-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, S+Nj+v1lLpdO5QcxedNOEja8e7flFvP1wVbNaiHFVy7jnAgdi1fSf1VQ3yzdDLbz rws5LR05QLlP+v+ciF22wA== 0000892569-96-000328.txt : 19960402 0000892569-96-000328.hdr.sgml : 19960402 ACCESSION NUMBER: 0000892569-96-000328 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960401 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: RAINBOW TECHNOLOGIES INC CENTRAL INDEX KEY: 0000819706 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 953745398 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-16641 FILM NUMBER: 96542198 BUSINESS ADDRESS: STREET 1: 9292 JERONIMO RD CITY: IRVINE STATE: CA ZIP: 92718 BUSINESS PHONE: 7144542100 MAIL ADDRESS: STREET 1: 9292 JERONIMO RD CITY: IRVINE STATE: CA ZIP: 92718 10-K405 1 FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1995 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (MARK ONE) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1995 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) Commission file number: 0-16641 RAINBOW TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 953745398 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 50 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92718 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (714) 450-7300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock 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 . --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K /X/. As at March 26, 1996, the aggregate market value of the voting stock of the Registrant (based upon the closing sales price of the shares on the NASDAQ National Market System) held by non-affiliates was approximately $131,000,000. As at March 26, 1996, there were outstanding 7,401,277 shares of Common Stock of the Registrant, par value $.001 per share. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Proxy Statement to be submitted to the Commission on or before April 29, 1996, are incorporated by reference into Part III. 2 INTRODUCTORY NOTE The Annual Report on Form 10-K 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 included (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. ITEM 1. BUSINESS General Rainbow Technologies, Inc. and its subsidiaries (the "Company") design, develop and manufacture (i) software program protection products (the "Software Protection Products"), which the Company markets to software developers and information publishers worldwide, and (ii) products that provide secure voice communication and data transmission using encryption technology (the "Information Security Products") which the Company markets to organizations of the United States Government, such as the Department of Defense and National Aeronautics and Space Administration ("NASA"), and to contractors and manufacturers in the aerospace and related industries. In May 1995, the Company acquired Mykotronx, Inc. ("Mykotronx") in a transaction accounted for as a pooling-of-interests. Located in Torrance California, Mykotronx is a leading supplier of information security products. 1 3 The Company's principal subsidiaries are located in California, the United Kingdom, Germany and France. Unless the context otherwise requires, the term "Company" refers to Rainbow Technologies, Inc. and its subsidiaries. The Company's general business strategy consists of four main elements. First, as to Software Protection Products, the Company focuses on improvements to its technology and products to enhance product performance and maintain the Company's competitive advantage in the software protection market. The Company believes that the software protection market will experience a unit growth rate of 20% per year over the next several years, based on estimates by the Software Publisher's Association. As to its Information Security Products, the Company concentrates on technology supporting new telecommunications and hardware cryptographic applications. Currently, the Company's Information Security Products are primarily sold to agencies of the U.S. Government, aerospace or related industry contractors. The Company believes that this market is greater than $500 million and is one of the fastest growth segments of the U.S. Government budget. Second, the Company intends to expand its marketing and distribution efforts for its Software Protection Products both domestically and internationally. The Company also plans to focus on areas where there is high incidence of software piracy, such as eastern Europe and the Far East. The Company intends to actively pursue new markets in the United States for its Information Security Products. Third, the Company seeks to leverage the core competencies of both of its business segments to address broad and emerging issues of information security such as information privacy, information integrity and digital signature validation. The Company believes that these emerging markets for security will experience significant growth over the next five years. Fourth, the Company intends to acquire and invest in technologies and companies that either expand its core product markets or have the potential for market leadership. The Company markets its Software Protection Products worldwide to software developers and information providers. In 1995, 47% of the Company's sales of Software Protection Products were made internationally. The Company markets its Information Security Products to various organizations of the U.S. Government, including the Department of Defense, NASA and the United States Air Force, and contractors and manufacturers in the aerospace and related industries. Approximately 67% of the Company's revenues are derived from Software Protection Products and approximately 33% of the Company's revenues are derived from Information Security Products. Software Protection Products The Company's Software Protection Products contain hardware and software components. The hardware component is a "key" which the software publisher includes with each copy of a protected software program sold to an end user. The software component is the software licensed to the software developer which enables the software developer to direct their programs to "look for and communicate with" the key. The keys incorporate either the Company's proprietary algorithms programmed into Company designed Application Specific Integrated Circuits ("ASIC") computer chips, or customer specific information programmed into a standard computer memory chip. The key is attached by the end user to the parallel printer port of a stand alone personal computer or a local area network file server. In "looking for and communicating with" the key, the protected software program interacts with the key. The interaction consists of a continuous challenge-and-response procedure requiring the key to be attached to the computer for the protected software program to operate. In operation, the 2 4 interactions of the protected software and the key are transparent to a user. In addition, other software programs may operate concurrently with the protected software program and corresponding key, without interference. Printer operation is not affected and protected software programs can be copied and backed up to a hard disk if required by the user. The Company's Software Protection Products include: SentinelSuperPro. Features the Company's latest ASIC technology. This is the Company's first key to combine multiple algorithms with programmable memory for increased security and flexibility. This product is compatible with DOS, Windows, Windows NT and Windows 95 based applications. SentinelPro. An algorithm-based key utilizing the Company's proprietary ASIC technology for the protection of DOS, Windows, Windows NT, Windows 95, OS/2, UNIX or XENIX based applications. SentinelScribe. A field writable memory key with full read/write capabilities for simple field upgrades or where sophisticated software metering is required for DOS, Windows, Windows NT or OS/2 software. SentinelC-Plus. A memory-based key designed for DOS, Windows, Windows NT, OS/2, UNIX or XENIX applications where custom security protection for special or multiple/modular applications is required. SentinelEve3. Software protection for Apple Macintosh-based software. Attaches to the ADB port making it compatible with Apple Power Mac and PowerBook computers. Protects stand-alone and/or multiple modular applications. NetSentinel. For sophisticated network license management to control concurrent users over LANs running DOS, OS/2, Windows, Windows NT and Windows 95 based applications. This product is compatible with Novell, NETBIOS, TCP/IP and IPX/SPX. MicroSentinel UX. Specifically designed for UNIX and open systems applications, this key features an intelligent microprocessor for sophisticated operation control. It can serve many marketing functions including execution control, software leasing, site license management and can be used as a portable host-ID. SentinelLM. A software based license management product for Windows, Netware and UNIX environments. The product allows developers to offer end-users highly flexible licensing models and payment schemes. Information Security Products The Company believes the importance of protecting the privacy and security of voice communication and data transmission has increased in direct proportion with the technological advances, capabilities and overall growth in the telecommunications field. Information security remains critical to military and government applications and is increasingly valued by private sector businesses to protect voice and data communication. The Company's Information Security Products are integrated circuits and electronic assemblies which encrypt and decrypt 3 5 (scramble and unscramble) electronic communications and are designed and developed by the Company for use in military settings, government applications and for private industry purposes. The Company, through its subsidiary Mykotronx, enters into development contracts with agencies of the U.S. Government, aerospace or related industry contractors. In such contracts, the Company generally agrees to develop an integrated circuit or other electronic assembly for the customer's particular application, or modify and enhance one of the Company's Information Security Products to meet the customer's requirements. As to contracts with agencies of the U.S. Government, the Company usually serves as the prime contractor or as a subcontractor, under fixed-price or cost-plus-fixed-fee contracts. The terms of development contracts with other customers are based upon the customer's requirements. Contracts with the U.S. Government account for a majority of the revenues received by the Company from sales of its Information Security Products. The Company has recently begun to market its Information Security Products to wider commercial applications that require the transmission of secure data such as banking and financial transaction information, telecommunications networks and company-wide intranets. The Company's Information Security Products are currently categorized into four general areas of customer applications: U.S. Government Space. Products for use in connection with satellite systems launched by the U.S Government or its agencies. U.S. Government Ground Based Communication Networks. Products to support a variety of intra and inter-agency ground-based communications networks such as Department of Defense, Department of State, Department of the Treasury and other agencies transmitting classified and sensitive information. Commercial Space. Products are used for commercial space applications in connection with direct broadcast satellite (DBS) and other commercial space based communication satellite systems. Commercial Ground Based Communications Networks. Products to secure communications through cellular voice systems, fax machines, computer networks, portable and standard phone systems. Research and Development Because technological advancement and other changes affecting the personal computer marketplace occur at a rapid pace, the Company's competitive positions in the software program and information protection industry hinge upon the adaptation of its current products, and upon the introduction of new products that gain market acceptance. Accordingly, the Company directs research and development activity toward applying its hardware and software technology and its ASIC technology in lowering the cost of existing products, the design and development of new hardware and software products, and the enhancement of existing products. The Company has also focused its development of Software Protection Products on current trends such as cross-platform interoperability and compatibility with the new operating environments including Windows 95, Windows NT and OS/2 Warp. Expenditures for research and development for the years ended December 31, 1995, 1994 and 1993 were $5,218,000, $4,584,000 and $3,945,000, respectively, or as a percentage of Software Protection Product sales, 12%, 12%, and 11%, 4 6 respectively. The Company believes that its research and development efforts are greater than any of its competitors and that the Company's technological leadership could broaden in the future. Also, the Company performs research and development with regard to its Information Security Products in connection with its U.S. Government agencies contracts. The costs incurred by the Company in connection with such research and development activities are substantially recoverable by the Company pursuant to the terms of these contracts. The Company believes that some of the research and development performed under such contracts can be applied to the emerging issues of information security. Sales and Marketing Software Protection Products The Company markets its Software Protection Products to software publishers throughout the world for use with their software programs selling at retail for $600 or more in the United States, and for use with lower priced software programs sold internationally. For 1995, 1994 and 1993, 53%, 58% and 57%, respectively, of the Company's Software Protection Product sales were made in the United States and 47%, 42% and 43%, respectively, were made internationally. Since its formation, the Company has shipped more than 7,900,000 keys to more than 24,000 customers. Among the Company's major customers are Autodesk, Inc., Encyclopaedia Britanica, SPSS, Inc., Adobe Systems, Inc., Wonderware Software Development Corp., Quark Systems, Inc. and Orcad. The Company has direct sales and marketing personnel in the United States, the United Kingdom, Germany and France. The Company also has a telemarketing sales force that responds to inquiries and referrals and which makes cold calls to generate sales. In addition, the Company uses 43 distributors in Europe, Asia Pacific, the Middle East, Mexico and South America. During 1995, 1994 and 1993 the Company had no single customer which accounted for ten percent or more of the Company's revenues. The Company's direct sales force makes personal sales calls to targeted software publishers in order to introduce the Company's products. The direct sales personnel also make personal calls on software publishers who currently use the Company's products in an effort to broaden usage of the Company's products to other software programs. The direct sales force pursues a global marketing plan which focuses on targeting multinational software publishers and coordinates the worldwide sales initiative to such publishers. The Company attends trade shows and uses trade advertising to increase the level of awareness of the Company and its products. The Company's technical support personnel, who interact directly with software publishers' engineers, also assist in the Company's marketing effort through such interaction. Information Security Products The Company markets its Information Security Products directly to the U.S. Government and government related agencies. The Company maintains close relationships with the 5 7 Department of Defense and the aerospace community. Through these relationships, the Company receives certain contracts for services and products on a selected source basis. In addition, contracts are awarded to the Company as the successful bidder in response to requests for proposal from U.S. Government agencies and aerospace companies. Manufacturing Software Protection Products The Company's hardware keys are manufactured by subcontractors in the United States, Asia Pacific and Europe, from components specified and approved by the Company. The components include ASIC chips, standard computer memory chips and standard computer hardware parts. The Company maintains control over the purchasing of materials and the planning and scheduling of the manufacturing and assembly process. After assembly of the components, the keys are delivered to the Company's facilities in the United States and Europe where the products are inspected, tested and configured. The Company believes that it is the lowest cost producer of software protection products and believes that will continue to be a competitive advantage. The Company currently has one supplier of the ASIC chips used in the Company's largest selling product, SentinelSuperPro. In the event that such supplier is unable to fulfill the Company's requirements, the Company may experience an interruption in the production of SentinelSuperPro until an alternative source of supply is developed. The Company maintains a three month inventory of ASIC chips in order to limit the potential for such an interruption. The Company believes that there are a number of companies capable of commencing the manufacture of its ASIC chips within approximately three months of such an interruption. Information Security Products For its Information Security Products, the Company's manufacturing operations include the final assembly and testing of electronic components and PC boards. PC boards and PC board components are purchased and then assembled by outside contractors. The Company assembles the parts and components, creating a finished unit which is then tested and shipped. The Company has specific cryptographic technology embedded into ASIC integrated circuits which are fabricated to the Company's specifications by integrated circuit manufacturers. The Company currently has relationships with two such integrated circuit manufacturers, VLSI Technologies and United Technologies Microelectronics Center. These ASIC integrated circuits are processed to the specifications of the U.S. Government and the Company. These two suppliers are the only suppliers capable of meeting the U.S. Government specifications. Until an alternate source of supply is developed, any interruption in the availability of these integrated circuits could have a material adverse effect on the operations of the Company. 6 8 Backlog The Company manufactures its Software Protection Products on the basis of its forecast of near-term demand and maintains inventory in advance of receipt of firm customer orders. Orders from software publishers are generally placed on an "as needed" basis and are usually shipped by the Company within one week after receipt of the order. For these reasons, the Company's backlog of Software Protection Product orders at any particular time is generally not large and not indicative of future sales levels. As of December 31, 1995, the backlog for the Company's Information Security Products represented in excess of six months of revenues. Actual revenue recognition of the backlog mix of contracts can vary from three months to two years. Trade Secrets The Company believes that the value of its Software Protection Products is dependent upon its proprietary algorithms and encryption techniques remaining "trade secrets." The Company has obtained copyright protection on certain of its products and trademark protection for certain of its trade names. The Company has not obtained, and presently does not intend to obtain, patents on certain of the other designs used in its products, since an issued patent may make public certain information that should be kept secret for the benefit of those using the Company's products. There can be no assurance that the Company's proprietary technology will remain a secret or that others will not develop similar technology and use such technology to compete with the Company. There can be no assurance that if the Company decides to apply for patents in the future for any of its products, or on any new technology or products derived therefrom, that patents will be granted. Competition Software Protection Products The worldwide software protection industry is highly competitive and characterized by rapid technological advances in both computer hardware and software development. The Company believes it is the industry leader with an estimated 50% worldwide market share. The Company's principal competitors in the software protection industry are FAST Security, AG, Aladdin Knowledge Systems, Ltd. and Software Security, Inc. The Company also competes with smaller companies. The Company believes that it offers the most cost effective Software Protection Products available to software publishers. Although certain of the Company's competitors offer lower prices, the Company believes that its technical support services and the ease of implementation of its products favorably distinguish the Company from its competitors. Information Security Products The Company's principal competitors for its Information Security Products are Group Technologies, National Semiconductor and Motorola. Employees The Company presently employs 270 full-time employees divided among sales and marketing, manufacturing, research and development and administration. The Company believes 7 9 that its employee relations are excellent. The employees and the Company are not parties to collective bargaining agreements. Recent Events On March 6, 1996, the Company entered into an agreement to acquire up to 58% of Quantum Manufacturing Technologies, Inc. ("QMT") of Albuquerque, New Mexico, in exchange for $4.2 million, subject to certain technological and business milestones. The Company made an initial investment of $1.2 million for 35% of the common stock of QMT. QMT, a developmental stage company formed in 1995, has recently obtained the exclusive worldwide license from Sandia National Laboratories for the commercial use and exploitation of patented pulsed power ion beam surface treatment technology known as "IBEST". QMT believes IBEST technology benefits and enhances the surface durability and utility of a large number of industrial and consumer products at relatively low cost and without creating any impact on the environment. According to a recent issue of New Coatings and Surface Finishings Newsletter, the overall market for the surface treatment industry worldwide is $8 - 10 billion. One of the fastest growing areas is in the replacement of solvent, chrome and heavy metal based processes, with environmentally friendly processes. 8 10 ITEM 2. PROPERTIES The Company's executive offices and principal facility are located in a 55,800 square foot building in Irvine, California. The Company leases the facility pursuant to a lease expiring June 2000. The Company owns a 5,000 square foot facility in the United Kingdom which is used primarily for northern European sales and administration. The Company also owns an 8,000 square foot facility in Paris, France which is used primarily for southern European sales and administration. The Company leases a facility in Torrance, California, at which Mykotronx maintains its principal offices, design and production facilities. The lease is for 27,000 square feet, and expires in 2000. ITEM 3. LEGAL PROCEEDINGS The Company believes that there are no legal proceedings, pending or contemplated, to which the Company, or any of its subsidiaries, is the subject or to which the Company or any of its subsidiaries is a party. The Company also knows of no material legal proceeding pending or threatened, or judgments entered against any director or executive officer of the Company or any of its subsidiaries in his/her capacity as such where the position of any such director or executive officer is adverse to the Company or any of its subsidiaries. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Neither the Board of Directors nor any security holder submitted any matter during the fourth quarter of the fiscal year covered by this Report to a vote of the security holders through solicitation of proxies or otherwise. 9 11 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock of the Company is traded on the NASDAQ National Market System under the symbol "RNBO". The following table sets forth high and low "sales" prices of the shares of Common Stock of the Company for the periods indicated (as reported by the National Quotation Bureau).
SALES PRICE ----------- HIGH LOW ---- --- 1996 First Quarter $23 5/8 $18 1/4 (through February 29, 1996) 1995 First Quarter 18 1/8 13 7/8 1995 Second Quarter 24 1/2 15 1/4 1995 Third Quarter 26 1/4 17 1/2 1995 Fourth Quarter 24 11/16 17 1/2 1994 First Quarter 24 15 1/2 1994 Second Quarter 18 11 3/4 1994 Third Quarter 15 3/8 9 1/2 1994 Fourth Quarter 17 1/4 11 1/8
As of February 29, 1996, there were approximately 4,000 holders of record of the Company's Common Stock including those shares held in "street name". The Company has never paid cash dividends on its Common Stock and the Board of Directors intends to retain all of its earnings, if any, to finance the development and expansion of its business. However, there can be no assurance that the Company can successfully expand its operations, or that such expansion will prove profitable. Future dividend policy will depend upon the Company's earnings, capital requirements, financial condition and other factors considered relevant by the Company's Board of Directors. ITEM 6. SELECTED FINANCIAL DATA The following selected financial data has been derived from the consolidated financial statements of the Company for the five years ended December 31, 1995. Data for the years ended December 31, 1994, 1993, 1992 and 1991 have been restated to include the financial information of Mykotronx, which was acquired in May 1995 and accounted for as a pooling-of-interests. 10 12
YEARS ENDED DECEMBER 31 -------------------------------------------------------------- 1995 1994 1993 1992* 1991 ---------- ---------- ---------- ---------- ---------- (dollars in thousands, except per share data) Selected Consolidated Income Statement Data: Revenues $ 66,308 $ 55,083 $ 44,113 $ 33,927 $ 21,657 Income before taxes 16,610 12,163 10,669 9,537 6,334 Net income 9,638 6,996 6,669 5,803 4,055 Net income per share $ 1.25 $ 0.94 $ 0.92 $ 0.83 $ 0.68 Proforma net income (unaudited) 9,638 6,996 6,376 5,517 3,818 Proforma net income per share (unaudited) $ 1.25 $ 0.94 $ 0.88 $ 0.79 $ 0.64 Shares used in Calculating Net Income per share 7,700,000 7,415,000 7,251,000 7,023,000 5,988,264 Selected Consolidated Balance Sheet Data: Total assets $ 79,825 $ 64,867 $ 54,901 $ 46,707 $ 29,321 Working capital 49,249 37,911 29,666 20,079 24,497 Long-term debt 2,616 2,695 2,730 3,275 -- Shareholders' equity 66,503 54,323 45,461 36,259 26,362
*Reflects the operations, assets and liabilities of Microphar S.A. which was acquired effective June 1, 1992 and accounted for as a purchase. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The following is management's discussion and analysis of certain significant factors that have affected the profitability of the Company's business segments (Software Protection and Information Security Products) and its consolidated results of operations and financial condition during the periods included in the accompanying consolidated financial statements. The discussion reflects the impact of the acquisition of Mykotronx, which was accounted for using the pooling-of-interests method as described more fully in Note 2 to the consolidated financial statements. The following should be read in conjunction with the consolidated financial statements and related notes. 11 13 1995 COMPARED WITH 1994 Global Software Protection Products revenue for the year ended December 31, 1995 increased 15% to $44,346,000 as compared with 1994. The revenue growth was primarily due to increased unit sales in European markets. Software Protection Products revenue for the year ended December 31, 1995 in Europe increased by 39%. The average selling price per product in the year ended December 31, 1995 decreased approximately 6% from the year ended December 31, 1994. During the year ended December 31, 1995, approximately 24% of the Company's Software Protection Products revenue was subject to currency fluctuations, up from 23% in 1994. Software Protection Products revenue in the future is expected to continue to be affected by foreign currency rate fluctuations. Information Security Products revenue for the year ended December 31, 1995 increased 33% to $21,962,000, as compared with 1994. The revenue growth was due to higher performance on software and service contracts across various product lines. Additionally, the space communication security business experienced strong growth, particularly in high grade security products for government network security. Software Protection Products gross profit for the year ended December 31, 1995 was 71% of revenue compared with 70% for the year ended December 31, 1994. The increase in gross margin was due to increased sales in Europe with corresponding higher margins. There can be no assurance that the Company will improve or maintain the level of gross profit percentage it experienced during the year ended December 31, 1995. Gross profit from Information Security Products for the year ended December 31, 1995 was 23% of revenues compared with 18% of revenues for the year ended December 31, 1994. The increase in gross profit was due to the increased volume of space communications products that benefited from continued economies of scale. Gross profit is highly dependent on the mix of contracts with higher margin percentages versus contracts with lower margin percentages. Consolidated selling, general and administrative expenses for the years ended December 31, 1995 and 1994 were 21% and 20% of revenues, respectively. Selling, general and administrative expenses for the year ended December 31, 1995 increased by $3,066,000 as compared with 1994. This increase was primarily due to additional staff, increased compensation expenses, expenses incurred in connection with the Mykotronx acquisition and amortization expense related to other minor acquisitions. Total research and development expenses were 8% of revenue for the years ended December 31, 1995 and 1994. In 1994, the Company capitalized $735,000 of software development costs. There were no such capitalized software costs during 1995. Current research and development activities are focused on additional ASIC development for future software protection and the adaptation of the Company's existing products to additional software operating environments and computer platforms. Interest income for the year ended December 31, 1995 increased by 128% to $1,689,000, as compared with 1994, primarily because of higher investment balances. 12 14 During the year ended December 31, 1995, the Company incurred foreign currency losses of $268,000, primarily due to dollar denominated deposit accounts maintained in Europe. During the year ended December 31, 1994, the Company recognized foreign currency losses of $588,000, also primarily due to dollar denominated deposit accounts maintained in Europe. Such foreign currency gains and losses result from the movement in the value of the U.S. dollar against the functional currencies used by the Company's foreign subsidiaries. During the year ended December 31, 1994, the Company wrote off a $252,000 investment it held in a company that subsequently filed for bankruptcy protection in January 1995. The effective tax rate decreased to 42.0% for the year ended December 31, 1995 from 42.5% for the year ended December 31, 1994. The decrease in the tax rate is due to the expansion of business unit profits in European countries with lower effective tax rates. 1994 COMPARED WITH 1993 Software Protection Products revenue for the year ended December 31, 1994 increased 10% to $38,512,000, when compared to the same period in 1993. The revenue growth was primarily due to increased unit sales to both existing and new customers in the North American market and the Asia Pacific region. Software Protection Products revenue for the year ended December 31, 1994 in the United States increased by 12% and international revenue increased by 5% over the year ended December 31, 1993. The average selling price per product in the year ended December 31, 1994 decreased approximately 12% from the year ended December 31, 1993. During the year ended December 31, 1994, approximately 23% of the Company's Software Protection Products revenue was subject to currency fluctuations, down from 29% in 1993. Information Security Products revenue for the year ended December 31, 1994 increased 84% to $16,571,000, when compared to 1993. The revenue growth was primarily due to comparable increases in volume of product sold. The core space communication security business area benefited from increased sales of mature products and the development and introduction of two new products. In the commercial business area, increased revenues were realized because of increased acceptance of the Mykotronx "key escrow" Clipper and Capstone chips and the related PCMCIA card called Fortezza. Gross profit for Software Protection Products for the year ended December 31, 1994 was 70% of Software Protection Products revenue compared with 74% for the year ended December 31, 1993. The decrease was primarily due to lower average selling prices. Gross profit from Information Security Products for the year ended December 31, 1994 was 18% of revenues compared with 9% of revenues for the year ended December 31, 1993. The increase in gross profit was due to the increased volume of space communications products which benefited from economies of scale. Selling, general and administrative expenses for the years ended December 31, 1994 and 1993 were 20% and 25% of total revenues, respectively. Selling, general and administrative expenses for the year ended December 31, 1994 decreased by $36,000 compared to the year 13 15 ended December 31, 1993. This decrease was primarily due to reductions in management overhead. Total research and development expenses for the year ended December 31, 1994 were 8% of total revenues and increased by 16% to $4,584,000, when compared to the year ended December 31, 1993. The increase was primarily due to the addition of engineering personnel. In 1994, the Company capitalized $735,000 of software development costs. Interest income for the year ended December 31, 1994, increased by 25% to $742,000, as compared to 1993, because of a general rise in interest rates and higher investment balances. During the year ended December 31, 1994, the Company incurred foreign currency losses of $588,000, primarily due to dollar denominated deposit accounts maintained in Europe. During the year ended December 31, 1993, the Company recognized foreign currency gains of $439,000, also primarily due to dollar denominated deposit accounts maintained in Europe. Such foreign currency gains and losses result from the movement of the value of the U.S. dollar against the functional currencies used by the Company's foreign subsidiaries. During the year ended December 31, 1994, the Company wrote off a $252,000 investment in a company that filed for bankruptcy protection in January 1995. The effective tax rate increased to 42.5% for the year ended December 31, 1994, from the proforma effective tax rate of 40.0% for the year ended December 31, 1993. The increase in the tax rate was primarily due to the decreased availability of research and experimentation credits. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of operating funds have been from operations and proceeds from sales of the Company's equity securities. The Company's cash flow from operations during 1995, 1994 and 1993 was $13,203,000, $8,422,000, and $7,434,000, respectively. The Company intends to use its capital resources to expand its product lines and for possible acquisitions of additional products and technologies. There are no significant capital requirements at this time. The Company's subsidiaries in France carry $5.2 million 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. Management believes that the effect of inflation on the business of the Company for the past three years has been minimal. The Company believes that its current working capital of $49,249,000 and anticipated working capital to be generated by future operations will be sufficient to support the Company's working capital requirements through at least December 31, 1996. 14 16 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements and Schedule of the Company are listed in Item 14 (a) and included herein on pages F-1 through F-23. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The Company has not had any disagreement with its independent auditors on any matter of accounting principles or practices or financial statement disclosure. 15 17 PART III ITEM 10. ALL DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Reference is made to the information appearing under the caption "Election of Directors" in the Company's Proxy Statement to be submitted to the Commission on or before April 29, 1996. ITEM 11. EXECUTIVE COMPENSATION Reference is made to the information appearing under the caption "Executive Compensation" in the Company's Proxy Statement to be submitted to the Commission on or before April 29, 1996. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reference is made to the information appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement to be submitted to the Commission on or before April 29, 1996. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the information appearing under the caption "Certain Relationships and Related Transactions" in the Company's Proxy Statement to be submitted to the Commission on or before April 29, 1996. 16 18 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Consolidated Financial Statements Report of Independent Auditors. Consolidated Balance Sheets at December 31, 1995 and 1994. Consolidated Statements of Income for the years ended December 31, 1995, 1994 and 1993. Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1994 and 1993. Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1994 and 1993. Notes to Consolidated Financial Statements. (a) 2. Consolidated Financial Statement Schedule II. Consolidated Valuation and Qualifying Accounts for the years ended December 31, 1995, 1994 and 1993. All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto. (a) 3. Exhibits 2. 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). 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). 17 19 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. 10(b) Agreement, dated May 26, 1989, between the Company and Catalyst Semiconductor, Inc. (incorporated by reference to Exhibit 10(h) of the Company's 1989 Annual Report on Form 10-K under the Securities Exchange Act of 1934 filed in March 1990 (the "1989 10-K"). 10(c) Agreement, dated August 17, 1989, between the Company and Catalyst Semiconductor, Inc. (incorporated by reference to Exhibit 10(i) of the 1989 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) Asset Purchase Agreement, dated January 20, 1994, between the Company and the AND Group, Inc. (incorporated by reference to Exhibit 10(s) to the Company's 1993 Annual Report on Form 10-K under the Securities Exchange Act of 1934 filed in March 1994 (the "1993 10-K"). 10(f) 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(g) 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(h) 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(i) 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(j) 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(k) 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(l) 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). 10(m) 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(n) 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(o) 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). 18 20 10(p) Employment Agreement, dated May 31, 1995, among Mykotronx, the Company and Theodore S. Bettwy. 10(q) Employment Agreement dated May 31, 1995, among Mykotronx, the Company and John C. Droge. 21(a) List of Rainbow's wholly-owned subsidiaries. 23 Consents of Independent Auditors. (a) Ernst & Young LLP. (b) KMPG Peat Marwick LLP. 27 Financial Data Schedule. (b) Reports on Form 8-K No reports on Form 8-K have been filed during the three months ended December 31, 1995. 19 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. RAINBOW TECHNOLOGIES, INC., Registrant By: /s/ Walter W. Straub -------------------------- Walter W. Straub, President Chief Executive Officer, and Chairman of the Board Date: March 29, 1996 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------- ----- ---- /s/ Walter W. Straub President, Chief Executive March 29, 1996 - -------------------- Officer, and Walter W. Straub Chairman of the Board /s/ Peter M. Craig Executive Vice President, March 29, 1996 - -------------------- Secretary and Director Peter M. Craig /s/ Patrick E. Fevery Vice President and March 29, 1996 - --------------------- Chief Financial Officer Patrick E. Fevery Director March , 1996 - --------------------- Alan K. Jennings Director March , 1996 - --------------------- Richard P. Abraham Director March , 1996 - --------------------- Marvin Hoffman Director March , 1996 - --------------------- Frederick M. Haney
20 22 RAINBOW TECHNOLOGIES, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE For the year ended December 31, 1995
Page ---- Reports of Independent Auditors..................................... F-2 Consolidated Balance Sheets......................................... F-4 Consolidated Statements of Income................................... F-5 Consolidated Statements of Shareholders' Equity .................... F-6 Consolidated Statements of Cash Flows............................... F-7 Notes to Consolidated Financial Statements.......................... F-8 Schedule II - Consolidated Valuation and Qualifying Accounts ....... F-23
F-1 23 REPORT OF INDEPENDENT AUDITORS Board of Directors Rainbow Technologies, Inc. We have audited the accompanying consolidated balance sheets of Rainbow Technologies, Inc. as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and the schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits. We did not audit the financial statements of Mykotronx, Inc., a wholly-owned subsidiary acquired on June 1, 1995 and accounted for as a pooling-of-interests, which statements reflect total assets of $6,340,000 as of December 31, 1994, and total revenues of $16,571,000 and $8,995,000 for the years ended December 31, 1994 and 1993, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the data included for Mykotronx, Inc., is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based upon our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Rainbow Technologies, Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Ernst & Young LLP Orange County, California February 16, 1996 F-2 24 REPORT OF INDEPENDENT AUDITORS The Board of Directors Mykotronx, Inc. We have audited the balance sheet of Mykotronx, Inc. as of December 31, 1994 and the related statements of earnings, shareholders' equity and cash flows (not presented herein) for the two years ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mykotronx, Inc., as of December 31, 1994 and the results of its operations and its cash flows for the two years ended December 31, 1994 in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Los Angeles, California February 16, 1995 F-3 25 RAINBOW TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS
December 31, December 31, 1995 1994 ----------- ----------- ASSETS Current assets: Cash and cash equivalents ................................................ $25,058,000 $19,755,000 Marketable securities available-for-sale ................................. 11,799,000 3,592,000 Accounts receivable, net of allowance for doubtful accounts of $450,000 and $368,000 in 1995 and 1994, respectively ................ 12,725,000 10,337,000 Note receivable .......................................................... - 3,000,000 Inventories .............................................................. 2,927,000 2,862,000 Unbilled costs and fees .................................................. 3,962,000 2,895,000 Prepaid expenses and other current assets ................................ 1,716,000 1,878,000 ----------- ----------- Total current assets ................................................ 58,187,000 44,319,000 Property, plant and equipment, at cost: Buildings ................................................................ 9,572,000 8,889,000 Furniture ................................................................ 797,000 750,000 Equipment ................................................................ 4,075,000 3,322,000 Leasehold improvements ................................................... 221,000 494,000 ----------- ----------- 14,665,000 13,455,000 Less accumulated depreciation and amortization ........................... 3,708,000 3,586,000 ----------- ----------- Net property, plant and equipment ................................... 10,957,000 9,869,000 Goodwill, net of accumulated amortization of $6,602,000 and $4,380,000 in 1995 and 1994, respectively ................................ 6,186,000 7,425,000 Other assets, net of accumulated amortization of $1,193,000 and $627,000 in 1995 and 1994, respectively .............................. 4,495,000 3,254,000 ----------- ----------- $79,825,000 $64,867,000 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable ......................................................... $ 3,476,000 $ 2,098,000 Accrued payroll and related expenses ..................................... 2,077,000 1,858,000 Other accrued liabilities ................................................ 1,151,000 1,264,000 Income taxes payable ..................................................... 1,916,000 402,000 Billings in excess of costs and fees ..................................... 2,000 422,000 Long-term debt, due within one year ...................................... 316,000 364,000 ----------- ----------- Total current liabilities ........................................... 8,938,000 6,408,000 Long-term debt, net of current portion ..................................... 2,616,000 2,695,000 Deferred income taxes ...................................................... 1,768,000 1,441,000 Commitments ................................................................ Shareholders' equity: Common stock, $.001 par value, 20,000,000 shares authorized, 7,311,267 and 7,165,105 shares issued and outstanding in 1995 and 1994, respectively (Note 8) ................................ 7,000 7,000 Additional paid-in capital ............................................... 29,823,000 28,222,000 Cumulative translation adjustment ........................................ 424,000 (465,000) Cumulative difference between cost and market value of marketable securities .................................. 52,000 - Retained earnings ........................................................ 36,197,000 26,559,000 ----------- ----------- Total shareholders' equity .......................................... 66,503,000 54,323,000 ----------- ----------- $79,825,000 $64,867,000 =========== ===========
See accompanying notes. F-4 26 RAINBOW TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 1995, 1994 and 1993
1995 1994 1993 ----------- ----------- ----------- Revenues: Software protection products ......... $44,346,000 $38,512,000 $35,118,000 Information security products ........ 21,962,000 16,571,000 8,995,000 ----------- ----------- ----------- Total revenues .................. 66,308,000 55,083,000 44,113,000 Operating expenses: Cost of software protection products . 12,701,000 11,589,000 9,190,000 Cost of information security products 16,865,000 13,521,000 8,188,000 Selling, general and administrative .. 14,135,000 11,069,000 11,105,000 Research and development ............. 5,218,000 4,584,000 3,945,000 Goodwill amortization ................ 1,830,000 1,676,000 1,608,000 ----------- ----------- ----------- Total operating expenses ........ 50,749,000 42,439,000 34,036,000 ----------- ----------- ----------- Operating income ....................... 15,559,000 12,644,000 10,077,000 Interest income ........................ 1,689,000 742,000 593,000 Interest expense ....................... (370,000) (383,000) (440,000) Foreign currency gains (losses) ........ (268,000) (588,000) 439,000 Write-down of investment ............... - (252,000) - ----------- ----------- ----------- Income before provision for income taxes 16,610,000 12,163,000 10,669,000 Provision for income taxes ............. 6,972,000 5,167,000 4,000,000 ----------- ----------- ----------- Net income ............................. $ 9,638,000 $ 6,996,000 $ 6,669,000 =========== =========== =========== Net income per common and common equivalent share ..................... $ 1.25 $ 0.94 $ 0.92 =========== =========== =========== Weighted average common and common equivalent shares outstanding ........ 7,700,000 7,415,000 7,251,000 =========== =========== =========== Proforma data (unaudited): Net income ............................. $ 9,638,000 $ 6,996,000 $ 6,669,000 Proforma provision for income taxes .... - - 293,000 ----------- ----------- ----------- Net income after proforma income tax adjustment ................ $ 9,638,000 $ 6,996,000 $ 6,376,000 =========== =========== =========== Proforma net income per common and common equivalent share .............. $ 1.25 $ 0.94 $ 0.88 =========== =========== ===========
See accompanying notes. F-5 27 RAINBOW TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years ended December 31, 1995, 1994 and 1993
Cumulative difference between cost Additional Cumulative and market value Common Stock paid-in translation of marketable Retained Shares Amount capital adjustment securities earnings Total ------------------------------------------------------------------------------------------- Balance, December 31, 1992 .... 6,742,207 $6,000 $22,541,000 $(1,458,000) $ - $15,169,000 $36,258,000 Exercise of common stock options .................... 364,641 1,000 1,980,000 - - - 1,981,000 Tax benefit of employee stock options .................... - - 1,460,000 - - - 1,460,000 Distribution to former Mykotronx shareholders ...... - - - - - (399,000) (399,000) Translation adjustment, net ... - - - (508,000) - - (508,000) Net income .................... - - - - - 6,669,000 6,669,000 ------------------------------------------------------------------------------------------- Balance, December 31, 1993 .... 7,106,848 7,000 25,981,000 (1,966,000) - 21,439,000 45,461,000 Exercise of common stock options .................... 138,117 - 593,000 - - - 593,000 Tax benefit of employee stock options .................... - - 173,000 - - - 173,000 Repurchase of shares of former Mykotronx shareholders ...... (79,860) - (5,000) - - (101,000) (106,000) Distribution to former Mykotronx shareholders ...... - - - - - (295,000) (295,000) Transfer of retained earnings to additional paid-in capital upon termination of Mykotronx S Corporation election ...... - - 1,480,000 - - (1,480,000) - Translation adjustment, net ... - - - 1,501,000 - - 1,501,000 Net income .................... - - - - - 6,996,000 6,996,000 ------------------------------------------------------------------------------------------- Balance, December 31, 1994 .... 7,165,105 7,000 28,222,000 (465,000) - 26,559,000 54,323,000 Exercise of common stock options .................... 146,162 - 1,192,000 - - - 1,192,000 Tax benefit of employee stock options .................... - - 409,000 - - - 409,000 Unrealized gain on marketable securities ....... - - - - 52,000 - 52,000 Translation adjustment, net ... - - - 889,000 - - 889,000 Net income .................... - - - - - 9,638,000 9,638,000 ------------------------------------------------------------------------------------------- Balance, December 31, 1995 .... 7,311,267 $7,000 $29,823,000 $ 424,000 $52,000 $36,197,000 $66,503,000 ===========================================================================================
See accompanying notes. F-6 28 RAINBOW TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1995, 1994 and 1993
1995 1994 1993 ------------ ------------ ----------- Cash flows from operating activities: Net income ................................................. $ 9,638,000 $ 6,996,000 $ 6,669,000 Adjustments to reconcile net income to net cash provided by operating activities: Amortization ............................................. 2,352,000 2,034,000 1,676,000 Depreciation ............................................. 1,186,000 1,080,000 1,002,000 Change in deferred income taxes .......................... 621,000 25,000 (87,000) Allowance for doubtful accounts .......................... 73,000 16,000 163,000 Loss from retirement of property, plant and equipment .... 7,000 28,000 16,000 Write-down of investment ................................. - 252,000 - Changes in operating assets and liabilities: Accounts receivable .................................... (2,311,000) (1,413,000) (1,961,000) Inventories ............................................ (6,000) 298,000 (1,150,000) Unbilled costs and fees ................................ (1,067,000) (1,460,000) (867,000) Prepaid expenses and other current assets .............. 150,000 225,000 (207,000) Other assets ........................................... - (31,000) (127,000) Accounts payable ....................................... 1,353,000 391,000 1,050,000 Accrued liabilities .................................... 71,000 376,000 1,422,000 Billings in excess of costs and fees ................... (420,000) 417,000 (134,000) Income taxes payable ................................... 1,556,000 (812,000) (31,000) ------------ ------------ ----------- Net cash provided by operating activities ............ 13,203,000 8,422,000 7,434,000 Cash flows from investing activities: Purchases of marketable securities ......................... (12,271,000) (12,376,000) (9,361,000) Sales of marketable securities ............................. 4,115,000 16,990,000 4,851,000 Purchases of property, plant and equipment ................. (1,670,000) (559,000) (639,000) Notes receivable ........................................... 3,000,000 (3,000,000) - Other long-term assets ..................................... (1,751,000) (578,000) (352,000) Acquisition of AND Group, Inc. ............................. - (1,498,000) - Capitalized software development costs ..................... - (735,000) - ------------ ------------ ----------- Net cash used in investing activities ................ (8,577,000) (1,756,000) (5,501,000) Cash flows from financing activities: Exercise of common stock options ........................... 1,192,000 593,000 1,981,000 Payment of long-term debt .................................. (357,000) (496,000) (395,000) Principal payments of capital lease ........................ (31,000) (25,000) (5,000) Repurchase of shares of former Mykotronx shareholders....... - (106,000) (399,000) Distribution to former Mykotronx S Corporation shareholders ............................................. - (295,000) - ------------ ------------ ----------- Net cash provided by (used in) financing activities .. 804,000 (329,000) 1,182,000 Effect of exchange rate changes on cash ...................... (127,000) 482,000 (249,000) ------------ ------------ ----------- Net increase in cash and cash equivalents .................... 5,303,000 6,819,000 2,866,000 Cash and cash equivalents at beginning of year ............... 19,755,000 12,936,000 10,070,000 ------------ ------------ ----------- Cash and cash equivalents at end of year ..................... $ 25,058,000 $ 19,755,000 $12,936,000 ============ ============ =========== Supplemental disclosure of cash flow information: Income taxes paid .......................................... $ 6,005,000 $ 6,059,000 $ 2,927,000 Interest paid .............................................. 302,000 381,000 440,000
See accompanying notes. F-7 29 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General Rainbow Technologies, Inc. (the Company) develops, manufactures, programs and markets products which prevent the unauthorized use of intellectual property, including software programs (known as the Software Protection Products segment of the business), and also develops and manufactures information security products to provide privacy and security for voice communication and data transmission (known as the Information Security Products segment of the business). The accompanying financial statements consolidate the accounts of the Company and its wholly-owned subsidiaries and have been restated for all prior periods presented to reflect the acquisition of Mykotronx, Inc. (Mykotronx) which has been accounted for using the pooling-of-interests method (Note 2). All significant intercompany balances and transactions have been eliminated. Certain amounts previously reported have been reclassified to conform with the 1995 presentation. Use of Estimates 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. Significant estimates made in preparing these financial statements include the allowance for doubtful accounts, the allowance for inventory obsolescence, accrued warranty costs, the allowance for deferred tax assets and total estimated contract costs associated with billed and unbilled contract revenues. Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Marketable Securities The Company's marketable securities consist of tax-exempt and other debt instruments that bear interest at variable rates. At December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115). SFAS No. 115 requires that the Company's marketable securities be carried at fair value; and that unrealized gains and losses on securities available-for-sale be reported net of tax as a separate component of shareholders' equity. The adoption of SFAS No. 115 has had no effect on the Company's results of operations nor has it had a material impact on the Company's equity for any of the years presented. The Company's portfolio of marketable debt securities at December 31, 1995 matures as follows: 85% in 1996, 0% in 1997-2000, 2% in 2001-2005 and 14% thereafter. F-8 30 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 Software Development Costs Software development costs incurred subsequent to the determination of technological feasibility and marketability of a software product are capitalized. 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. At December 31, 1995 and 1994, the Company had capitalized computer software costs of $735,000 which will not be amortized until technological feasibility and marketability is established. Inventories Inventoried costs relating to long-term contracts are stated at the actual production cost, 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 (on a first-in, first-out basis) or market. Property, Plant and Equipment Property, plant, equipment and leasehold improvements are depreciated using the straight-line method over their estimated useful lives as follows: Buildings................................ 31 years Furniture................................ 5 to 7 years Equipment................................ 3 to 7 years Leasehold improvements .............. Term of lease
Intangible Assets Intangible assets consisting of goodwill and patents are amortized using the straight-line method over seven years. Goodwill represents the excess of purchase price over the estimated fair value of assets acquired. Long-Lived Assets The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No. 121) in March 1995. The Company will adopt SFAS No. 121 during 1996. Such adoption will not have a material effect on the Company's consolidated results of operations or financial position. F-9 31 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 Revenue Recognition: Software Protection Products The Company recognizes revenues from Software Protection Product sales at the time of shipment. Provision is made currently for estimated product returns which may occur under programs the Company has with certain of its distributors. Information Security Products Catalog product revenues and revenues under certain fixed-price contracts calling for delivery of a specified number of units are recognized as deliveries are made. Revenues under cost-reimbursement contracts are recognized as costs are incurred and include estimated earned fees in the proportion that costs incurred to date bear to total estimated costs. Certain contracts are awarded on a fixed-price incentive fee basis. Incentive fees on such contracts are considered when estimating revenues and profit rates and are recognized when the amounts can reasonably be determined. The costs attributed to units delivered under fixed-price contracts are based on the estimated average cost per unit at contract completion. For research and development and other cost-plus-fee type contracts, the Company recognizes contract revenues using the percentage-of-completion method. The estimated contract revenues are recognized based on percentage-of-completion as determined by the cost-to-cost basis whereby revenues are recognized ratably as contract costs are incurred. Profits expected to be realized on long-term contracts are based on total revenues and estimated costs at completion. Revisions to contract profits are recorded in the accounting periods in which the revisions are made. Estimated losses on contracts are recorded when identified. Warranty The Company generally warrants its products for one year. An estimate of the amount required to cover warranty expense on products sold is charged against income at the time of sale. Advertising The Company expenses the costs of advertising as incurred. Advertising expense was $908,000, $807,000 and $620,000 for 1995, 1994 and 1993, respectively. Research and Development Expenditures for research and development are expensed as incurred. Income Taxes Deferred taxes are provided for items recognized in different periods for financial and tax reporting purposes in accordance with Financial Accounting Standards Board Statement No. 109, "Accounting For Income Taxes." Foreign 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 Stockholders' 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. F-10 32 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 The Company may enter into foreign exchange contracts as a hedge against foreign currency denominated receivables. It does not engage in currency speculation. Foreign currency transaction gains and losses are included in current earnings. There were no foreign exchange contracts at December 31, 1995. Stock Option Plans The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123) in October 1995. SFAS No. 123 establishes financial accounting and reporting standards for stock-based compensation plans and to transactions in which an entity issues its equity instruments to acquire goods and services from nonemployees. The new accounting standards prescribed by SFAS No. 123 are optional, and the Company may continue to account for its plans under previous standards. The Company does not expect to adopt the new accounting standards, consequently, SFAS No. 123 will not have an impact on the Company's consolidated results of operations or financial position. However, proforma disclosures of net earnings and earnings per share will be made in 1996 as if the SFAS No. 123 accounting standards had been adopted. Earnings Per Share Earnings per share are based on the weighted average number of common and common equivalent shares outstanding during each period. Common equivalent shares include the potential dilution from the exercise of stock options determined using the treasury stock method, when the effect of such options is dilutive. Concentrations of Business and Credit Risk Financial instruments which potentially subject the Company to credit risk consist principally of trade receivables and interest bearing investments. The Company performs on-going credit evaluations of its customers and generally does not require collateral. The Company maintains adequate reserves for potential losses and such losses, which have historically been minimal, have been included in management's estimates. The Company places substantially all its interest bearing investments with major financial institutions and, by policy, limits the amount of credit exposure to any one financial institution. The Company sells the majority of its Software Protection Products to software developers and wholesale distributors throughout North America, Europe and Asia Pacific. The majority of the Company's Information Security Products are sold to the U.S. Government (Note 3). The U.S. Government accounted for over 81%, 95% and 80% of contract revenues in 1995, 1994 and 1993, respectively. In addition, approximately 90% of contract accounts receivable and over 90% of unbilled costs and fees at December 31, 1995 and 1994, respectively, were related to the U.S. Government. F-11 33 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 2. ACQUISITIONS On June 1, 1995, the Company acquired Mykotronx in a merger transaction resulting in Mykotronx becoming a wholly-owned subsidiary of Rainbow. The merger was accounted for as a pooling-of-interests. Mykotronx, a California corporation with headquarters in Torrance, California, designs, develops and manufactures information security products to provide privacy and security for voice communication and data transmission. These products are sold to the U.S. Government and customers in the aerospace and telecommunications industries. Shareholders of Mykotronx received 2.64 shares of the Company's common stock for each share of issued and outstanding Mykotronx common stock. Accordingly, the Company issued 1,620,564 shares of its common stock to Mykotronx shareholders in exchange for all outstanding Mykotronx shares. In addition, 195,096 shares of Rainbow common stock were reserved for issuance upon the exercise of assumed Mykotronx stock options. Expenses associated with the merger of approximately $552,000 were included in the consolidated results of operations for the year ended December 31, 1995. Revenue and net income from the combining companies included in the accompanying consolidated results of operations were as follows:
Rainbow Mykotronx Consolidated ------- --------- ------------- For the five months ended May 31, 1995 (prior to the effective date of the merger): Revenue $ 16,634,000 $ 9,663,000 $ 26,297,000 Net income 2,426,000 1,278,000 3,704,000 For the year ended December 31, 1994: Revenue 38,512,000 16,571,000 55,083,000 Net income 5,552,000 1,444,000 6,996,000 For the year ended December 31, 1993: Revenue 35,118,000 8,995,000 44,113,000 Net income 5,963,000 706,000 6,669,000
There were no significant intercompany transactions between Rainbow and Mykotronx during any period presented. In January 1994, the Company purchased the assets of the AND Group Inc., a Canadian corporation, in exchange for the sum of $1.5 million. As a result, the Company acquired all of the intellectual property rights to a software product, and extinguished all previously existing obligations to pay royalties to the AND Group, Inc. In exchange for a minority interest, the Company contributed the assets acquired from the AND Group, Inc. and certain other assets to Vendor Systems International, Inc. (VSI). VSI is a company located in Minneapolis, Minnesota. F-12 34 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 3. GOVERNMENT CONTRACTS The Company is both a prime contractor and subcontractor under fixed-price and cost reimbursement 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 contracts completed during the previous fiscal year. 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. These provisional billing rates are adjusted to actual at year-end and are subject to adjustment after Government audit. The Company has unbilled costs and fees of $3,962,000 and $2,895,000 at December 31, 1995 and 1994, respectively . Based on the Company's experience with similar contracts in recent years, the unbilled costs and fees are expected to be collected within one year. 4. INVENTORIES Inventories consist of the following at December 31:
1995 1994 ---- ---- Raw materials ................................... $1,083,000 $ 657,000 Work in process ................................. 434,000 318,000 Finished goods .................................. 1,313,000 1,389,000 Inventoried costs relating to long-term contracts, net of amounts attributed to revenue recognized to date............................ 97,000 498,000 ----------- ---------- $2,927,000 $2,862,000 ========== =========
The amount of general and administrative expenses remaining in inventoried costs relating to long-term contracts at December 31, 1995 and 1994 were $11,000 and $51,000, respectively. F-13 35 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 5. LONG-TERM DEBT Long-term debt consists of a note payable to a bank with principal and interest at 11.98% payable quarterly, in French Francs. The note matures in January 2005 and is secured by a building with a net book value of $7,451,000 at December 31, 1995. Annual principal payments are as follows: 1996 ............................. $ 316,000 1997 ............................. 317,000 1998 ............................. 317,000 1999 ............................. 317,000 2000 ............................. 317,000 Thereafter ............................. 1,348,000 ---------- $2,932,000 ==========
6. FAIR VALUE OF FINANCIAL INSTRUMENTS The fair values presented are estimates of the fair values of the financial instruments at a specific point in time using available market information and appropriate valuation methodologies. These estimates are subjective in nature and involve uncertainties and significant judgment in the interpretation of current market data. Therefore, the fair values presented are not necessarily indicative of amounts the Company could realize or settle currently. The Company does not intend to dispose of or liquidate such instruments prior to maturity. The carrying values and estimated fair values of the Company's financial instruments are as follows for the years ended December 31:
1995 1994 ------------------------------- ------------------------------- Estimated Estimated Carrying Value Fair Value Carrying Value Fair Value -------------- ----------- -------------- ---------- Marketable securities $11,799,000 $11,799,000 $3,592,000 $3,592,000 =========== =========== ========== ========== Long-term debt $ 2,932,000 $ 3,363,000 $3,059,000 $3,472,000 ============ =========== ========== ==========
7. COMMITMENTS The Company has purchase commitments with various vendors for approximately $2,540,000 as of December 31, 1995. These purchase commitments are payable during 1996. F-14 36 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 Annual obligations under non-cancelable operating leases are as follows: 1996 ........................... $ 1,055,000 1997 ........................... 1,061,000 1998 ........................... 1,022,000 1999 ........................... 1,007,000 2000 ........................... 678,000 Thereafter....................... 71,000 ----------- $ 4,894,000 ===========
Rent expense charged to operations for the years ended December 31, 1995, 1994 and 1993 was $1,076,000, $677,000 and $549,000, respectively. 8. COMMON STOCK In August 1987, the Board of Directors adopted an incentive stock option plan and a non-qualified stock option plan under which options could be granted to purchase up to an aggregate of 700,000 shares of the Company's common stock. The exercise price for options granted under these plans could not be less than 100% of the fair market value of the common stock on the date of grant. Options become exercisable and expire at the discretion of the Board of Directors, although the plans specify that no options shall be exercisable prior to 12 months from the date of grant and all options expire five years from the date of grant. On April 12, 1990, the Board of Directors of the Company terminated certain existing stock option plans and approved the Company's 1990 Stock Option Plan under which non-statutory or incentive stock options may be granted to key employees and individuals who provide services to the Company. Up to an aggregate of 450,000 shares of the Company's common stock were originally authorized for issuance. On June 29, 1993, the Board of Directors of the Company amended the Company's Restated 1990 Stock Option Plan to authorize the issuance of an additional 450,000 shares of common stock. At the May 31, 1995 shareholder meeting, an increase of 750,000 shares was approved. As of December 31, 1995 the total number of shares reserved for issuance under the existing stock option plan and agreements total 435,623. F-15 37 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 The following is a summary of changes in options outstanding pursuant to the plans for the years ended December 31:
1995 1994 ---- ---- Outstanding options at beginning of year.................................... 1,040,596 819,769 Granted ....................................... 351,300 530,996 Canceled....................................... (14,590) (172,052) Exercised ..................................... (146,162) (138,117) --------- --------- Outstanding options at end of year ............ 1,231,144 1,040,596 ========= ========= Options exercisable at end of year ............ 430,306 325,684 ========= ========= Prices of options exercised during the year.... $3.125 - $17.25 $1.075 - $17.00 Prices of outstanding options at end of year... $2.038 - $18.75 $2.038 - $17.25
9. INCOME TAXES The provision (benefit) for income taxes consists of the following for the years ended December 31:
1995 1994 1993 ---- ---- ---- Current: Federal ....................................... $3,558,000 $3,511,000 $1,949,000 State ....................................... 1,193,000 855,000 447,000 Foreign ....................................... 1,728,000 812,000 1,691,000 ---------- ---------- --------- 6,479,000 5,178,000 4,087,000 Deferred: Federal ....................................... 329,000 (308,000) (151,000) State ....................................... 34,000 99,000 264,000 Foreign ....................................... 130,000 198,000 (200,000) ---------- ---------- ------------ 493,000 (11,000) (87,000) ---------- ---------- ------------- $6,972,000 $5,167,000 $4,000,000 ========== ========== ==========
F-16 38 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 The proforma unaudited income tax adjustment represents taxes which would have been reported had Mykotronx been subject to federal and state income taxes as a C Corporation. Prior to January 1, 1994, Mykotronx was an S Corporation and, therefore, its income was generally not taxable to the corporation as it passed through to its shareholders. The S Corporation election was terminated on January 1, 1994, and Mykotronx became a reporting tax paying (C Corporation) entity. The proforma unaudited provision for income taxes for the year ended December 31, 1993 consisted of the following: Current: Federal $264,000 State 77,000 -------- 341,000 Deferred: Federal (39,000) State (9,000) -------- (48,000) -------- $293,000 ========
As a result of the termination of the S Corporation status of Mykotronx, Inc., on January 1, 1994, Rainbow assumed the tax basis of the assets and liabilities of the former Mykotronx, Inc., which differed from the financial statement basis of those items. A deferred tax asset of $44,000 was recorded as a result of this S Corporation termination. Additionally, upon termination of the S Corporation status, undistributed retained earnings totaling $1,480,000 were transferred to additional paid-in capital. A reconciliation of the statutory federal income tax provision to the actual provision follows for the years ended December 31:
1995 1994 1993 ---- ---- ---- Statutory federal income tax expense............... $5,714,000 $4,244,000 $3,380,000 Non-deductible amortization of goodwill............ 610,000 587,000 546,000 State taxes, net of federal benefit................ 797,000 623,000 477,000 Non-deductible merger related costs................ 185,000 123,000 - Effect of foreign operations, net ................. (50,000) 103,000 (26,000) Research and experimentation credit ............... (30,000) (185,000) (250,000) Municipal interest................................. (156,000) (166,000) (52,000) Other.............................................. (98,000) (162,000) (75,000) ----------- --------- ----------- $6,972,000 $5,167,000 $4,000,000 ========== ========== ==========
F-17 39 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows for the years ended December 31:
1995 1994 ---- ---- Deferred tax assets: Foreign tax loss carryforwards ....................... $ 423,000 $ 531,000 Contract revenue recognized for tax reporting purposes 184,000 184,000 State taxes not currently deductible ................. 380,000 290,000 Accruals and reserves not currently tax deductible ... 271,000 334,000 Cumulative translation adjustment .................... - 328,000 ----------- ----------- Total deferred tax assets ........................ 1,258,000 1,667,000 Valuation allowance for deferred tax assets .......... (423,000) (531,000) ----------- ----------- 835,000 1,136,000 Deferred tax liabilities: Cumulative translation adjustment .................... (298,000) - Accruals without tax effect .......................... (37,000) (315,000) Tax depreciation ..................................... (1,433,000) (1,349,000) ----------- ----------- Total deferred tax liabilities ................... (1,768,000) (1,664,000) ----------- ----------- Net deferred tax liabilities .............................. $ (933,000) $ (528,000) =========== ===========
United States and foreign earnings before income taxes are as follows for the years ended December 31:
1995 1994 1993 ---- ---- ---- United States...................... $13,000,000 $10,000,000 $7,352,000 Foreign............................ 3,610,000 2,163,000 3,317,000 ------------ ----------- --------- $16,610,000 $12,163,000 $10,669,000 =========== =========== ===========
The Company realized tax benefits of $409,000, $173,000 and $1,460,000 in 1995, 1994 and 1993, respectively, from the exercise of non-qualified stock options and disqualifying disposition of incentive stock options. 10. BENEFIT PLANS At December 31, 1995, the Company sponsored two tax deferred defined contribution plans (the Plans) for all eligible US employees, each of which was sponsored by the predecessor companies prior to the merger between Rainbow and Mykotronx. The Plans were merged effective January 1, 1996. Under both Plans, the employer matches certain employee contributions. Under the Mykotronx plan, the employer may also make discretionary contributions. During the years ended December 31, 1995, 1994 and 1993, Company contributions under both Plans totaled approximately $166,000, $147,000 and $103,000, respectively. F-18 40 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 11. RELATED PARTY TRANSACTIONS During the year ended December 31, 1995, 1994 and 1993 the Company made purchases of services on competitive terms from a company controlled by a director of the Company totaling $112,000, $168,000 and $123,000, respectively. 12. INDUSTRY SEGMENTS The Company operates in two industry segments. The first segment is the development and sale of devices which protect data and software from unauthorized use (Software Protection Products segment). The second segment is the development and sale of information security products to provide privacy and security for voice communication and data transmission (Information Security Products segment). A summary of the Company's operations by industry segment follows:
For the year ended December 31, 1995 ----------------------------------------------------------------- Software Information Protection Security Elimination Consolidated ----------------------------------------------------------------- Net sales $44,346,000 $21,962,000 $ - $66,308,000 Operating income 10,613,000 4,946,000 - 15,559,000 Identifiable assets 70,962,000 8,863,000 - 79,825,000 Depreciation and amortization 3,386,000 152,000 - 3,538,000 Capital expenditures 1,308,000 362,000 - 1,670,000 For the year ended December 31, 1994 ----------------------------------------------------------------- Software Information Protection Security Elimination Consolidated ----------------------------------------------------------------- Net sales $38,512,000 $16,571,000 $ - $55,083,000 Operating income 9,978,000 2,666,000 - 12,644,000 Identifiable assets 58,527,000 6,340,000 - 64,867,000 Depreciation and amortization 3,043,000 71,000 - 3,114,000 Capital expenditures 418,000 141,000 - 559,000 For the year ended December 31, 1993 ----------------------------------------------------------------- Software Information Protection Security Elimination Consolidated ----------------------------------------------------------------- Net sales $35,118,000 $8,995,000 $ - $44,113,000 Operating income 9,361,000 716,000 - 10,077,000 Identifiable assets 50,884,000 4,017,000 - 54,901,000 Depreciation and amortization 2,602,000 76,000 - 2,678,000 Capital expenditures 537,000 102,000 - 639,000
F-19 41 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 A summary of the Company's operations by geographic area follows:
For the year ended December 31, 1995 ----------------------------------------------------------------- United States Europe Elimination Consolidated ----------------------------------------------------------------- Sales to unaffiliated customers $50,154,000 $16,154,000 $ - $66,308,000 Transfers between geographic areas 892,000 3,249,000 (4,141,000) - ----------- ----------- ------------ ----------- Net sales $51,046,000 $19,403,000 $(4,141,000) $66,308,000 =========== =========== ============ =========== Operating income $12,201,000 $ 5,007,000 $(1,649,000) $15,559,000 Identifiable assets 43,782,000 36,163,000 (120,000) 79,825,000 For the year ended December 31, 1994 ----------------------------------------------------------------- United States Europe Elimination Consolidated ----------------------------------------------------------------- Sales to unaffiliated customers $43,423,000 $11,660,000 $ - $55,083,000 Transfers between geographic areas 532,000 2,531,000 (3,063,000) - ---------- ----------- ----------- ----------- Net sales $43,955,000 $14,191,000 $(3,063,000) $55,083,000 =========== =========== =========== =========== Operating income $11,811,000 $ 2,793,000 $(1,960,000) $12,644,000 Identifiable assets 36,248,000 28,779,000 (160,000) 64,867,000
F-20 42 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995
For the year ended December 31, 1993 ----------------------------------------------------------------- United States Europe Elimination Consolidated ----------------------------------------------------------------- Sales to unaffiliated customers $32,956,000 $11,157,000 $ - $44,113,000 Transfers between geographic areas 1,393,000 2,918,000 (4,311,000) - ----------- ----------- ------------ ----------- Net sales $34,349,000 $14,075,000 $(4,311,000) $44,113,000 =========== =========== ============ =========== Operating income $ 7,287,000 $ 3,030,000 $ (240,000) $10,077,000 Identifiable assets 28,357,000 26,784,000 (240,000) 54,901,000
Geographic information for Europe encompasses the Company's operations in France, the United Kingdom and Germany. In determining operating income for each geographic area, sales and purchases between geographic areas have been accounted for on the basis of internal transfer prices set by the Company. Identifiable assets are those tangible and intangible assets used in operations in each geographic area. 13. SUBSEQUENT EVENT On March 6, 1996, the Company entered into an agreement to acquire up to 58% of Quantum Manufacturing Technologies, Inc. ("QMT") of Albuquerque, New Mexico, in exchange for $4.2 million, subject to certain technological and business milestones. The Company made an initial investment of $1.2 million for 35% of the common stock of QMT. QMT, a developmental stage company formed in 1995, has recently obtained the exclusive worldwide license from Sandia National Laboratories for the commercial use and exploitation of patented pulsed power ion beam surface treatment technology known as "IBEST". F-21 43 RAINBOW TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 14. SUPPLEMENTARY QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)
March 31, 1995 June 30, 1995 September 30, 1995 December 31, 1995 -------------- ------------- ------------------ ----------------- Revenues: Software Protection $10,662,000 $10,570,000 $10,720,000 $12,394,000 Information Security 5,091,000 6,091,000 5,090,000 5,690,000 ----------- ----------- ----------- ----------- Total revenues 15,753,000 16,661,000 15,810,000 18,084,000 =========== =========== =========== =========== Cost of revenues: Software Protection 2,947,000 3,095,000 2,910,000 3,749,000 Information Security 3,870,000 4,650,000 4,007,000 4,338,000 ----------- ----------- ----------- ----------- Total cost of revenues 6,817,000 7,745,000 6,917,000 8,087,000 =========== =========== =========== =========== Operating income 3,616,000 3,594,000 3,685,000 4,664,000 Net income 2,154,000 2,257,000 2,480,000 2,747,000 Net income per share $0.28 $0.30 $0.32 $0.35
March 31, 1994 June 30, 1994 September 30, 1994 December 31, 1994 -------------- ------------- ------------------ ----------------- Revenues: Software Protection $ 9,023,000 $ 9,279,000 $ 9,011,000 $11,199,000 Information Security 3,733,000 5,181,000 3,721,000 3,936,000 ----------- ----------- ----------- ----------- Total revenues 12,756,000 14,460,000 12,732,000 15,135,000 =========== =========== =========== =========== Cost of revenues: Software Protection 2,403,000 2,744,000 2,856,000 3,586,000 Information Security 3,382,000 4,075,000 3,119,000 2,945,000 ----------- ----------- ----------- ----------- Total cost of revenues 5,785,000 6,819,000 5,975,000 6,531,000 =========== =========== =========== =========== Operating income 2,774,000 3,001,000 2,901,000 3,968,000 Net income 1,663,000 1,592,000 1,661,000 2,080,000 Earnings per share $0.22 $0.22 $0.22 $0.28
Net income per share is computed independently for each of the quarters presented and the summation of quarterly amounts may not equal the total net income per share reported for the year. F-22 44 RAINBOW TECHNOLOGIES, INC. SCHEDULE II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1995, 1994 and 1993
BALANCE AT DEDUCTIONS/ BEGINNING RECOVERIES BALANCE AT DESCRIPTION OF YEAR ADDITIONS AND WRITE-OFFS END OF YEAR - ------------------------------------------------------------------------------------------------------ For the year ended December 31: 1995 Allowance for doubtful accounts receivable $368,000 $ 73,000 $ 9,000 $450,000 1994 Allowance for doubtful accounts receivable $486,000 $ 16,000 $(134,000) $368,000 1993 Allowance for doubtful accounts receivable $390,000 $163,000 $ (67,000) $486,000
F-23 EX-10.A 2 LEASE FOR PREMISES AT 50 TECHNOLOGY DRIVE 1 Exhibit 10(a) STANDARD SUBLEASE American Industrial Real Estate Association 1. PARTIES. This Sublease, dated, for reference purposes only, May 3, 1995, is made by and between Birtcher Medical Systems, Inc., a California corporation (herein called "Sublessor") and Rainbow Technologies, Inc., a Delaware corporation (herein called "Sublessee"). 2. PREMISES. Sublessor hereby subleases to Sublessee and Sublessee hereby subleases from Sublessor for the term, at the rental, and upon all of the conditions set forth herein, that certain real property situated in the County of Orange, State of California commonly known as 50 Technology Drive, Irvine Spectrum, Irvine, CA and described as a building consisting of approximately 55,872 square feet located at the Lakeview Business Park. Said real property, including the land and all improvements thereon, is hereinafter called the "Premises". 3. TERM. 3 1 TERM. The term of this Sublease shall be for five (5) years , and three (3) months commencing on June 1, 1995 and ending on August 22, 2000 unless sooner terminated pursuant to any provision hereof 3 2 DELAY IN COMMENCEMENT. Notwithstanding said commencement date, it for any reason Sublessor cannot deliver possession of the Premises to Sublessee on said date, Sublessor shall not be subject to any liability therefore, nor shall such failure affect the validity of this lease or the obligations of Sublessee hereunder or extend the term hereof, but in such case Sublessee shall not be obligated to pay rent until possession of the Premises is tendered to Sublessee, provided, however, that if Sublessor shall not have delivered possession of the Premises within sixty (60) days from said commencement date, Sublessee may, at Sublessee's option, by notice in writing to Sublessor within ten (10) days thereafter, cancel this Sublease,in which event the parties shall be discharged from all obligations thereunder. If Sublessee occupies the Premises prior to said commencement date, such occupancy shall be subject to all provisions hereof, such occupancy shall not advance the termination date and Sublessee shall pay rent for such period at the initial monthly rates set forth below. 4. RENT. Sublessee shall pay to Sublessor as rent for the Premises equal monthly payments of $ 40,000, in advance, on the lst day of each month of the term hereof. 2 Sublessee shall pay Sublessor upon the execution hereof $40,0000 as rent for June l, 1995 through June 30, 1995 (first month's rent). Rent for any period during the term hereof which is for less than one month shall be a prorata portion of the monthly installment. Rent shall be payable in lawful money of the United States to Sublessor at the address stated herein or to such other persons or at such other places as Sublessor may designate in writing. 5. SECURITY DEPOSIT. Sublessee shall deposit with Sublessor upon execution hereof $40,000.00 as security for Sublessees faithful performance of Sublessee's obligations hereunder. If Sublessee fails to pay rent or other charges due hereunder, or otherwise defaults with respect to any provision of this Sublease, Sublessor may use, apply or retain all or any portion of said deposit for the payment of any rent or other charge in default or for the payment of any other sum to which Sublessor may become obligated by reason of Sublessee's default, or to compensate Sublessor for any loss or damage which Sublessor may suffer thereby. If Sublessor so uses or applies all or any portion of said deposit, Sublessee shall within ten (10) days after written demand therefore deposit cash with Sublessor in an amount sufficient to restore said deposit to the full amount here and above stated and Sublessee's failure to do so shall be a material breach of this Sublease. Sublessor shall not be required to Keep said deposit separate from its general accounts. If Sublessee performs all of Sublessee's obligations hereunder, said deposit, or so much thereof as has not theretofore been applied by Sublessor, shall be returned, without payment of interest or other increment for its use to Sublessee (or at Sublessor's option, to the last assignee, if any, of Sublessee's interest hereunder) at the expiration of the term hereof, and after Sublessee has vacated the Premises. No trust relationship is created herein between Sublessor and Sublessee with respect to said Security Deposit. 6 1 USE The Premises shall be used and occupied only for see Item 12 of the Master Lease. 6 2 COMPLIANCE WITH LAW. (a) Sublessor warrants to Sublessee that the Premises, in its existing state but without regard to the use for which Sublessee will use the premisis, does not violate any applicable building code regulation or oradinance at the time that this Sublease is executed. In the event, that it is determined that this warranty has been violated, then it shall be the obligation of the Sublessor, after written notice from Sublessee, to promptly at Sublessor's sole cost and expense, rectify any such violation. In the event that Sublessee does not give to Sublessor written notice of the violation of this warranty within one year from the commencement of the term of this sublease, it shall be conclusively deemed that such violation did not exist and the correction of the same shall be the obligation of the Sublessee. 3 (b) Except as provided in paragraph 6.2 (a), Sublessee shall, at Sublessee's expense, comply promptly with all applicable statutes ordinances, rules regulations, orders, restrictions of record, and requirements in effect during the term or any part of the term hereof regulating the use by Subessee of the Premses. Sublessee shall not use or permit the use of the Premises in any manner that will tend to create waste or a nuisance or, if there shall be more than one tenant of the building containing the Premises, which shall tend to disturb such other tenants. 6.3 CONDITION OF PREMISES. See Addendum Section 6.3. 7. MASTER LEASE 7.1 Sublessor is the Lessee of the Premisis by virtue of a Lease, hereinafter referred to as the "Master Lease" a copy of which is attached hereto marked Exhibit 1, dated March 16, 1990, wherein the Irvine Company is the Lessor, hereinafter referred to as the "Master Lessor". 7.2 This Sublease is and shall be at all times subject and subordinate to the Master Lease. 7.3 The terms, condition and respective obligations of Sublessor and Sublessee to each other under this Sublease, shall be the terms and condition of the Master Lease, except for those provisions of the Master Lease which are directly contradicted by this Sublease, in which event the terms of this Sublease document shall control over the Master Lease. Therefore, for the purposes of this Sublease, wherever in the Master Lease the word "Landlord" is used, it shall be deemed to mean the Sublessor herein and wherever in the Master Lease "Tenant" it shall be deemed to mean the Sublessee herein. 7.4 During the term of this Sublease and for all periods subsequent for obligations which have arisen prior to the termination of this Sublease, Sublessee does hereby expressly assume and agree to perform and comply with, for the benefit of Sublessor and Master Lessor, each and every obligation of Sublessor under the Master Lease, except for the following paragraphs which are excluded therefrom. Article 1-2, 3, 4, 7, 8, 9, 11, 13, 14, and Sections 3.2, 3.3, 3.4, 3.5, 3.6, 4.1, 4.2, 4.7, and Section Six, Exhibits C, D, E, Lease Riders #1, 5, 8, and Work Letter Riders #5, 6, and First, Second, Third and Fourth Amendments to the Lease. 7.5 The obligations that Sublessee has assumed under Paragraph 7.4 hereof and hereinafter referred to as the "Sublessee's Assumed Obligations". The obligations that Sublessee has not assumed under Paragraph 7.4 hereof are hereinafter referred to as the "Sublessor's Remaining Obligations". 7.6 Sublessee shall hold Sublessor free and harmless of and from all liability, judgments, costs, damages, claims or demands, including reasonable attorneys fees, 4 arising out of Sublessee's failure to comply with or perform Sublessee's Assumed Obligations. 7.7 Sublessor agrees to maintain the Master Lease during the entire term of this Sublease, subject, however, to any earlier termination of the Master Lease without the fault of the Sublessor, and to comply with or perform Sublessor's Remaining Obligations and to hold Sublessee free and harmless of and from all liability, judgments, costs, damages, claims or demands arising out of Sublessor's failure to comply with or perform Sublessor's Remaining Obligations. 7.8 Sublessor represents to Sublessee that the Master Lease is in full force and effect and that no default exists on the part of any parts to the Master Lease. 8 ASSIGNMENT OF SUBLEASE AND DEFAULT. 8.1 Sublessor hereby assigns and transfers to Master Lessor the Sublessor's interest in this Sublease and all rentals and income arising therefrom, subject however to terms of Paragraph 8 2 hereof. 8.2 Master Lessor, by executing this document, agrees that until a default shall occur in the performance of Sublessor's Obligations under the Master Lease, that Sublessor may receive, collect and enjoy the rents accruing under this Sublease. However, if Sublessor shall default in the performance of its obligations to Master Lessor then Master Lessor may, at its option, receive and collect, directly from Sublessee, all rent owing and to be owed under this Sublease. Master Lessor shall not, by reason of this assignment of the Sublease nor by reason of the collection of rents from the Sublessee, be deemed liable to Sublessee for any failure of the Sublessor to perform and comply with Sublessor's Remaining Obligations. 8.3 Sublessor hereby irrevocably authorizes and directs Sublessee, upon receipt of any written notice from the Master Lessor stating that a default exists in the performance of Sublessor's obligations under the Master Lease, to pay to Master Lessor the rents due and to become due under the Sublease. Sublessor agrees that Sublessee shall have the right to rely upon any such statement and request from Master Lessor, and that Sublessee shall pay such rents to Master Lessor without any obligation or right to inquire as to whether such default exists and notwithstanding any notice from or claim from Sublessor to the contrary and Sublessor shall have no right or claim against Sublessee for any such rents so paid by Sublessee. 8.4 No changes or modifications shall be made to this Sublease without the consent of Master Lessor. 9. CONSENT OF MASTER LESSOR. 5 9.1 In the event that the Master Lease requires that Sublessor obtam the consent of Master Lessor to any subletting by Sublessor then, this Sublease shall not be effective unless, on or before May 26, 1995 Master Lessor signs this Sublease thereby giving its consent to this Subletting. 9.2 In the event that the obligations of the Sublessor under the Master Lease have been guaranteed by third parties then this Sublease,nor the Master Lessor's consent, shall not be effective unless, within 10 days of the date hereof, said guarantors sign this Sublease thereby giving guarantors consent to this Sublease and the terms thereof. 9.3 In the event that Master Lessor does give such consent then: (a) Such consent will not release Sublessor of its obligations or alter the primary liability of Sublessor to pay the rent and perform and comply with all of the obligations of Sublessor to be performed under the Master Lease. (b) The acceptance of rent by Master Lessor from Sublessee or any one else liable under the Master Lease shall not be deemed a waiver by Master Lessor of any provisions the Master Lease. (c) The consent to this Sublease shall not constitute a consent to any subsequent subletting or assignment. (d) in the event of any default of Sublessor under the Master Lease, Master Lessor may proceed directly against Sublessor, any guarantors or any one else liable under the Master Lease or this Sublease without first exhaustmg Master Lessor's remedies against any other person or entity liable thereon to Master Lessor. (e) Master Lessor may consent to subsequent sublettings and assignments of the Master Lease or this Sublease or any amendments or moditications thereto without notifying Sublessor nor any one else liable under the Master Lease and without obtaining their consent and such action shall not relieve such persons from liability. (f) In the event that Sublessor shall default in its obligations under the Master Lease, then Master Lessor, at its option and without being obligated to do so, may require Sublessee to attorn to Master Lessor in which event Master Lessor shall undertake the obilgations of Sublessor under this Sublease from the time of the exercise of said option to termination of this Sublease but Master Lessor shall not be liable for any prepay rents nor any security deposit paid by Sublessee, nor shall Master Lessor be liable for any other defaults of the Sublessor under the Sublease. 9.4 The signatures of the Master Lessor and any Guarantors of Sublessor at the end of this document shall constitute their consent to the terms of this Sublease. 6 9.5 Master Lessor acknowledges that, to the best of Master Lessor's knowledge, no default presently exists under the Master Lease of obligations to be performed by Sublessor and that the Master Lease is in full force and effect. 9.6 In the event that Sublessor defaults under its obligations to be performed under the Master Lease by Sublessor, Master Lessor agrees to deliver to Sublessee a copy of any such notice of default. Sublessee shall have the right to cure any default of Sublessor described in any notice of default within ten days after service of such notice of default on Sublessee. If such default is cured by Sublessee then Sublessee shall have the right of reimbursement and offset from and against Sublessor. 10. BROKERS FEE. 10.1 Upon execution hereof by all parties, Sublessor shall pay to Cushman & Wakefield of California, Inc. a licensed real estate broker, (herein called "Broker"), a fee as set forth in a separate agreement between Sublessor and Broker, or in the event there is no separate agreement between Sublessor and Broker, the sum of $134,200.00 for brokerage services rendered by Broker to Sublessor in this transaction. Cushman & Wakefield will pay to Grubb & Ellis Company $73,200.00 of the $134,200.00. 10.2 Sublessor agrees that it Sublessee exercises any option or right of first refusal granted by Sublessor herein, or any option or right substantially similar thereto, either to extend the term of this Sublease, to renew this Sublease, to purchase the Premises, or to lease or purchase adjacent property which Sublessor may own or in which Sublessor has an interest, or if Broker is the procuring cause of any lease, sublease, or sale pertaining to the Premises or any adjacent property which Sublessor may own or in which Sublessor has an interest, then as to any of said transactions Sublessor shall pay to Broker a fee, in cash, in accordance with the schedule of Broker in effect at the time of the execution this Sublease. Notwithstanding the foregoing, Sublessor's obligation under this Paragraph 10 2 is limited to a transaction in which Sublessor is acting as a Sublessor, lessor, or seller. 11. ATTORNEY'S FEES. If any party or the Broker named herein brings an action to enforce the terms hereof or to declare rights hereunder, the prevailing party in any such action, on trial and appeal, shall be entitled to his reasonable attorney's fees to be paid by the losing party as fixed by the Court. The provision of this paragraph shall inure to the benefit of the Broker named herein who seeks to enforce a right hereunder. 12. ADDITIONAL PROVISIONS. [if there are no additional provisions draw a line from this point to the next printed word after the space left here. If there are additional provisions place the same here.] SEE ATTACHED ADDENDUM FOR ADDITIONAL PROVISIONS 7 It this Sublease has been filled in it has been prepared for submission to your attorney for his approval. No representation or recommendation is made by the real estate broker or its agents or employees as to the legal sufficiency, legal effect, or tax consequences of this Sublease or the transaction relating thereto. Executed at Birtcher Medical Systems on ______________________ a California corporation Execited at "Sublessor" Rainbow Technologies, Inc. a Delaware corporation 9292 Jeronimo Road Irvine, CA 92718 The Irvine Company 550 Newport Center Drive Newport Beach, CA 92660 8 CONSENT TO SUBLETTING I. PARTIES AND DATES. This Consent to Subletting ("Consent") dated May 31, 1995, is by and between THE IRVINE COMPANY, a Michigan corporation ("Landlord"), BIRTCHER MEDICAL SYSTEMS, INC., a California corporation ("Tenant"), and RAINBOW TECHNOLOGIES INC., a Delaware corporation ("Subtenant"). II. RECITALS. Landland and Tenant are parties to a standard form space lease dated March 16, 1990, as amended by a First Amendment to Lease dated February 26, 1991 (collectively the "Lease"), for certain space located at 50 Technology Drive, Irvine, California ("Premises"). The Lease contains provisions which require, among other things, Tenant to obtain Landlord's consent to any subletting of the Premises. Tenant has requested Landlord to consent to a subletting of the Premises to Subtenant. III. CONSENT TO SUBLETTING. For valuable consideration including Tenant's and Subtenant's agreement to the provisions of this Consent, Landlord consents to a subletting to Subtenant of approximately 55,872 rentable square feet of the Premises. Tenant and Subtenant agree that this Consent is conditioned upon their agreement that: A. The sublease agreement ("Sublease") between Tenant and Subtenant is expressly subject to the provisions of the Lease, a copy of which Subtenant acknowledges it has received. B. Tenant will deliver a copy of the Sublease to Landlord within five (5) business days of Landlord's request, provided that if the Sublease is not in writing, Tenant may deliver a reasonably detailed summary of the Sublease including information respecting the length of the term and the amount of rent and other charges payable under the Sublease, which summary shall be approved by Subtenant. C. Tenant's obligations under the Lease shall not be affected by this Consent. D. Landlord shall be entitled to receive profits derived by Tenant from this subletting in accordance with the provisions of the Lease. E. The provisions of the Lease respecting assignment and subletting are not waived with respect to future assignments and sublettings. F. Subtenant is not claiming any interest in a right belonging solely to Tenant pursuant to the Lease. 1 9 G. The Lease is in full force and effect and that Landlord is not in breach of any provision of the Lease. H. That if the Sublease terminates by reason of a termination of the Lease, Landlord may, at its option, by delivering written notice to Subtenant, assume the obligation of Tenant under the Sublease in which event Subtenant shall recognize Landlord as if it were Sublandlord under the Sublease. IV. SUBTENANT'S PRINCIPAL PLACE OF BUSINESS. The address of Subtenant's principal place of business is: 50 Technology Drive Irvine, CA 92718 V. GENERAL. A. EFFECT OF SUBLETTING. The Lease and Tenant's obligations to Landlord shall not be deemed to have been modified by this Consent. B. ENTIRE AGREEMENT. This Consent embodies the entire understanding between Landlord, Tenant and Subtenant with respect to the subletting and can be changed only by an instrument in writing signed by the party against whom enforcement is sought. C. COUNTERPARTS. If this Consent is executed in counterparts, each is hereby declared to be an original; all, however, shall constitute but one in the same Consent. In any action or proceeding, any photographic, photostatic, or other copy of this Consent may be introduced into evidence without foundation. D. DEFINED TERMS. All words commencing with initial capital letters in this Consent and defined in the Lease shall have the same meaning in this Consent as in the Lease. E. CORPORATE AND PARTNERSHIP AUTHORITY. If Tenant is a corporation or partnership, or is comprised of either or both of them, each individual executing this Consent for the corporation or partnership represents that he or she is duly authorized to execute and deliver this Consent on behalf of the corporation or partnership and that this Consent is binding upon the corporation or partnership in accordance with its terms. F. ATTORNEYS' FEES. The provisions of the Lease respecting payment of attorneys' fees shall also apply to this Consent to Subletting. VI. EXECUTION. 2 10 Landlord, Tenant and Subtenant have entered into this Consent as of the date set forth in "I. PARTIES AND DATE" above. TENANT: LANDLORD: BIRTCHER MEDICAL SYSTEMS, INC. THE IRVINE COMPANY, a California corporation a Michigan corporation By: __________________ By: ____________________ Name: ________________ Clarence W. Barker, President Title: _________________ Irvine Industrial Company, a division of The Irvine Company By: ___________________ By:_____________________ Name: _________________ John C. Tsu, Title: __________________ Assistant Secretary SUBTENANT: RAINBOW TECHNOLOGIES INC., a Delaware corporation By: _________________________ Name: ______________________ Title: _______________________ By: ________________________ Name: ______________________ Title: _______________________ 3 11 Grubb & Ellis Company Commercial Real Estate Services State of California SALE/LEASE AMERICANS WITH DISABILITIES ACT AND HAZARDOUS MATERIALS DISCLOSURE The United States Congress has enacted the Americans With Disabilities Act. Among other things, this act is intended to make many business establishments equally accessible to persons with a variety of disabilities; modifications to real property may be required. State and local laws also may mandate changes. The real estate brokers in this transaction are not qualified to advise you as to what, if any, changes may be required now, or in the future. Owners and tenants should consult the attorneys and qualified design professionals of their choice for information regarding these matters. Real estate brokers cannot determine which attorneys or design professionals have the appropriate expertise in this area. Various construction materials may contain items that have been or may be in the future be determined to be hazardous (toxic) or undesirable and may need to be specifically treated/handled or removed. For example, some transformers and other electrical components contain PCB's, and asbestos has been used in components such as fire-proofing, heating and cooling systems, air duct insulation, spray-on and tile acoustical materials, linoleum, floor tiles, roofing, dry wall and plaster. Due to prior or current uses of the Property or in the area, the Property may have hazardous or undesirable metals, minerals, chemicals, hydrocarbons, or biological or radioactive items (including electric and magnetic fields) in soils, water, building components, above or below ground containers or elsewhere in areas that may or may not be accessible or noticeable. Such items may leak or otherwise be released. Real estate agents have no expertise in the detection or correction of hazardous or undesirable items. Expert inspections are necessary . Current or future laws may require clean up by past. present and/or future owners and/or operators. It is the responsibility of the Seller/Lessor and Buyer/Tenant to retain qualified experts to detect and correct such matters and to consult with legal counsel of their choice to determine what provisions, if any, they may wish to include in transaction documents regarding the Property. To the best of Seller/Lessor's knowledge, Seller/Lessor has attached to this Disclosure copies of all existing surveys and reports known to Seller/Lessor regarding asbestos and other hazardous materials and undesirable substances related to the Property. Sellers/Lessors are required under California Health and Safety Code Section 25915 et seq. to disclose reports and surveys regarding asbestos to certain persons, including their employees, contractors, co-owners, purchasers and tenants. Buyers/Tenants have similar disclosure obligations. Sellers/Lessors and Buyers/Tenants have additional hazardous materials disclosure responsibilities to each other under California Health and Safety 12 Code Section 25359.7 and other California laws. Consult your attorney regarding this matter. Grubb & Ellis Company is not qualified to assist you in this matter or provide you with other legal or tax advice. SUBLESSOR SUBLESSEE By: ____________________ By: ________________________ Title: ___________________ Title: _______________________ Date: ___________________ Date: _______________________ EX-10.P 3 EMPLOYMENT AGREEMENT-THEODORE S. BETTWY 1 Exhibit 10(p) EMPLOYMENT AGREEMENT, dated as of May 31, 1995 by and between Theodore S. Bettwy residing at 4478 Spencer Street, Torrance, California 90503 ("Employee") and Mykotronx, Inc., a California corporation with offices at 357 Van Ness Way, Suite 200, Torrance, California 90501 ("Mykotronx") and Rainbow Technologies, Inc., a Delaware corporation with offices at 9292 Jeronimo Road, Irvine, California 92718 ("Rainbow"). RECITALS WHEREAS, Employee is presently the President of Mykotronx, and has extensive knowledge with respect thereto; WHEREAS, Mykotronx and Rainbow are concurrently herewith entering into an Agreement and Plan of Reorganization (the "Reorganization Agreement"), pursuant to which it is anticipated that Rainbow Acquisition, Inc., a California corporation and wholly-owned subsidiary of Rainbow, will be merged with and into Mykotronx (the "Merger"), with Mykotronx, as the surviving corporation, becoming a wholly-owned subsidiary of Rainbow on the items and conditions set forth in the Reorganization Agreement; WHEREAS, Mykotronx and Rainbow desire that Mykotronx employs Employee after the date the Merger is consummated (the "Closing Date") and Employee's willingness to serve as an employee of Mykotronx on the terms herein specified was a material factor in inducing Rainbow to enter into the Reorganization Agreement; WHEREAS, it is a condition to Mykotronx' and Rainbow's obligations to consummate the Merger that Employee enter into this Employment Agreement (the "Agreement"); and WHEREAS, the parties wish to set forth the terms of their employment relationship in this Agreement. NOW, THEREFORE, in consideration of the premises, mutual covenants and agreements set forth herein, the parties hereto agree to as follows: 1. EMPLOYMENT WITH MYKOTRONX. Mykotronx agrees to employ Employee and Employee agrees to serve as an employee of Mykotronx. During the "Term" (as defined in Section 4.1 of this Agreement), Employee will devote his full skill, efforts, business time and attention to his employment with Mykotronx under this Agreement. Employee will report to the Board of Directors of Mykotronx. Employee's duties will be executive in nature and are expected to include, but not necessarily be limited to, serving in the capacity of President of Mykotronx and such other duties as the Board of Directors of Mykotronx shall from time to time direct (such services are referred to as the "Services"). 2. COMPENSATION AND BENEFITS. 2.1 BASE COMPENSATION. During the Term, Mykotronx will pay Employee biweekly payments of base compensation at the rate of $124,800 per annum (the "Base Compensation"). 2.2 ADDITIONAL COMPENSATION. As additional compensation during the Term, Mykotronx will pay Employee an amount equal to .5% of Mykotronx "sales" and 3% of Mykotronx "profits after taxes" (the "Additional Compensation"). Any earned Additional Compensation will be paid by Mykotronx to Employee biannually within 10 days of the issuance of its profit and loss statement for the first six month period and the fiscal year then ended, which payment at year end will be adjusted for any overpayment or underpayment in the six month installment for such fiscal year. The terms "sales" and "profit after tax" as used herein shall have the meanings imputed to them in the Mykotronx financial statements for the Mykotronx fiscal years ended December 31, 1993 and 1994, consistently applied. 1 2 2.3 COMPENSATION PROCEDURE. Base Compensation and Additional Compensation will be paid and withholding effected in accordance with Mykotronx' standard payroll practices. 2.4 STOCK OPTIONS. On the Closing Date, Employee will receive options to purchase 20,000 shares of Rainbow Common Stock, subject to Rainbow's standard vesting requirements, at an exercise price to be determined in accordance with the provisions of Rainbow's Restated 1990 Incentive Stock Option Plan (the "Plan"). Employee acknowledges that the grant of additional stock options by Rainbow to Employee under the Plan, if any, shall be made at the sole discretion of the Stock Option Committee of the Board of Directors of Rainbow. 2.5 BENEFITS. Mykotronx shall provide Employee with benefits during the Term in an amount and type commensurate with other executive employees of Mykotronx. 3. ANNUAL REVIEW. The parties agree that subsequent to the end of each calendar year during the Term, Mykotronx will review Employee job performance and the Base Compensation and Additional Compensation then paid to Employee. 4. TERMINATION; EFFECT OF TERMINATION. 4.1 TERM. The initial term of this Agreement shall be a period of two (2) years commencing on the Closing Date (the "Initial Term"). The term of this Agreement will be automatically renewable for one (1) year periods (the "Subsequent Term") upon the expiration of the Initial Term and any Subsequent Term unless this Agreement has been terminated by either party upon notice of at least 90 days prior to the end of the then current Term. The Initial Term and the Subsequent Term are referred to collectively as the "Term." 4.2 TERMINATION PROCEDURE. Employee may terminate his employment relationship with Mykotronx pursuant to this Agreement for any reason upon 30 days notice to Mykotronx. If Employee gives such notice, or Mykotronx notifies Employee of its intent to terminate Employee's employment for "Cause" pursuant to Section 4.3 below, Mykotronx, in its sole discretion, may require Employee to cease exercise of his responsibilities and performance of Services for Mykotronx at any time prior to the effective date of the notice of termination. The effective date of the termination of Employee's employment relationship with Mykotronx is referred to as the "Termination Date." Except as provided in this Section 4.2, Mykotronx may require Employee to cease exercise of his responsibilities and/or performance of services, but may not terminate his employment during the Initial Term. 4.3 TERMINATION FOR CAUSE. Notwithstanding any contrary provision of this Agreement, Mykotronx shall have the right to terminate Employee's employment with Mykotronx during the Term for "Cause" (as defined herein) or in the event of Employee's death or "Disability" (as defined herein). For the purposes of this Agreement, the term "Cause" will mean: 4.3.1 Employee's repeated material breach in respect of, or refusal to perform his duties, as reasonably assigned by the Board of Directors consistent with his position; 4.3.2 Employee is convicted of any felony or crime of moral turpitude; 4.3.3 Abusive use of drugs or alcohol by Employee; 4.3.4 Embezzlement or misappropriation by Employee of Mykotronx assets; or 4.3.5 Repeated, unexcused breaches or absences in contravention of 2 3 Mykotronx' reasonable policies as pronounced from time to time. The term "Disability" shall be defined as Mykotronx' inability, through physical or mental illness or other cause, to perform the majority of Employee's usual duties for at least a period of three (3) continuous months or more. 4.4 PAYMENT ON TERMINATION. Any termination of Employee's employment relationship with Mykotronx under this Section 4 will be without damages or liability to Mykotronx for compensation and other benefits which would have accrued hereunder after the Termination Date, but all Base Compensation and Additional Compensation, and benefits accrued through the Termination Date will be paid to Employee within thirty (30) days of the Termination Date. 5. RESTRICTIVE COVENANTS. 5.1 ACKNOWLEDGMENTS. Employee acknowledges that fulfillment of the obligations hereunder will result in the Employee becoming familiar with the business affairs of Mykotronx and Rainbow and any present or future parent, subsidiary or affiliate of Mykotronx or Rainbow, including, but not limited to, information about costs, profits, markets, sales, technology and customers. The Employee further acknowledges that this information is essential to the operation of Mykotronx and such information constitutes trade secrets of Mykotronx (the "Trade Secrets"). 5.2 ACKNOWLEDGMENT OF PROPRIETARY INFORMATION AGREEMENT. Mykotronx and the Employee acknowledge that they are parties to an "Employee Proprietary Information and Invention Agreement, dated February 3, 1993 (the "Proprietary Information Agreement") pursuant to which Employee has agreed to certain restrictions regarding the Mykotronx "Proprietary Information" (as that term is defined in the Proprietary Information Agreement). In addition, the parties agree that for the purposes of this Agreement, the description of "Proprietary Information" shall be supplemented to include any information exchanged by the parties regarding the business and affairs of Rainbow. Accordingly, the parties agree that the term "Proprietary Information" when used in this Agreement shall have the meaning assigned to it in the Proprietary Information Agreement as supplemented by the preceding sentence, and that all such Proprietary Information shall be treated in the manner set forth in the Proprietary Information Agreement. The parties further agree that except for the supplement contained in this paragraph, the Proprietary Information Agreement remains in full force and effect, and any conflicts between this Agreement and the Proprietary Information Agreement regarding Proprietary Information shall be resolved in favor of the Proprietary Information Agreement. 5.3 RETURN OF MATERIALS. At the end of the Term or upon earlier termination of Employee's relationship with Mykotronx pursuant to this Agreement, Employee will promptly return to Mykotronx all items of any nature that belong to Mykotronx and all records (in any form, format or medium) containing or relating to, the Proprietary Information or the Trade Secrets. 5.4 RESTRICTIVE COVENANT. The Employee agrees that during his employment, the Employee shall not directly or indirectly through any other person, firm or corporation compete with or be engaged in the same business as Mykotronx or directly or indirectly, for Employee's own benefit or for, with or through any other person, firm, or corporation, own, manage, operate, control, loan money to, or participate in the ownership, management, operation, control of, or be connected as a director, officer, employee, partner, consultant, agent, independent contractor, or otherwise with, or acquiesce in the use of his name to any organization competing with or that is engaged in the same business as Mykotronx (the "Restrictive Covenant"). 5.5 EXTENSION OF RESTRICTIVE COVENANTS. If the employment of Employee is terminated by Rainbow for Cause or voluntarily by Employee at any time during the Initial Term, Mykotronx may, but shall not be obligated to, extend the Restrictive Covenant for a period of one year following termination 3 4 of employment; and if Employee's employment is terminated for such reasons at any time following the Initial Term, Mykotronx may extend the Restrictive Covenant for a period of six (6) months following termination. In either such event, Mykotronx shall pay to Employee, at normal intervals, during and for the period that the Restrictive Covenant remains in effect, an amount equal to Employee's Base Compensation as of the date of termination. 5.6 RESTRICTIVE COVENANTS REASONABLE AND NECESSARY. The Employee agrees that the provisions of this Section 5 are reasonable and necessary to protect Mykotronx in the conduct of its business. If any restriction contained in this Section 5 shall be deemed to be invalid, illegal, or unenforceable by reason of the extent, duration or geographical scope, or other provisions hereof and in its reduced form such restriction shall then be enforceable in the manner contemplated hereby. 6. SPECIFIC PERFORMANCE. Employee, recognizing that irreparable injury shall result to Mykotronx in the event of Employee's breach of the terms and conditions of this Agreement, agrees that in the event of his breach or threatened breach, Mykotronx shall be entitled to injunctive relief restraining Employee, and any and all persons or entities acting for or with him, from such breach or threatened breach. Nothing herein contained, however, shall be construed as prohibiting Mykotronx from pursuing any other remedies available to it by reason of such breach or threatened breach. 7. GENERAL. 7.1 OTHER AGREEMENTS. Employee represents to Mykotronx that Employee is not a party to any other agreements or commitments that would materially impair his ability to perform his obligations under this Agreement and Employee will not enter into any other such agreements unless authorized to do so by Mykotronx. 7.2 ENFORCEABILITY. If any provision of this Agreement will be found by any court of competent jurisdiction to be invalid or unenforceable, the parties hereby waive such provision to the extent that it is found to be invalid or unenforceable. Such provision will, to the extent allowable by law, be modified by a court so that it becomes enforceable and, as modified, will be enforced as any other provision hereof, all the other provisions continuing in full force and effect. 7.3 NO WAIVER. The failure by either party at any time to require performance or compliance by the other of any of its obligations or agreements will in no way affect the right to require such performance or compliance at any time thereafter. The waiver by either party of a breach of any provision hereof will not be taken or held to be a waiver of any preceding or succeeding breach of such provision or as a waiver of the provision itself. No waiver of any kind will be effective or binding, unless it is in writing and is signed by the party against which such waiver is sought to be enforced. 7.4 ASSIGNMENT. This Agreement and all rights hereunder are personal to Employee and may not be transferred or assigned by Employee at any time. Mykotronx may assign its rights, together with its obligations hereunder, to any parent, subsidiary, affiliates or successors, in connection with any sale, transfer or other disposition of all or substantially all of its business and assets, provided, however, that any such assignee assumes Mykotronx' obligations. 7.5 HEADINGS. The headings contained in this Agreement are for reference purposes only and will in no way affect the meaning or interpretation of this Agreement. In this Agreement, the singular includes the plural, and plural the singular, the masculine gender includes both male and female referents, and the word "or" is used in the inclusive sense. 7.6 GOVERNING LAW. This Agreement will be governed by and construed in accordance with the laws of the State of California, excluding that body of law applicable to conflict of laws. 4 5 7.7 SURVIVAL. The provisions of Section 5 will survive the termination or expiration of this Agreement as a continuing agreement of Mykotronx and Employee. 7.8 NOTICE. All notices, requests, demands and other communications hereunder will be in writing and will be deemed to have been duly given when (A) delivered personally; or (B) three days after mailing by certified mail, return receipt requested, postage prepaid or upon proof of delivery by prepaid express courier, to the address of the applicable party as set forth in the preamble to this Agreement. Addresses may be changed by notice given in accordance with the provisions of the Reorganization Agreement, except that a notice of change of address will not be deemed to have been duly given until actually received by the addressee. 7.9 COUNTERPARTS. This Agreement may be executed in counterparts, each of which will be deemed to be an original, and all of which together will comprise one and the same instrument. 8. GUARANTEE. If for any reason Mykotronx fails or is unable to perform its obligations under this Agreement, Rainbow, the parent of Mykotronx, guarantees the performance of, and agrees to perform in the place of Mykotronx, all such obligations of Mykotronx. 5 6 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. MYKOTRONX, INC. By:________________________________ _________________________________ John C. Droge, Vice President Theodore S. Bettwy, Employee AGREED AS TO SECTION 8 RAINBOW TECHNOLOGIES, INC. By:________________________________ Walter W. Straub, President 6 EX-10.Q 4 EMPLOYMENT AGREEMENT-JOHN C. DROGE 1 Exhibit 10(q) EMPLOYMENT AGREEMENT, dated as of May 31, 1995 by and between John C. Droge residing at 414 Sixth Street, Hermosa Beach, California 90254 ("Employee") and Mykotronx, Inc., a California corporation with offices at 357 Van Ness Way, Suite 200, Torrance, California 90501 ("Mykotronx") and Rainbow Technologies, Inc., a Delaware corporation with offices at 9292 Jeronimo Road, Irvine, California 92718 ("Rainbow"). RECITALS WHEREAS, Employee is presently the Vice President of Program Development of Mykotronx, and has extensive knowledge with respect thereto; WHEREAS, Mykotronx and Rainbow are concurrently herewith entering into an Agreement and Plan of Reorganization (the "Reorganization Agreement"), pursuant to which it is anticipated that Rainbow Acquisition, Inc., a California corporation and wholly-owned subsidiary of Rainbow, will be merged with and into Mykotronx (the "Merger"), with Mykotronx, as the surviving corporation, becoming a wholly-owned subsidiary of Rainbow on the items and conditions set forth in the Reorganization Agreement; WHEREAS, Mykotronx and Rainbow desire that Mykotronx employs Employee after the date the Merger is consummated (the "Closing Date") and Employee's willingness to serve as an employee of Mykotronx on the terms herein specified was a material factor in inducing Rainbow to enter into the Reorganization Agreement; WHEREAS, it is a condition to Mykotronx' and Rainbow's obligations to consummate the Merger that Employee enter into this Employment Agreement (the "Agreement"); and WHEREAS, the parties wish to set forth the terms of their employment relationship in this Agreement. NOW, THEREFORE, in consideration of the premises, mutual covenants and agreements set forth herein, the parties hereto agree as follows: 1. EMPLOYMENT WITH MYKOTRONX. Mykotronx agrees to employ Employee and Employee agrees to serve as an employee of Mykotronx. During the "Term" (as defined in Section 4.1 of this Agreement), Employee will devote his full skill, efforts, business time and attention to his employment with Mykotronx under this Agreement. Employee will report to the President of Mykotronx. Employee's duties will be executive in nature and are expected to include, but not necessarily be limited to, serving in a program development capacity for Mykotronx and such other duties as the Board of Directors of Mykotronx shall from time to time direct (such services are referred to as the "Services"). 2. COMPENSATION AND BENEFITS. 2.1 BASE COMPENSATION. During the Term, Mykotronx will pay Employee biweekly payments of base compensation at the rate of $110,968 per annum (the "Base Compensation"). 2.2 ADDITIONAL COMPENSATION. As additional compensation during the Term, Mykotronx will pay Employee an amount equal to .3% of Mykotronx "sales" and 2% of Mykotronx "profits after taxes" (the "Additional Compensation"). Any earned Additional Compensation will be paid by Mykotronx to Employee biannually within 10 days of the issuance of its profit and loss statement for the first six month period and the fiscal year then ended, which payment at year end will be adjusted for any overpayment or underpayment in the six month installment for such fiscal year. The terms "sales" and "profit after tax" as used herein shall have the meanings imputed to them in the Mykotronx financial statements for the Mykotronx fiscal years ended December 31, 1993 and 1994, consistently applied. 1 2 2.3 COMPENSATION PROCEDURE. Base Compensation and Additional Compensation will be paid and withholding effected in accordance with Mykotronx' standard payroll practices. 2.4 STOCK OPTIONS. On the Closing Date, Employee will receive options to purchase 20,000 shares of Rainbow Common Stock, subject to Rainbow's standard vesting requirements, at an exercise price to be determined in accordance with the provisions of Rainbow's Restated 1990 Incentive Stock Option Plan (the "Plan"). Employee acknowledges that the grant of additional stock options by Rainbow to Employee under the Plan, if any, shall be made at the sole discretion of the Stock Option Committee of the Board of Directors of Rainbow. 2.5 BENEFITS. Mykotronx shall provide Employee with benefits during the Term in an amount and type commensurate with other executive employees of Mykotronx. 3. ANNUAL REVIEW. The parties agree that subsequent to the end of each calendar year during the Term, Mykotronx will review Employee job performance and the Base Compensation and Additional Compensation then paid to Employee. 4. TERMINATION; EFFECT OF TERMINATION. 4.1 TERM. The initial term of this Agreement shall be a period of two (2) years commencing on the Closing Date (the "Initial Term"). The term of this Agreement will be automatically renewable for one (1) year periods (the "Subsequent Term") upon the expiration of the Initial Term and any Subsequent Term unless this Agreement has been terminated by either party upon notice of at least 90 days prior to the end of the then current Term. The Initial Term and the Subsequent Term are referred to collectively as the "Term." 4.2 TERMINATION PROCEDURE. Employee may terminate his employment relationship with Mykotronx pursuant to this Agreement for any reason upon 30 days notice to Mykotronx. If Employee gives such notice, or Mykotronx notifies Employee of its intent to terminate Employee's employment for "Cause" pursuant to Section 4.3 below, Mykotronx, in its sole discretion, may require Employee to cease exercise of his responsibilities and performance of Services for Mykotronx at any time prior to the effective date of the notice of termination. The effective date of the termination of Employee's employment relationship with Mykotronx is referred to as the "Termination Date." Except as provided in this Section 4.2, Mykotronx may require Employee to cease exercise of his responsibilities and/or performance of services, but may not terminate his employment during the Initial Term. 4.3 TERMINATION FOR CAUSE. Notwithstanding any contrary provision of this Agreement, Mykotronx shall have the right to terminate Employee's employment with Mykotronx during the Term for "Cause" (as defined herein) or in the event of Employee's death or "Disability" (as defined herein). For the purposes of this Agreement, the term "Cause" will mean: 4.3.1 Employee's repeated material breach in respect of, or refusal to perform his duties, as reasonably assigned by the President consistent with his position; 4.3.2 Employee is convicted of any felony or crime of moral turpitude; 4.3.3 Abusive use of drugs or alcohol by Employee; 4.3.4 Embezzlement or misappropriation by Employee of Mykotronx assets; or 4.3.5 Repeated, unexcused breaches or absences in contravention of Mykotronx' reasonable policies as pronounced from time to time. 2 3 The term "Disability" shall be defined as Mykotronx' inability, through physical or mental illness or other cause, to perform the majority of Employee's usual duties for at least a period of three (3) continuous months or more. 4.4 PAYMENT ON TERMINATION. Any termination of Employee's employment relationship with Mykotronx under this Section 4 will be without damages or liability to Mykotronx for compensation and other benefits which would have accrued hereunder after the Termination Date, but all Base Compensation and Additional Compensation, and benefits accrued through the Termination Date will be paid to Employee within thirty (30) days of the Termination Date. 5. RESTRICTIVE COVENANTS. 5.1 ACKNOWLEDGMENTS. Employee acknowledges that fulfillment of the obligations hereunder will result in the Employee becoming familiar with the business affairs of Mykotronx and Rainbow and any present or future parent, subsidiary or affiliate of Mykotronx or Rainbow, including, but not limited to, information about costs, profits, markets, sales, technology and customers. The Employee further acknowledges that this information is essential to the operation of Mykotronx and such information constitutes trade secrets of Mykotronx (the "Trade Secrets"). 5.2 ACKNOWLEDGMENT OF PROPRIETARY INFORMATION AGREEMENT. Mykotronx and the Employee acknowledge that they are parties to an "Employee Proprietary Information and Invention Agreement, dated April 2, 1990 (the "Proprietary Information Agreement") pursuant to which Employee has agreed to certain restrictions regarding the Mykotronx "Proprietary Information" (as that term is defined in the Proprietary Information Agreement). In addition, the parties agree that for the purposes of this Agreement, the description of "Proprietary Information" shall be supplemented to include any information exchanged by the parties regarding the business and affairs of Rainbow. Accordingly, the parties agree that the term "Proprietary Information" when used in this Agreement shall have the meaning assigned to it in the Proprietary Information Agreement as supplemented by the preceding sentence, and that all such Proprietary Information shall be treated in the manner set forth in the Proprietary Information Agreement. The parties further agree that except for the supplement contained in this paragraph, the Proprietary Information Agreement remains in full force and effect, and any conflicts between this Agreement and the Proprietary Information Agreement regarding the Proprietary Information shall be resolved in favor of the Proprietary Information Agreement. 5.3 RETURN OF MATERIALS. At the end of the Term or upon earlier termination of Employee's relationship with Mykotronx pursuant to this Agreement, Employee will promptly return to Mykotronx all items of any nature that belong to Mykotronx and all records (in any form, format or medium) containing or relating to, the Proprietary Information or the Trade Secrets. 5.4 RESTRICTIVE COVENANT. The Employee agrees that during his employment, the Employee shall not directly or indirectly through any other person, firm or corporation compete with or be engaged in the same business as Mykotronx or directly or indirectly, for Employee's own benefit or for, with or through any other person, firm, or corporation, own, manage, operate, control, loan money to, or participate in the ownership, management, operation, control of, or be connected as a director, officer, employee, partner, consultant, agent, independent contractor, or otherwise with, or acquiesce in the use of his name to any organization competing with or that is engaged in the same business as Mykotronx (the "Restrictive Covenant"). 5.5 EXTENSION OF RESTRICTIVE COVENANTS. If the employment of Employee is terminated by Rainbow for Cause or voluntarily by Employee at any time during the Initial Term, Mykotronx may, but shall not be obligated to, extend the Restrictive Covenant for a period of one year following termination of employment; and if Employee's employment is terminated for such reasons at any time following the Initial Term, Mykotronx may extend the Restrictive Covenant for a period of six (6) months following 3 4 termination. In either such event, Mykotronx shall pay to Employee, at normal intervals, during and for the period that the Restrictive Covenant remains in effect, an amount equal to Employee's Base Compensation as of the date of termination. 5.6 RESTRICTIVE COVENANTS REASONABLE AND NECESSARY. The Employee agrees that the provisions of this Section 5 are reasonable and necessary to protect Mykotronx in the conduct of its business. If any restriction contained in this Section 5 shall be deemed to be invalid, illegal, or unenforceable by reason of the extent, duration or geographical scope, or other provisions hereof and in its reduced form such restriction shall then be enforceable in the manner contemplated hereby. 6. SPECIFIC PERFORMANCE. Employee, recognizing that irreparable injury shall result to Mykotronx in the event of Employee's breach of the terms and conditions of this Agreement, agrees that in the event of his breach or threatened breach, Mykotronx shall be entitled to injunctive relief restraining Employee, and any and all persons or entities acting for or with him, from such breach or threatened breach. Nothing herein contained, however, shall be construed as prohibiting Mykotronx from pursuing any other remedies available to it by reason of such breach or threatened breach. 7. GENERAL. 7.1 OTHER AGREEMENTS. Employee represents to Mykotronx that Employee is not a party to any other agreements or commitments that would materially impair his ability to perform his obligations under this Agreement and Employee will not enter into any other such agreements unless authorized to do so by Mykotronx. 7.2 ENFORCEABILITY. If any provision of this Agreement will be found by any court of competent jurisdiction to be invalid or unenforceable, the parties hereby waive such provision to the extent that it is found to be invalid or unenforceable. Such provision will, to the extent allowable by law, be modified by a court so that it becomes enforceable and, as modified, will be enforced as any other provision hereof, all the other provisions continuing in full force and effect. 7.3 NO WAIVER. The failure by either party at any time to require performance or compliance by the other of any of its obligations or agreements will in no way affect the right to require such performance or compliance at any time thereafter. The waiver by either party of a breach of any provision hereof will not be taken or held to be a waiver of any preceding or succeeding breach of such provision or as a waiver of the provision itself. No waiver of any kind will be effective or binding, unless it is in writing and is signed by the party against which such waiver is sought to be enforced. 7.4 ASSIGNMENT. This Agreement and all rights hereunder are personal to Employee and may not be transferred or assigned by Employee at any time. Mykotronx may assign its rights, together with its obligations hereunder, to any parent, subsidiary, affiliates or successors, in connection with any sale, transfer or other disposition of all or substantially all of its business and assets, provided, however, that any such assignee assumes Mykotronx' obligations. 7.5 HEADINGS. The headings contained in this Agreement are for reference purposes only and will in no way affect the meaning or interpretation of this Agreement. In this Agreement, the singular includes the plural, and plural the singular, the masculine gender includes both male and female referents, and the word "or" is used in the inclusive sense. 7.6 GOVERNING LAW. This Agreement will be governed by and construed in accordance with the laws of the State of California, excluding that body of law applicable to conflict of laws. 7.7 SURVIVAL. The provisions of Section 5 will survive the termination or expiration of this Agreement as a continuing agreement of Mykotronx and Employee. 4 5 7.8 NOTICE. All notices, requests, demands and other communications hereunder will be in writing and will be deemed to have been duly given when (A) delivered personally; or (B) three days after mailing by certified mail, return receipt requested, postage prepaid or upon proof of delivery by prepaid express courier, to the address of the applicable party as set forth in the preamble to this Agreement. Addresses may be changed by notice given in accordance with the provisions of the Reorganization Agreement, except that a notice of change of address will not be deemed to have been duly given until actually received by the addressee. 7.9 COUNTERPARTS. This Agreement may be executed in counterparts, each of which will be deemed to be an original, and all of which together will comprise one and the same instrument. 8. GUARANTEE. If for any reason Mykotronx fails or is unable to perform its obligations under this Agreement, Rainbow, parent of Mykotronx, guarantees the performance of, and agrees to perform in the place of Mykotronx, all such obligations of Mykotronx. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. MYKOTRONX, INC. By:________________________________ _________________________________ Theodore S. Bettwy, President John C. Droge, Employee AGREED AS TO SECTION 8 RAINBOW TECHNOLOGIES, INC. By:________________________________ Walter W. Straub, President 5 EX-21.A 5 LIST OF RAINBOW'S WHOLLY-OWNED SUBSIDIARIES 1 EXHIBIT 21(a) THE COMPANY'S WHOLLY-OWNED SUBSIDIARIES Rainbow Microphar 122, Ave. Charles de Gaulle 92522 Neuilly sur Seine, Cedex, FRANCE TEL: 33-1-41-43-29-00 FAX: 33-1-46-24-76-91 Rainbow Technologies, Ltd. 4 The Forum, Hanworth Lane Chertsey, Surrey KT16 9JX UNITED KINGDOM TEL: 44-1-932-570066 FAX: 44-1-932-570743 Rainbow Technologies, GmbH Lise Meitner Strasse 1 85716 Untersehleissheim GERMANY TEL: 49-89-32-17-98-00 FAX: 49-89-32-17-98-50 Mykotronx 357 Van Ness Way, Suite 200 Torrance, CA 90501 TEL: 310-533-8100 FAX: 310-533-0527 EX-23.A 6 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23(a) CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-60267 and Form S-8 No. 33-60265) pertaining to the Assumed Options of Mykotronx, Inc., 1987 Non-Qualified Stock Option Plan, 1987 Incentive Stock Option Plan and 1990 Stock Option Plan of Rainbow Technologies, Inc., of our report dated February 16, 1996, with respect to the consolidated financial statements and schedule of Rainbow Technologies, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1995. Ernst and Young LLP Orange County, California March 29, 1996 EX-23.B 7 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23(b) CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (No. 33-60267) on Form S-8 of Rainbow Technologies, Inc., of our report dated February 16, 1995, with respect to the balance sheet of Mykotronx, Inc., as of December 31, 1994, and the related statements of earnings, shareholders' equity and cash flows for the two years ended December 31, 1994, insofar as it relates to the data included in the consolidated financial statements and schedule of Rainbow Technologies, Inc., included in the 1995 Annual Report on Form 10-K. KPMG Peat Marwick LLP Los Angeles, California March 29, 1996 EX-27 8 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS YEAR DEC-31-1995 JAN-01-1995 DEC-31-1995 1 25,058 11,799 13,175 (450) 2,927 58,187 14,665 3,708 79,825 8,938 0 0 0 7 66,496 79,825 44,346 66,308 12,701 29,566 7,048 73 (370) 16,610 6,972 16,610 0 0 0 9,638 1.25 1.25
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