-----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, DqMCJK98pTiOklDYigtF6S0c52J/9J1oM4toyONg2yDoZq2KVgWKJLv3QJMTLwfi e7tbFjyX6t5U11T/F6b8ZQ== 0000892569-99-001343.txt : 19990513 0000892569-99-001343.hdr.sgml : 19990513 ACCESSION NUMBER: 0000892569-99-001343 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990512 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-Q SEC ACT: SEC FILE NUMBER: 000-16641 FILM NUMBER: 99618772 BUSINESS ADDRESS: STREET 1: 50 TECHNOLOGY DRIVE CITY: IRVINE STATE: CA ZIP: 92718 BUSINESS PHONE: 7144542100 MAIL ADDRESS: STREET 1: 50 TECHNOLOGY DRIVE CITY: IRVINE STATE: CA ZIP: 92718 10-Q 1 FORM 10-Q 1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended MARCH 31, 1999 Commission file number:0-16641 RAINBOW TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 95-3745398 (State of incorporation) (I.R.S. Employer Identification No.) 50 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92618 (Address of principal executive offices) (Zip Code) Indicate by check mark whether the Registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares of common stock, $.001 par value, outstanding as of May 10, 1999 was 11,281,574. 2 RAINBOW TECHNOLOGIES, INC. TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets at March 31, 1999 (unaudited) and December 31, 1998 4 Condensed Consolidated Statements of Income for the three months ended March 31, 1999 and 1998 (unaudited) 5 Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 1999 and 1998 (unaudited) 6 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1999 and 1998 (unaudited) 7 Notes to Condensed Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 PART II - OTHER INFORMATION Item 1 to 5 - Not applicable Item 6. Exhibits and reports on Form 8K 16 SIGNATURES 16
2 3 INTRODUCTORY NOTE The Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. These forward-looking statements include (i) the existence and development of the Company's technical and manufacturing capabilities, (ii) anticipated competition, (iii) potential future growth in revenues and income, (iv) potential future decreases in costs, and (v) the need for, and availability of additional financing. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. These forward-looking statements are based on the assumption that the Company will not lose a significant customer or customers or experience increased fluctuations of demand or rescheduling of purchase orders, that the Company's markets will continue to grow, that the Company's products will remain accepted within their respective markets and will not be replaced by new technology, that competitive conditions within the Company's markets will not change materially or adversely, that the Company will retain key technical and management personnel, that the Company's forecasts will accurately anticipate market demand, that there will be no material adverse change in the Company's operations or business and that the Company will not experience significant supply shortages with respect to purchased components, sub-systems or raw materials. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. In addition, the business and operations of the Company are subject to substantial risks which increase the uncertainty inherent in the forward-looking statements. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. 3 4 RAINBOW TECHNOLOGIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS A S S E T S
March 31, 1999 December 31, 1998 -------------- ----------------- (unaudited) Current assets: Cash and cash equivalents ...................................................... $ 22,820,000 $ 29,900,000 Marketable securities available-for-sale ....................................... 4,959,000 6,495,000 Accounts receivable, net of allowance for doubtful accounts of $278,000 and $291,000 in 1999 and 1998, respectively ....................... 18,578,000 20,753,000 Inventories .................................................................... 10,380,000 10,891,000 Unbilled costs and fees ........................................................ 1,834,000 2,740,000 Prepaid expenses and other current assets ...................................... 6,176,000 3,815,000 ------------- ------------- Total current assets ...................................................... 64,747,000 74,594,000 Property, plant and equipment, at cost: Buildings ...................................................................... 7,944,000 8,580,000 Furniture ...................................................................... 1,414,000 1,338,000 Equipment ...................................................................... 14,754,000 13,738,000 Leasehold improvements ......................................................... 1,439,000 1,177,000 ------------- ------------- 25,551,000 24,833,000 Less accumulated depreciation and amortization ................................. 9,510,000 8,873,000 ------------- ------------- Net property, plant and equipment ......................................... 16,041,000 15,960,000 Goodwill, net of accumulated amortization of $11,532,000 and $11,731,000 in 1999 and 1998, respectively .................................... 5,757,000 6,318,000 Product licenses, net of accumulated amortization of $1,351,000 and $1,190,000 in 1999 and 1998, respectively ................................. 5,683,000 5,855,000 Other assets, net of accumulated amortization of $1,792,000 and $1,463,000 in 1999 and 1998, respectively ................................. 6,631,000 7,026,000 ------------- ------------- $ 98,859,000 $ 109,753,000 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable ............................................................... $ 4,180,000 $ 5,542,000 Accrued payroll and related expenses ........................................... 2,780,000 5,150,000 Other accrued liabilities ...................................................... 3,513,000 3,861,000 Long-term debt, due within one year ............................................ 255,000 278,000 ------------- ------------- Total current liabilities ................................................. 10,728,000 14,831,000 Long-term debt, net of current portion .......................................... 1,277,000 1,458,000 Other liabilities ............................................................... 1,147,000 1,263,000 Shareholders' equity: Common stock, $.001 par value, 20,000,000 shares authorized, 11,761,373 and 11,773,595 shares issued and outstanding in 1999 and 1998, respectively ................................................................. 12,000 12,000 Additional paid-in capital ..................................................... 29,563,000 30,335,000 Accumulated other comprehensive loss ............................................ (1,384,000) (447,000) Retained earnings ............................................................... 63,586,000 62,301,000 ------------- ------------- 91,777,000 92,201,000 Less cost of treasury shares (425,000 shares) ................................... (6,070,000) -- ------------- ------------- Total shareholders' equity ................................................. 85,707,000 92,201,000 ------------- ------------- $ 98,859,000 $ 109,753,000 ============= =============
See accompanying notes. 4 5 RAINBOW TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three months ended March 31, 1999 March 31, 1998 --------------------------------- Revenues: Software protection products ........................... $ 14,275,000 $ 14,171,000 Information security products .......................... 11,049,000 10,801,000 Internet security products ............................. 735,000 48,000 Ion beam surface treatment ............................. 27,000 10,000 ------------------------------- Total revenues .................................... 26,086,000 25,030,000 Operating expenses: Cost of software protection products ................... 3,994,000 3,555,000 Cost of information security products .................. 10,270,000 8,573,000 Cost of internet security products ..................... 442,000 32,000 Cost of ion beam surface treatment ..................... 26,000 20,000 Selling, general and administrative .................... 6,553,000 5,968,000 Research and development ............................... 2,629,000 2,722,000 Goodwill amortization .................................. 620,000 557,000 Acquired research and development ...................... -- 1,500,000 ------------------------------- Total operating expenses .......................... 24,534,000 22,927,000 ------------------------------- Operating income ......................................... 1,552,000 2,103,000 Interest income .......................................... 302,000 319,000 Interest expense ......................................... (50,000) (56,000) Other income (expense), net .............................. 272,000 (1,134,000) ------------------------------- Income before provision for taxes ........................ 2,076,000 1,232,000 Provision for income taxes ............................... 791,000 1,851,000 ------------------------------- Net income (loss) ........................................ $ 1,285,000 $ (619,000) =============================== Net income (loss) per share: Basic .................................................. $ 0.11 $ (0.05) =============================== Diluted ................................................ $ 0.10 $ (0.05) =============================== Shares used in computing net income (loss) per share: Basic .................................................. 11,804,000 11,650,500 =============================== Diluted ................................................ 12,628,000 11,650,500 ===============================
See accompanying notes. 5 6 RAINBOW TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)
Three Months Ended March 31, 1999 March 31, 1998 -------------- -------------- Net income (loss) ..................................... $ 1,285,000 $ (619,000) Other comprehensive income: Foreign currency translation adjustment ............ (1,466,000) 805,000 Unrealized gain (loss) on securities ............... (45,000) (7,000) Reclassification adjustment ........................ -- (6,000) ----------------------------- Other comprehensive income (loss), before income taxes .............................. (1,511,000) 792,000 Provision for income taxes related to other comprehensive income (loss) ...................... 574,000 (309,000) ----------------------------- Other comprehensive income (loss), net of taxes .... (937,000) 483,000 ----------------------------- Comprehensive income (loss) .......................... $ 348,000 $ (136,000) =============================
See accompanying notes. 6 7 RAINBOW TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Three Months Ended March 31, 1999 March 31, 1998 -------------- -------------- Cash flows from operating activities: Net income ..................................................... $ 1,285,000 $ (619,000) Adjustments to reconcile net income to net cash provided by operating activities: Amortization .................................................. 1,198,000 717,000 Depreciation .................................................. 864,000 698,000 Change in deferred income taxes ............................... (740,000) (817,000) Allowance for doubtful accounts ............................... (6,000) (123,000) Loss from retirement of property, plant, and equipment ........ (2,000) (3,000) Write-down of long-term investment ............................ -- 1,320,000 Write-off of capitalized software ............................. -- 784,000 Minority interest in subsidiary's earnings .................... (195,000) (186,000) Write-off of in-process research and development .............. -- 1,500,000 Provision for restructured operations ......................... -- 370,000 Changes in operating assets and liabilities: Accounts receivable .......................................... 1,783,000 (1,288,000) Inventories .................................................. 419,000 1,712,000 Unbilled costs and fees ...................................... 906,000 597,000 Prepaid expenses and other current assets .................... (1,117,000) 64,000 Accounts payable ............................................. (1,287,000) (1,064,000) Accrued liabilities .......................................... (2,688,000) (3,589,000) Deferred revenues ............................................ (89,000) 169,000 Income taxes payable ......................................... (320,000) (214,000) ------------------------------- Net cash provided by operating activities .................. 11,000 28,000 Cash flows from investing activities: Purchase of marketable securities .............................. -- (1,300,000) Sale of marketable securities .................................. 1,536,000 4,152,000 Purchases of property, plant, and equipment .................... (1,478,000) (812,000) Net cash paid for acquisition of Wyatt River Software, Inc. .... -- (7,239,000) Other non-current assets ....................................... 245,000 (522,000) Capitalized software development costs ......................... (200,000) (211,000) ------------------------------- Net cash provided by (used in) investing activities ........ 103,000 (5,932,000) Cash flows from financing activities: Exercise of Rainbow common stock options ....................... 647,000 491,000 Payment of long-term debt ...................................... (76,000) (68,000) Purchase of treasury stock ..................................... (6,070,000) (149,000) Purchase and retirement of common stock ........................ (1,419,000) (179,000) ------------------------------- Net cash provided by (used in) financing activities ......... (6,918,000) 95,000 Effect of exchange rate changes on cash ......................... (276,000) 501,000 ------------------------------- Net decrease in cash and cash equivalents ....................... (7,080,000) (5,308,000) Cash and cash equivalents at beginning of period ................ 29,900,000 29,556,000 ------------------------------- Cash and cash equivalents at end of period ...................... $ 22,820,000 $ 24,248,000 =============================== Supplemental disclosure of cash flow information: Income taxes paid .............................................. $ 117,000 $ 2,004,000 Interest paid .................................................. 53,000 56,000
See accompanying notes. 7 8 RAINBOW TECHNOLOGIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999 (Unaudited) 1. Basis of presentation Rainbow Technologies, Inc. (the Company) develops, manufactures, programs and markets products which prevent the unauthorized use of intellectual property, including software programs; develops and manufactures information security products for satellite communications; and develops and manufactures internet security products to provide privacy and security for network communications. The accompanying financial statements consolidate the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain amounts previously reported have been reclassified to conform with the 1999 presentation. Share amounts for all periods presented have been adjusted to reflect the impact of a 3-for-2 stock split effective July 1, 1998 In the opinion of the Company's management, the accompanying condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position at March 31, 1999 and results of operations for the three months ended March 31, 1999 and 1998. The condensed consolidated financial statements do not include footnotes and certain financial information normally presented annually under generally accepted accounting principles and, therefore, should be read in conjunction with the Company's December 31, 1998 Annual Report on Form 10-K. Results of operations for the three months ended March 31, 1999 are not necessarily indicative of results to be expected for the full year. The Company has subsidiaries in the United Kingdom, Germany, France, the Netherlands, India, Russia, Australia, China and Taiwan. The Company utilizes the currencies of the countries where its foreign subsidiaries operate as the functional currency. Balance sheet accounts denominated in foreign currency are translated at exchange rates as of the date of the balance sheet and income statement accounts are translated at average exchange rates for the period. Translation gains and losses are accumulated as a separate component of Accumulated Other Comprehensive Income within Shareholders' Equity. The Company has adopted local currencies as the functional currencies for its subsidiaries because their principal economic activities are most closely tied to the respective local currencies. As of January 1, 1998, the Company adopted Statement 130, "Reporting Comprehensive Income" (SFAS No. 130). SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or shareholders' equity. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities and foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity to be included in other comprehensive income. During the three months ended March 31, 1999 total comprehensive income amounted to $348,000 while during the three months ended March 31, 1998 total comprehensive loss amounted to $136,000. 2. Earnings per share Basic earnings per share is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the assumed conversion of all diluted securities. 8 9 3. Government Contracts The Company is both a prime contractor and a subcontractor under fixed-price and cost-plus-fixed-fee contracts with the U.S. Government (Government). At the commencement of each contract or contract modification, the Company submits pricing proposals to the Government to establish indirect cost rates applicable to such contracts. These rates, after audit and approval by the Government, are used to settle costs on 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 amounts in these financial statements. These provisional billing rates are adjusted to actual at year-end and are subject to adjustment after Government audit. 4. Inventories Inventoried costs relating to long-term contracts are stated at the actual production costs, including pro-rata allocations of factory overhead and general and administrative costs incurred to date, reduced by amounts identified with revenue recognized on units delivered. The costs attributed to units delivered under such long-term contracts are based on the estimated average cost of all units expected to be produced. Inventories, other than inventoried costs relating to long-term contracts, are stated at the lower of cost (first-in, first-out basis) or market. Inventories consist of the following:
March 31,1999 December 31, 1998 ------------- ----------------- Inventoried costs related to long-term contracts $ 4,431,000 $ 5,237,000 Finished goods 3,616,000 4,426,000 Raw materials 820,000 917,000 Work in process 1,513,000 311,000 ----------- ----------- $10,380,000 $10,891,000 =========== ===========
5. Acquisitions On February 26, 1998, the Company completed the acquisition of Wyatt River Software, Inc. (Wyatt). Wyatt develops, manufactures, and markets network license management software. The total transaction value was $9 million, including $3.9 million paid in cash to Wyatt stockholders and $5.1 million in assumed liabilities. The Company may be required to pay Wyatt shareholders an additional sum of up to $2 million based upon sales of the Wyatt technology through June 30, 1999. This acquisition has been accounted for under the purchase method of accounting. The purchase price has been allocated based upon estimated fair values at the date of acquisition. Approximately $1.5 million of the purchase price was written off as in-process research and development at the acquisition date, approximately $2.7 million was allocated to developed software, and the remaining $4.8 million was allocated to goodwill and other intangibles. The goodwill and other intangibles are being amortized on a straight-line basis over five years. On March 6, 1998, the Company entered into an agreement to purchase certain assets from Elan Computer Group, Inc. (Elan) for $800,000. The assets included Elan's license manager software technology, which the Company had previously licensed from Elan, and Elan's end-user maintenance and support relationships. In connection with the transaction, the Company entered into a Litigation Cooperation Agreement with Elan in connection with a patent infringement lawsuit entitled Globetrotter Software, Inc. vs. Elan Computer Group, Inc. No. 97-4176CW which is currently pending in the United States District court for the Northern District of California. The action claims that the Elan technology infringes upon patents owned by Globetrotter. The lawsuit is deemed to include any and all claims made now or in the future by Globetrotter Software, Inc. The Company does not expect that this matter will have a material adverse effect on its financial position or results of operations. Prior to the asset purchase agreement with Elan, the Company had an investment in Elan of $1.3 million. The Company owned less than 20% of Elan's 9 10 stock and accounted for the investment under the cost method. During the first quarter of 1998 the Company wrote-off its investment in Elan, as it was determined that the Company's original investment was fully impaired. The write-off is included in other income (expense), net in the income statement for the quarter ended March 31, 1998. 6. Other assets Included in other assets are certain investments in early-stage companies. The Company closely monitors the operations and cash flows of these companies to evaluate their status and ensure that amounts reported for these investments do not exceed net realizable value. If the Company determines that impairment in the investment of any such company exists, an adjustment would be made to reduce the investment amount to net realizable value. Also included in other assets are capitalized software development costs. Based on the Company's product development process, technological feasibility is established upon completion of a working model. Amortization of capitalized software development costs commence when the products are available for general release to customers and are determined using the straight line method over the expected useful lives of the respective products. These amounts are written-off if it is determined that the projects can not be brought to market. 7. Stock split On March 17, 1998 the Company announced that its Board of Directors approved a 3-for-2 split of its common stock. The effective date was July 1, 1998 and the payout date was July 15, 1998. These financial statements have been adjusted to reflect the impact of the stock split. 8. Subsequent Event On May 11, 1999 the Company acquired Systematic Systems Integration, Inc. (Systematic Systems) in a cash transaction valued at approximately $9.5 million. Systematic Systems is a leading California-based eCommerce integration services firm enabling companies to seamlessly integrate diverse software and hardware platforms, communication systems and Internet technologies. 10 11 RAINBOW TECHNOLOGIES, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of certain significant factors which have affected the consolidated results of operations and the consolidated financial position of the Company during the periods included in the accompanying condensed consolidated financial statements. This discussion should be read in conjunction with the related condensed consolidated financial statements and associated notes. RESULTS OF OPERATIONS (dollars in thousands)
Three Months Ended March 31, ----------------------- 1999 1998 -------- -------- Revenues Software Protection $ 14,275 $ 14,171 Information Security 11,049 10,801 Internet Security 735 48 Ion Beam Surface Treatment 27 10 -------- -------- Total revenues $ 26,086 $ 25,030 ======== ======== Operating Income Software Protection $ 2,665 $ 1,815 Information Security 571 2,140 Internet Security (1,262) (1,564) Ion Beam Surface Treatment (422) (288) -------- -------- Total operating income $ 1,552 $ 2,103 ======== ========
REVENUES Revenues from Software Protection Products for the three months ended March 31, 1999 increased by 1% to $14,275,000, when compared to the same period in 1998. The overall business has been impacted by the economic problems in Asia and other emerging markets as well as by the erosion of average selling prices. Revenues from Europe increased by 14% while revenues from the U.S. decreased by 12%. The decrease in U.S. revenues is due to slower sales to U.S. customers who export their products to Asia. The average selling price per product in the quarter ended March 31, 1999 increased approximately 9% when compared to the same period in 1998. Unit volume for the three months ended March 31, 1999 decreased by 10% when compared to the corresponding period in 1998. The increase in average selling prices and the decrease in unit volume is primarily due to a change in customer mix. Information Security Products revenue for the three months ended March 31, 1999 increased 2% to $11,049,000 when compared to the same period in 1998. The revenue growth was primarily due to a higher demand for network security products. 11 12 Internet Security Products revenue for the three months ended March 31, 1999 increased 1,431% to $735,000 when compared to the same period in 1998. The revenue growth was primarily due to the increase in sales of Cryptoswift products. GROSS PROFIT Gross profit from Software Protection Products for the three months ended March 31, 1999 decreased to 72% of revenues compared to 75% of revenues for the corresponding period in 1998. The decrease in gross profit was due to higher costs of sales as a result of increased labor, overhead and non-recurring engineering expenses. Gross profit from Information Security Products for the three months ended March 31, 1999 decreased to 7% of revenues compared to 21% for the three months ended March 31, 1998. The decrease was due to change in mix from more profitable product contracts to less profitable research and development contracts. Gross profit from Internet Security Products for the three months ended March 31, 1999 increased to 40% of revenues compared to 33% for the three months ended March 31, 1998. The increase in gross profit was due to a decrease in unit costs. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses for the quarter ended March 31, 1999 were 25% of revenues compared with 24% of revenues for the quarter ended March 31, 1998. Selling, general and administrative expenses for the quarter ended March 31, 1999 increased by $585,000 as compared with 1998. This increase was primarily due to additional staff and higher marketing expenses for new product introductions in software protection and internet security products. RESEARCH AND DEVELOPMENT Total research and development expenses for the three months ended March 31, 1999 decreased by 3% when compared to the corresponding 1998 period. The decrease in research and development expenses was due primarily to the deferral of non-recurring engineering expenses related to several projects. ACQUIRED RESEARCH AND DEVELOPMENT During the quarter ended March 31, 1998, the Company wrote-off $1,500,000 of in-process research and development acquired in the Wyatt River Software, Inc. ("Wyatt") acquisition. OTHER INCOME (EXPENSE) Other income was $272,000 for the quarter ended March 31, 1999 compared to other expense of $1,134,000 for the quarter ended March 31, 1998. During the first quarter of 1998, the Company wrote-off a $1,320,000 investment which was determined to be fully impaired. PROVISION FOR INCOME TAXES The effective tax rate was 38% for the three months ended March 31, 1999. The effective tax rate in the first three months of 1998 was negatively affected due to the non-deductibility of the charges related to the acquired in- 12 13 process research and development. Excluding the effect of these charges, the effective tax rate was 39% for the three months ended March 31, 1998 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 for the three months ended March 31, 1999 and 1998 were $11,000 and $28,000, respectively. Net cash provided by investing activities for the three months ended March 31, 1999 was $103,000 while net cash used in investing activities for the three months ended March 31, 1998 was $5,932,000. Investing activities in 1998 included the acquisition of Wyatt River Software and certain assets of Elan Computer Group. The Company intends to use its capital resources to expand its product lines and for possible acquisitions of additional products and technologies. The Company has no significant capital commitments or requirements at this time. The Company's subsidiary in France carry approximately $9,900,000 in interest earning deposits which may result in foreign exchange gains or losses due to the fact that the functional currency in those subsidiaries is not the U.S. dollar. The Company believes that its current working capital of $54,019,000 and anticipated working capital to be generated by future operations will be sufficient to support the Company's working capital requirements for at least the next twelve months. IMPACT OF YEAR 2000 The Year 2000 issue exists because many computer systems, applications and embedded microprocessors use two rather than four digits to define the applicable year. Because this issue has the potential to disrupt the Company's business operations, a comprehensive, company wide, Year 2000 program was initiated to identify and remediate the potential issues surrounding the Year 2000 problem. The Year 2000 program addresses the problems that may arise in computer technologies, which include both information technology ("IT") and non-IT systems, and those Year 2000 issues related to third parties with which the Company has a material relationship. One of the Company's first priorities was communicating to customers the Year 2000 compliance status of the Company's products. To aid in this effort, the Company developed an Internet web site that describes the type of date-related processing in the products (if any), which products have been tested for Year 2000 compliance, and the results of that testing. The site is updated as new products and new information become available. In addition, the Company's Year 2000 program includes a process for responding to customer inquiries and for handling special customer requests. For the purposes of process management and progress reporting, the Year 2000 program activities are divided into 5 phases, some of which are being conducted concurrently: AWARENESS - This phase included definition of the systems, project and scope, overall approach, determination of teams, briefings, and setting of a compliance standard. The awareness phase has been completed. ASSESSMENT - The assessment phase included the development of a comprehensive inventory and assessment of the criticality of systems, prioritization, determination of resource requirements, and estimation of costs. General decisions were made about modification, re-engineering, replacement or removal of systems and business partners. The validation approach and schedule was determined. RENOVATION: The renovation phase includes the re-engineering, replacement, or retirement of systems. Test plans are developed for revised and replaced systems. 13 14 VALIDATION: Tests are run in an isolated test environment to determine functionality. IMPLEMENTATION: In this phase, the implementation dates are scheduled, and the need for parallel processing, back-up, recovery and contingency plans are determined. Following implementation, there is a review for effectiveness. STATE OF READINESS IT and Non-IT Systems The Company's IT systems principally consist of business information systems (such as mainframe and other shared computers and associated business application software) and infrastructure (such as personal computers, operating systems, networks and devices like switches and routers). As of March 31, 1999, the inventory of these systems is complete and the assessment and validation of systems deemed "business critical" is more than 75% complete. The implementation of upgraded, renovated or replacement business critical systems is scheduled to be completed by June, 1999. All of the remaining, non-critical, IT systems are being evaluated on the basis of tests (if deemed necessary), and manufacturer statements regarding Year 2000 compliance. The Company expects that the assessment and, when required, renovation or replacement of all IT systems will be completed in time to ensure no significant adverse effect on business operations. Non-IT systems are those business tools that may contain embedded microprocessors, such as elevators, phones, security systems and climate control systems. The inventory of these items is completed and the vendors have been contacted to obtain Year 2000 compliance information. The decision to remediate, replace or otherwise address equipment that poses a material Year 2000 impact is based primarily upon analysis of the information received from the manufacturer. To date, more than 85% of the manufacturers have responded and indicated that no Year 2000 related problems will be experienced with the equipment as provided. The Company anticipates completion, in all material respects, of the non-IT infrastructure portion of its program by June 1999. EXTERNAL RELATIONSHIPS The Company also faces a potential risk should one or more of its principal suppliers, service providers or other parties with whom the Company has a material business relationship suffer a Year 2000 related problem. A comprehensive inventory of business partners was made, and the Company has initiated contact with them in an effort to determine their state of readiness. Assessment of the risk posed to the Company will be based on the level of criticality to the Company (the potential business impact, available alternatives and resources required to replace) and the response received from each party. A cut-off date has been assigned to each business critical third party by which time that company must be assessed as "Year 2000 Ready" or a contingency plan will be implemented to ensure the Company will suffer no material impact to its ability to provide products and services to customers. Approximately 1300 companies were contacted, about 100 of which are considered business critical, and to-date more than 50% of the total and more than 60% of the business critical suppliers have responded. The Company anticipates that this evaluation will be ongoing through 1999. Contingency Planning The Company recognizes the need for contingency planning in those areas where it known, or is reasonably likely that an event or an uncertainty will create a Year 2000 system-related failure with a significant negative impact on its business operations. The Company has identified the date by which each business critical IT system, non-IT system, and business partner must be validated for Year 2000 readiness, and by which a contingency plan must be implemented to ensure uninterrupted business operations. Contingency planning is expected to be completed for each of these systems no later than that date, and in all cases, no later than October 1999. COSTS The Company has incurred approximately $548,000 as of March 31, 1999, to address its Year 2000 issues. The Company presently estimates that the total cost of addressing its Year 2000 issues will be approximately $750,000 to $1,000,000. This estimate was derived utilizing numerous assumptions. First, the current staff is adequate to 14 15 finish the project. Second, the product is already Year 2000 compliant. Next, to the best of its knowledge, the Company estimates that approximately half of the work is already done and that no system changes are anticipated. However, there can be no guarantee that these assumptions are accurate, and actual results could differ materially from those anticipated. RISKS The Company's Year 2000 program is designed to discover and remediate or reduce the risks associated with the Year 2000 issue. The Company anticipates that it will complete the remediation, risk assessment and contingency planning for its internal IT and non-IT systems, and immediate, business critical third-party providers. The most reasonably likely worst case scenario involves the disruption of operations caused by the Company's reliance upon a network of critical suppliers (such as utility, telecommunications, and transportation service providers) whose own systems unexpectedly fail. While such failures could directly or indirectly affect important operations of the Company, in a significant manner, the Company does not have sufficient information about or control over its third party suppliers to determine either the likelihood or potential costs of these failures. Accordingly, the costs and results of the Company's Year 2000 program and the extent of the impact on operations could materially differ from the Company's expectations. 15 16 PART II OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K (a) Exhibits 27 Financial Data Schedule (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. Dated: May 12, 1999 RAINBOW TECHNOLOGIES, INC. By: /s/ Patrick Fevery ------------------------- Chief Financial Officer 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 22,820 4,959 18,856 (278) 10,380 64,747 25,551 9,510 98,859 10,728 0 0 0 12 85,695 98,859 26,086 26,086 14,732 24,534 272 0 (50) 2,076 791 1,285 0 0 0 1,285 0.11 0.10
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