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FORM 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
[X]  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACTS OF 1934

|                                         |  |                                
|---------------------------------------- |  | -------------------------------
|For the Quarter ended SEPTEMBER 30, 2001 |  | Commission file number: 0-16641

RAINBOW TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)

|                                         |  |                                     
|---------------------------------------- |  | ------------------------------------
|DELAWARE                                 |  | 95-3745398                          
|(State of incorporation)                 |  | (I.R.S. Employer Identification No.)
|                                        
|50 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA  |  | 92618                               
|(Address of principal executive offices) |  | (Zip Code)                          

Indicate by check mark whether the Registrant (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (ii) has been subject to
such filing requirements for the past 90 days.

Yes [X]  No [   ]

The number of shares of common stock, $.001 par value, outstanding as of
November 7, 2001, was 26,077,633.



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|                          |                                                                                       |                                                                  |  |  |  |  |  | 
|------------------------- | ------------------------------------------------------------------------------------- | ---------------------------------------------------------------- |  |  |  |  |  | 
|                          |                                                                                       | CONDENSED CONSOLIDATED BALANCE SHEETS                           
|                          |                                                                                       | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                 
|                          |                                                                                       | CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
|                          |                                                                                       | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                 
|                          |                                                                                       | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS            
|                          | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|PART II OTHER INFORMATION
|                          | Item 6 Exhibits and Reports on Form 8-K                                              
|SIGNATURES               



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##### Table of Contents



RAINBOW TECHNOLOGIES, INC.
 
TABLE OF CONTENTS

|                               |                                                                                                                                              |      |    |  | 
|------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------- | ---- | -- |  | 
|PART I - FINANCIAL INFORMATION |                                                                                                                                              | Page
|                               |                                                                                                                                             
|Item 1.                        | Condensed Consolidated Financial Statements                                                                                                  |     
|                              
|                               | Condensed Consolidated Balance Sheets at September 30, 2001 (unaudited) and December 31, 2000                                                |      | 4  | 
|                              
|                               | Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2001 and
2000 (unaudited)                  |      | 5  | 
|                              
|                               | Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended
September 30, 2001 and 2000 (unaudited) |      | 6  | 
|                              
|                               | Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000 (unaudited)                            |      | 7  | 
|                              
|                               | Notes to Condensed Consolidated Financial Statements (unaudited)                                                                             |      | 8  | 
|                              
|Item 2.                        | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                        |      | 12 | 
|                              
|PART II - OTHER INFORMATION    |                                                                                                                                             
|                              
|Item 1 to 5  Not applicable   |                                                                                                                                             
|                              
|Item 6.                        | Exhibits and reports on
Form 8-K                                                                                                             |      | 15 | 
|                              
|SIGNATURES                     |                                                                                                                                              | 17   |   



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INTRODUCTORY NOTE

The Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 and the Company intends that
such forward-looking statements be subject to the safe harbors created thereby.
These forward-looking statements include (i) the existence and development of
the Companys technical and manufacturing capabilities, (ii) anticipated
competition, (iii) potential future growth in revenues and income, (iv)
potential future decreases in costs, and (v) the need for, and availability of
additional financing.

The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties. These
forward-looking statements are based on the assumption that the Company will
not lose a significant customer or customers or experience increased
fluctuations of demand or rescheduling of purchase orders, that the Companys
markets will continue to grow, that the Companys products will remain accepted
within their respective markets and will not be replaced by new technology,
that competitive conditions within the Companys markets will not change
materially or adversely, that the Company will retain key technical and
management personnel, that the Companys forecasts will accurately anticipate
market demand, that there will be no material adverse change in the Companys
operations or business and that the Company will not experience significant
supply shortages with respect to purchased components, sub-systems or raw
materials. Assumptions relating to the foregoing involve judgments with respect
to, among other things, future economic, competitive and market conditions, and
future business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. In
addition, the business and operations of the Company are subject to substantial
risks, which increase the uncertainty inherent in the forward-looking
statements. In light of the significant uncertainties inherent in the
forward-looking information included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the objectives or plans of the Company will be achieved.



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RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |            |             | 
|--------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------- | ----------- | ------------------ | ----------- | ----------------- | ----------- | ---------- | ----------- | 
|                                        |                                                                                                                                                     |                                   |             | September 30, 2001 |             | December 31, 2000
|                                        |                                                                                                                                                     |                                   |             |                    |             |                  
|                                        |                                                                                                                                                     |                                   |             | (Unaudited)        |             |                   |             |           
|ASSETS                                 
|Current assets:                         |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        | Cash and cash equivalents                                                                                                                           |                                   | $           | 24,988,000         |             |                   | $           | 19,458,000 |            
|                                        | Marketable securities available-for-sale                                                                                                            |                                   |             | 933,000            |             |                   |             | 1,582,000  |            
|                                        | Marketable securities trading                                                                                                                       |                                   |             | 107,000            |             |                   |             | 3,669,000  |            
|                                        | Accounts receivable, net of allowance for doubtful accounts of $2,885,000 and
$1,460,000 in 2001 and 2000, respectively                             |                                   |             | 20,196,000         |             |                   |             | 40,710,000 |            
|                                        | Inventories                                                                                                                                         |                                   |             | 21,017,000         |             |                   |             | 30,395,000 |            
|                                        | Income tax receivable                                                                                                                               |                                   |             | 5,627,000          |             |                   |             | 7,444,000  |            
|                                        | Deferred income taxes                                                                                                                               |                                   |             | 15,939,000         |             |                   |             | 5,862,000  |            
|                                        | Unbilled costs and fees                                                                                                                             |                                   |             | 2,077,000          |             |                   |             | 1,039,000  |            
|                                        | Prepaid expenses and other current assets                                                                                                           |                                   |             | 3,440,000          |             |                   |             | 3,325,000  |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | Total current assets              |             |                    | 94,324,000  |                   |             |            | 113,484,000 | 
|Property, plant and equipment, at cost: |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        | Buildings                                                                                                                                           |                                   |             | 6,794,000          |             |                   |             | 7,005,000  |            
|                                        | Furniture                                                                                                                                           |                                   |             | 2,790,000          |             |                   |             | 1,645,000  |            
|                                        | Equipment                                                                                                                                           |                                   |             | 19,854,000         |             |                   |             | 18,467,000 |            
|                                        | Leasehold improvements                                                                                                                              |                                   |             | 2,867,000          |             |                   |             | 1,837,000  |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     |                                   | 32,305,000  |                    |             |                   | 28,954,000  |           
|                                        | Less accumulated depreciation and amortization                                                                                                      |                                   |             | 16,400,000         |             |                   |             | 13,266,000 |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | Net property, plant and equipment |             |                    | 15,905,000  |                   |             |            | 15,688,000  | 
|                                        | Goodwill, net of accumulated amortization of $21,926,000 and $15,549,000 in
2001
and 2000, respectively                                             |                                   |             | 15,959,000         |             |                   |             | 21,524,000 |            
|                                        | Software development costs, net of accumulated amortization of $9,895,000 and
$4,411,000 in 2001 and 2000, respectively                             |                                   |             | 11,112,000         |             |                   |             | 12,833,000 |            
|                                        | Product licenses, net of accumulated amortization of $2,786,000 and
$2,267,000 in
2001 and 2000, respectively                                       |                                   |             | 4,788,000          |             |                   |             | 4,900,000  |            
|                                        | Other assets                                                                                                                                        |                                   |             | 3,132,000          |             |                   |             | 2,780,000  |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | $                                 | 145,220,000 |                    |             | $                 | 171,209,000 |           
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                       
|                                       
|                                       
|                                       
|LIABILITIES AND SHAREHOLDERS EQUITY   
|                                       
|                                       
|                                       
|                                       
|Current liabilities:                    |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        | Accounts payable                                                                                                                                    |                                   | $           | 7,056,000          |             |                   | $           | 8,579,000  |            
|                                        | Accrued payroll and related expenses                                                                                                                |                                   |             | 5,750,000          |             |                   |             | 8,671,000  |            
|                                        | Other accrued liabilities                                                                                                                           |                                   |             | 9,977,000          |             |                   |             | 6,713,000  |            
|                                        | Long-term debt, due within one year                                                                                                                 |                                   |             | 216,000            |             |                   |             | 223,000    |            
|                                        | Line of credit                                                                                                                                      |                                   |             |                   |             |                   |             | 3,129,000  |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | Total current liabilities         |             |                    | 22,999,000  |                   |             |            | 27,315,000  | 
|                                        | Long-term debt, net of current portion                                                                                                              |                                   |             | 540,000            |             |                   |             | 726,000    |            
|                                        | Deferred income taxes                                                                                                                               |                                   |             | 2,551,000          |             |                   |             | 2,718,000  |            
|                                        | Other liabilities                                                                                                                                   |                                   |             | 2,845,000          |             |                   |             | 702,000    |            
|                                        | Commitments and contingencies                                                                                                                       |                                   |             |                    |             |                   |             |            |            
|                                        | Shareholders equity:                                                                                                                               |                                   |             |                    |             |                   |             |            |            
|                                        | Common stock, $.001 par value, 55,000,000 shares authorized, 26,062,093 and
25,980,252 shares issued and outstanding in 2001 and 2000, respectively |                                   |             | 26,000             |             |                   |             | 26,000     |            
|                                        | Additional paid-in capital                                                                                                                          |                                   |             | 56,305,000         |             |                   |             | 55,689,000 |            
|                                        | Accumulated other comprehensive income (loss)                                                                                                       |                                   |             | 241,000            |             |                   |             | (851,000   | )          
|                                        | Retained earnings                                                                                                                                   |                                   |             | 59,713,000         |             |                   |             | 84,884,000 |            
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | Total shareholders equity        |             |                    | 116,285,000 |                   |             |            | 139,748,000 | 
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           
|                                        |                                                                                                                                                     | $                                 | 145,220,000 |                    |             | $                 | 171,209,000 |           
|                                        |                                                                                                                                                     |                                   |             |                    |             |                   |             |           

See accompanying notes.



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RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |            |             |  | 
|------------------------------------------------------- | -------------------------------------- | ------------------------ | ----------- | ---------- | ------------------ | - | ------------------ | ---------- | ------------------ | - | ------------------ | ---------- | ----------- | - | ---------- | ---------- | ----------- |  | 
|                                                        |                                        |                          |             |            | Three Months Ended |   | Nine Months Ended 
|                                                        |                                        |                          |             |            |                    |   |                   
|                                                        |                                        |                          |             |            | September 30, 2001 |   | September 30, 2000 |            | September 30, 2001 |   | September 30, 2000
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                   
|Revenues:                                               |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        | eSecurity                              |                          | $           | 10,305,000 |                    |   | $                  | 24,341,000 |                    |   | $                  | 43,958,000 |             |   | $          | 66,509,000 |            
|                                                        | Secure Communications                  |                          |             | 14,855,000 |                    |   |                    | 14,396,000 |                    |   |                    | 50,640,000 |             |   |            | 37,581,000 |            
|                                                        | Spectria                               |                          |             | 2,896,000  |                    |   |                    | 5,033,000  |                    |   |                    | 11,003,000 |             |   |            | 15,017,000 |            
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Total revenues           |             |            | 28,056,000         |   |                    |            | 43,770,000         |   |                    |            | 105,601,000 |   |            |            | 119,107,000 | 
|Operating expenses:                                     |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        | Cost of eSecurity Revenues             |                          |             | 16,092,000 |                    |   |                    | 6,978,000  |                    |   |                    | 30,928,000 |             |   |            | 19,354,000 |            
|                                                        | Cost of Secure Communications Revenues |                          |             | 11,892,000 |                    |   |                    | 10,912,000 |                    |   |                    | 40,041,000 |             |   |            | 29,575,000 |            
|                                                        | Cost of Spectria Revenues              |                          |             | 1,981,000  |                    |   |                    | 3,232,000  |                    |   |                    | 6,669,000  |             |   |            | 9,011,000  |            
|                                                        | Selling, general and administrative    |                          |             | 11,181,000 |                    |   |                    | 11,484,000 |                    |   |                    | 37,243,000 |             |   |            | 32,622,000 |            
|                                                        | Research and development               |                          |             | 2,664,000  |                    |   |                    | 3,141,000  |                    |   |                    | 9,076,000  |             |   |            | 8,602,000  |            
|                                                        | Goodwill amortization                  |                          |             | 726,000    |                    |   |                    | 822,000    |                    |   |                    | 2,252,000  |             |   |            | 2,316,000  |            
|                                                        | Restructuring costs                    |                          |             | 6,402,000  |                    |   |                    |           |                    |   |                    | 6,402,000  |             |   |            |           |            
|                                                        | Goodwill impairment                    |                          |             | 4,030,000  |                    |   |                    |           |                    |   |                    | 4,030,000  |             |   |            |           |            
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Total operating expenses |             |            | 54,968,000         |   |                    |            | 36,569,000         |   |                    |            | 136,641,000 |   |            |            | 101,480,000 | 
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|Operating income (loss)                                 |                                        |                          | (26,912,000 | )          |                    |   | 7,201,000          |            |                    |   | (31,040,000        | )          |             |   | 17,627,000 |           
|Unrealized gain (loss) on marketable
trading securities |                                        |                          | (14,000     | )          |                    |   | 67,000             |            |                    |   | (3,562,000         | )          |             |   | 4,285,000  |           
|Asset impairment charge                                 |                                        |                          |            |            |                    |   |                   |            |                    |   |                   |            |             |   | (2,173,000 | )         
|Write-off of long-term investment                       |                                        |                          | (1,206,000  | )          |                    |   |                   |            |                    |   | (1,206,000         | )          |             |   |           |           
|Foreign
currency gain (loss)                            |                                        |                          | (2,092,000  | )          |                    |   | 129,000            |            |                    |   | (2,373,000         | )          |             |   | 394,000    |           
|Interest income                                         |                                        |                          | 88,000      |            |                    |   | 283,000            |            |                    |   | 453,000            |            |             |   | 702,000    |           
|Interest expense                                        |                                        |                          | (32,000     | )          |                    |   | (31,000            | )          |                    |   | (113,000           | )          |             |   | (101,000   | )         
|Other expense                                           |                                        |                          | (179,000    | )          |                    |   | (151,000           | )          |                    |   | (290,000           | )          |             |   | (11,000    | )         
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|Income (loss) before income taxes                       |                                        |                          | (30,347,000 | )          |                    |   | 7,498,000          |            |                    |   | (38,131,000        | )          |             |   | 20,723,000 |           
|Benefit (provision) for income taxes                    |                                        |                          | 10,002,000  |            |                    |   | (2,852,000         | )          |                    |   | 12,960,000         |            |             |   | (7,918,000 | )         
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|Net income (loss)                                       |                                        | $                        | (20,345,000 | )          |                    | $ | 4,646,000          |            |                    | $ | (25,171,000        | )          |             | $ | 12,805,000 |           
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|Net income (loss) per share:                            |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Basic                    |             | $          | (0.78              | ) |                    | $          | 0.18               |   |                    | $          | (0.97       | ) |            | $          | 0.52        | 
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Diluted                  |             | $          | (0.78              | ) |                    | $          | 0.17               |   |                    | $          | (0.97       | ) |            | $          | 0.46        | 
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|Shares used in computing net income
(loss) per share:   |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Basic                    |             |            | 26,062,000         |   |                    |            | 25,214,000         |   |                    |            | 26,046,000  |   |            |            | 24,716,000  | 
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           
|                                                        |                                        | Diluted                  |             |            | 26,062,000         |   |                    |            | 28,148,000         |   |                    |            | 26,046,000  |   |            |            | 27,770,000  | 
|                                                        |                                        |                          |             |            |                    |   |                    |            |                    |   |                    |            |             |   |            |           

See accompanying notes.



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RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)

|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |            |  
|---------------------------------- | --------------------------------------------------------------------------------- | - | ------------------ | ---------- | ------------------ | - | ------------------ | ---------- | ------------------ | - | ----------- | --------- | - | - | ---------- | ---------- | -
|                                   |                                                                                   |   | Three Months Ended |            | Nine Months Ended 
|                                   |                                                                                   |   |                    |            |                   
|                                   |                                                                                   |   | September 30, 2001 |            | September 30, 2000 |   | September 30, 2001 |            | September 30, 2000
|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                   
|Net income (loss)                  |                                                                                   | $ | (20,345,000        | )          |                    | $ | 4,646,000          |            |                    | $ | (25,171,000 | )         |   | $ | 12,805,000 |           
|Other comprehensive income (loss): |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |           
|                                   | Foreign currency translation adjustment                                           |   |                    | 4,196,000  |                    |   |                    | (1,793,000 | )                  |   |             | 1,959,000 |   |   |            | (1,067,000 | )
|                                   | Unrealized loss on securities                                                     |   |                    | (28,000    | )                  |   |                    | (44,000    | )                  |   |             | (199,000  | ) |   |            | (382,000   | )
|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |           
|                                   | Other comprehensive income (loss), before income taxes                            |   |                    | 4,168,000  |                    |   |                    | (1,837,000 | )                  |   |             | 1,760,000 |   |   |            | (1,449,000 | )
|                                   | Benefit (provision) for income taxes related to other
comprehensive income (loss) |   |                    | (1,583,000 | )                  |   |                    | 699,000    |                    |   |             | (668,000  | ) |   |            | 554,000    |  
|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |           
|                                   | Other comprehensive income (loss), net of taxes                                   |   |                    | 2,585,000  |                    |   |                    | (1,138,000 | )                  |   |             | 1,092,000 |   |   |            | (895,000   | )
|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |           
|Comprehensive income (loss)        |                                                                                   | $ | (17,760,000        | )          |                    | $ | 3,508,000          |            |                    | $ | (24,079,000 | )         |   | $ | 11,910,000 |           
|                                   |                                                                                   |   |                    |            |                    |   |                    |            |                    |   |             |           |   |   |            |           

See accompanying notes.



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RAINBOW TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |            |             |             |  
|---------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------- | --------------------------------------------------- | ----------- | ------------------ | ---------- | ------------------ | ---------- | ----------- | ----------- | -
|                                                     |                                                                                                    |                                           |                                                     |             | Nine Months Ended 
|                                                     |                                                                                                    |                                           |                                                     |             |                   
|                                                     |                                                                                                    |                                           |                                                     |             | September 30, 2001 |            | September 30, 2000
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                   
|Cash flows from operating activities:                |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     | Net income (loss)                                                                                  |                                           | $                                                   | (25,171,000 | )                  |            | $                  | 12,805,000 |            
|                                                     | Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities: |                                           |                                                     |             |                    |            |                    |            |            
|                                                     | Amortization                                                                                       |                                           |                                                     | 6,241,000   |                    |            |                    | 4,014,000  |            
|                                                     | Depreciation                                                                                       |                                           |                                                     | 2,980,000   |                    |            |                    | 2,505,000  |            
|                                                     | Change in deferred income taxes                                                                    |                                           |                                                     | (10,205,000 | )                  |            |                    | (8,534,000 | )          
|                                                     | Gain on sale of property, plant and equipment                                                      |                                           |                                                     | (13,000     | )                  |            |                    |           |            
|                                                     | Minority interest in subsidiarys earnings                                                         |                                           |                                                     | 196,000     |                    |            |                    |           |            
|                                                     | Unrealized (gain) loss on marketable trading securities                                            |                                           |                                                     | 3,562,000   |                    |            |                    | (4,285,000 | )          
|                                                     | Provision
for restructured operations                                                              |                                           |                                                     | 6,402,000   |                    |            |                    |           |            
|                                                     | Reserve
for excess and obsolete inventory                                                          |                                           |                                                     | 7,414,000   |                    |            |                    |           |            
|                                                     | Warranty
reserve                                                                                   |                                           |                                                     | 2,440,000   |                    |            |                    |           |            
|                                                     | Goodwill impairment                                                                                |                                           |                                                     | 4,030,000   |                    |            |                    |           |            
|                                                     | Asset impairment                                                                                   |                                           |                                                     |            |                    |            |                    | 2,173,000  |            
|                                                     | Write-off of long-term investment                                                                  |                                           |                                                     | 1,206,000   |                    |            |                    |           |            
|                                                     | Write-off of capitalized and developed software                                                    |                                           |                                                     | 2,392,000   |                    |            |                    |           |            
|                                                     | Foreign currency loss on repayment of loan to foreign subsidiary                                   |                                           |                                                     | 1,252,000   |                    |            |                    |           |            
|                                                     | Tax benefit of exercise of common stock options                                                    |                                           |                                                     | 138,000     |                    |            |                    | 6,588,000  |            
|                                                     | Provision for doubtful accounts                                                                    |                                           |                                                     | 1,334,000   |                    |            |                    | 250,000    |            
|                                                     | Changes in operating assets and liabilities:                                                       |                                           |                                                     |             |                    |            |                    |            |            
|                                                     |                                                                                                    | Accounts receivable                       |                                                     |             | 18,086,000         |            |                    |            | (12,962,000 | )          
|                                                     |                                                                                                    | Inventories                               |                                                     |             | 1,651,000          |            |                    |            | (12,206,000 | )          
|                                                     |                                                                                                    | Unbilled costs and fees                   |                                                     |             | (1,038,000         | )          |                    |            | (222,000    | )          
|                                                     |                                                                                                    | Prepaid expenses and other current assets |                                                     |             | (115,000           | )          |                    |            | (164,000    | )          
|                                                     |                                                                                                    | Note receivable                           |                                                     |             |                   |            |                    |            | (940,000    | )          
|                                                     |                                                                                                    | Accounts payable                          |                                                     |             | (1,325,000         | )          |                    |            | 3,024,000   |            
|                                                     |                                                                                                    | Accrued liabilities                       |                                                     |             | (5,203,000         | )          |                    |            | (570,000    | )          
|                                                     |                                                                                                    | Billings in excess of costs and fees      |                                                     |             | (935,000           | )          |                    |            | (318,000    | )          
|                                                     |                                                                                                    | Income taxes                              |                                                     |             | 2,039,000          |            |                    |            | 6,976,000   |            
|                                                     |                                                                                                    | Other                                     |                                                     |             | (33,000            | )          |                    |            | (532,000    | )          
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     |                                                                                                    |                                           | Net cash provided by (used in) operating activities |             |                    | 17,325,000 |                    |            |             | (2,398,000  | )
|Cash flows from investing activities:                |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     | Purchases of property, plant and equipment                                                         |                                           |                                                     | (3,385,000  | )                  |            |                    | (3,328,000 | )          
|                                                     | Net cash paid for acquisition of Systematic Systems Integration, Inc.                              |                                           |                                                     |            |                    |            |                    | (1,765,000 | )          
|                                                     | Investment in Datasafe Technologies, China                                                         |                                           |                                                     | (231,000    | )                  |            |                    |           |            
|                                                     | Investment in Rainbow Technologies K.K., Japan                                                     |                                           |                                                     | (1,357,000  | )                  |            |                    |           |            
|                                                     | Additional investment in Rainbow Goldensoft, China                                                 |                                           |                                                     | (809,000    | )                  |            |                    |           |            
|                                                     | Other non-current assets                                                                           |                                           |                                                     | (161,000    | )                  |            |                    | (2,159,000 | )          
|                                                     | Capitalized software development costs                                                             |                                           |                                                     | (4,020,000  | )                  |            |                    | (5,020,000 | )          
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     |                                                                                                    |                                           | Net cash used in investing activities               |             |                    | (9,963,000 | )                  |            |             | (12,272,000 | )
|Cash flows from financing activities:                |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     | Exercise of common stock options                                                                   |                                           |                                                     | 478,000     |                    |            |                    | 8,672,000  |            
|                                                     | Payments on line of credit                                                                         |                                           |                                                     | (3,129,000  | )                  |            |                    | (2,000,000 | )          
|                                                     | Repayments of long-term debt                                                                       |                                           |                                                     | (126,000    | )                  |            |                    | (165,000   | )          
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|                                                     |                                                                                                    |                                           | Net cash provided by (used in) financing activities |             |                    | (2,777,000 | )                  |            |             | 6,507,000   |  
|Effect of exchange rate changes on cash              |                                                                                                    |                                           | 945,000                                             |             |                    |            | (17,000            | )         
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|Net increase (decrease) in cash and cash equivalents |                                                                                                    |                                           | 5,530,000                                           |             |                    |            | (8,180,000         | )         
|Cash and cash equivalents at beginning of period     |                                                                                                    |                                           | 19,458,000                                          |             |                    |            | 26,709,000         |           
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           
|Cash and cash equivalents at end of period           |                                                                                                    | $                                         | 24,988,000                                          |             |                    | $          | 18,529,000         |           
|                                                     |                                                                                                    |                                           |                                                     |             |                    |            |                    |           

See accompanying notes.



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RAINBOW TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
(Unaudited)

1. Basis of presentation

Rainbow Technologies, Inc. (the Company) develops, manufactures, programs and
markets secure software distribution products which prevent the unauthorized
use of intellectual property, including software programs; develops and
manufactures secure communications products for satellite communications;
develops and manufactures internet performance and security products to provide
privacy and security for network communications; and provides customized
eBusiness consulting services. The accompanying financial statements
consolidate the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated.
Certain amounts previously reported have been reclassified to conform to the
2001 presentation.

In the third quarter 2001, the Company created Rainbow eSecurity, a new
division focusing on the commercial security industry which combines all of the
desktop, software security, and Internet and network infrastructure security
solutions into a single business unit. Rainbow eSecurity was created through
the consolidation of the Companys Digital Rights Management (DRM) and iVEA
operations.

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

Management determines the appropriate classification of its investments in
marketable securities at the time of purchase. Securities that are bought and
held principally for the purpose of selling them in the near term are
classified as trading securities and carried at fair value with the unrealized
holding gains and losses included in earnings. Available-for-sale securities
are carried at fair value, with the unrealized gains and losses, net of tax,
reported as a separate component of Accumulated Other Comprehensive
Income (Loss) within Shareholders Equity.

In the opinion of the Companys management, the accompanying condensed
consolidated financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the
financial position at September 30, 2001 and results of operations for the
three and nine months ended September 30, 2001 and 2000. The condensed
consolidated financial statements do not include certain footnotes and
financial information normally presented annually under generally accepted
accounting principles and, therefore, should be read in conjunction with the
Companys December 31, 2000 Annual Report on Form 10-K. Results of operations
for the three and nine months ended September 30, 2001 are not necessarily
indicative of results to be expected for the full year.

The Company has subsidiaries in the United Kingdom, Germany, France, the
Netherlands, India, Australia, China and Taiwan. The Company utilizes the
currencies of the countries where its foreign subsidiaries operate as the
functional currency. Balance sheet accounts denominated in foreign currency are
translated at exchange rates as of the date of the balance sheet and income
statement accounts are translated at average exchange rates for the period. Translation
gains and losses are accumulated as a separate component of Accumulated Other
Comprehensive Income (Loss) within Shareholders Equity. The Company has adopted local
currencies as the functional currencies for its subsidiaries because their
principal economic activities are most closely tied to the respective local
currencies.

2. Earnings per share

Basic earnings per share is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding for
the period. Diluted earnings per share reflect the assumed conversion of all
diluted securities.



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3. Government contracts

The Company is both a prime contractor and a subcontractor under fixed-price
and cost-plus-fixed-fee contracts with the U.S. Government (Government). At the
commencement of each contract or contract modification, the Company submits
pricing proposals to the Government to establish indirect cost rates applicable
to such contracts. These rates, after audit and approval by the Government, are
used to settle costs on completed contracts.

To facilitate interim billings during the performance of its contracts, the
Company establishes provisional billing rates, which are used in recognizing
contract revenue and contract accounts receivable amounts in these financial
statements. These provisional billing rates are adjusted to actual at year-end
and are subject to adjustment after Government audit.

4. Marketable trading securities

During the second and third quarter of fiscal year 2000, the Company acquired
securities and classified them as trading securities, as defined by SFAS No.
115 Accounting for Certain Investments in Debt and Equity Securities. The
difference between the estimated fair value and the cost of the securities
acquired resulted in a loss of $3,562,000 and a gain of $4,285,000 for the nine months ended September 30, 2001 and 2000,
respectively.

5. Inventories

Inventoried costs relating to long-term contracts are stated at actual
production costs, including pro-rata allocations of factory overhead and
general and administrative costs incurred-to-date, reduced by amounts
identified with revenue recognized on units delivered. The costs attributed to
units delivered under such long-term contracts are based on the estimated
average cost of all units expected to be produced.

Inventories, other than inventoried costs relating to long-term contracts, are
stated at the lower of cost (first-in, first-out basis) or market. Inventories
consist of the following (in thousands):

|                                                                                                            |  |                    |        |                   |  |   |        | 
|----------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | - | ------ | 
|                                                                                                            |  | September 30, 2001 |        | December 31, 2000
|                                                                                                            |  |                    |        |                  
|Raw materials                                                                                               |  | $                  | 12,985 |                   |  | $ | 11,659 | 
|Work in process                                                                                             |  |                    | 4,046  |                   |  |   | 2,538  | 
|Finished goods                                                                                              |  |                    | 737    |                   |  |   | 10,699 | 
|Inventoried costs relating to long-term contracts, net of
amounts attributed to revenues recognized to date |  |                    | 3,249  |                   |  |   | 5,499  | 
|                                                                                                            |  |                    |        |                   |  |   |        | 
|                                                                                                            |  | $                  | 21,017 |                   |  | $ | 30,395 | 
|                                                                                                            |  |                    |        |                   |  |   |        | 

6. Other assets

Included in other assets are certain investments in early-stage companies. The
Company closely monitors the operations and cash flows of these companies to
evaluate their status and ensure that amounts reported for these investments do
not exceed net realizable value. If the Company determines that impairment in
the investment of any such company exists, an adjustment would be made to
reduce the investment amount to net realizable value.

In the third quarter of 2001, the Company determined
that the carrying value of one of Spectria's long-term investments
become fully impaired. This resulted from a downturn in the current
economic conditions. Accordingly, the Company
recorded a pre-tax charge of $1,206,000 to write-off the investment.

At June 30, 2000, the Company performed a
review for impairment of the long-lived assets related to Quantum
Manufacturing Technology (QMT). Based on its evaluation, the Company
determined that all of the long-lived assets related to QMT were
fully impaired and as a result recorded an impairment charge of
$2,173,000.

7. Software development costs

Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,
requires capitalization of certain software development costs subsequent to the
establishment of



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technological feasibility. Based on the Companys product development process,
technological feasibility is established upon completion of a working model.
Amortization of capitalized software development costs commences when the
products are available for general release to customers and are determined
using the straight-line method over the expected useful lives of the respective
products. These amounts are written-off if it is determined that the projects
cannot be brought to market.

8. Industry segments

The Company operates in three industry segments. The first segment includes the
development and sale of devices, which protect data and software from
unauthorized use, products that provide access control to computer networks,
Internet Websites and virtual private networks and products which accelerate
performance of security servers and network equipment (eSecurity segment). The
second segment is the development and sale of information security products to
provide privacy and security for voice communication and data transmission
(Secure Communications segment). The third segment provides services that
enable companies to integrate diverse software and hardware platforms (Spectria
segment). The identifiable assets, after applicable eliminations, for each
segment as of September 30, 2001 were $105,387,000, $23,637,000, and
$16,196,000, respectively, compared with $113,714,000, $32,909,000 and
$24,586,000 as of December 31, 2000.

Intercompany revenues for the three and nine months ended September 30, 2001
were $14,000 and $280,000, respectively, and $560,000 and $1,710,000,
respectively, for the corresponding periods in the prior year. Intercompany
revenues are generated by the Secure Communications Segment.

9. Stock split

On September 19, 2000 the Company announced that its Board of Directors
approved a 2-for-1 split of its common stock. The effective date was October 9,
2000 and the payout date was October 23, 2000. All common stock information
presented as of and for the nine months ended September 30, 2001 has been
adjusted to reflect the stock split.

10. Recent accounting pronouncements

In September 2001, the Financial Accounting Standards Board (FASB) issued
Statements of Financial Accounting Standards (SFAS) No. 141 Business
Combinations and No. 142 Goodwill and other Intangible Assets. SFAS No. 141
addresses financial accounting and reporting for a business combination and
requires all business combinations to be accounted for using the purchase
method. SFAS No. 141 is effective for any business combinations initiated
after June 30, 2001. SFAS No. 142, effective for the Company January 1, 2002,
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. Goodwill and other
intangible assets with indefinite lives will no longer be amortized
but instead be subject to impairment tests at least annually. Based upon the Companys
current goodwill level, amortization expense will decrease by approximately $2
million annually beginning January 1, 2002.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144, effective for the Company January 1,
2002, supersedes FASB Statement No. 121, Accounting for the Impairment 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  Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business (as previously
defined in that opinion). SFAS 144 requires that one accounting model be used
for long-lived assets to be disposed of by sale, whether previously held and
used or newly acquired, and broadens the presentation of discontinued
operations to include more disposal transactions than were included under the
previous standards. The Company is currently assessing, but has not yet
determined, the impact of SFAS No. 144 on its financial position and results of
operations.

11. Restructuring and other charges

In the third quarter 2001, the Company restructured and consolidated its DRM
and iVEA operations (eSecurity segment), resulting in a net staff
reduction of 97 employees and recorded restructuring and other charges of $26,090,000.



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The following table summarizes the Company's
restructuring costs and activities in the restructuring reserves (in thousands):

|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |       |        |   |  |  | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------- | ------ | -------------- |  | ---------- | ----- | ------- |  | ----- | ------ | - |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  | FACILITIES |        |                |  |            |       |         |  |       |        |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  | AND        |        |                |  |            |       |         |  |       |        |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  | EQUIPMENT  |        | SEVERANCE      |  | Total      |       |         |  |       |       
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |       |        |   |  | 
|Charged to costs and expenses                                                                                                                                                                                                                                                                                                                                   |  | $          | 5,271  |                |  | $          | 1,131 |         |  | $     | 6,402  |   |  |  | 
|Cash payments                                                                                                                                                                                                                                                                                                                                                   |  |            | (304   | )              |  |            | (764  | )       |  |       | (1,068 | ) |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |       |        |   |  |  | 
|Restructuring
balance, September 30, 2001                                                                                                                                                                                                                                                                                                                       |  | $          | 4,967  |                |  | $          | 367   |         |  | $     | 5,334  |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |       |        |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                               
|The current portion of the restructuring reserve
of $2,955,000 relating to office space reduction and
severance is recorded in other accrued liabilities while the
long-term portion of the reserve of $2,379,000 is
recorded in other liabilities. Exit activities are anticipated to
continue through 2002 with lease obligations currently expiring in
2004.
|                                                                                                                                                                                                                                                                                                                                                               
|The following table summarizes the other charges
recorded in the third quarter of 2001 (in thousands):                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        | SELLING        |  |            |       |         |  |       |        |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  | COST OF    |        | GENERAL AND    |  | GOODWILL   |       | OTHER   |  |      
|                                                                                                                                                                                                                                                                                                                                                                |  | REVENUES   |        | ADMINISTRATIVE |  | IMPAIRMENT |       | EXPENSE |  | Total
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |      
|Reserve for excess and obsolete inventory                                                                                                                                                                                                                                                                                                                       |  | $          | 7,414  |                |  |            |       |         |  |       |        |   |  |  | 
|Write-off of capitalized software                                                                                                                                                                                                                                                                                                                               |  |            | 2,392  |                |  |            |       |         |  |       |        |   |  |  | 
|Warranty
reserve                                                                                                                                                                                                                                                                                                                                                |  |            | 1,782  |                |  |            |       |         |  |       |        |   |  |  | 
|Provision for bad debts                                                                                                                                                                                                                                                                                                                                         |  |            |        |                |  |            | 1,612 |         |  |       |        |   |  |  | 
|Goodwill impairment                                                                                                                                                                                                                                                                                                                                             |  |            |        |                |  |            |       |         |  |       | 4,030  |   |  |  | 
|Write-off
of long-term investment                                                                                                                                                                                                                                                                                                                               |  |            |        |                |  |            |       |         |  |       |        |   |  |  | 
|Foreign
currency transaction loss                                                                                                                                                                                                                                                                                                                               |  |            |        |                |  |            |       |         |  |       |        |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |      
|Total
third quarter 2001 other charges                                                                                                                                                                                                                                                                                                                          |  | $          | 11,588 |                |  | $          | 1,612 |         |  | $     | 4,030  |   |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                |  |            |        |                |  |            |       |         |  |      



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RAINBOW TECHNOLOGIES, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is managements discussion and analysis of certain significant
factors, which have affected the consolidated results of operations, and the
consolidated financial position of the Company during the periods included in
the accompanying condensed consolidated financial statements. This discussion
should be read in conjunction with the related condensed consolidated financial
statements and associated notes.

RESULTS OF OPERATIONS
(in thousands)

|                        |                       |                               |   |                                  |         |      |   |        |        | 
|----------------------- | --------------------- | ----------------------------- | - | -------------------------------- | ------- | ---- | - | ------ | ------ | 
|                        |                       |                               |   | Three Months Ended September 30,
|                        |                       |                               |   |                                 
|                        |                       |                               |   | 2001                             |         | 2000
|                        |                       |                               |   |                                  |         |     
|Revenues                |                       |                               |   |                                  |         |      |   |       
|                        | eSecurity             |                               | $ | 10,305                           |         |      | $ | 24,341 |       
|                        | Secure Communications |                               |   | 14,855                           |         |      |   | 14,396 |       
|                        | Spectria              |                               |   | 2,896                            |         |      |   | 5,033  |       
|                        |                       |                               |   |                                  |         |      |   |       
|                        |                       | Total revenues                |   | $                                | 28,056  |      |   | $      | 43,770 | 
|                        |                       |                               |   |                                  |         |      |   |       
|Operating Income (Loss) |                       |                               |   |                                  |         |      |   |       
|                        | eSecurity             |                               | $ | (25,659                          | )       |      | $ | 4,696  |       
|                        | Secure Communications |                               |   | 2,770                            |         |      |   | 3,275  |       
|                        | Spectria              |                               |   | (4,023                           | )       |      |   | (770   | )     
|                        |                       |                               |   |                                  |         |      |   |       
|                        |                       | Total operating income (loss) |   | $                                | (26,912 | )    |   | $      | 7,201  | 
|                        |                       |                               |   |                                  |         |      |   |       

|                        |                       |                               |   |                                 |         |      |   |        |         | 
|----------------------- | --------------------- | ----------------------------- | - | ------------------------------- | ------- | ---- | - | ------ | ------- | 
|                        |                       |                               |   | Nine Months Ended September 30,
|                        |                       |                               |   |                                
|                        |                       |                               |   | 2001                            |         | 2000
|                        |                       |                               |   |                                 |         |     
|Revenues                |                       |                               |   |                                 |         |      |   |       
|                        | eSecurity             |                               | $ | 43,958                          |         |      | $ | 66,509 |        
|                        | Secure Communications |                               |   | 50,640                          |         |      |   | 37,581 |        
|                        | Spectria              |                               |   | 11,003                          |         |      |   | 15,017 |        
|                        |                       |                               |   |                                 |         |      |   |       
|                        |                       | Total revenues                |   | $                               | 105,601 |      |   | $      | 119,107 | 
|                        |                       |                               |   |                                 |         |      |   |       
|Operating Income (Loss) |                       |                               |   |                                 |         |      |   |       
|                        | eSecurity             |                               | $ | (35,452                         | )       |      | $ | 12,414 |        
|                        | Secure Communications |                               |   | 9,296                           |         |      |   | 7,460  |        
|                        | Spectria              |                               |   | (4,884                          | )       |      |   | (2,247 | )      
|                        |                       |                               |   |                                 |         |      |   |       
|                        |                       | Total operating income (loss) |   | $                               | (31,040 | )    |   | $      | 17,627  | 
|                        |                       |                               |   |                                 |         |      |   |       

REVENUES

On a consolidated basis, revenues for the three and nine months ended September
30, 2001, decreased by 36% to $28,056,000 and 11% to $105,601,000,
respectively, when compared to the same periods in the prior year. These
decreases were due to lower revenues in the eSecurity and Spectria segments,
partially offset by higher revenues in the Secure Communications segment.

Revenues from eSecurity for the three and nine months ended September 30, 2001
decreased by 58% to $10,305,000 and 34% to $43,958,000, respectively, when
compared to the same periods in 2000. This was primarily due to continued
softness in the OEM market for Cryptoswift SSL acceleration devices and a
decreased demand for high-end business application software, PC hardware and PC
software.

Secure Communications revenues for the three and nine months ended September 30,
2001 increased 3% to $14,855,000 and 35% to $50,640,000, respectively, when
compared to the same periods in 2000. The increase in revenues was primarily
due to continued growth in demand for network security products.



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Spectria revenues for the three and nine months ended September 30, 2001
decreased 42% to $2,896,000 and 27% to $11,003,000, respectively, when compared
to the same periods in 2000. The decrease was due to the continued decline in demand for Information Technology
services because of economic weakness.

GROSS PROFIT

Gross profit from eSecurity for the three months ended September 30, 2001
decreased to (56)% of revenues compared to 71% of revenues for the corresponding
period in 2000. Gross profit for the nine months ended September 30, 2001
decreased to 30% of revenues compared to 71% of revenues for the corresponding
period in 2000. These decreases were primarily due to increases in cost of
revenues which included other charges of $7,414,000 in inventory
reserves, $1,782,000 in warranty reserves
and $2,392,000 of write-off of capitalized and developed software. Excluding
these charges, the decrease in gross profit as a percentage of revenues was due
to fixed overhead costs allocated over a lower revenue base and increases in certain component costs.

Gross profit from Secure Communications for the three months ended September
30, 2001 decreased to 20% of revenues as compared to 24% of revenues for the
corresponding period in 2000. The decrease was due to a 9% increase in cost of
revenues relating to cost overruns on certain projects. Gross profit for the
nine months ended September 30, 2001 was 21% of revenues which was consistent
with the same period in 2000.

Gross profit from Spectria for the three months ended September 30, 2001
decreased to 32% of revenues as compared to 36% of revenues for the
corresponding period in 2000. The decrease in gross profit as a percentage of
revenues was due to fixed overhead costs allocated over a lower
revenue base. Gross profit for the nine months ended September 30, 2001
decreased to 39% of revenues compared to 40% of revenues for the corresponding
period in 2000. The decrease in gross profit was primarily due to a decrease
in high margin projects.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative expenses consist primarily of
personnel-related expenses, sales commission, promotional activities, and
professional fees. Selling, general and administrative expenses for the three
months ended September 30, 2001 were $11,181,000 or 40% of revenues as compared
to $11,484,000 or 26% of revenues for the corresponding period in 2000. The
decrease was primarily due to lower marketing expenses partially offset by
other charges relating to provision for bad debts of $1,612,000. Selling,
general and administrative expenses for the nine months ended September 30,
2001 were $37,243,000 or 35% of revenues as compared to $32,622,000 or 27% of
revenues for the corresponding period in 2000. The increase was due to higher
personnel related expenses resulting from the hiring of sales, marketing and
management and administrative personnel at the beginning of 2001, and
higher legal and other professional fees.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of salaries and other
personnel-related expenses, costs related to engineering development tools, and
subcontracting costs. Research and development expenses for the three months
ended September 30, 2001 were $2,664,000 or 10% of revenues, as compared to
research and development expense of $3,141,000 or 7% of revenues for the
corresponding period in 2000. The decrease was primarily a result of a
reduction in staff. Research and development expenses for the nine months
ended September 30, 2001 were $9,076,000 or 9% of revenues, as compared to
research and development expense of $8,602,000 or 7% of revenues for the
corresponding period in 2000. The increase was due to increased
staffing at the beginning of 2001 for
the development of new products.

MARKETABLE TRADING SECURITIES

During the second and third quarter of fiscal year 2000, the Company acquired
securities and classified them as trading securities, as defined by SFAS No.
115 Accounting for Certain Investments in Debt and Equity Securities. The
difference between the estimated fair value and the cost of the securities
acquired resulted in an unrealized loss of $3,562,000 and a gain of $4,285,000,
which were recognized during the nine months ended September 30, 2001
and 2000, respectively.

PROVISION FOR INCOME TAXES

The effective tax rates for the three and nine months ended September 30, 2001,
were 33% and 34%, respectively, as compared to 38% for the corresponding
periods in 2000. The decrease was due to certain other charges recorded in
the third quarter of 2001.



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##### Table of Contents



ACCOUNTS RECEIVABLE

Accounts receivable at September 30, 2001 decreased by approximately
$20,514,000 to $20,196,000 as compared with $40,710,000 at December 31, 2000.
This decrease was due to increased collection activities and the decline in
revenues.

INVENTORIES

Finished goods decreased by approximately $9,962,000 to $737,000 at September
30, 2001 as compared with $10,699,000 at December 31, 2000. The decrease was
primarily due to a reserve for excess and
obsolete inventory of $7,414,000 and the Companys reduced production
activities because of adequate inventory levels.

Raw materials increased by approximately $1,326,000 to $12,985,000 at September
30, 2001 as compared with $11,659,000 at December 31, 2000. The increase was
due primarily to the decline in demand for the Companys internet
infrastructure products.

LIQUIDITY AND CAPITAL RESOURCES

The Companys principal sources of operating funds have been from operations.
Net cash provided by operations for the nine months ended September 30, 2001
was $17,325,000 while net cash used in operations for the nine months ended
September 30, 2000 was $2,398,000. Operating activities in 2001 included
decreases in accounts receivable of $18,086,000 and in accrued
liabilities of $5,203,000, partially offset by an increase in
deferred taxes of $10,205,000.

Net cash used in investing activities for the nine months ended September 30,
2001 and 2000 were $9,963,000 and $12,272,000, respectively. Investing
activities in 2001 included $3,385,000 in capital expenditures, $4,020,000 in
development of new products and $2,397,000 of new and additional investments in
China and Japan. Investing activities in 2000 included $1,765,000
related to the
acquisition of Systematic and $5,020,000 in the development of new
products.

Net cash used in financing activities for the nine months ended September 30,
2001 was $2,777,000 while net cash provided by financing activities for the
nine months ended September 30, 2000 was $6,507,000. Financing activities
included in 2001 and 2000 were payments to the line of credit of $3,129,000 and
$2,000,000, respectively, and approximately $478,000 and $8,672,000 received
from common stock options exercised.

The Company intends to use its capital resources to expand its product lines
and for possible acquisitions of additional products and technologies. The
Company has no significant capital commitments or requirements at this time.

At September 30, 2001, the Companys subsidiaries in France, The United
Kingdom, Germany and The Netherlands carried approximately $972,000, $923,000,
$642,000 and $2,132,000, respectively, in interest earning deposits which may
result in foreign exchange gains or losses due to the fact that the functional
currency in those subsidiaries is not the U.S. dollar.

The Company believes that its current working capital of $71,325,000 and
anticipated working capital to be generated by future operations will be
sufficient to support the Companys working capital requirements for at least
the next twelve months.



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##### Table of Contents






PART II OTHER INFORMATION




Item 6 Exhibits and Reports on Form 8-K

(a)  Exhibits

|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                    
|2(i)    |  | Agreement and Plan of Reorganization, dated as of January 26, 1995 among the Company, Rainbow Acquisition
Inc., a California corporation and a wholly owned subsidiary of Rainbow, and Mykotronx, Inc., a
California corporation (Mykotronx) (incorporated by reference to the Companys Registration Statement
on Form S-4 under the Securities Act of 1933, as amended, effective on April 20, 1995, Registration No.
33-89918)
|       
|       
|       
|       
|2(ii)   |  | Agreement and Plan of Merger, dated September 30, 1996, by and among the Company, RNBO Acquisition
Corporation, a Nevada corporation and a wholly-owned subsidiary of the Company, and Software Security,
Inc., a Connecticut corporation (incorporated by reference to Exhibit 2(ii) of the Companys 1996 Annual
Report on Form 10-K under the Securities Exchange Act of 1934 filed in March 1997 (the 1996 10-K))            
|       
|       
|       
|       
|2(iii)  |  | Agreement and Plan of Merger, dated March 6, 1998, by and among the Company, WRS Acquisition Corp., a
California corporation and wholly owned subsidiary of the Company, and Wyatt River Software, Inc.
(incorporated by reference to Exhibit 2(iii) of the Companys 1997 Annual Report on Form 10-K under the
Securities Exchange Act of 1934 filed in March 1998 (the 1997 10-K))                                             
|       
|       
|       
|       
|3(i)    |  | Articles of Incorporation of Rainbow, as amended (incorporated by reference to Exhibit 3(a) to Rainbows
Registration Statement on Form S-18 under the Securities Act of 1933, as amended, filed on July 20, 1987
- File No. 33-15956-LA (the S-18 Registration Statement))                                                                                                                                                      
|       
|       
|       
|       
|3(ii)   |  | By-Laws of Rainbow (incorporated by reference to Exhibit 3(b) to the S-18 Registration Statement)                                                                                                                                                                                                                                                                                                                                  
|       
|       
|       
|       
|4(a)    |  | See Exhibit 3(i)                                                                                                                                                                                                                                                                                                                                                                                                                   
|       
|       
|       
|       
|4(b)    |  | See Exhibit 3(ii)                                                                                                                                                                                                                                                                                                                                                                                                                  
|       
|       
|       
|       
|4(c)    |  | Rights Agreement, dated as of July 29, 1997, between the Company and U.S. Stock Transfer Corporation, as
Rights Agent (incorporated by reference to Exhibit 4(c) to the Companys 1997 10-K)                                                                                                                                                                                                                                       
|       
|       
|       
|       
|10(a)   |  | Lease for premises at 50 Technology Drive, Irvine, California, dated June 1, 1995, between the Company
and Birtcher Medical Systems, Inc., a California corporation (filed as an exhibit to the Companys 1995
Form 10-K)                                                                                                                                                                                                          
|       
|       
|       
|       
|10(b)   |  | Agreement, dated October 1996, between the Company and National Semiconductor Corporation (incorporated
by reference to Exhibit 10(b) of the Companys 1998 Annual Report on Form 10-K under the Securities
Exchange Act of 1934 filed in March, 1999 (the 1998 10-K))                                                                                                                                                           
|       
|       
|       
|       
|10(c)   |  | Agreement, dated December 1998, between the Company and EM Microelectronic  Marin S.A. (incorporated by
reference to Exhibit 10(c) of the 1998 10-K)                                                                                                                                                                                                                                                                              
|       
|       
|       
|       
|10(d)   |  | 1990 Incentive Stock Option Plan as amended (incorporated by reference to Exhibit 10(j) of the 1991 10-K)                                                                                                                                                                                                                                                                                                                          
|       
|       
|       
|       
|10(e)   |  | Employment Agreement, dated February 16, 1990, between the Company and Walter W. Straub (incorporated by
reference to Exhibit 10(j) of the 1989 10-K)                                                                                                                                                                                                                                                                              
|       
|       
|       
|       
|10(f)   |  | Change of Control Agreement, dated February 16, 1990, between the Company and Walter W. Straub
(incorporated by reference to Exhibit 10(k) of the 1989 10-K)                                                                                                                                                                                                                                                                       
|       
|       
|       
|       
|10(g)   |  | Employment Agreement, dated January 15, 1992, between the Company and Peter M. Craig (incorporated by
reference to Exhibit 10(m) of the 1991 10-K)                                                                                                                                                                                                                                                                                 
|       
|       
|       
|       
|10(h)   |  | Change of Control Agreement, dated January 15, 1992, between the Company and Peter M. Craig (incorporated
by reference to Exhibit 10(n) of the 1991 10-K)                                                                                                                                                                                                                                                                          
|       
|       
|       
|       
|10(i)   |  | Employment Agreement, dated January 5, 1995, between the Company and Norman L. Denton, III (incorporated
by reference to Exhibit 10(j) of the Companys 1994 Annual Report on Form 10-K under the Securities
Exchange Act of 1934, filed in March 1995 (the 1994 10-K))                                                                                                                                                          
|       
|       
|       
|       
|10(j)   |  | Change of Control Agreement, dated January 5, 1995, between the Company and Norman L. Denton, III
(incorporated by reference to Exhibit 10(k) to the 1994 10-K)                                                                                                                                                                                                                                                                    
|       
|       
|       
|       
|10(k)   |  | Employment Agreement, dated January 5, 1995, between the Company and Patrick E. Fevery (incorporated by
reference to Exhibit 10(l) of the 1994 10-K)                                                                                                                                                                                                                                                                               



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|        |  |                                                                                                                                                                                                                                                                                                                                                   
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT
|NUMBER  |  | DESCRIPTION                                                                                                                                                                                                                                                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                                                                   
|       
|       
|       
|       
|10(l)   |  | Change of Control Agreement, dated January 5, 1995, between the Company and Patrick E. Fevery
(incorporated by reference to Exhibit 10(m) of the 1994 10-K)                                                                                                                                                                                       
|       
|       
|       
|       
|10(m)   |  | Employment Agreement, dated January 5, 1995, between the Company and Paul A. Bock (incorporated by
reference to Exhibit 10(n) of the 1994 10-K)                                                                                                                                                                                                   
|       
|       
|       
|       
|10(n)   |  | Change of Control Agreement, dated January 5, 1995, between the Company and Paul A. Bock (incorporated by
reference to Exhibit 10(o) of the 1994 10-K)                                                                                                                                                                                            
|       
|       
|       
|       
|10(o)   |  | Employment Agreement, dated April 7, 1997, between the Company and Aviram Margalith (incorporated by
reference to Exhibit 10(o) of the 1997 10-K)                                                                                                                                                                                                 
|       
|       
|       
|       
|10(p)   |  | Change of Control Agreement, dated April 7, 1997, between the Company and Aviram Margalith (incorporated
by reference to Exhibit 10(p) of the 1997 10-K)                                                                                                                                                                                          
|       
|       
|       
|       
|10(q)   |  | Employment Agreement, dated January 1, 1998, between the Company and Laurie Casey (incorporated by
reference to Exhibit 10(q) of the 1997 10-K)                                                                                                                                                                                                   
|       
|       
|       
|       
|10(r)   |  | Change of Control Agreement, dated January 1, 1998, between the Company and Laurie Casey (incorporated by
reference to Exhibit 10(r) of the 1997 10-K)                                                                                                                                                                                            
|       
|       
|       
|       
|10(s)   |  | Employment Agreement, dated January 1, 1998, between the Company and Richard Burris (incorporated by
reference to Exhibit 10(s) of the 1997 10-K).                                                                                                                                                                                                
|       
|       
|       
|       
|10(t)   |  | Change of Control Agreement, dated January 1, 1998, between the Company and Richard Burris (incorporated
by reference to Exhibit 10(t) of the 1997 10-K)                                                                                                                                                                                          
|       
|       
|       
|       
|10(u)   |  | Manufacturing Agreement, dated September 30, 1997, between AlliedSignal, Inc. and Mykotronx, Inc.
(incorporated by reference to Exhibit 10(u) of the 1998 10-K)                                                                                                                                                                                   
|       
|       
|       
|       
|10(v)   |  | Development Agreement, dated September 30, 1997, between AlliedSignal, Inc. and Mykotronx, Inc.
(incorporated by reference to Exhibit 10(v) of the 1998 10-K)                                                                                                                                                                                     
|       
|       
|       
|       
|10(w)   |  | Agreement for Design and Product Purchase, dated September 4, 1997, between IBM Microelectronics and
Rainbow Technologies, Inc. and Mykotronx, Inc. (incorporated by reference to Exhibit 10(w) of the 1998
10-K).                                                                                                                                
|       
|       
|       
|       
|10(x)   |  | Leases for premises at 357, 359, and 371 Van Ness Way, Torrance, California, dated September 8, 1993,
September 25, 1996 and October 2, 1997, respectively, between Surf Management Associates, a California
limited partnership, and Mykotronx, Inc., a California Corporation (incorporated by reference to Exhibit
10(x) of the 1999 Form 10-K)
|       
|       
|       
|       
|10(y)   |  | Lease for premises at 111 West Ocean Boulevard, Long Beach, California, between Stevens Creek Associates,
a California general partnership, and the Company (incorporated by reference to Exhibit 10(y) of the 1999
Form 10-K)                                                                                                                    
|       
|       
|       
|       
|10(z)   |  | Lease for premises at 8 Hughes, Irvine, California, between Alton Irvine Partners, LLC, a California
limited liability company, and the Company. (Incorporated by reference to Exhibit 10(z) of the 2000 Form
10-K)                                                                                                                               
|       
|       
|       
|       
|10(aa)  |  | 2000 Incentive Stock Option Plan (incorporated by reference to Rainbows Registration Statement on Form
S-8 filed under the Securities Act of 1933)                                                                                                                                                                                               
|       
|       
|       
|       
|10(bb)  |  | Asset Purchase Agreement, dated December 29, 2000 between Kaster Chase Applied Research Limited and
Mykotronx, Inc. (incorporated by reference to Exhibit 10(bb) of the 2000 Form 10-K)                                                                                                                                                           

(b) Reports on Form 8-K

None



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.

Dated: November 14, 2001

| |                            |                               
| | -------------------------- | ------------------------------
| | RAINBOW TECHNOLOGIES, INC.
|
| | By:                        | /s/             Patrick Fevery
| |                           
| | Chief Financial Officer   



17