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

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 000-25120

SECURITY DYNAMICS TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 04-2916506
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

20 CROSBY DRIVE
BEDFORD, MA 01730
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 687-7000

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days:

Yes [X] No [ ]

As of April 30, 1998, there were 40,880,844 shares of the Registrant's
Common Stock, $.01 par value per share, outstanding.
================================================================================
2

SECURITY DYNAMICS TECHNOLOGIES, INC.
FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 1998

TABLE OF CONTENTS

PAGE
----

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997....................................... 3
Condensed Consolidated Statements of Income for the three
months ended March 31, 1998 and 1997........................ 4
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 1998 and 1997.................. 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 17
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................... 17
Item 6. Exhibits and Reports on Form 8-K............................ 17
Signature................................................... 18

2
3

PART I. FINANCIAL INFORMATION

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

ITEM 1. FINANCIAL STATEMENTS

MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
(UNAUDITED)

ASSETS
Current assets:
Cash and equivalents...................................... $ 45,667 $ 96,595
Marketable securities..................................... 119,476 68,064
Accounts receivable (less allowance for doubtful accounts
of $882 in 1998 and $742 in 1997)...................... 25,215 27,551
Inventory................................................. 4,914 3,035
Prepaid expenses and other................................ 6,183 9,338
Prepaid income taxes...................................... -- 2,562
Deferred taxes............................................ 1,238 1,426
-------- --------
Total current assets.............................. 202,693 208,571
-------- --------
Property and equipment -- net............................... 19,295 17,515
-------- --------
Other assets:
Investments............................................... 6,155 3,699
Purchased technology and capitalized software costs,
net.................................................... 60 86
Deferred taxes............................................ 3,371 3,371
Other..................................................... 985 733
-------- --------
Total other assets................................ 10,571 7,889
-------- --------
Total....................................................... $232,559 $233,975
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 7,355 $ 11,137
Accrued payroll and related benefits...................... 2,233 5,254
Accrued expenses and other................................ 6,575 4,071
Income taxes payable...................................... 672 159
Deferred revenue.......................................... 7,529 9,602
-------- --------
Total current liabilities......................... 24,364 30,223
-------- --------
Minority interests........................................ 2,851 3,099
-------- --------
Commitments and contingencies: (notes 4 and 7)
Stockholders' equity:
Common stock, $.01 par value; authorized 80,000,000
shares; issued, 40,857,118 and 35,800,782 shares in
1998 and 1997; outstanding, 40,856,609 and 35,800,486
shares in 1998 and 1997................................ 409 405
Additional paid-in capital................................ 168,131 165,751
Retained earnings......................................... 37,851 35,284
Deferred stock compensation............................... (101) (116)
Treasury stock, common, at cost, 509 and 296 shares in
1998 and 1997.......................................... -- --
Accumulated other comprehensive income.................... (946) (671)
-------- --------
Total stockholders' equity........................ 205,344 200,653
-------- --------
Total....................................................... $232,559 $233,975
======== ========

See notes to condensed consolidated financial statements.

3
4

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------

Revenue..................................................... $40,246 $29,319
Cost of revenue............................................. 8,616 6,456
------- -------
Gross profit................................................ 31,630 22,863
------- -------
Costs and expenses:
Research and development.................................. 7,113 3,948
Purchased research and development........................ 210 --
Marketing and selling..................................... 13,480 8,869
General and administrative................................ 4,719 3,589
Merger and integration.................................... 2,600 --
------- -------
Total............................................. 28,122 16,406
------- -------
Income from operations...................................... 3,508 6,457
Interest income and other................................... 2,410 1,275
------- -------
Income before provision for income taxes.................... 5,918 7,732
Provision for income taxes.................................. 3,202 2,863
Minority interests.......................................... 248 --
------- -------
Net income.................................................. $ 2,964 $ 4,869
======= =======
Basic earnings per share
Per share amount.......................................... $ .07 $ .13
======= =======
Weighted average shares................................... 40,665 38,480
======= =======
Diluted earnings per share
Per share amount.......................................... $ .07 $ .12
======= =======
Weighted average shares................................... 40,665 38,480
Effect of dilutive options................................ 1,486 1,603
------- -------
Adjusted weighted average shares............................ 42,151 40,083
======= =======

See notes to condensed consolidated financial statements.

4
5

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)

THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1997
-------- --------

Cash flows from operating activities:
Net income................................................ 2,964 4,869
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Deferred taxes......................................... 189 (141)
Purchased research and development..................... 210 --
Depreciation and amortization.......................... 1,594 632
Stock compensation..................................... 295 17
Minority interests..................................... (248) --
Increase (decrease) in cash from changes in:
Accounts receivable.................................. 356 1,332
Inventory............................................ (1,880) (193)
Prepaid expenses and other........................... 3,048 (1,130)
Accounts payable..................................... (4,070) (1,871)
Accrued payroll and related benefits................. (3,018) (885)
Accrued expenses and other........................... 2,713 (1,409)
Prepaid and income taxes payable..................... 3,068 19
Deferred revenue..................................... (2,387) (359)
-------- --------
Net cash provided by (used for) operating
activities...................................... 2,834 881
-------- --------
Cash flows from investing activities:
Purchases of marketable securities........................ (95,056) (22,351)
Proceeds from sale and maturities of marketable
securities............................................. 43,331 27,019
Purchases of property and equipment....................... (3,346) (1,600)
Investments and other..................................... (709) 313
-------- --------
Net cash provided by (used for) investing
activities...................................... (55,780) 3,381
-------- --------
Cash flows from financing activities:
Proceeds from exercise of stock options................... 2,104 2,108
Minority interest......................................... -- 492
-------- --------
Net cash provided by financing activities......... 2,104 2,600
-------- --------
Effects of exchange rate changes on cash and equivalents.... (86) (1,146)
-------- --------
Net increase (decrease) in cash and equivalents........... (50,928) 5,716
Cash and equivalents, beginning of period................... 96,595 11,688
-------- --------
Cash and equivalents, end of period......................... $ 45,667 $ 17,404
======== ========

See notes to condensed consolidated financial statements.

5
6

SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)

1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
include the accounts of Security Dynamics Technologies, Inc. (the "Company") and
its wholly owned subsidiaries and have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission regarding interim
financial reporting. Accordingly, they do not include all of the information and
notes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, as amended.

In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared on the same basis as the
audited consolidated financial statements, and include all adjustments,
consisting only of normal recurring adjustments, necessary for fair presentation
of the results of the interim periods presented. The operating results for the
interim periods presented are not necessarily indicative of the results expected
for the full year.

On July 15, 1997, the Company completed an acquisition of DynaSoft AB,
("DynaSoft") (the "DynaSoft Acquisition"). On March 26, 1998, the Company
completed an acquisition of Intrusion Detection Inc. ("IDI") (the "IDI
Acquisition"). The DynaSoft Acquisition and the IDI Acquisition have been
accounted for as poolings of interests and therefore the consolidated financial
statements for all periods prior to the respective acquisitions have been
restated to include the accounts and operations of DynaSoft and IDI with those
of the Company.

2. EARNINGS PER COMMON SHARE

In the fourth quarter of 1997, the Company adopted the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 128 "Earnings per
Share." The Company changed the method used to compute earnings per share and
restated all prior periods in accordance with SFAS No. 128. SFAS No. 128
supersedes Accounting Principles Board Opinion No. 15 and is intended to
simplify the computation of earnings per share and to make the U.S. computations
more comparable with international computations by requiring the presentation of
basic and fully diluted earnings per share. The Company's only dilutive stock
equivalents are stock options.

3. INCOME TAXES

The Company provides for income taxes at the end of each interim period
based on the estimated effective tax rate for the full year. Cumulative
adjustments to the tax provision are recorded in the interim period in which a
change in the estimated annual effective rate is determined.

Cash payments for income taxes were approximately $127 and $3,321 for the
three months ended March 31, 1998 and 1997, respectively.

4. CONTINGENCIES

From time to time the Company is named as a defendant in legal actions
arising from its normal business activities. The Company carries insurance
against liability for certain types of risks. Although the amount of liability
that could result from any litigation cannot be predicted, in the opinion of
management, the Company's potential liability on all known claims would not have
a material adverse effect on the consolidated financial position or results of
operations of the Company.

6
7
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INVESTMENTS

VERISIGN

In January 1998, VeriSign, Inc. ("VeriSign") had an initial public offering
of 3 million shares of its common stock. The VeriSign series A and B convertible
preferred stock held by the Company converted to common stock in connection with
the offering. The offering diluted the Company's ownership to approximately 22%
but increased the value of the Company's equity in VeriSign.

As a result of VeriSign's initial public offering, in accordance with the
equity method of accounting, the Company will recognize an increase in the
amount of its investment in VeriSign, representing its proportionate share of
VeriSign's equity as of December 31, 1997, after considering VeriSign's net
proceeds from the offering. The increase in the investment will be recorded with
a corresponding increase to additional paid in capital, net of deferred income
taxes payable. On April 23, 1998, VeriSign announced it had incurred a net loss
of $5.2 million for the first quarter of 1998 and at March 31, 1998 had total
assets and liabilities of $63.9 million and $12.7 million, respectively. The
Company will record the increase in its investment (approximately $12 million)
and its proportionate share of VeriSign's first quarter net loss (approximately
$1 million) in the second quarter of 1998 as the Company recognizes its
proportionate interest in VeriSign's operating results one quarter in arrears.

VPNET

In December 1996, the Company purchased 250,000 shares of Series B
Preferred Stock of VPNet Technologies, Inc. ("VPNet") of San Jose, California,
for an aggregate purchase price of $1.5 million. VPNet was organized to develop
and market products and technologies for implementing high-performance virtual
private networks. In January 1998, the Company purchased $120,000 of VPNet 8%
convertible debt. The debt is convertible into preferred stock which is
convertible into common stock. The Company also received a warrant to purchase
VPNet Common Stock. The Company's investment in VPNet represents a minority
interest of less than 10% of VPNet's capitalization.

TRINTECH

On March 31, 1998 the Company purchased, in a non-cash transaction, 482,756
ordinary shares of Trintech Group ("Trintech") for $2.0 million. Trintech Group
is an Irish development company organized to develop and market software
products designed to enable secure payment in the electronic marketplace. The
Company's investment represents a minority interest of less than 5% of
Trintech's capitalization. The Company has also agreed to purchase up to $3.0
million of Trintech's Series A Convertible Preferred Shares at such time as
Trintech completes a private placement of such securities.

NCIPHER

In October 1997, the Company purchased 175,285 Ordinary Shares of nCipher
Corporation Limited ("nCipher") for an aggregated purchase price of $512,000.
nCipher is located in the United Kingdom and develops products designed to
accelerate cryptographic processes in Internet security, electronic commerce and
other applications. In January 1998, the Company purchased 93,896 Ordinary
Shares of nCipher for an aggregate purchase price of $336,418. The Company's
investment in nCipher represents a minority interest of less than 5% of
nCipher's capitalization.

6. ACQUISITIONS

In connection with the IDI Acquisition, the Company issued approximately
784,000 shares of common stock in exchange for all of IDI's outstanding common
stock. IDI develops and markets intrusion detection software. Merger and
integration expenses incurred in connection with the IDI acquisition were
approximately $2.6 million. No adjustments were required to conform accounting
policies of the Company and IDI.

7
8
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Revenue and net income (loss) for each of the previously separate companies
for the periods prior to the IDI Acquisition follow:

THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31,
------------------ ------------
1998 1997 1997
------- ------- ------------

REVENUE
Security Dynamics(a)............................. $39,346 $28,419 $135,930
IDI.............................................. 900 900 4,700
------- ------- --------
Total.................................... $40,246 $29,319 $140,630
======= ======= ========
NET INCOME (LOSS)
Security Dynamics(a)............................. $ 3,101 $ 4,561 $ 16,368
IDI.............................................. (137) 308 680
------- ------- --------
Total.................................... $ 2,964 $ 4,869 $ 17,048
======= ======= ========

- ---------------
(a) Includes revenues and net income of DynaSoft.

7. COMMITMENTS

Effective April 1, 1998, the Company amended its agreement with Progress
Software Corporation ("Progress Software") for the right to use certain of its
software to enhance the functionality of the Company's ACE/Server software. In
order to obtain favorable pricing, the Company agreed to prepay $6.0 million in
installments over the remaining three quarters of 1998. The prepaid royalty will
be recorded as a component of cost of sales as the related products are sold.

8. COMPREHENSIVE INCOME

Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." The
following is presented in accordance with this statement:

For the three months ended March 31, 1998 and 1997, comprehensive income
is:

THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------

Net income.................................................. $2,964 $4,869
Other comprehensive income, net of tax:
Unrealized holding (loss) gain on securities arising
during period.......................................... (102) (1,298)
Foreign currency translation adjustments.................. (173) (239)
------ ------
Comprehensive income........................................ $2,689 $3,332

Accumulated other comprehensive income consists of the following:

FOREIGN UNREALIZED ACCUMULATED
CURRENCY HOLDING (LOSS) OTHER
TRANSLATION GAIN ON COMPREHENSIVE
ADJUSTMENTS SECURITIES INCOME
----------- -------------- -------------

Balance, December 31, 1997.................. $(750) $ 79 $(671)
Current period change....................... (173) (102) (275)
----- ----- -----
Balance, March 31, 1998..................... $(923) $ (23) $(946)
===== ===== =====

8
9
SECURITY DYNAMICS TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. RECENT ACCOUNTING PRONOUNCEMENTS

In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") No. 97-2, "Software Revenue
Recognition", which supersedes SOP No. 91-1. The Company adopted SOP No. 97-2
prospectively on January 1, 1998. SOP No. 97-2 generally requires revenue earned
on software arrangements involving multiple elements to be allocated to each
element based on the relative fair values of the elements. In March 1998, the
AICPA postponed the adoption date of certain provisions of SOP No. 97-2. The
adoption of SOP No. 97-2 did not have a material effect on the Company's
revenues and operating results for the three months ended March 31, 1998.

In June 1997, the Financial Accounting Standards Board issued Statements of
Financial Accounting Statement No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). The Company will be required
to adopt the provisions of this statement in its annual financial statements for
fiscal 1998. SFAS 131 establishes new standards for reporting information about
operating segments. The Company believes the segment information required to be
disclosed under SFAS 131 will be more comprehensive than previously provided,
including expanded disclosure of income statement and balance sheet items for
each reportable operating segment. The Company has not yet completed its
analysis of the operating segments on which it will report.

10. 1994 STOCK OPTION PLAN

On January 22, 1998 and March 8, 1998, the Board of Directors adopted, and
on April 30, 1998 the stockholders approved, an amendment and restatement of the
1994 Stock Option Plan, as amended increasing the number of shares of Common
Stock authorized for issuance thereunder from 6,570,000 to 9,570,000 shares in
the aggregate.

9
10

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)

OVERVIEW

This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions are intended to identify forward-looking statements. There are a
number of factors that could cause the Company's actual results to differ
materially from those indicated by such forward-looking statements. These
factors include, without limitation, those set forth below under the caption
"Certain Factors That May Affect Future Results."

The IDI Acquisition was completed on March 26, 1998 and has been accounted
for as a pooling of interests. Accordingly, the results of operations for all
periods discussed below have been restated to include the financial results of
IDI. See Notes 1 and 6 of Notes to Condensed Consolidated Financial Statements.

RESULTS OF OPERATIONS

The following table sets forth income and expense items as a percentage of
total revenue, and the percentage change in dollar amounts of such items, for
the three months ended March 31, 1998 and 1997.

PERCENTAGE OF
TOTAL PERIOD-TO-PERIOD
REVENUE CHANGE
-------------- ----------------
THREE MONTHS ENDED MARCH 31,
----------------------------------
1998 1997
----- -----

Revenue..................................................... 100.0% 100.0% 37.3%
Cost of revenue............................................. 21.4 22.0 33.5
----- ----- -----
Gross profit................................................ 78.6 78.0 38.3
----- ----- -----
Costs and expenses:
Research and development.................................. 17.7 13.5 80.2
Purchased research and development........................ .5 -- 100.0
Marketing and selling..................................... 33.5 30.3 52.0
General and administrative................................ 11.7 12.2 31.5
Merger and integration.................................... 6.5 -- 100.0
----- ----- -----
Total............................................. 69.9 56.0 71.4
----- ----- -----
Income from operations...................................... 8.7 22.0 (45.7)
Interest income and other................................... 6.0 4.3 89.0
----- ----- -----
Income before provision for income taxes.................... 14.7 26.3 (23.5)
Provision for income taxes.................................. 8.0 9.7 11.8
Minority interests.......................................... .6 -- 100.0
----- ----- -----
Net income.................................................. 7.3% 16.6% (39.1)%
===== ===== =====

REVENUE

The Company's revenue is derived principally from the sales of SecurID
tokens; licensing of ACE/Server, BoKS and SecurPC software; licensing of BSAFE,
TIPEM, S/PAY and S/MAIL encryption engines; licensing of patents; licensing of
Kane Security Analyst and Kane Security Monitor Software and revenues from
maintenance and professional services.

Total revenue increased 37.3% in the first quarter of 1998 to $40,246 from
$29,319 in the first quarter of 1997. This increase in revenue reflected
increases in unit sales of all of the Company's products, except

10
11

ACM/400 and ACM/1600 hardware products. Approximately 60% of the increase in
revenue was attributable to increased sales of SecurID tokens. Approximately 15%
of the increase in revenue was attributable to increased sales of encryption
engine licenses and patent licensing. Approximately 19% of the increase in
revenue was attributable to increased sales of ACE/Server and ACM software
products. The balance of the increase in revenue resulted from increased
maintenance revenue offset by decreased hardware revenue. The Company believes
that the overall increase in sales was attributable in part to growth of the
information security market, with the increased use of the Internet and
corporate intranets and extranets continuing to play significant roles in
developing new opportunities for the Company.

International revenue (excluding Canada) increased 76.3% in the first
quarter of 1998 to $10.4 from $5.9 in the first quarter of 1997 and accounted
for 25.9% and 20.1% of total revenue in the first quarters of 1998 and 1997,
respectively. This increase in international revenue was primarily attributable
to the continuing expansion of the Company's international direct sales force
and increased market penetration of the Company's products in foreign markets.

COST OF REVENUE AND GROSS PROFIT

The Company's cost of revenue consists primarily of costs associated with
the manufacture and delivery of SecurID tokens and hardware products. The
Company's utilizes assembly contractors for most manufacturing. Cost of revenue
also includes royalty fees incurred on the sale of ACE/Server software, royalty
fees payable on the licensing of patent technology and royalties payable under
certain OEM agreements. Cost of revenue includes customer support costs and
production costs, which include labor costs associated with the programming of
SecurID tokens, inspection and quality control functions and shipping costs.

The Company's gross profit increased 38.3% in the first quarter of 1998 to
$31,630, or 78.6% of revenue, from $22,863, or 78.0% of revenue, in the first
quarter of 1997. Approximately 58% of the increase in gross profit was
attributable to increased unit sales of SecurID tokens. Approximately 18% of the
increase in gross profit was attributable to increased licensing sales of
encryption engine technology and patent licensing. Approximately 22% of the
increase in gross profit was attributable to increased licensing sales of
ACE/Server software. In addition, gross profit increased due to increased
maintenance revenues. Gross profit as a percentage of revenue in the first
quarter of 1998 was relatively stable compared to the first quarter of 1997.

In the future, gross profit may be affected by several factors, including
changes in product mix and distribution channels, price reductions (resulting
from volume discounts or otherwise), competition, increases in the cost of
revenue (including increases in material costs associated with the manufacture
of SecurID tokens and hardware products and any software license fees or
royalties payable by the Company) and other factors.

RESEARCH AND DEVELOPMENT

Research and development expenses consist primarily of personnel costs as
well as fees for development services provided by consultants.

Research and development expenses increased 80.2% in the first quarter of
1998 to $7,113 from $3,948 in the first quarter of 1997, and increased as a
percentage of revenue to 17.7% from 13.5% primarily due to increased payroll
costs associated with the employment of additional staff.

MARKETING AND SELLING

Marketing and selling expenses consist primarily of salaries, commissions
and travel expenses of direct sales and marketing personnel and marketing
program expenses.

Marketing and selling expenses increased 52.0% in the first quarter of 1998
to $13,480 from $8,869 in the first quarter of 1997, and increased as a
percentage of revenue to 33.5% from 30.3%. Approximately 57% of the increase in
marketing and selling expenses was attributable to increased payroll costs
associated with the employment of additional staff. Approximately 43% of the
increase in marketing and selling expenses resulted from increased travel
expenses and marketing program expenses. Commission expense remained relatively

11
12

stable for the first quarter of 1998 compared to the first quarter of 1997
primarily because the Company modified its commission plans in 1998.

GENERAL AND ADMINISTRATIVE

General and administrative expenses consist primarily of personnel costs
for administration, finance, human resources, general management and legal and
accounting fees.

General and administrative expenses increased 31.5% in the first quarter of
1998 to $4,719, or 11.7% of revenue, from $3,589, or 12.2% of revenue, in the
first quarter of 1997. The increase in general and administrative expenses was
primarily due to increased payroll costs associated with the employment of
additional staff.

MERGER AND INTEGRATION EXPENSES

Merger and integration expenses, consisting of legal, accounting,
investment banking and other expenses, incurred in connection with the IDI
Acquisition were $2.6 million in the first quarter of 1998.

INTEREST INCOME AND OTHER

Interest income and other consists primarily of interest earned on the
Company's cash balances and marketable securities.

Interest income increased 89.0% in the first quarter of 1998 to $2,410 from
$1,275 in the first quarter of 1997 due to interest earned on higher cash and
marketable securities balances.

PROVISION FOR INCOME TAXES

The provision for income taxes increased to $3,202 during the first quarter
of 1998 from $2,863 in the first quarter of 1997. This increase was primarily
the result of non-deductible merger and integration expenses incurred in
connection with the IDI Acquisition.

The Company's effective tax rate was 54.1% for the first quarter of 1998
compared to 37.0% for the first quarter of 1997. The effective tax rate increase
was due to non-deductible merger and integration expenses, partially offset by
benefits resulting from the Company's foreign tax strategy.

MINORITY INTERESTS

Minority interests in the consolidated net income was $248 during the three
months ended March 31, 1998. An aggregate of 26% of RSA's Japanese subsidiary is
owned by minority interest stockholders.

NET INCOME

As a result of the above factors, net income in the first quarter of 1998
decreased to $2,964, or 7.3% of revenue, from $4,869, or 16.6% of revenue, in
the first quarter of 1997.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

At March 31, 1998, the Company had cash, cash equivalents and marketable
securities of $165.1 million and working capital of $178.3 million. The Company
has historically funded its operations primarily from cash generated from its
operating activities. During the first quarter of 1998 the Company used the cash
provided by operations principally for working capital needs and to finance
certain costs in connection with the IDI Acquisition. The Company believes that
working capital will be sufficient to meet its anticipated cash requirements
through at least 1999.

12
13

Mergers and Acquisitions

On July 26, 1996, a wholly owned subsidiary of the Company acquired RSA
(the "RSA Merger"). The RSA Merger costs were approximately $6.1 million. On
July 15, 1997, the Company acquired approximately 95% of the outstanding shares
and certain of the outstanding options to acquire shares of DynaSoft in exchange
for approximately 2.7 million shares of the Company's Common Stock. The Company
also paid approximately $6.0 million in cash to certain of stockholders of
DynaSoft in exchange for the remaining outstanding shares and options. The
DynaSoft Acquisition costs were approximately $5.7 million, which included
integration costs, primarily severance, of $0.3 million. The RSA Merger and
DynaSoft Acquisition were accounted for as poolings of interests.

On March 26, 1998, a wholly owned subsidiary of the Company acquired IDI.
The acquisition was accounted for as a pooling of interests merger. The Company
issued approximately 784,000 shares of Common Stock of the Company in exchange
for all of IDI's outstanding common stock. The IDI Acquisition costs were
approximately $2.6 million. See Note 6 of Notes to the Company's Consolidated
Financial Statements.

The Company intends to seek acquisitions of businesses, products and
technologies that are complementary to those of the Company. The Company is
continuing to identify and prioritize additional security technologies which it
may wish to develop, either internally or through the licensing or acquisition
of products from third parties. While the Company engages from time to time in
discussions with respect to potential acquisitions, there can be no assurances
that any such acquisitions will be made or that the Company will be able to
successfully integrate any acquired business. In order to finance such
acquisitions, it may be necessary for the Company to raise additional funds
through public or private financings. Any equity or debt financings, if
available at all, may be on terms which are not favorable to the Company and, in
the case of equity financings, may result in dilution to the Company's
stockholders.

Sales of Common Stock

In October 1997, the Company sold 1,626,000 shares of Common Stock in a
follow-on public offering, which generated $61.1 million of net cash proceeds to
the Company.

The Company generated $2.4 million of cash from employees exercising of
stock options during the first quarter of 1998.

Strategic Investments

During 1995, RSA granted certain rights and privileges in certain
technology to VeriSign in connection with VeriSign's incorporation and received
4,000,000 shares of VeriSign common stock. On April 17, 1995 and February 20,
1996, the Company purchased 425,000 shares of Series A and 72,091 shares of
Series B Convertible Preferred Stock, respectively, of VeriSign for an aggregate
purchase price of $687,000. VeriSign was organized to provide digital
certificates and related services that use public-key cryptography to ensure
essential privacy and authentication features. VeriSign introduced its first
products and services in June 1995; as such, it has a limited operating history
and through December 31, 1997 has incurred significant net losses in each year
since its inception. There can be no assurance that VeriSign will achieve
profitability in the foreseeable future. The Company's voting interest in
VeriSign was approximately 27% and 26% at December 31, 1996 and 1997,
respectively. The Company uses the equity method to account for its investment
in VeriSign. In January 1998, VeriSign has an initial public offering which
diluted the Company's ownership to approximately 22% but increased the Company's
equity in VeriSign.

13
14

mately $12 million) and its proportionate share of VeriSign's first quarter net
loss (approximately $1 million) in the second quarter of 1998 as the Company
recognizes its proportionate interest in VeriSign's operating results one
quarter in arrears.

In December 1996, the Company purchased 250,000 shares of Series B
Preferred Stock of VPNet Technologies, Inc. ("VPNet") of San Jose, California,
for an aggregate purchase price of $1.5 million. VPNet was organized to develop
and market products and technologies for implementing high-performance virtual
private networks. In January 1998, the Company purchased $120,000 of VPNet 8%
convertible debt. The debt is convertible into preferred stock which is
convertible into common stock. The Company also received a warrant to purchase
VPNet common stock. The Company's investment in VPNet represents a minority
interest of less than 10% of VPNet's capitalization.

Capital Expenditures

The Company's capital expenditures during the first quarter of 1998 were
$3.3 million and were for additional leasehold improvements, office furniture
and equipment, as well as computer equipment for product development, testing
and support to accommodate the Company's continued growth. During the fourth
quarter of 1997, the Company commenced implementation of an information system
which is designed to better meet the Company's growing world-wide information
and business process needs. The Company expects the system, which is represented
by the manufacturer to be Year 2000 compliant, to be operational in 1998 and
estimates the total cost at approximately $5.0 million, of which approximately
$3.5 million will be spent in 1998 ($219,000 was spent in the first quarter of
1998).

Leasing Expenditures

In March 1998, the Company entered into an amendment to its noncancelable
operating lease for facilities in Bedford, Massachusetts. The facilities leased
under the amended agreement provide for approximately 183,000 square feet of
office space, and the annual base rent is approximately $2.6 million per year
through February 2008.

In August and December 1997, the Company entered into two noncancelable
ten-year leases expiring in 2008 for RSA offices in Redwood City, California.
The first facility consists of approximately 27,000 square feet of office space,
and the annual base rent is approximately $1.0 million. The Company plans to
occupy the second facility in June 1998. The second facility consists of
approximately 31,000 square feet of office space, and the annual base rent is
approximately $912,000 and annual operating expenses of approximately $245,000.
Both leases have rent escalation provisions covering years two through ten based
on the Consumer Price Index.

14
15

Royalty Arrangements and Purchased Research and Development

Effective April 1, 1998, the Company amended its agreement with Progress
Software for the right to use certain of its software to enhance the
functionality of the Company's ACE/Server software. In order to obtain favorable
pricing, the Company agreed to prepay $6.0 million in installments over the
remaining three quarters of 1998. The prepaid royalty will be recorded as a
component of cost of sales as products are sold.

The Company expended approximately $210,000 for purchased research and
development technology during the first quarter of 1998.

Year 2000 Compliance

Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, software and computer systems may need to be
upgraded or replaced in order to comply with such "Year 2000" requirements.
Although the Company believes that its products and systems are Year 2000
compliant, the Company utilizes third-party equipment and software that may not
be Year 2000 compliant. Failure of such third-party equipment or software to
operate properly with regard to the year 2000 and thereafter could require the
Company to incur unanticipated expenses to remedy any problems, which could have
a material adverse effect on the Company's business, operating results and
financial condition.

Furthermore, the purchasing patterns of customers or potential customers
may be affected by Year 2000 issues as companies expend significant resources to
correct their current systems for Year 2000 compliance. These expenditures may
result in reduced funds available to implement the infrastructure needed to
conduct trusted and secure communications and commerce over information networks
or to purchase products and services such as those offered by the Company, which
could have a material adverse effect on the Company's business, operating
results and financial condition.

The Company has formed a Year 2000 task force. The task force consists of
employees with expertise in areas the Company believes could be affected if not
Year 2000 compliant. The task force has established a Year 2000 compliance plan.
The scope of the plan is to (i) identify the third-party equipment, software,
vendors, systems and suppliers used by the Company which are not Year 2000
compliant, (ii) replace non-compliant third party equipment and software with
compliant equipment and software and find alternatives to non-compliant vendors,
systems and suppliers, and (iii) work with Company customers to overcome
questions and concerns they may have about the impact of Year 2000 compliance on
the Company and its products. The task force has almost completed the
identification phase of the project and anticipates completion of the
replacement phase of the project in 1998. Except for the previously described
worldwide business and information system, the Company does not believe the
identification and replacement of third party equipment and software will have a
material cost to the Company.

Recent Accounting Pronouncements

15
16

comprehensive than previously provided, including expanded disclosure of income
statement and balance sheet items for each reportable operating segment. The
Company has not yet completed its analysis of the operating segments on which it
will report.

Certain Factors That May Affect Future Results

This 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. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes," "anticipates," "plans," "expects" and similar expressions are
intended to identify forward-looking statements. The following important
factors, among others, could cause actual results to differ materially from
those indicated by forward-looking statements made in this report and presented
elsewhere by management from time to time. Such forward-looking statements
represent management's current expectations and are inherently uncertain.
Investors are warned that actual results may differ from management's
expectations.

A number of uncertainties exist that could affect the Company's future
operating results, including, without limitation, general economic conditions,
the Company's continued ability to develop and introduce products, the
introduction of new products by competitors, pricing practices of competitors,
expansion of the Company's sales distribution capability, the cost and
availability of components and the Company's ability to control costs.

The Company's success is dependent in part on its ability to complete its
integration of the operations of IDI, DynaSoft and RSA in an efficient and
effective manner. The successful combination of the Company, IDI, DynaSoft and
RSA in a rapidly changing high technology industry may be more difficult to
accomplish than in other industries. The combination of these companies and any
future acquisitions will require, among other things, integration of the
companies' respective product offerings and coordination of their sales and
marketing and research and development efforts. There can be no assurance that
such integration will be accomplished smoothly or successfully. The difficulties
of such integration may be increased by the necessity of coordinating
geographically separated organizations. The integration of certain operations
will require the dedication of management resources which may temporarily
distant attention from the day-to-day business of the combined company. The
inability of management to successfully integrate the operations of these
companies could have a material adverse effect on the business and results of
operations of the Company.

The Company's success is also dependent on the success of its SecurSight
strategy, which is a family of enterprise security solutions being developed by
the Company that would enable organizations to support and manage the growing
use of public and private keys, digital signatures and digital certificates for
assuring confidentiality and privacy on an enterprise-wide scale. The success of
SecurSight is dependent on a number of factors, including without limitation
delays in product development, undetected software errors or bugs, competitive
pressures, technical difficulties, market acceptance of new technologies,
including without limitation the use and implementation of various certificate
management and key management technologies, changes in customer requirements and
government regulations, delays in developing strategic partnerships and general
economic conditions.

The Company's success is highly dependent on its ability to enhance its
existing products and to develop and introduce new products in a timely manner.
If the Company were to fail to introduce new products on a timely basis, the
Company's operating results could be adversely affected. To date, substantially
all of the Company's revenues have been attributable to sales of its enterprise
network and data security products, the licensing of encryption engines and the
provision of related services, and existing and new versions of such products
are expected to continue to represent a high percentage of the Company's revenue
for the foreseeable future. As a result, any factor adversely affecting sales of
these products and services could have a material adverse effect on the
Company's financial condition and results of operations.

Certain components of the Company's products are currently purchased from a
single or limited sources and any interruption in the supply of such components
could adversely affect the Company's operating results.

16
17

The Company's quarterly operating results may vary significantly depending
on a number of factors, including the timing of the introduction or enhancement
of products by the Company or its competitors, the sizes, timing and shipment of
individual orders, market acceptance of new products, changes in the Company's
operating expenses, personnel changes, mix of products sold, changes in product
pricing, development of the Company's direct and indirect distribution channels
and general economic conditions.

International sales have represented a significant portion of the Company's
sales. The international business and financial performance of the Company may
be affected by fluctuations in foreign exchange rates, difficulties in managing
accounts receivable, tariff regulations and difficulties in obtaining export
licenses.

All of the Company's products are subject to export controls under U.S. law
and applicable foreign government restrictions, including without limitation
restrictions on the export of encryption technology. The Company believes it has
obtained necessary export approvals for the export of the products it currently
exports. There can be no assurance, however, that the list of products and
countries for which export approval is required, and the regulatory policies
with respect thereto, will not be revised from time to time, or that the Company
will be able to obtain necessary regulatory approvals for the export of future
products. The inability of the Company to obtain required approvals under these
regulations could adversely affect the ability of the Company to make
international sales. In addition, the Company may be at a disadvantage in
competing for international sales compared to companies located outside the
United States that are not subject to such restrictions.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

PART II. OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On March 26, 1998, the Company acquired all of the outstanding capital
stock of IDI pursuant to an Agreement and Plan of Merger (the "Merger
Agreement"), dated as of March 26, 1998, by and among the Company, IDI, Apple
Acquisition Corp., a wholly owned subsidiary of the Company, and Robert Kane and
Lillian Kane (the "IDI Stockholders"). Pursuant to the Merger Agreement, the
Company issued 784,342 shares of its Common Stock (the "Shares") to the IDI
Stockholders in exchange for all of the outstanding capital stock of IDI. The
Shares were issued and sold in reliance on Section 4(2) of the Securities Act of
1933, as amended, as a sale by the Company not involving a public offering. No
underwriters were involved with such issuance and sale of Common Stock.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

A) EXHIBITS

The Exhibits listed in the Exhibit Index immediately preceding such
Exhibits are filed as part of or are included in this Quarterly Report on Form
10-Q.

B) REPORTS ON FORM 8-K:

On March 27, 1998, the Company filed a Current Report on Form 8-K, dated
March 26, 1998, announcing under Item 5 (Other Events) that the Company had
acquired IDI. No financial statements were required to be filed with such
report.

17
18

SIGNATURE

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, thereunto duly authorized.

SECURITY DYNAMICS TECHNOLOGIES, INC.

/s/ MARIAN G. O'LEARY
---------------------------------------
Marian G. O'Leary
Senior Vice President,
Finance, Chief Financial Officer and
Treasurer

Dated: May 15, 1998

18
19

EXHIBIT INDEX

ITEM DESCRIPTION
- ---- -----------

2.1 Agreement and Plan of Merger by and among the Registrant,
Intrusion Detection Inc., Apple Acquisition Corp., Robert
Kane and Lillian Kane, dated March 26, 1998 is incorporated
herein by reference to Exhibit 2.1 to the Registrant's
Current Report on Form 8-K, dated March 26, 1998 (File No.
000-25120) (the "Form 8-K").
10.1 Registration Rights Agreement by and among the Registrant,
Robert Kane and Lillian Kane, dated March 26, 1998 is
incorporated herein by reference to Exhibit 10.1 to the Form
8-K.
10.2 1994 Stock Option Plan, as amended -- 1998 Restatement is
incorporated herein by reference to Annex A to the
Registrant's Definitive Schedule 14A filed April 1, 1998
(File No. 000-25120).
10.3 Amendment No. 4 to 1994 Stock Option Plan, as amended.
10.4 1998 Deferred Compensation Plan.
10.5 Second Amendment to Lease, dated as of April 8, 1998, by and
between the Registrant and EOP -- Crosby Corporate Center,
L.L.C.
10.6 Rider to Indenture of Lease, dated as of March 11, 1996
between the Registrant and Beacon Properties, L.P.
10.7 Lease Agreement, dated as of August 15, 1997, by and between
the Registrant and Peninsula Office Park Associates, L.P.
10.8 Lease Agreement, dated as of December 19, 1997, by and
between the Registrant and Peninsula Office Park Associates,
L.P.
11 Computation of Income Per Common and Common Equivalent
Share.
27 Financial Data Schedule.