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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999

[ ] 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.
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(Exact name of Registrant as Specified in Its Charter)

DELAWARE 04-2916506
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

36 CROSBY DRIVE
BEDFORD, MA 01730
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(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (781) 301-5000

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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 [ ]

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As of July 31, 1999, there were 38,864,440 shares of the Registrant's
Common Stock, $.01 par value per share, outstanding.

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2
SECURITY DYNAMICS TECHNOLOGIES, INC.
FORM 10-Q
FOR THE SIX MONTHS ENDED JUNE 30, 1999

TABLE OF CONTENTS

PAGE
----

PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 1999
and December 31, 1998 ...................................... 3
Condensed Consolidated Statements of Income for the three
and six months ended June 30, 1999 and 1998 ................ 4
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 1999 and 1998 .................... 5
Notes to Condensed Consolidated Financial Statements ......... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk ....................................................... 23

PART II OTHER INFORMATION
Item 1. Legal Proceedings ............................................ 24
Item 4. Submission of Matters to a vote of Security Holders .......... 24
Item 6. Exhibits and Reports on Form 8-K ............................. 25
Signature ............................................................ 26

2
3

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

JUNE 30, DECEMBER 31,
1999 1998
--------- -----------

ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 82,561 $ 33,178
Marketable securities......................................................... 159,508 125,058
Accounts receivable (less allowance for doubtful
accounts of $747 in 1999 and $710 in 1998)................................... 36,840 36,712
Inventory..................................................................... 4,420 7,025
Prepaid expenses and other.................................................... 7,685 10,596
Prepaid income taxes.......................................................... -- 3,930
--------- ---------
Total current assets..................................................... 291,014 216,499
--------- ---------
Property and equipment, net........................................................ 31,720 29,568
--------- ---------
Other assets:
Investments................................................................... 21,179 14,248
Deferred taxes................................................................ 19,852 19,285
Other......................................................................... 1,489 1,255
--------- ---------
Total other assets....................................................... 42,520 34,788
--------- ---------
Total.............................................................................. $ 365,254 $ 280,855
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.............................................................. $ 4,448 $ 8,169
Accrued payroll and related benefits.......................................... 11,081 9,695
Accrued expenses and other.................................................... 7,049 4,659
Income taxes payable.......................................................... 32,339 --
Deferred taxes................................................................ 1,878 2,120
Deferred revenue.............................................................. 13,410 10,971
--------- ---------
Total current liabilities................................................ 70,205 35,614
--------- ---------
Minority interests............................................................ 2,584 2,521
--------- ---------
Commitments and contingencies:
Stockholders' equity:
Common stock, $.01 par value; authorized 150,000,000 shares in 1999 and
80,000,000 shares in 1998; issued, 42,180,613 shares in 1999 and
41,534,359 shares in 1998; outstanding, 38,795,104 shares in 1999
and 40,475,850 shares in 1998 ............................................... 422 415
Additional paid-in capital.................................................... 199,857 191,185
Retained earnings............................................................. 148,287 64,302
Deferred stock compensation................................................... (68) (74)
Treasury stock, common, at cost, 3,385,509 shares in
1999 and 1,058,509 shares in 1998............................................ (54,644) (12,135)
Accumulated other comprehensive loss.......................................... (1,389) (973)
--------- ---------
Total stockholders' equity............................................... 292,465 242,720
--------- ---------
Total.............................................................................. $ 365,254 $ 280,855
========= =========

See notes to condensed consolidated financial statements.

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

THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ------------------------
1999 1998 1999 1998
-------- -------- --------- --------

Revenue ........................................... $ 51,809 $ 43,372 $ 100,481 $ 83,618
Cost of revenue ................................... 10,382 11,893 21,820 20,509
-------- -------- --------- --------
Gross profit ...................................... 41,427 31,479 78,661 63,109
-------- -------- --------- --------
Costs and expenses:
Research and development ..................... 9,150 7,525 17,378 14,848
Marketing and selling ........................ 19,243 14,774 37,186 28,254
General and administrative ................... 6,181 4,941 12,114 9,660
Merger and integration ....................... -- -- -- 2,600
Exit costs ................................... -- -- 6,550 --
-------- -------- --------- --------
Total ................................... 34,574 27,240 73,228 55,362
-------- -------- --------- --------

Income from operations ............................ 6,853 4,239 5,433 7,747
Interest income and other ......................... 1,905 2,082 3,948 4,492
Gain on sale of VeriSign common stock ............. 54,802 -- 129,291 --
Gain from increase in investment value ............ 12,576 11,976 12,576 11,976
Equity in loss from operations of equity investment (167) (1,173) (525) (1,173)
-------- -------- --------- --------
Income before provision for income taxes .......... 75,969 17,124 150,723 23,042
Provision for income taxes ........................ 32,844 6,661 66,676 9,863
Minority interests ................................ (130) 210 (63) 458
-------- -------- --------- --------
Net income ........................................ $ 42,995 $ 10,673 $ 83,984 $ 13,637
======== ======== ========= ========
Basic earnings per share:
Per share amount ............................. $ 1.11 $ 0.26 $ 2.14 $ 0.33
======== ======== ========= ========

Weighted average shares ...................... 38,789 40,907 39,254 40,815
======== ======== ========= ========
Diluted earnings per share:
Per share amount ............................. $ 1.05 $ 0.25 $ 2.03 $ 0.32
======== ======== ========= ========

Weighted average shares ...................... 38,789 40,907 39,254 40,815
Effect of dilutive options ................... 1,967 968 2,175 1,186
-------- -------- --------- --------
Adjusted weighted average shares .................. 40,756 41,875 41,429 42,001
======== ======== ========= ========

See notes to condensed consolidated financial statements.

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

SIX MONTHS ENDED
JUNE 30,
-------------------------
1999 1998
--------- ---------

Cash flows from operating activities:
Net income ......................................... $ 83,984 $ 13,637
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain from sale of VeriSign common stock .......... (129,291) --
Gain from increase in investment value ........... (12,576) (11,976)
Equity in loss from operations of equity
investment ...................................... 524 1,173
Deferred taxes ................................... (825) 4,685
Depreciation and amortization .................... 4,502 2,841
Stock compensation ............................... 564 597
License write off ................................ -- 3,000
Minority interests ............................... 63 (458)
Increase (decrease) in cash from changes in:
Accounts receivable ........................... (1,372) (2,405)
Inventory ..................................... 2,606 (4,947)
Prepaid expenses and other .................... 2,876 (272)
Accounts payable .............................. (3,718) (2,941)
Accrued payroll and related benefits .......... 2,124 332
Accrued expenses and other .................... 2,404 64
Prepaid and income taxes payable .............. 35,820 4,351
Deferred revenue .............................. 3,264 (1,334)
--------- ---------
Net cash provided by operating activities ... (9,051) 6,347
--------- ---------
Cash flows from investing activities:
Purchases of marketable securities ................. (253,517) (140,993)
Proceeds from sale and maturities of marketable
securities ........................................ 353,337 79,651
Purchases of property and equipment ................ (6,648) (8,389)
Proceeds from sale of VeriSign common stock ........ -- --
Investments ........................................ (219) (5,971)
--------- ---------
Net cash provided by (used for) investing
activities ............................... 92,953 (75,702)
--------- ---------
Cash flows from financing activities:
Proceeds from exercise of stock options and purchase
plans ............................................. 7,847 2,298
Share repurchase program ........................... (42,509) --
--------- ---------
Net cash provided by (used for) financing
activities ............................... (34,662) 2,298
--------- ---------
Effects of exchange rate changes on cash and cash
equivalents ........................................... 143 (535)
--------- ---------
Net increase (decrease) in cash and cash equivalents .. 49,383 (67,592)
Cash and cash equivalents, beginning of period .......... 33,178 96,595
--------- ---------
Cash and cash equivalents, end of period ................ $ 82,561 $ 29,003
========= =========

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 SHARE AND 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, 1998.

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 a 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.

The Company's principal markets for its products are, in order of
significance, the United States, Europe, Canada, Asia/Pacific and Latin America.

2. EARNINGS PER COMMON SHARE

The Company computes earnings per share in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 128 "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 $29,507 and $29,532 for
the three and six months ended June 30, 1999, respectively, and $551 and $678
for the three and six months ended June 30, 1998, respectively.

4. CONTINGENCIES

On or about December 11, 1998, a purported class action was filed in the
United States District Court for the District of Massachusetts on behalf of all
purchasers of the Company's Common Stock during the period from and including
September 30, 1997 through July 15, 1998: Fitzer v. Security Dynamics
Technologies, Inc., Charles R. Stuckey, Jr., D. James Bidzos, Arthur W.
Coviello, Jr., John Adams, Marian G. O'Leary and Linda B. Saris, Civil Action
No. 98-CV-12496-WGY. The plaintiff subsequently dismissed without prejudice the
claims against Ms. Saris. The plaintiff filed an amended complaint on May 4,
1999. The amended complaint in the action asserts that the defendants misled the
investing public concerning demand for the Company's products, the strengths of
its technologies, and certain trends in the Company's business. Plaintiffs seek
unspecified damages, interest, costs and fees of their attorneys, accountants
and experts. On July 30, 1999, the Company served its Motion to Dismiss the
amended complaint on the plaintiff. The Company intends to defend the lawsuit
vigorously. Although the amounts claimed may be substantial, the Company cannot
predict the ultimate outcome or estimate the potential loss, if any, related to
the lawsuit. The Company believes that the disposition of this matter will not
have a material adverse effect on the Company's consolidated financial position.
However, the adverse resolution of the lawsuit could materially affect the
Company's results of operations or liquidity in any one annual or quarterly
reporting period.

by refusing to release certain assignments of patents. The Company believes that
Mr. Weiss' claims are without merit, and intends to defend the matter
vigorously. On July 26, 1999, the Company filed, with the American Arbitration
Association, an answering statement and counterclaim to Mr. Weiss' demand.

5. INVESTMENTS

In January 1998, VeriSign, Inc. ("VeriSign") had an initial public offering
of three 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 but
increased the value of the Company's equity in VeriSign.

As a result of VeriSign's initial public offering, and in accordance with
the equity method of accounting, the Company recognized as a gain the increase
in the amount of its investment in VeriSign of $12.0 million, representing its
proportionate share of VeriSign's equity as of December 31, 1997, after
considering VeriSign's net proceeds from the offering. During 1998, the Company
sold 895,500 shares of its VeriSign common stock for a gain of $31.3 million. In
January 1999, VeriSign completed a secondary offering of 3.2 million shares of
its common stock, including the sale of 1.0 million shares held by the Company.
The Company realized a gain of $74.5 million on the sale in January 1999.

In the second quarter of 1999, the Company recognized, as a gain, the
increase in the amount of its investment in VeriSign of $12.6 million,
representing its proportionate share of VeriSign's net increase in equity from
this offering. In addition, the Company sold 510,000 shares of common stock for
a gain of $54.8 million during the second quarter of 1999. As of June 30, 1999,
the Company owned approximately 4.2 million shares of VeriSign common stock, an
approximate ownership percentage of 8%, with a market value of approximately
$362 million. The Company recognizes its proportionate interest in VeriSign's
operating results one quarter in arrears. The Company's proportionate share of
VeriSign's 1999 first quarter net loss was $167. On July 22, 1999, VeriSign
announced it had incurred a net loss of $2 million for the six months ended June
30,1999 and at June 30, 1999 had total assets, liabilities and equity of $197
million, $32 million and $164 million respectively. A director of the Company
serves as Chairman of the Board of VeriSign.

In June 1999, the Company's ownership percentage in VeriSign decreased below
10%. Beginning July 1, 1999, the Company will classify its VeriSign investment
as an available for sale marketable security.

6. EXIT COSTS

During the first quarter of 1999, the Company commenced and substantially
completed consolidation of certain operations in order to promote operational
efficiency. The Company incurred costs of $6,550 which consisted of severance
costs of $3,800, facility exit costs of $2,000 and legal and other direct costs
of completing the consolidation plan of $750. The consolidation involved the
termination of 36 employees, as well as placing for sublet, for the remainder of
the lease terms, excess facilities in Bedford, Massachusetts, New York, New
York, and San Mateo, California. The Company vacated the excess facilities in
San Mateo, California and New York, New York during the first quarter of 1999
and plans to vacate the excess facility in Bedford, Massachusetts in September
1999. The Company has engaged real estate brokers to seek sublease tenants for
the vacated facilities. An initial sublease agreement has been entered for the
San Mateo facility. Facility exit costs consist primarily of estimated
shortfalls of sublease rental income compared to minimum lease payments due
under the lease agreements. Costs of approximately $2,300 were accrued and
unpaid at June 30, 1999 and consisted of facility exit costs of $2,000 and
termination benefits of $300, payable through the first quarter of 2000.

The Company anticipates that it may incur additional costs in connection
with severance.

7
8

7. COMPREHENSIVE INCOME

The Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive
Income" effective January 1, 1998. For the three and six months ended June 30,
1999 and 1998, comprehensive income was:

THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
--------------------- -----------------------
1999 1998 1999 1998
------- -------- -------- --------

Net income .................................. $42,995 $ 10,673 $ 83,984 $ 13,637
Other comprehensive income, net of tax:
period ................................ 84 14 (135) (87)

Foreign currency translation adjustments (24) (270) (281) (443)
------- -------- -------- --------
Comprehensive income ........................ $43,055 $ 10,417 $ 83,568 $ 13,107
======= ======== ======== ========

Accumulated other comprehensive income consists of the following:

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

Balance, December 31, 1998...................... $ (1,175) $ 202 $ (973)
Period change................................... (257) (219) (476)
-------- ------ -------
Balance, March 31, 1999......................... $ (1,432) $ (17) $(1,449)
======== ====== =======
Period change................................... (24) 84 60
-------- ------ -------
Balance, June 30, 1999.......................... $ (1,456) $ 67 $(1,389)
======== ====== =======

Unrealized holding gains (losses) were $140 and ($225) for the three and
six months ended June 30, 1999, respectively, and $27 and ($143) for the three
and six months ended June 30, 1998, respectively. Unrealized holding gains
(losses) net of related tax benefits were $84 and ($135) for the three and six
months ended June 30, 1999 and $14 and ($87) for the three and six months ended
June 30, 1998, respectively.

8. STOCKHOLDERS' EQUITY

Common Stock

On January 27, 1999, the Board of Directors adopted, and on May 5, 1999 the
stockholders approved, an amendment to the Company's Third Restated Certificate
of Incorporation to increase the number of authorized shares of Common Stock
available for issuance from 80,000,000 to 150,000,000 shares.

1994 Stock Option Plan

On January 27, 1999, the Board of Directors adopted, and on May 5, 1999 the
stockholders approved, amendments to the Company's 1994 Stock Option Plan, as
amended (the "1998 Restatement"), which, among other things, increased the
aggregate number of shares of Common Stock authorized for issuance thereunder
from 9,570,000 to 11,570,000 shares.

1994 Director Stock Option Plan

On January 27, 1999, the Board of Directors adopted, and on May 5, 1999 the
stockholders approved, an amendment to the Company's 1994 Director Stock Option
Plan increasing the number of shares of Common Stock authorized for issuance
thereunder from 300,000 to 500,000 shares.

8
9

Share Repurchase Program

On October 12, 1998, the Company announced that its Board of Directors had
authorized the Company to repurchase up to four million shares of its Common
Stock during the 12-month period ending October 11, 1999. The timing and amount
of shares repurchased will be determined by the Company's management based on
its evaluation of market and economic conditions. Repurchased shares will be
used for the Company's stock option plans, employee stock purchase plan and
other stock benefit plans, and for general corporate purposes. As of June 30,
1999, the Company had repurchased 3,385,000 shares of its Common Stock, for an
aggregate purchase price of $54,644.

Employee Stock Purchase Plan

On July 2, 1999, the Board of Directors adopted, and on July 30, 1999 the
stockholders approved, an amendment to the Company's 1994 Employee Stock
Purchase Plan, as amended (the "Purchase Plan"), which, among other things,
increased the aggregate number of shares of Common Stock authorized for issuance
thereunder from 400,000 to 1,000,000 shares.

Stockholders Rights Plan

On July 20, 1999 the Company announced that its Board of Directors had
adopted a Stockholder Rights Plan in which common stock purchase rights will be
distributed as a dividend at the rate of one Right for each share of the
Company's Common Stock outstanding as of the close of business on July 30, 1999.

Each Right will entitle Company stockholders to purchase one share of Common
Stock of the Company at a purchase price of $125.00. The Rights will be
exercisable if another party acquires, or obtains the right to acquire,
beneficial ownership of 15% or more of the Company's Common Stock, or upon the
commencement of a tender or exchange offer that, if consummated, would result in
another party acquiring 15% or more of the Company's Common Stock.

In the event of such an acquisition or similar event as described in the
Rights Plan, each Right, except those owned by the acquiring party, will enable
the holder of the Right to purchase that number of shares of the Company's
Common Stock which equals the purchase price of the Right divided by one-half of
the market price of such Common Stock.

In addition, if the Company is involved in a merger or other transaction
with another company in which it is not the surviving corporation, or it sells
or transfers 50% or more of its assets or earning power to another company, each
Right will entitle its holder to purchase that number of shares of common stock
of the acquiring company which equals the purchase price of such company's
common stock. The Company will generally be entitled to redeem the Rights at
$0.001 per Right at any time until the tenth business day following the later of
a public announcement that an acquiring party has acquired, or obtained the
right to acquire 15% or more of the Company's Common Stock or the actual
knowledge by an executive officer of the Company of such acquisition. Unless the
Rights are redeemed or exchanged earlier, they will expire on July 20, 2009.

9. SEGMENTS

The following is presented in accordance with SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." This statement
establishes new standards for defining and disclosing information about a
company's business segments and requires a company to define its segments along
its internal structure and reporting methodology. The Company has identified
only one distinct and reportable segment that meets the criteria established
under SFAS No. 131: Enterprise network and data security solutions. The segment
generates revenue from two distinct product lines: Enterprise solutions (which
includes sales of SecurID(R) tokens, licensing of ACE/Server(R) software,
Keon(TM) (formerly known as BoKS)software, Kane Security Analyst(TM) and Kane
Security Monitor(TM)(R) software, RSA SecurPC(R) software and maintenance and
professional services) and OEM solutions (which includes licensing of BSAFE(R)
cryptography toolkits and protocol products, TIPEM and S/MIME products, KEON(TM)
components, and maintenance and professional services). The Company's chief
operating decision makers (determined to be the Chief Executive Officer and the
President) and the Board of Directors do not manage any part of the Company
separately, and the allocation of resources and assessment of performance is
based solely on the Company's consolidated operations and operating results.

9
10

The Company's operations are conducted throughout the world. Operations in
the United States represent individually more than 10% of revenues or income
from operations. The Company's operations in other countries are individually
insignificant and have been included in "Rest of world" below. The following
table presents information about the Company's operating segments:

THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
PRODUCTS AND SERVICES 1999 1998 1999 1998
--------------------- ------- ------- -------- -------

Enterprise solutions.................................... $39,674 $33,211 $ 75,891 $65,195
OEM solutions........................................... 12,135 10,161 24,590 18,423
------- ------- -------- -------
Total.............................................. $51,809 $43,372 $100,481 $83,618
======= ======= ======== =======

GEOGRAPHIC AREAS

THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
REVENUES 1999 1998 1999 1998
-------- ------- ------- -------- -------

United States........................................... $36,186 $32,672 $ 69,921 $62,518
Rest of world........................................... 15,623 10,700 30,560 21,100
======= ======= ======== =======
Total.............................................. $51,809 $43,372 $100,481 $83,618
======= ======= ======== =======

10
11

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE, PER SHARE, PERCENTAGE AND SQUARE
FOOTAGE 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 Company is a leading provider of enterprise network and data security
solutions to corporate end users ("Enterprise") and original equipment
manufacturer ("OEM") customers. The Company was founded in 1984, began shipping
its SecurID(R) tokens and Access Control Module ("ACM") hardware products in
1986, and introduced its first ACM software products for minicomputers and
mainframe computers in 1988. Prior to 1986, the Company was primarily engaged in
research and development activities. In December 1991, the Company introduced
its ACE/Server software products for enterprise information protection using
client/server architecture. The Company believes that its growth has
historically been driven by the emergence of local and wide-area networks and a
corresponding increase in users with direct access to core enterprise systems
and confidential data. The Company also believes that the number of users with
such direct access is increasing because of the growth of the Internet and
corporate intranets and extranets.

The Company's revenue is derived primarily from two distinct product lines:
Enterprise solutions (which includes sales of SecurID(R) tokens, licensing of
ACE/Server(TM) software, Keon (formerly known as BoKS) software, Kane Security
Analyst(TM) and Kane Security Monitor(TM) software, RSA SecurPC(R) software and
maintenance and professional services) and OEM solutions (which includes
licensing of BSAFE cryptography toolkits and protocol products, TIPEM, S/MIME
products, KEON components, and maintenance and professional services). Sales to
existing customers typically include sales of SecurID tokens and ACE/Server
software for use by different branches or divisions, sales of replacement tokens
(which are programmed at the request of the customer to operate for a fixed
period of up to four years) and sales of additional tokens for use by vendors,
suppliers, customers and clients of the Company's customers. Sales to existing
ACE/Server and Keon customers are typically associated with an increase in the
number of users authorized under a license, and the sales of additional
functionality that can be added to the customer installation. ACE/Server, Keon,
Kane Security Analyst and Kane Security Monitor software license fees are
typically based on the number of users authorized under a license. Sales to
existing customers also include revenue associated with amendments to encryption
engine and patent licensing agreements, usually in order to accommodate
licensing of new software or technology to the customer, to increase the field
of use rights of the customer, or both. Encryption engine and protocol software
licensing terms vary by product, and are typically composed of both initial fees
plus ongoing royalties paid as a percentage of the OEM's product or service
revenues. Sales of ACM hardware and software products have been decreasing
relative to sales of ACE/ Server software for several years due to increased
emphasis by the Company on sales to customers with larger security needs better
met by client/server software solutions such as ACE/Sever software. The Company
believes that this trend will continue.

The Company's direct sales to customers in countries outside of the United
States are denominated in the local currency. As a result, fluctuations in
currency exchange rates could affect the profitability in U.S. dollars of the
Company's products sold in these markets. See Note 9 of Notes to the Company's
Condensed Consolidated Financial Statements. The Company's sales through
indirect distribution channels are generally denominated in U.S. dollars.

The Company's cost of revenue consists primarily of costs associated with
the manufacture and delivery of SecurID tokens and hardware products. The
Company utilizes assembly contractors for most manufacturing. Cost of revenue
also includes royalty fees incurred in connection with the sale of ACE/Server
software and KEON 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. 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, changes in the cost of revenue (including any software license fees
or royalties payable by the Company) and other factors.

11
12

Operating expenses are incurred for research and development, marketing and
selling and general and administrative activities. Research and development
expenses consist primarily of personnel expenses as well as fees for development
services provided by consultants. From time to time the Company has also
purchased, and expensed, research and development technology. Marketing and
selling expenses consist primarily of personnel expenses, commissions and travel
expenses of direct sales and marketing personnel and marketing program expenses.
General and administrative expenses consist primarily of personnel expenses for
administration, finance, human resources, general management and legal and
accounting fees.

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

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 and six months ended June 30, 1999 and 1998.

PERCENTAGE OF PERIOD-TO- PERCENTAGE OF PERIOD-TO-
TOTAL PERIOD TOTAL PERIOD
REVENUE CHANGE REVENUE CHANGE
------------------- --------- ------------------- ---------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------------- -------------------------------
1999 1998 1999 1998
------ ------ ------ ------

Revenue......................................... 100.0% 100.0% 19.5% 100.0% 100.0% 20.2%
Cost of revenue................................. 20.0 27.4 (12.7) 21.7 24.5 6.4
----- ----- ------ ----- ----- ------
Gross profit.................................... 80.0 72.6 31.6 78.3 75.5 24.6
----- ----- ------ ----- ----- ------
Costs and expenses:
Research and development...................... 17.7 17.3 21.6 17.3 17.8 17.0
Marketing and selling......................... 37.1 34.1 30.2 37.0 33.7 31.6
General and administrative.................... 11.9 11.4 25.1 12.1 11.6 25.4
Merger and integration........................ -- -- -- -- 3.1 (100.0)
Exit costs.................................... -- -- -- 6.5 -- 100.0
----- ----- ------ ----- ----- ------
Total................................. 66.7 62.8 26.9 72.9 66.2 32.3
----- ----- ------ ----- ----- ------
Income (loss) from operations................... 13.3 9.8 61.7 5.4 9.3 (29.9)
Interest income and other....................... 3.7 4.8 (8.5) 3.9 5.4 (12.1)
Gain on sale of VeriSign common stock........... 105.8 -- 100.0 128.7 -- 100.0
Gain from increase in market value of equity
investment .................................... 24.3 27.6 5.0 12.5 14.3 5.0
Equity in loss from operations of equity
investment..................................... (.3) (2.7) (85.8) (.5) (1.4) (55.2)
------ ----- ------ ------ ----- ------
Income before provision for income taxes........ 146.8 39.5 343.6 150.0 27.6 554.1
Provision for income taxes...................... 63.4 15.4 393.1 66.4 11.8 576.0
Minority interests.............................. (.3) 5 (161.9) (.1) .5 (113.8)
----- ----- ------ ------ ----- ------
Net income...................................... 83.1% 24.6% 302.8% 83.5% 16.3% 515.2%
===== ===== ====== ====== ===== ======

REVENUE

Total revenue increased 19.5% in the second quarter of 1999 to $51,809 from
$43,372 in the second quarter of 1998. Total revenue increased 20.2% in the
first six months of 1999 to $100,481 from $83,618 in the first six months of
1998. Approximately 77% and 63%, of the increase in revenue during the second
quarter and first six months of 1999, respectively, was attributable to
increased sales from the Enterprise product line, primarily SecurID tokens and
AceServer software. The remaining increase in revenue during the second quarter
and the first six months of 1999 was primarily attributable to increased sales
from the OEM product line, primarily licensing of BSAFE cryptography products.

International revenue (outside of the United States) increased 46.0% in the
second quarter of 1999 to $15,623 from $10,700 in the second quarter of 1998 and
increased 44.8% in the first six months of 1998 to $30,560 from $21,100 in the
first six months of 1998. International revenue accounted for 30.2% and 24.7% of
total revenue in the second quarters of 1999 and 1998, respectively, and 30.4%
and 25.2% of total revenue in the first six months of 1999 and 1998,
respectively. The increase in international revenue was primarily attributable
to the continuing expansion of the Company's international sales force and
increased market penetration of the Company's products in foreign markets.

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13

COST OF REVENUE AND GROSS PROFIT

The Company's gross profit increased 31.6% in the second quarter of 1999 to
$41,427 from $31,479 in the second quarter of 1998 and increased 24.6% in the
first six months of 1999 to $78,661 from $63,109 in the first six months of
1998. Gross profit as a percentage of revenue increased in the second quarter
and the first six months of 1999 to 80.0% and 78.3% of revenues, respectively,
compared to 72.6% and 75.5% of revenues for the second quarter and first six
months of 1998, respectively. The percentage increase in the second quarter and
first six months of 1999 was due primarily to increased revenue with lower
material costs in the Enterprise product line. In addition, the Company
wrote-off, in the second quarter of 1998, a prepaid license fee of $3,000 under
a license agreement with a third party.

RESEARCH AND DEVELOPMENT

Research and development expenses increased 21.6% in the second quarter of
1999 to $9,150 from $7,525 in the second quarter of 1998, and increased 17.0% in
the first six months of 1999 to $17,378 from $14,848 in the first six months of
1998. The majority of the increase in research and development expenses resulted
from increased payroll and overhead expenses associated with the employment of
additional staff. During the first six months of 1998, the Company purchased and
recorded as purchased research and development certain technology from a third
party for $210.

MARKETING AND SELLING

Marketing and selling expenses increased 30.2% in the second quarter of 1999
to $19,243 from $14,774 in the second quarter of 1998, and increased 31.6% in
the first six months of 1999 to $37,186 from $28,254 in the first six months of
1998. Marketing and selling expenses increased as a percentage of revenue to
37.1% and 37.0% in the second quarter and first six months of 1999,
respectively, from 34.1% and 33.7%, in the second quarter and first six months
of 1998, respectively. Approximately 63% and 55% of the increase in marketing
and selling expenses during the second quarter and the first six months of 1999,
respectively, were attributable to increased payroll costs associated with the
employment of additional staff. Approximately 26% and 33% of the increase in
marketing and selling expenses during the second quarter and the first six
months of 1999, respectively, were attributable to increased sales commission
due to increased revenue. The remainder of the increase during the second
quarter and the first six months of 1999 resulted primarily from increased
marketing program expenses.

GENERAL AND ADMINISTRATIVE

General and administrative expenses increased 25.1% in the second quarter of
1999 to $6,181 from $4,941 in the second quarter of 1998, and increased 25.4% in
the first six months of 1999 to $12,114 from $9,660 in the first six months of
1998. General and administrative expenses increased as a percentage of revenue
to 11.9% and 12.1% in the second quarter and the first six months of 1999,
respectively from 11.4% and 11.6% in the second quarter and first six months of
1998, respectively. Approximately 47% and 37% of the increase in general and
administration expenses during the second quarter and the first six months of
1999, respectively were primarily due to an increase in professional fees.
Approximately 28% and 21% of the increase in general and administration expenses
during the second quarter and the first six months of 1999, respectively,
resulted from increased payroll and overhead costs. The remainder of the
increase during the second quarter and the first six months of 1999 were
primarily due to an increase in legal expenses associated with patent
infringement lawsuits.

MERGER AND INTEGRATION EXPENSE

Merger and integration expenses, consisting of legal, accounting, investment
banking and other expenses, incurred in connection with the acquisition of
Intrusion Detection, Inc. were $2,600 in the first six months of 1998.

13
14

EXIT COSTS

During the first six months of 1999, the Company commenced and substantially
completed consolidation of certain operations in order to promote operational
efficiency. In the first quarter of 1999, the Company incurred costs, primarily
severance and facility exit costs, of $6,550 in connection with this effort
costs of approximately $2,300 were accrued and unpaid at June 30, 1999 and
consisted of facility exit costs of $2,000 and termination benefits of $300,
payable through the first quarter of 2000.

The Company anticipates that it may incur additional costs in connection
with severance.

INTEREST INCOME AND OTHER

Interest income and other decreased 8.5% and 12.1% in the second quarter and
the first six months of 1999, respectively to $1,905 and $3,948 from $2,082 and
$4,492 in the second quarter and the first six months of 1998, respectively. The
decrease in interest income and other was primarily due to movement of a portion
of the Company's marketable securities portfolio from taxable investments to tax
exempt obligations.

GAIN ON SALE OF VERISIGN COMMON STOCK

During the second quarter of 1999, the Company sold 510,000 shares of its
VeriSign common stock for a gain of $54,802. The Company sold 1,510,000 shares
of its VeriSign common stock for a gain of $129,291 during the first six months
of 1999. See Note 5 of Notes to Condensed Consolidated Financial Statements.

GAIN FROM INCREASE IN MARKET VALUE OF EQUITY INVESTMENT

The Company recorded a gain of $12,576 and $11,976 resulting from the
write-up under the equity method of its investment in VeriSign during the second
quarter of 1999 and the second quarter of 1998, respectively.

EQUITY IN LOSS FROM OPERATIONS OF EQUITY INVESTMENT

The Company recorded a loss from its proportionate share of VeriSign's
operating results of $167 and $525 in the second quarter and the first six
months of 1999, respectively, from $1,173 in the second quarter and first six
months of 1998.

PROVISION FOR INCOME TAXES

The provision for income taxes increased to $32,844 and $66,676, during the
second quarter and the first six months of 1999, respectively from $6,661 and
$9,863 in the second quarter and the first six months of 1998, respectively,
primarily due to higher income subject to taxation. The Company's effective tax
rates were 43.2% and 44.2% for the second quarter and the first six months of
1999, respectively compared to 38.9% and 42.8% for the second quarter and the
first six months of 1998. The effective tax rate for the second quarter of 1999
decreased compared to the effective tax rate for the second quarter of 1998
primarily due to benefits resulting from the Company's investment strategies
which include the migration of the marketable securities portfolio from taxable
investments to tax exempt obligations. In addition, the Company's tax rate for
the first six months of 1998 also reflected non-deductible expenses associated
with the acquisition of IDI.

MINORITY INTERESTS

A 26% interest of the Company's RSA Japan subsidiary is held by minority
interest shareholders. Minority interests in the subsidiary's net income was
$130 and $63 during the second quarter and the first six months of 1999,
respectively and minority interests in the subsidiary's net loss was $210 and
$458 in the second quarter and the first six months of 1998, respectively.

NET INCOME

As a result of the above factors, net income in the second quarter and the
first six months of 1999 increased to $42,995 and $83,984, respectively, or
83.1% and 83.5% of revenue, respectively, from $10,673 and $13,637,
respectively, or 24.6% and 16.3% of revenue, respectively, in the second quarter
and first six months of 1998.

14
15

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

At June 30, 1999, the Company had cash, cash equivalents and marketable
securities of $242,069 and working capital of $220,809. The Company has
historically funded its operations primarily from cash generated from its
operating activities. The Company believes that working capital will be
sufficient to meet its anticipated cash requirements through at least 2001.

Mergers and Acquisitions

The Company intends to seek acquisitions of businesses, strategic
investments, 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.

Capital Expenditures

The Company's capital expenditures during the first six months of 1999 were
$6,297, which related to additional leasehold improvements, as well as the
purchase of office furniture and equipment, 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 a
management information system, which is designed to better meet the Company's
worldwide information and business process needs. The system, which is
represented by the manufacturer to be Year 2000 compliant, became operational in
October 1998. See "Year 2000 Issues". The Company incurred costs of
approximately $5,300 in connection with the implementation of the system, of
which $500 was spent in the first six months of 1999. The Company does not
anticipate any additional spending of significant amounts on the system, for the
remainder of 1999.

Leasing Expenditures

The Company's principal administrative, sales and marketing, research and
development and support facilities are located in Bedford, Massachusetts under
non-cancelable ten-year leases expiring in August 2008. The facilities aggregate
approximately 183,000 square feet of office space, and the annual base rents
aggregate approximately $3,000, including certain operating expenses. The
Company also leases facilities for research and development and sales and
marketing in San Mateo, California under non-cancelable ten-year leases expiring
in 2008. The facilities aggregate approximately 58,000 square feet of office
space, and the annual base rents aggregate approximately $2,000 including
certain operating expenses. Annual rent escalation provisions for all of theses
leases are based on the Consumer Price Index. The Company also leases facilities
for administration, field sales and customer support throughout the United
States, Canada, Asia, Japan and Europe at annual base rents aggregating
approximately $1,400.

In connection with the consolidation of certain operations that commenced in
January 1999, the Company sublet approximately 10,000 square feet of its San
Mateo, California facility and is actively seeking to sublet approximately
40,000 square feet of facilities at various locations including Bedford,
Massachusetts. The successful sublet of all of these facilities will reduce the
Company's annual rental payment obligations by approximately $100 per month.

15
16

Certain Agreements

The Company has an 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 and Keon software. The agreement has
been amended several times. In order to obtain favorable pricing, the Company
has, from time to time, prepaid Progress Software royalties due under the
agreement. In 1998, the Company prepaid an aggregate of $6,000 in three
installments. The prepaid royalty is recorded as a component of cost of sales as
the related products are sold. Un-amortized prepaid royalties were $3,300 at
June 30, 1999.

During September 1998, the Company entered into Employment Agreements with
substantially all of the Company's management team, including most of the
Company's executive officers. The Board of Directors determined that such
Employment Agreements were necessary to effectively incent and retain key
management team members in a competitive employment marketplace. The Employment
Agreements generally provide for minimum annual salaries aggregating $1,900 and,
among other things, that during the period commencing on September 1, 1998 and
ending on March 1, 2000, the Company may terminate the employee only for
nonperformance of his or her duties, or for cause, subject to criteria and
definitions set forth therein.

In December 1998, the Company amended its Development Agreement with
VeriSign (the "Amendment") to appoint the Company the exclusive distributor of
VeriSign's certificate authority software. The Amendment provides, among other
things, that each year during the first five years following the date of the
Amendment, the Company may elect to retain its exclusive status, subject to
payment by the Company of certain prepaid license fees each year during that
five-year period. In addition to $500 paid at the execution of the agreement,
prepaid license fees are due in minimum quarterly installments and aggregate
$1,100 in 1999, of which $522 was paid in the first six months of 1999, $2,300
in 2000, $3,000 in 2001, $4,000 in 2002, and $4,000 in 2003.

Equity Investments

VeriSign

Sales of Common Stock

The Company generated $6,910 of cash from employees exercising stock options
and employee stock purchase plan purchases during the first six months of 1999.

16
17

Stock Option Repricing

On July 24, 1998 and August 6, 1998, the Board of Directors of the Company
approved a stock option repricing program pursuant to which each holder (other
than certain executive officers and the directors of the Company) of an
outstanding stock option granted under the Plan during the period commencing on
January 1, 1996 and ending on June 30, 1998 (collectively, the "Old Options"),
could elect to receive a new stock option (collectively, "New Options") granted
on August 12, 1998 under the Plan in exchange for cancellation of such holder's
Old Option. The Company repriced the options because the exercise prices of such
options were significantly higher than the fair market value of the Company's
Common Stock, and therefore did not provide the desired incentive to employees.
The Company believes that stock options are a valuable tool in retaining
employees. Each New Option is, among other things, (i) exercisable for the
number of shares of the Company's Common Stock covered by the outstanding
unexercised portion of the Old Option canceled in exchange therefore; (ii) has
an exercise price of $12.062525 (equal to the closing price of the Common Stock
on the Nasdaq National Market on August 12, 1998 and the fair market value of
the Common Stock on such date); and (iii) has the identical vesting schedule as
the Old Option, provided, however, that each such New Option shall not be
exercisable prior to February 12, 1999, with such prohibition on exercise
expiring at a rate of 25% at the end of each three-month period thereafter. New
Options to purchase an aggregate of approximately 5.3 million shares of Common
Stock were granted in exchange for Old Options with exercise prices ranging from
$19.00 to $44.125.

Share Repurchase Program

17
18

Stockholders' Rights Plan

18
19

YEAR 2000 ISSUES

Overview

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
must 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.

State of Readiness

Company Products

The Company has implemented a testing program designed to ensure that its
products continue to operate after December 31, 1999. The testing program has
been completed for the most recent versions of all of the Company's software
products, and substantially completed with respect to the Company's hardware
products.

In measuring Year 2000 readiness, the Company has applied the following
specifications: "Year 2000 Ready" means that: (1) no value for current date will
cause any interruption in operation; (2) date-based functionality must be
consistent for dates prior to, during and after Year 2000; (3) in all interfaces
and data storage, the century in any date must be specified either explicitly or
by unambiguous algorithms or inferencing rules; and (4) Year 2000 must be
recognized as a leap year.

The Company's SecurID Tokens are Year 2000 Ready. Assuming that a customer
is utilizing the Company's software products in conjunction with a Year 2000
Ready operating system, then the Company's most recent software releases,
ACE/Server v3.3, Kane Security Analyst v4.5, Kane Security Monitor v3.2, Keon
Security Server v4, Keon Desktop v4, Keon Agents v4, Keon Agent SDK, Keon UNIX
Platform Security v4, (Keon software products were formerly known as BoKS), KEON
Certificate Server V5.0, SoftID, RSA SecurPC, BSAFE-Crypto-C, BSAFECrypto-J,
BSAFE Cert-C, BSAFE SSL-C and BSAFE SSL-J, are Year 2000 Ready. The Company's
ACE/Sentry hardware products are Year 2000 Ready. Certain prior versions of the
Company's software products, as well as the Company's ACM 100, 400 and 1600
hardware products, are not fully Year 2000 Ready, and customers have been
informed of the status of the Company's products in the ordinary course of
business. In certain circumstances, the Company may make available to customers
who have implemented prior releases of the Company's software products software
patches to make the products Year 2000 Ready.

While the Company has created and implemented what it believes to be an
effective Year 2000 Readiness testing program for its products, the Company's
products may contain undetected errors or defects associated with Year 2000 date
functions. Such errors or defects in the Company's products could result in
delay or loss of revenue and diversion of development resources, which might
materially adversely affect the Company's business, financial condition or
results of operations.

Company Systems

The Company has established a Year 2000 task force to determine the state of
readiness of all Company information technology ("IT") and non-IT systems,
including the microprocessors contained in infrastructure products, such as
card-swipe entry devices, which are used at the Company's facilities. The task
force consists of employees with expertise in areas the Company believes could
be affected if any system is not Year 2000 Ready. 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 Ready, and (ii) replace non-Year 2000 Ready
third-party equipment and software with Year 2000 Ready equipment and software.

The Year 2000 compliance plan is divided into the following phases: (1) the
Inventory Phase, in which the Company identifies all products and systems which
are created or used by the Company in the course of its operations; (2) the
Analysis Phase, in which the Company determines what, if any, Year 2000
Readiness issues may exist with respect to any product or system; (3) the
Solution Development Phase, in which the Company designs and/or obtains from
third-party vendors methods to correct any Year 2000 Readiness issues which were
identified in the prior phase; and (4) the Implementation Phase, in which the
Company deploys solutions for the identified problems.

The Company's Year 2000 task force has substantially completed the
Inventory, Analysis, Solution Development and Implementation phases for all of
the Company's IT and non-IT systems. The task force has identified certain
remaining projects to be completed in the Implementation Phase and the Company
expects those tasks to be substantially completed by October 30, 1999.

19
20

The Year 2000 task force has identified certain IT systems licensed by the
Company's Customer Support and Engineering groups that must be upgraded in order
to make the systems Year 2000 Ready. In each case, the Company has purchased
maintenance and support from those application vendors, and has received or
expects to receive upgrades from the vendors at no additional cost. With respect
to certain other business applications and systems licensed by the Company from
third parties (including but not limited to the Company's PBX and the Company's
management information system installed in 1998), the Company is relying on
those licensors' written representations that the applications are Year 2000
Ready.

Costs to Address Year 2000 Issues

The Company has incurred and anticipates that it will continue to incur
direct costs to modify or replace existing systems used by the Company in the
operation of its business to ensure that all systems will become Year 2000
Ready. Except for the implementation of the worldwide management information
system described above, the Company believes that total amounts spent by it to
date and which it expects to spend during the remainder of 1999 addressing this
issue are not material. See "Capital Expenditures."

In addition, the Company has spent substantial time and effort testing and
evaluating its own products to determine Year 2000 Readiness of those products.
In the case of prior product releases which are not Year 2000 Ready, the Company
expects to devote internal engineering and customer support resources to
resolving issues for existing customers of those products. This effort may
result in a longer development cycle for new Company products.

Risks to the Company

In the event of a failure of some or all of the Company's IT and non-IT
systems on January 1, 2000, the Company's operations may be substantially
curtailed until the Company or its third-party suppliers develop a solution to
address each system's failure. In such event, the Company might be unable to:
(a) produce SecurID tokens, (b) track development of Company software products,
(c) book orders for products, (d) access customer support records, (e) operate
its Internet site, (f) receive email, or (g) prepare its financial statements
for fourth quarter 1999 or periods thereafter.

In addition, the Company has made representations and warranties, both in
contracts and in written communications, to certain of its customers regarding
the Year 2000 Readiness of its products. The Company has reviewed all of those
representations to determine the accuracy of those statements, given the ongoing
Year 2000 testing of the Company's products. The Company has determined that it
made Year 2000 Readiness representations in fewer than 10% of its customer
contracts; many of those customers have requested, and received, Year 2000 Ready
versions of the Company products.

In the event that any contractual representation made by the Company
regarding Year 2000 Readiness is not accurate, the Company will seek to upgrade
the affected customer to the Company's current, Year 2000 Ready, version of the
product(s) being used by that customer. In the event any affected customer
chooses not to upgrade to the most recent versions of the Company's products,
the Company will seek to amend the affected license agreement to address the
error. In the event that the Company: (i) has made a materially inaccurate
statement regarding Year 2000 Readiness of its products, and (ii) is not able to
amend the contract to address the error, the Company may face the risk of one or
more lawsuits from its customers alleging breach of representation.

Contingency Plans

As described above, the Company has identified potential vulnerabilities
associated with the change of the century, both in its own product offerings and
in the systems utilized by the Company in the ordinary course of business. The
Company is devoting resources to resolving the issues inherent in its own
product offerings, as well as working with providers of systems to the Company
to ensure that business is not substantially interrupted as a result of the date
change. However, given the possibility of system failure as a result of the
century change, the Company is currently in the process of formulating one or
more contingency plans. The Company anticipates implementing contingency plans
on or before October 30, 1999.

The foregoing shall be considered a Year 2000 readiness disclosure to the
maximum extent allowed under the Year 2000 Information and Readiness Disclosure
Act.

20
21

Conversion to Euro

Certain of the common member countries of the European Union have agreed to
adopt a new currency, the euro, as their legal currency. On January 1, 1999, the
countries established fixed conversion rates between their existing currencies
and the euro. The Company's systems are configured to process euro denominated
transactions. The Company does not believe the euro will have a significant
effect on its business, financial position, cash flows or the results of its
operations.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

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 on the success of its Keon(TM) product
line, 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
verifying user identities and establishing information access privileges for
such users in an enterprise. The success of the Keon software 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. 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 materially adverse effect on the
Company's financial condition and results of operations.

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

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 general economic conditions abroad, fluctuations in foreign
exchange rates, difficulties in managing accounts receivables, tariff
regulations and difficulties in obtaining export licenses.

All of the Company's products are subject to U.S. export control laws and
applicable foreign government import, export, and/or use restrictions. Minimal
U.S. export restrictions apply to all products, whether or not they perform
encryption. Current U.S. export regulations require export licenses, or at least
a one-time technical review, before most encryption products may be exported to
countries other than Canada. The Company believes that it has obtained necessary
approvals for the export of the products it currently exports. There can be no
assurance, however, that the list of products and countries requiring government
approvals and the applicable regulatory policies 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.

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Exports of RSA's encryption products, or third-party products bundled with
RSA encryption technology, are expected to continue to be restricted by the
United States and various foreign governments. Exports of commercial encryption
products are regulated by the Export Administration Regulations of the U.S.
Commerce Department, while exports of encryption products designed or adapted
for military use require export licenses under the International Traffic in Arms
Regulations of the U.S. State Department. Until recently, the U.S. government
generally prohibited exports of encryption products with key lengths of greater
than 40 bits. Under new regulations issued in 1996 and 1998, commercial
encryption products with key lengths of up to 56 bits may be widely exported
after a one-time technical review by the U.S. Commerce Department. "Key
recovery" encryption products which enable authorized law enforcement agencies
to obtain readable text without the knowledge or cooperation of the end-user may
be exported, regardless of key length, after a one-time technical review.
Certain non-recovery products of any key length are eligible for export to
limited classes of end-users in certain countries, following a one-time
technical review and subject to various post-shipment reporting requirements;
eligible recipients include subsidiaries of U.S. companies, banks and financial
institutions, health and medical organizations, and online merchants. Other
non-recovery encryption products may be exported to other countries and
end-users under special Encryption Licensing Agreements or individual export
licenses which may be issued at the discretion of the U.S. Commerce Department.
These regulations may be modified at any time, and there can be no assurance
that RSA will be authorized to export encryption products from the United States
in the future. As a result, RSA 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.

In the fourth quarter of 1998, the Company established a subsidiary in
Australia which developed a protocol-level encryption technology known as "SSL"
without using any export-controlled U.S.-origin encryption technologies or
software and without "technical assistance" from any U.S. persons. Accordingly,
the Company obtained a written opinion from the U.S. Commerce Department that
this technology is not subject to the jurisdiction of the U.S. export laws. The
technology, however, is subject to the export laws of Australia, and the Company
has received a license from the Australian Government to export object code
versions of the SSL technology to specified countries, including the United
States. In order to remain outside of U.S. export control jurisdiction, the
Company has implemented policies and procedures to ensure that U.S. personnel
working for the Company do not inadvertently provide technical assistance to the
Company's Australian subsidiary which is developing future versions of the SSL
technology. However, there can be no assurance that the U.S. government will not
deem the SSL technology to be subject to U.S. export laws in the future, or that
the applicable Australian export restrictions will not be modified in the
future, or that the Company will continue to receive the required Australian
export authorizations.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

The Company does not use derivative financial instruments. The Company
generally places its marketable security investments in high credit quality
instruments, primarily U.S. Government and Federal Agency obligations,
tax-exempt municipal obligations and corporate obligations with contractual
maturities of ten years or less. The Company does not expect any material loss
from its marketable security investments and therefore believes that its
potential interest rate exposure is not material. The Company also makes
strategic equity investments determined by the Board of Directors which are
strategically synergistic to the Company. The Company routinely evaluates the
realizable value of these investments using qualitative and quantitative factors
including discounted cash flow analysis and liquidation value assessments. Based
on these evaluations the Company reduced investments by $3.6 million in December
1998.

The Company invoices customers primarily in U.S. Dollars and in local
currency in those countries in which the Company has branch and subsidiary
operations. The Company is exposed to foreign exchange rate fluctuations from
when customers are invoiced in local currency until collection occurs. The
Company does not enter into foreign currency hedge transactions. Through June
30, 1999, foreign currency fluctuations have not had a material impact on the
Company's financial position or results of operation, and therefore the Company
believes that its potential foreign currency exchange rate exposure is not
material.

The forgoing risk management discussion and the effects thereof are
forward-looking statements. Actual results in the future may differ materially
from these projected results due to actual developments in global financial
markets. The analytical methods used by the Company to assess and mitigate risk
discussed above should not be considered projections of future events or losses.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On or about December 11, 1998, a purported class action was filed in the
United States District Court for the District of Massachusetts on behalf of all
purchasers of the Company's Common Stock during the period from and including
September 30, 1997 through July 15, 1998: Fitzer v. Security Dynamics
Technologies, Inc., Charles R. Stuckey, Jr., D. James Bidzos, Arthur W.
Coviello, Jr., John Adams, Marian G. O'Leary and Linda B. Saris, Civil Action
No. 98-CV-12496-WGY. The plaintiff subsequently dismissed without prejudice the
claims against Ms. Saris. The plaintiff filed an amended complaint on May 4,
1999. The amended complaint in the action asserts that the defendants misled the
investing public concerning demand for the Company's products, the strength of
its technologies, and certain trends in the Company's business. Plaintiffs seek
unspecified damages, interest, costs and fees of their attorneys, accountants
and experts. On July 30, 1999, the Company served its Motion to Dismiss the
Amended Complaint on the plaintiffs. An amended complaint, to which the
defendants will respond, has not yet been filed. The Company intends to defend
the lawsuit vigorously. Although the amounts claimed may be substantial, the
Company cannot predict the ultimate outcome or estimate the potential loss, if
any, related to the lawsuit. The Company believes that the disposition of this
matter will not have a material adverse effect on the Company's consolidated
financial position. However, the adverse resolution of the lawsuit could
materially affect the Company's results of operations or liquidity in any one
annual or quarterly reporting period.

On or about May 20, 1999, Kenneth P. Weiss, the founder and a former
director, officer and employee of the Company, filed a demand for arbitration
alleging that: (a) the Company constructively terminated Mr. Weiss in May 1996
in violation of his Employment Agreement with the Company, and (b) the Company
breached its obligations under Mr. Weiss' Employment Agreement by refusing to
release certain assignments of patents. The Company believes that Mr. Weiss'
claims are without merit, and intends to defend the matter vigorously. On July
26, 1999, the Company filed, with the American Arbitration Association, an
answering statement and counterclaim to Mr. Weiss' demand.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

At the 1998 Annual Meeting of Stockholders of the Company (the "Annual Meeting")
on April 22, 1999 which was convened and adjourned to May 5, 1999, the following
matters were acted upon by the stockholders of the Company:

1. The election of three Class II Directors for the ensuing three years;

2. The approval of the amendment to the Company's Third Restated Certificate
of Incorporation, as amended, to increase the number of authorized shares
of Common Stock from 80,000,000 to 150,000,000 shares;

3. The approval of the amendment of the Company's 1994 Stock Option Plan, as
amended - 1998 Restatement to (i) increase from 9,570,000 to 11,570,000 the
number of shares of Common Stock authorized thereunder; and (ii) increase
the maximum number of shares of Common Stock that may be issued in any
calendar year to a participant thereunder from 300,000 to 400,000 shares;

4. The approval of the amendment to the Company's 1994 Director Stock Option
Plan, as amended, to increase the number of shares of Common Stock
authorized for issuance thereunder from 300,000 to 500,000 shares; and

5. Ratification of the appointment of Deloitte & Touche LLP as independent
auditors of the Company for the current year.

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The number of shares of Common Stock issued, outstanding and eligible to
vote as of the record date of March 4, 1999 were 41,508,349. The other directors
of the Company, whose terms of office as directors continued after the Annual
Meeting, are Arthur W. Coviello, Jr., George M. Middlemas, Joseph B. Lassiter,
III, Charles R. Stuckey, Jr. and James K. Sims. The results of the voting on
each of the matters presented to stockholders at the Annual Meeting are set
forth below:

VOTES VOTES VOTES BROKER
FOR WITHHELD AGAINST ABSTENTIONS NON-VOTES
---------- --------- --------- ----------- -----------

1. Election of three Class II Directors:
D. James Bidzos.............................. 38,088,042 451,068 N.A. N.A. N.A.
Richard L. Earnest........................... 36,415,534 2,123,576 N.A. N.A. N.A.
Taher Elgamal................................ 37,713,266 825,844 N.A. N.A. N.A.

2. Amendment of the Third Restated
Certificate of Incorporation................... 31,059,501 N.A. 7,340,537 139,072 N.A.

3. Amendment of the 1994 Stock Option Plan,
as amended - 1998 restatement.................. 14,551,526 N.A. 13,245,003 158,905 10,583,676

4. Amendment of the 1994 Director
Stock Option Plan.............................. 15,589,528 N.A. 12,201,868 164,038 10,583,676

5. Ratification of Independent Auditors........... 35,139,229 N.A. 3,267,434 132,447 N.A.

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:

The Company filed no Current Reports on Form 8-K during the quarter for
which this report is filed.

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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/ JOHN F. KENNEDY
----------------------------------------------
John F. Kennedy
Senior Vice President,
Finance, Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)

Dated: August 16, 1999

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EXHIBIT INDEX

ITEM DESCRIPTION
- ----- -----------
3.1 Third Restated Certificate of Incorporation, as amended.
10.1 Sublease Agreement, dated as of April 12, 1999, by and between
the Registrant and netDialog Incorporated
10.2 1994 Stock Option Plan, as amended - 1998 Restatement,
as amended, is incorporated herein by reference to Appendix A
to the Registrant's Preliminary Schedule 14A filed
March 5, 1999 (File No. 000-25120).
10.3 1994 Director Stock Option Plan, as amended.
11 Computation of Income Per Common and Common Equivalent
Share.
27 Financial Data Schedule.