17.00 per share.Warrants for 23,050 of these shares were exercised in June 1999 and theremaining 6,950 were exercised in January 2000.

 

At December 31, 2001, the Company hadreserved 2,313,095 shares of common stock for exercise of outstanding stockoptions and additional stock options authorized for granting under existingstock option plans.

 

**(9)           CYBERGUARD ADVANCE**

** **

In August 1996, the Company signed a two yearJoint Development and Marketing Agreement with CyberGuard Corporation(CyberGuard). The companies intended to develop and market a product thatcombined the Company’s SafeNet Enterprise products and CyberGuard’s Firewallproduct. In connection therewith, the Company prepaid a refundable $1,000,000license fee to CyberGuard.  In June 1998,the agreement was modified and CyberGuard was required to refund the prepaidlicense fee.  As of December 31, 1998,CyberGuard defaulted on this obligation.

 

During 1999, the Company agreed to accept a$650,000 note receivable from CyberGuard as payment in full of CyberGuard’sobligation. CyberGuard fulfilled their obligation to SafeNet by paying $275,000in 2000 and $375,000 in 1999 on the note.

 

**(10)          SEGMENTS OF THE COMPANY AND RELATEDINFORMATION**

** **

The Company has three reportable segments:products, chips and software designed and manufactured in the United States forsale to companies that will embed the Company’s products into their productsfor ultimate sale to end-users (“Technology Operations”), network securityproducts designed and manufactured in the United States for direct sales toend-users (“Product Operations”), and security products designed andmanufactured outside the United States (“European Operations”). The reportablesegments are strategic business units that offer different products. Thesegments are managed separately because each segment requires differenttechnology and marketing strategies. The Technology Operations and ProductOperations include some international sales mainly to South America and Asia.

 

48

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|                                            |   | **2001**   |       | **2000**   |   | **1999**   |   |
|-------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
| Revenue from external customers:                |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | 7,583,198  |       | $      | 15,952,594 |   | $ | 3,929,064 |   |
| Product operations                              |   | 8,878,758  |       | 9,325,882  |   | 6,635,574  |   |
| European operations                             |   | 1,665,051  |       | 3,547,108  |   | 8,362,255  |   |
| Consolidated revenues                           |   | $          | 18,127,007 |       | $      | 28,825,584 |   | $ | 18,926,893 |   |
| Intersegment revenues:                          |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | —     |       | $      | —     |   | $ | 2,000,000 |   |
| Product operations                              |   | 50,012     |       | 139,110    |   | 12,399     |   |
| European operations                             |   | —     |       | 32,716     |   | 27,318     |   |
| Intersegment revenues                           |   | $          | 50,012     |       | $      | 171,826    |   | $ | 2,039,717 |   |
| Reconciling items:                              |   |       |       |       |   |       |   |
| Intersegment revenues                           |   | $          | (50,012    | )          | $      | (171,826   | )      | $ | (2,039,717 | ) |
| Total consolidated revenues                     |   | $          | 18,127,007 |       | $      | 28,825,584 |   | $ | 18,926,893 |   |
| Operating income (loss):                        |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | (2,023,701 | )          | $      | 4,652,295  |   | $ | (3,645,922 | ) |
| Product operations                              |   | 578,044    |       | 1,287,946  |   | (1,823,782 | )      |
| European operations                             |   | (3,473,121 | )          | (1,555,908 | )      | 2,344,679  |   |
| Consolidated operating income (loss)            |   | $          | (4,918,778 | )          | $      | 4,384,333  |   | $ | (3,125,025 | ) |
| Income (loss) before income taxes:              |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | (1,408,744 | )          | $      | 5,484,095  |   | $ | (3,598,659 | ) |
| Product operations                              |   | 1,299,524  |       | 1,776,463  |   | (1,776,519 | )      |
| European operations                             |   | (3,452,294 | )          | (1,503,414 | )      | 2,399,789  |   |
| Consolidated income (loss) before income taxes  |   | $          | (3,561,514 | )          | $      | 5,757,144  |   | $ | (2,975,389 | ) |
| Depreciation and amortization:                  |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | 1,163,277  |       | $      | 1,076,002  |   | $ | 269,236 |   |
| Product operations                              |   | 398,027    |       | 698,552    |   | 768,709    |   |
| European operations                             |   | 138,819    |       | 140,178    |   | 153,317    |   |
| Consolidated depreciation and amortization      |   | $          | 1,700,123  |       | $      | 1,914,732  |   | $ | 1,191,262 |   |
| Segment assets:                                 |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | 17,053,845 |       | $      | 22,001,187 |   | $ | 9,790,620 |   |
| Product operations                              |   | 21,498,911 |       | 16,337,605 |   | 15,792,342 |   |
| European operations                             |   | 1,324,862  |       | 4,766,987  |   | 6,312,850  |   |
| Consolidated segment assets                     |   | $          | 39,877,618 |       | $      | 43,105,779 |   | $ | 31,895,812 |   |
| Expenditures for long-lived assets              |   |       |       |       |   |       |   |
| Technology operations                           |   | $          | 414,770    |       | $      | 875,649    |   | $ | 833,950 |   |
| Product operations                              |   | 209,535    |       | 278,556    |   | 679,297    |   |
| European operations                             |   | 86,738     |       | 27,326     |   | 113,072    |   |
| Consolidated expenditures for long-lived assets |   | $          | 711,043    |       | $      | 1,181,531  |   | $ | 1,626,319 |   |

 

49

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|                           |   | **2001**  |       | **2000**  |   | **1999**   |   |
|--------------------------------|--------|-----------|------------|-----------|--------|------------|--------|
| **Geographic Information**     |   |      |       |      |   |       |   |
| Revenues:                      |   |      |       |      |   |       |   |
| United States                  |   | $         | 15,343,628 |      | $      | 23,956,018 |   | $ | 10,347,908 |   |
| Switzerland                    |   | 776,340   |       | 2,097,325 |   | 4,179,224  |   |
| Germany                        |   | 324,398   |       | 739,448   |   | 2,108,528  |   |
| Other foreign countries        |   | 1,682,641 |       | 2,032,793 |   | 2,291,233  |   |
| Consolidated revenues          |   | $         | 18,127,007 |      | $      | 28,825,584 |   | $ | 18,926,893 |   |
|                           |   |      |       |      |   |       |   |
| Long-lived assets:             |   |      |       |      |   |       |   |
| United States                  |   | $         | 1,695,833  |      | $      | 2,696,094  |   | $ | 3,304,341 |   |
| Switzerland                    |   | 221,068   |       | 270,784   |   | 226,755    |   |
| Consolidated long-lived assets |   | $         | 1,916,901  |      | $      | 2,966,878  |   | $ | 3,531,096 |   |

 

**(11)         SIGNIFICANT CUSTOMERS ANDCONCENTRATIONS OF CREDIT RISK**

 

Financial instruments thatpotentially subject the Company to significant concentrations of credit riskconsist primarily of accounts receivable. The Company performs ongoing creditevaluations of its customers and generally does not require collateral.  Sales terms with clients, includingdistributors, do not provide for right of return privileges for credit, refundor other products.  The Company’s paymentterms are generally 30 days from delivery of products, but could fluctuatedepending on the terms of each specific contract.  The Company’s clients, who include both commercial companies andgovernmental agencies, are in various industries, including banking, security,communications and distributors of electronic products.

 

In 2001, one commercial clientof the Product Group accounted for 11% of the Company’s consolidated revenues.In 2000, one commercial client of the Technology Group accounted for 25% of theCompany’s consolidated revenues. In 1999, no commercial client accounted forgreater than 10% of the Company’s consolidated revenues.

 

As of December 31, 2001, onecommercial client of the Technology Group accounted for 30% of accountsreceivable and two commercial clients of the Production Group accounted for acombined 28% of accounts receivable.

 

**(12)         INCOME (LOSS) PER SHARE**

 

The following table sets forththe computation of basic and diluted net income (loss) per common share for theyears ended December 31:

 

50

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|                                                                                                             |   | **2001**  |         | **2000**  |         | **1999**  |   |
|------------------------------------------------------------------------------------------------------------------|--------|-----------|--------------|-----------|--------------|-----------|--------|
| Numerator:                                                                                                       |   |      |         |      |         |      |   |
| Net income (loss)                                                                                                |   | $         | (3,561,514   | )         | $            | 5,757,144 |   | $ | (3,060,522 | ) |
|                                                                                                             |   |      |         |      |         |      |   |
| Denominator:                                                                                                     |   |      |         |      |         |      |   |
| Denominator for basic income (loss) per share — weighted average  shares                                    |   | 7,056,930 |    | 6,751,465 |    | 5,504,440 |   |
| Effect of employee stock options                                                                                 |   | —    |         | 442,698   |         | —    |   |
| Denominator for diluted income (loss) per share — adjusted  weighted-average shares and assumed conversions |   | 7,056,930 |         | 7,194,163 |         | 5,504,440 |   |
|                                                                                                             |   |      |         |      |         |      |   |
| Basic income (loss) per share                                                                                    |   | $         | (.50         | )         | $            | .85       |   | $ | (.56 | ) |
| Diluted income (loss) per share                                                                                  |   | $         | (.50         | )         | $            | .80       |   | $ | (.56 | ) |

 

Diluted loss per common sharein 2001 and 1999 is equal to basic loss per common share because if potentiallydilutive securities were included in the computation, the result would beanti-dilutive.

 

**(13)         SUBSEQUENT EVENT — ACQUISITION OFSECUREALINK**

** **

On January 2, 2002, SafeNetacquired 100 percent of the outstanding common shares of PijnenburgSecurealink, Inc. (“Securealink”) in accordance with an Agreement and Plan ofReorganization dated December 14, 2001. The purchase price the Company paid tothe stockholders of Securealink in connection with the acquisition totaled$15,086,000 and consisted of an aggregate of 575,000 shares of SafeNet, Inc.common stock valued at $10,636,000, $2,000,000 in cash, convertible promissorynotes with an aggregate principal amount of $2,000,000, and estimated directcosts of acquisition of $450,000. The fair market value of common shares wasbased on the average market price of the shares over the period from three daysbefore to three days after the closing date. The cash portion of the consideration was funded with cash on hand. Theconvertible promissory notes have a three year term and bear interest at anannual rate of 5% and are convertible into the Company’s common stock at aconversion price of $18.37 per share. The amount and type of consideration wasdetermined on the basis of arm’s length negotiations between the Company andSecurealink. Securealink develops security chips and sells them in Europe andthroughout the world.  Securealink willcontinue to operate as a provider of security chips and will be a subsidiary ofSafeNet. As a result of the acquisition, SafeNet has broadened its market withthe addition of new technologies and a larger presence in Europe.  Additionally, Securealink brings over thirtycryptographic experts who will compliment and strengthen SafeNet’s alreadyworld-class development team.  Theresults of Securealink will be included in the Company’s consolidated resultsbeginning on the date of acquisition.

 

51

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The following table summarizes the estimatedfair values of the assets acquired and liabilities assumed at the date ofacquisition.  SafeNet is in the processof obtaining third-party valuations of certain intangible assets; thus, theallocation of the purchase price is subject to adjustment.

 
| **At January 2, 2002**                     |
|--------------------------------------------|
| Current Assets                             |   |   |   | $ | 1,826,000 |   |
| Property and equipment                     |   |   |   | 325,000 |   |
| Software licenses                          |   |   |   | 462,000 |   |
| Goodwill                                   |   |   |   | 10,678,000 |   |
| In-process research and development assets |   |   |   | 3,012,000 |   |
| Other intangible assets                    |   |   |   | 1,906,000 |   |
|                                       |   |   |   |   |   |
| **Total assets acquired**                  |   |   |   | **$** | **18,209,000** | ** ** |
|                                       |   |   |   |   |   |
| Current liabilities                        |   |   |   |   |   |
| Short term borrowings                      |   |   |   | (1,484,000 | ) |
| Other current liabilities                  |   |   |   | (1,639,000 | ) |
|                                       |   |   |   |   |   |
| **Total liabilities assumed**              |   |   |   | **$** | **(3,123,000** | **)** |
|                                       |   |   |   |   |   |
| **Net assets acquired**                    |   |   |   | **$** | **15,086,000** | ** ** |

 

Upon completion of a valuation,amounts to be accounted for as acquired in-process research and developmentassets will be written off as of the date of acquisition in accordance withFASB Interpretation No.4, *Applicability ofFASB Statement No. 2 to Business Combinations Accounted for by the PurchaseMethod*.  Those charges willbe included in research and development expenses.

 

The unaudited proforma combinedhistorical results, as if Securealink had been acquired on January 1, 2001, isas follows:

 
| Revenues       |   | $          | 25,010,000 |   |
|----------------|--------|------------|------------|--------|
| Net loss       |   | (7,826,000 | )          |
|           |   |       |       |
| Loss per share |   | $          | (1.03      | )      |

 

The proforma results includethe estimated amortization of intangibles and interest expense on thepromissory notes used to finance part of the purchase.  As described in Note 2, the Company will notrecord amortization expense related to the goodwill. The proforma results arenot necessarily indicative of the results that would have occurred if theacquisition had been completed on January 1, 2001, nor are they necessarilyindicative of future consolidated results.

 

52

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**(14)         SUBSEQUENT EVENT — DISCONTINUEDOPERATIONS**

** **

SafeNet’s acquisition of Securealink resultedin changes to SafeNet’s business initiatives. One of the areas impacted was the Company’s Swiss subsidiary, GretaCoderData Systems (“GDS”).  Based on theamount of GDS operating and cash losses during 2000 and 2001 as well as asignificant downturn in future business prospects due to the loss of twosubstantial contracts in February 2002, SafeNet management made the decision onFebruary 11, 2002 to discontinue operations at GDS.  Certain employees from GDS’s sales and marketing team will betransferred to SafeNet to create a new European sales office focused on sellingSafeNet's Enterprise Security Systems in Europe.  All of the operations at GDS, including research and development,manufacturing and administration will be closed during the first quarter of2002.  In total, 26 employees will beterminated, by the end of April 2002.

 

As a result of the discontinued operations,the Company will incur a one-time charge of $3.5 million in the first quarterof 2002 related to the write-off of the abandoned assets and the accrual of theestimated costs of the closing and severance and related costs.  The disposition of GDS operations representsthe disposal of a business segment under Statement of Financial AccountingStandard No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets.*  Accordingly, beginning January 1, 2002, results of this operation willbe classified as discontinued, and prior periods will be restated.  For business segment reporting purposes,GDS’s business results are classified in the segment “European Operations.”

 

Summarized operating results from thediscontinued operation included in our statement of operations are as follows:

 
|                                           |   | **2001**   |       | **2000**   |   | **1999**   |   |
|------------------------------------------------|--------|------------|------------|------------|--------|------------|--------|
| Revenues                                       |   | $          | 1,665,000  |       | $      | 3,547,000  |   | $ | 8,362,000 |   |
| Pretax (loss) from discontinued operation      |   | (3,452,000 | )          | (1,503,000 | )      | 2,400,000  |   |
| Pretax loss on disposal of business segment**  |   | —     |       | —     |   | —     |   |
| Income tax expense                             |   | —     |       | —     |   | (85,000    | )      |
| Net (loss) income  from discontinued operation |   | $          | (3,452,000 | )          | $      | (1,503,000 | )      | $ | 2,315,000 |   |

----

** Disposal of operations began and will be reported in January 2002.

 

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

 
|                                 |   | **2001** |    | **2000** |   |
|--------------------------------------|--------|----------|---------|----------|--------|
| Current assets                       |   | $        | 788,000 |     | $      | 4,095,000 |   |
| Property and equipment, net          |   | 221,000  |    | 195,000  |   |
| Other assets                         |   | 316,000  |    | 477,000  |   |
| Current liabilities                  |   | (833,000 | )       | (766,000 | )      |
| Net assets of discontinued operation |   | $        | 492,000 |     | $      | 4,001,000 |   |

 

 

53

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The estimated pre-tax lossrelated to the write-down of the carrying value of the discontinued operationto its fair value less cost to dispose is as follows:

 
| Inventory and purchase commitments                 |   | $         | 125,000   |   |
|----------------------------------------------------|--------|-----------|-----------|--------|
| Goodwill                                           |   | 316,000   |      |
| Property and equipment                             |   | 125,000   |      |
| Realization of foreign currency translation losses |   | 1,526,000 |      |
| Severance costs                                    |   | 602,000   |      |
| Lease termination costs                            |   | 600,000   |      |
| Consulting and professional fees                   |   | 125,000   |      |
| Travel and corporate closing costs                 |   | 50,000    |      |
|                                               |   |      |      |
| **Estimated loss on disposal of GDS**              |   | $         | 3,469,000 |   |

 

The estimated fair value ofassets to be disposed was based on the related assets estimated net realizablevalue at the time of disposal.

 

54

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ScheduleII

 

Valuationand Qualifying Accounts

 
|                                 |   | **Balance  at****Beginning   of  Period** |    | **Charged  to Costs  and  Expenses** |   | **Charges  to Other  Accounts  Describe (a)** |   | **Deductions  Describe (b)**   |   |    |   |    |   |
|--------------------------------------|--------|-------------------------------------------|---------|--------------------------------------|--------|-----------------------------------------------|--------|--------------------------------|--------|---------|--------|---------|--------|
|                                 |   |                                      |    |                                 |   |                                          |   | **Balance  at End  of Period** |   |
|                                 |   |                                      |    |                                 |   | **Recovery  Describe (c)**                    |   |                           |
|                                 |   |                                      |    |                                 |   |                                          |   |
| **Allowance for doubtful accounts:** |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2001         |   | $                                         | 231,724 |                                 | $      | 77,526                                        |   | $                              | (1,821 | )       | $      | 152,165 |   | $ | — |   | $ | 155,264 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2000         |   | 251,005                                   |    | 60,000                               |   | (419                                          | )      | 78,862                         |   | —  |   | 231,724 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 1999         |   | 86,725                                    |    | 170,842                              |   | (5,720                                        | )      | 842                            |   | —  |   | 251,005 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| **Reserve for obsolete inventory:**  |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2001         |   | $                                         | 400,536 |                                 | $      | 1,083,470                                     |   | $                              | (4,771 | )       | $      | 9,118   |   |   |   | $ |  1,470,117 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2000         |   | 402,812                                   |    | —                               |   | (2,276                                        | )      | —                         |   |    |   | 400,536 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 1999         |   | 424,818                                   |    | 100,000                              |   | (34,023                                       | )      | 87,983                         |   | —  |   | 402,812 |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| **Reserve for CyberGuard advance:**  |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2001         |   | $                                         | —  |                                 | $      | —                                        |   | $                              | — |    | $      | —  |   | $ | — |   | $ | — |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 2000         |   | 275,000                                   |    | —                               |   | —                                        |   | —                         |   | 275,000 |   | —  |   |
|                                 |   |                                      |    |                                 |   |                                          |   |                           |   |    |   |    |   |
| Year ended December 31, 1999         |   | 771,655                                   |    | —                               |   | —                                        |   | 121,655                        |   | 375,000 |   | 275,000 |   |

 

(a)Charges to other accounts represent the translation effect for the change inthe Swiss Franc exchange rate for balances existing at the beginning of theperiod.

 

(b) Deductions represent write-offs ofspecifically identified accounts.

 

(c) Other represents cash received onpreviously reserved account.

 

**ITEM9 — CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

Refer to SafeNet’s currentreport on Form 8-K dated June 19, 2000.

 

**PARTIII**

 

**ITEM10 — DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

** **

The information required bythis item is incorporated herein by reference to the definitive Proxy Statementof SafeNet, which will be filed with the Securities and Exchange Commission nolater than 120 days after the close of SafeNet’s fiscal year ended December 31,2001.

 

55

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**ITEM11 — EXECUTIVE COMPENSATION**

 

The information required bythis item is incorporated herein by reference to the definitive Proxy Statementof SafeNet, which will be filed with the Securities and Exchange Commission nolater than 120 days after the close of SafeNet’s fiscal year ended December 31,2001.

 

**ITEM12 — SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The information required bythis item is incorporated herein by reference to the definitive Proxy Statementof SafeNet, which will be filed with the Securities and Exchange Commission nolater than 120 days after the close of SafeNet’s fiscal year ended December 31,2001.

 

**ITEM13 — CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

** **

The information required bythis item is incorporated herein by reference to the definitive Proxy Statementof SafeNet, which will be filed with the Securities and Exchange Commission nolater than 120 days after the close of SafeNet’s fiscal year ended December 31,2001.

 

56

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**PARTIV**

 

**ITEM14 — EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8–K**

 
| (a)    | 1.    The financial statements filed as part of this report are listed  separately on the Index To Financial Statements on page 31 of this Form.                                                                                                                                                                         |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 2.   Financial Statement Schedules: Schedule  II Valuation and Qualifying Accounts   All other schedules for which provision is made in the applicable accounting  regulation of the Securities and Exchange Commission are not required under  the related instructions or are inapplicable therefore have been omitted |
| (b)    | Reports on  Form 8-K:  None                                                                                                                                                                                                                                                                                                   |
| (c)    | Exhibits  required by Item 601 of Regulation S-K:                                                                                                                                                                                                                                                                                  |
|   | 3A                                                                                                                                                                                                                                                                                                                                 | Restated  Certificate of Incorporation of Safenet, Inc., as filed with the Secretary of  State of Delaware on May 23, 2001 | I/B/R(3a) |
|   | 3B                                                                                                                                                                                                                                                                                                                                 | By-laws of  Registrant | I/B/R(2) |
|   | 4                                                                                                                                                                                                                                                                                                                                  | Specimen of  Common Stock Certificate of Registrant | I/B/R(2) |
|   | 10A                                                                                                                                                                                                                                                                                                                                | Sublease  dated November 2, 1993 for facility at 8029 Corporate Drive, Baltimore, MD. | I/B/R(3) |
|   | 10B                                                                                                                                                                                                                                                                                                                                | Stock Option  Plan of 1989 | I/B/R(4) |
|   | 10C                                                                                                                                                                                                                                                                                                                                | Employment  Agreement with Douglas Kozlay | I/B/R(2) |
|   | 10D                                                                                                                                                                                                                                                                                                                                | Form  Employee Non-Disclosure Agreement | I/B/R(2) |
|   | 10E                                                                                                                                                                                                                                                                                                                                | Employment  Agreement between GDS and Dr. Kurt H. Mueller | I/B/R(1) |
|   | 10F                                                                                                                                                                                                                                                                                                                                | Placement  Agent Warrant | I/B/R(1) |
|   | 10G                                                                                                                                                                                                                                                                                                                                | Joint  Development and Marketing Agreement between the Registrant and CyberGuard  Corporation | I/B/R(5) |
|   | 10H                                                                                                                                                                                                                                                                                                                                | Employment  Agreement with Anthony Caputo | I/B/R(5) |
|   | 10I                                                                                                                                                                                                                                                                                                                                | Agreement  between SafeNet Secure Solutions, Inc. (wholly-owned subsidiary of the  Registrant) and Analog Devices, Inc. | I/B/R(6) |
|   | 10J                                                                                                                                                                                                                                                                                                                                | 1999 Employee  Stock Option Plan | I/B/R(7) |
|   | 10K                                                                                                                                                                                                                                                                                                                                | 1999 Stock  Bonus Plan | I/B/R(7) |
|   | 10L                                                                                                                                                                                                                                                                                                                                | Non-Employee  Director Stock Option Plan | I/B/R(7) |
|   | 10M                                                                                                                                                                                                                                                                                                                                | 2000  Employee and Directors Stock Option Plan | I/B/R(7) |
|   | 10N                                                                                                                                                                                                                                                                                                                                | 2001 Omnibus  Stock Option Plan | I/B/R(1) |
|   | 21                                                                                                                                                                                                                                                                                                                                 | Subsidiaries  of Registrant |   |
|   | 23.1                                                                                                                                                                                                                                                                                                                               | Consent of  Ernst & Young LLP, independent auditors |   |
|   | 23.2                                                                                                                                                                                                                                                                                                                               | Consent of  KPMG LLP, independent auditors |   |

----

(1)       Filedas an exhibit to the Definitive Proxy Statement on Schedule 14a for the AnnualMeeting of Shareholders held on May 16, 2001, incorporated herein by reference.

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

 

57

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(3)         Filedas an exhibit to Form 10-KSB for the fiscal year ended December 31, 1993 andincorporated herein by reference.

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

(5)         Filedas an exhibit to Form 10-K for the fiscal year ended December 31, 1996 andincorporated herein by reference.

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

(7)         Filedas an exhibit to a Definitive Proxy Statement on Schedule 14A for the AnnualMeeting of Shareholders held on July 28, 1999 and incorporated herein byreference.

 

58

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**SIGNATURES**

 

Pursuant to the requirements ofSection 13 or 15(d) of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on behalf of the undersigned, thereuntoduly authorized.

 

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

 

Date:  March 18, 2002 

 

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

 
|                    | **Signature**                                  |                                                 |            | **Title** |   |   | **Date** |   |
|-------------------------|------------------------------------------------|------------------------------------------------------|-----------------|-----------|--------|--------|----------|--------|
|                    |                                           |                                                 |
| /s/ Anthony A. Caputo   |                                           | Chairman,  Chief Executive Officer                   | March 18,  2002 |
| Anthony A. Caputo       | and  President                                 |                                                 |
|                    |                                           |                                                 |
| /s/ Carole D. Argo      |                                           | Senior Vice  President and Chief   Financial Officer | March 18,  2002 |
| Carole D. Argo          | (Principal  Financial and Accounting  Officer) |                                                 |
|                    |                                           |                                                 |
| /s/ Thomas A. Brooks    |                                           | Director                                             | March 18,  2002 |
| Thomas A. Brooks        |                                           |                                                 |
|                    |                                           |                                                 |
| /s/ Shelley A. Harrison |                                           | Director                                             | March 18,  2002 |
| Shelley A. Harrison     |                                           |                                                 |
|                    |                                           |                                                 |
| /s/ Ira A. Hunt, Jr.    |                                           | Director                                             | March 18,  2002 |
| Ira A. Hunt, Jr.        |                                           |                                                 |
|                    |                                           |                                                 |
| /s/ Bruce R. Thaw       |                                           | Director                                             | March 18,  2002 |
| Bruce R. Thaw           |                                           |                                                 |
|                         |                                                |                                                      |                 |           |        |        |          |        |  |  |  |  |  |

 

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