Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No þ

     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 o No þ

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The aggregate market value of the Common Stock issued and outstanding and held by non-affiliates of the Registrant, based upon the closing price for the Common Stock on the NASDAQ National Market on June 30, 2005 was approximately $712,760,000. All executive officers and directors of the Registrant have been deemed, solely for the purpose of this calculation, to be “affiliates” of the Registrant. This determination of the affiliate status is not necessarily conclusive.

     The number of shares of the registrant’s Common Stock outstanding as of March 13, 2006 was 25,545,126.

     Part III incorporates information by reference from the Registrant’s proxy statement for the Annual Meeting of Stockholders, which proxy statement in definitive form (or an amendment to this Form 10-K) will be filed no later than 120 days after the close of the Registrant’s fiscal year ended December 31, 2005.

          Certain statements in this Annual Report on Form 10-K, the exhibits hereto and the information incorporated by reference herein are considered “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. These risks, uncertainties and other factors include, among others, the risk factors discussed in Item 1A of this Annual Report on Form 10-K. As a general matter, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of such terms or other comparable terminology. We expressly disclaim any obligation or undertaking to publicly release any revisions to “forward looking statements” to reflect events or circumstances after the date that this report is filed with the Securities and Exchange Commission or to reflect the occurrence of anticipated events.

Overview

          We develop, market, sell, and support a portfolio of hardware and software information security products and services that protect and secure communications, intellectual property, and information and identities. SafeNet’s own intellectual property has been a foundational part of the security industry, with our technology being used by numerous Global 2000 companies. We have a strong market position in each of the markets we serve: High Speed Encryption, Borderless Security (comprehensive identity management platform), Classified Government Encryption, Rights Management, and Original Equipment Manufacturer (OEM). Our products and services are used to create secure wide area networks (WANs) including asynchronous transfer mode (ATM), Frame, Link, and Synchronous Optical Networks (SONET), virtual private networks over the Internet (VPNs); wireless networks including 802.11, security management, intrusion prevention, software and entertainment content anti-piracy, license management and revenue protection; and identity management and privacy of information (POI) to prevent security breaches that could result in unauthorized access to confidential data, invasion of privacy, stolen information, and financial loss. Our information security solutions allow our customers to lower the cost of deploying and managing secure, reliable private networks and enable the use of the Internet and wireless networks for secure business communications and transactions with customers, suppliers, and employees

          SafeNet technology is a market leader in remote access client software and in USB authentication tokens that eliminate user names and passwords; Secured Socket Layer (SSL) acceleration devices providing fast and secure online transactions; software and entertainment content security, and licensing products preventing software piracy and enhancing revenue opportunities; high-assurance security products; and SecureIP Technology licensed to Internet infrastructure manufacturers, service providers, and security vendors.

SafeNet’s full range of security capabilities and products include:

          Our products are based on industry standard encryption algorithms and communication protocols that allow for integration into large networks and interoperability with other market-leading network devices and applications. Our solutions incorporate our security technologies, including our silicon chips, smart cards, USB tokens, network appliances, client software, and management software, to provide a vertically integrated solution that addresses the stringent security needs of our customers. Our products enable our customers to expand their existing networks efficiently and to integrate these networks with lower-cost VPNs. Our security products are centrally managed with our management software, which enables policy management and the secure, scalable monitoring of network devices, applications, network traffic, and security events.

          Founded in 1983, we are headquartered in Belcamp, Maryland. We have a long history of technology and security innovation and dedication to continuous product improvement. In 1995, we developed our first Internet VPN solution for a major financial institution. Through business relationships with end-user customers, such as the U.S. Department of Defense, the Internal Revenue Service, the U.S. Department of Homeland Security, Citigroup, and various OEMs, such as Cisco Systems and Texas Instruments, we have considerable experience developing and deploying network security solutions. Our Internet address is www.safenet-inc.com. On this web site, we post reports and other documents we file with or furnish to the Securities and Exchange Commission as soon as reasonably practicable after they are electronically filed or furnished, including our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and amendments to those reports.

          We periodically review and consider possible acquisitions of companies that we believe will contribute to our long-term objectives and discuss such acquisitions with the management of those companies. Such acquisitions, which may be material, may be made from time to time.

          On December 1, 2005, we completed the acquisition of Eracom Technologies AG, a leading IT security manufacturer and pioneer of Hardware Security Modules (HSM). Eracom augmented our Borderless security offering with the addition of its Hardware Security Modules designed for the Electronic Funds Transfer (EFT), credit card and ATM segments of the financial services market, and its POI products that encrypt data on PCs, laptops, servers, and portable media. The results of operations of Eracom Technologies AG have been included in our consolidated results of operations beginning December 1, 2005.

          Effective June 1, 2005, we acquired all of the issued and outstanding shares and vested stock options of MediaSentry, Inc. The results of operations of MediaSentry have been included in our consolidated results of operations beginning June 1, 2005. MediaSentry was a global provider of anti-piracy and business management services for the recording and motion picture industries. MediaSentry’s anti-piracy solutions help clients detect and deter unauthorized distribution of copyrighted content and prosecute those who engage in piracy. MediaSentry’s customers included the world’s largest music and print publishers, record labels, motion picture studios, software companies, and industry associations, such as Warner Brothers, The Motion Picture Association of America and the Business Software Alliance. This acquisition expands our anti-piracy offerings to include the protection of copyrighted content on peer-to-peer networks, while gaining a new competency in managed services with a desirable customer list.

          On April 4, 2005, we completed the acquisition of DMDsecure.com, B.V. in a cash transaction. DMDsecure was a leader in carrier grade server DRM software for solution providers and software vendors as well as broadcasters, broadband and mobile operators and service providers. DMDsecure broadened our Rights Management business by providing technology that protects the electronic delivery of wide ranging content. As a result of the acquisition, DMDsecure has become our wholly-owned subsidiary. The results of operations of DMDsecure have been included in our consolidated results of operation beginning on April 4, 2005.

          On December 15, 2004, we completed the acquisition of Datakey, Inc., which expanded our customer base and product offerings to include token-based solutions that simplify enterprise-wide access and identity management. Operations of Datakey have been integrated into our Enterprise Security Division.

          On March 15, 2004, we completed the acquisition of Rainbow Technologies, Inc. Rainbow provided information security solutions for mission-critical data and applications used in business, organization and government computing environments.

          On November 18, 2003, we completed the acquisition of the OEM Products Group of SSH Communications Security Corp, a company based in Finland. The business acquired included SSH’s VPN client software and security and networking toolkits.

          In February 2003, we acquired the assets of Raqia Networks, Inc., a development stage company, consisting primarily of technology-related intangible assets.

          In February 2003, we also acquired Cylink Corporation, which expanded our customer base and our product offerings to include security solutions for WANs, such as our ATM, Frame and Link encryptor products. Operations of Cylink were integrated into the Enterprise Security Division.

     On February 8, 2006, we announced that we reached an agreement with the board of directors of nCipher plc, a company incorporated under the laws of England and Wales, on the terms of a recommended cash offer for the entire issued (and issuable upon exercise of options granted) ordinary share capital of nCipher, for 300 pence in cash for each nCipher share (the “Offer” and the “Offer Price”, respectively). Based on the Offer Price, the number of nCipher outstanding shares and the number of nCipher shares issuable upon exercise of options granted, the total consideration to be paid by us would be approximately £86.1 million (approximately US$150 million). nCipher provides HSM technology, disk encryption technology and other products for identity protection and management. We expect the acquisition to close in the second quarter of 2006. See the discussion under the “Recent Development” section of Item 7 to this Form 10-K.

          Enterprises increasingly require secure and reliable networks to conduct electronic commerce, collaborate with customers, and provide remote access for employees. The pervasive

use of WANs and the Internet is substantially increasing the volume of electronic communications, transactions and the demand for network security products and services.

          Today, large networks contain numerous points of vulnerability, which can make passwords, network architecture, and other critical information vulnerable to attack. Communications may pass through dozens of countries, over satellites, through numerous operating systems in computers and routers, and through a variety of organizations or communications providers and their premises. Consequently, multiple parties have access, or can acquire access, to proprietary data within these networks. Because of this exposure, enterprises must have access to secure paths of communication.

          Secure electronic communications and transactions have traditionally required costly private networks and dedicated leased lines. Over time, enterprises have invested heavily in WANs (ATM, frame relay and link) to conduct secure communications and transactions, resulting in a significant installed base of these networks. However, there are several limitations that exist with traditional leased-line WANs. Their proprietary, fixed nature results in significant costs and reduced flexibility and scalability. The need for dedicated leased lines and excess capacity to meet peak load requirements results in networks that are significantly more expensive to maintain and administer. Additionally, providing network access is made difficult and expensive by the need to add another dedicated leased-line for each new location, partner and employee that needs to be connected to the network. In the future, we expect that most networks will utilize both WANs and the Internet, but will increasingly depend on the Internet as they expand to support a much larger number of users. As a result, these enterprises will require solutions that seamlessly manage both types of network technologies.

          The adoption of VPNs and, more recently, the Internet Protocol Security (IPSec), a widely used industry protocol to enable secure transmissions over the Internet, has enabled the secure transfer of information and data over the Internet. A VPN is a communications system using encryption technology that creates a private “tunnel” through the Internet and other communications systems, assuring authentication of users and privacy of information. Increased availability of VPN services has allowed a secure alternative to traditional WANs. VPNs allow organizations to use public networks for their communications backbone. Because the Internet is less expensive to use than private networks, enterprises can generally achieve substantial cost savings by using VPNs while taking advantage of the global availability and access to the Internet. VPNs have three key uses:

          Some network security products emphasize one or more forms of security technology other than VPNs, such as firewalls, intrusion detection, and anti-virus. Firewalls use filtering technology to control external access to an enterprise network. Intrusion detection, or intrusion prevention, is intended to alert network operators of attempts to penetrate customers’ networks. Similarly, anti-virus products address the prevalence of virus attacks that proliferate through the Internet, and migrate into private networks through their users’ computers. We believe that encryption and authentication should be the first line of defense in the network’s security strategy, with firewalls, intrusion detection and anti-virus solutions providing additional defense for communications received from remaining, unsecured sources. We further believe that encryption, by protecting the privacy of the information, ensuring the integrity of the data and authenticating the source and destination of the communication, is the foundation technology upon which a secure network can be built.

          Today’s economy survives on communication — from small businesses to globe-spanning enterprises to government, all require flexible solutions that connect their organizations together and enable the flow of information. VPNs have become the overwhelming choice to connect remote workers, branch offices, and wide area networks together using public networks like the Internet. But while VPN gateway hardware addresses the needs of the network and remote access entry points, every VPN also consists of hundreds of individuals who need remote access from their laptops and desktop computers while in small offices, at home, or while traveling.

          As a market leader in VPN technology, we have designed an SSL VPN remote access solution to address the needs of every remote access user. This solution includes an advanced VPN client offering Advance Encryption Standard (AES) encryption, device authentication, and Federal Information Processing Standards (FIPS) validation for high-security, mission critical remote access as well as an SSL VPN appliance providing instant remote access using SSL encryption to all communications over the Internet from a standard Web browser. All of our remote access solutions support two-factor authentication for your digital identity.

          Software is one of the most valuable assets of the information age, running everything from PCs to the Internet. As the number of computers grows, so does the rate of software piracy. Protecting valuable intellectual property and securing revenues are now critical concerns for every software development company. Development of software applications requires major investments in time, money and other resources. Software piracy denies developers their rightful return on investment. In addition, it harms paying customers, who ultimately bear a substantial portion of the cost of software theft in the form of higher license fees.

          We believe that developing the necessary tools for protecting revenue rights has become yet another strong security effort for us. Our product offering has been one of the industry’s most trusted anti-piracy solution for more than 20 years, now protecting more than 35 million applications worldwide. With an ongoing commitment to quality products and superior customer service and support, we deliver necessary solutions to help developers defend their applications against the growing threat of software piracy as well as anti-piracy hardware keys to help protect revenues and defends markets against software piracy and licensing non-compliance.

          As the Internet has become pervasive, the online distribution of content is gaining momentum. The Internet represents a new channel for content owners of all kinds, including software and entertainment, such as audio, video and gaming. We have assembled products and services that help establish a secure environment upon which content can be distributed, piracy can be combated, and various licensing models designed to embrace emerging opportunities can be adopted.

          We are also beginning to address interest by appliance manufacturers that want to exploit the efficiency of the Internet by remotely upgrading their products and engage additional features of deployed appliances. This approach reduces costs and improves customer service. On June 29, 2005, we introduced Sentinel RMS, a product designed to address the increasingly dynamic software licensing models. It is also being used by appliance manufacturers to improve their customer service and cost structures in the manner described above.

          Critical infrastructures cannot afford downtime. The lives and well-being of citizens and military personnel depend on impenetrable network security. Government, finance, utility, communications, medical, and research companies need a high performance solution that also provides extraordinary network security.

          We have developed a complete family of devices for encrypting high-speed communications, offering the flexibility to encrypt data at the Physical (Layer 1), Data Link (Layer 2), and Network layers (Layer 3), and providing a solution for implementing high-speed encryption without changing an organization’s existing network infrastructure. We believe our product line exceeds the industry standards for performance, high assurance, and management traditionally offered by network equipment providers.

          Whether maintaining or deploying a SONET or Synchronous Digital Hierarchy (SDH) network, we provide the highest level of encryption protection. Our SONET Encryptors are now being deployed by larger banks, utilities, and Federal Government agencies. They offer extremely high level security. They are also more bandwidth-efficient, which results in a noticeable increase in network performance. And we believe they are faster, easier, and less intrusive to implement than earlier technology.

          We develop, market, sell, and support a portfolio of hardware and software network security products and services that provide secure communications and data services over WANs and VPNs. Our products and services address a wide range of customer and market needs. Through our Enterprise Security Division, we sell high-performance security solutions to address the high-level security needs of governments, financial institutions, and other security-sensitive commercial customers. By providing a solution that incorporates our security technologies, including our silicon chips, appliances, servers, client software, USB tokens and smart cards, and management software, we are able to provide a vertically integrated solution that addresses the stringent security needs of these customers.

          For the development of technology for top secret and Type 1 secure data, voice, fax, and other electronic communication, we are a leading developer and manufacturer of NSA-certified, high-reliability cryptographic microcircuits, ground units, and flight units for space communication. Our communications security devices include network link encryptors and crypto cards, as well as advanced ASICs and cryptographic/acceleration equipment used in sensitive electronic messaging.

          From our beginnings, we have pioneered innovative information security solutions critical to homeland security — solutions that demand the utmost from solution providers. Time-to-market, quality and reliability are just a few of the key components. Our history, renown, and expertise enable these key components for any information security (INFOSEC) application or environment. As a leading manufacturer of high-grade encryption and decryption equipment essential to homeland security and critical infrastructure protection, our research and development personnel, product manufacturing teams,

and facilities operate at the forefront of INFOSEC technology. Because satellite uplink commands must be encrypted and authenticated to assure legitimate control of the satellite and its operation, and sensitive and classified communications via satellite must be encrypted to protect them from interception and compromise, we develop and maintain space communications security for government and commercial customers. On September 29, 2005, we announced the award of a $150 million contract for our next generation classified-grade, Cryptographic Modernization (Crypto Mod)-compliant KIV-7M Link Encryptor. This is the first in what we believe will be a series of products addressing the Crypto Mod opportunity

          We also provide, through our Embedded Security Division, a broad range of security solutions, including silicon chips, accelerator cards, servers, licensed intellectual property, and software products, to OEMs that embed them into their own network and wireless products. Added to this are our Rights Management solutions, including anti-piracy and revenue protection software and hardware. These solutions provide application developers, content publishers, and appliance manufacturers with the solutions they need to convert sharing of digital media from a revenue drain into an efficient distribution channel — securely leveraging the power of personal networking.

       Our objective is to be the leading provider of products and services that enable secure digital identities, secure communications, and secure applications over WANs, wireless networks, and the Internet. To achieve this objective, we continue to pursue the following strategies:

      Our Enterprise products and services are typically sold to government agencies, financial institutions and other commercial customers. Our Embedded products are typically sold to OEM customers as components, such as silicon chips, accelerator cards, licensed intellectual property and software. Additionally, our rights management products and services are sold to software vendors, appliance manufacturers, and content owners and aggregators.

     SafeEnterprise™ Security System. SafeEnterprise Security System provides security solutions for government and financial institutions that require a high level of security to protect their networks from unauthorized access and to protect sensitive information as it travels over both WANs and the Internet. These solutions, which include both appliances and software that can be sold as an integrated turnkey solution or separately as discreet hardware and software products, consist of network gateways, backbone encryptors, remote access, client software and our management software. The SafeEnterprise system provides management functionality, including policy creation, policy enforcement, network monitoring, activity auditing and troubleshooting. SafeEnterprise provides a secure solution for both WANs (ATM, frame relay, link, and SONET) and the Internet.

          Appliances. The SafeEnterprise Security System includes HighAssurance Gateways that employ the U.S. government endorsed Triple Data Encryption Standard (3DES) and Data Encryption Standard (DES) algorithms and AES algorithms. In addition, the SafeEnterprise Security System also includes ATM, Frame, Link and SONET Encryptors that employ 3DES and DES algorithms and the iGate SSL appliance.

     Borderless Security

          Our borderless security solution is a new approach to resolving the information security problems of today’s widely distributed, heterogeneous computing environments. Our solution, known as the borderless security platform, combines authentication, authorization, and confidentiality-wrapped with robust management into an easily deployed and easily managed solution that minimizes the challenges associated with perimeter-based solutions and security point products from multiple vendors. The platform enables granular authentication and authorization to applications, files, and networks, and provides enforcement of role and risk-based authorization policies. This approach is based on open standards, providing an organization with the ability to deploy all or part of the solution, each of which easily co-exists and complements existing technologies and consists of Client, Server, and Management components, tightly integrated in easy-to-deploy packages.

          These uniquely packaged components provide a product that merges authentication, Single Sign-On authorization, and confidentiality into one tightly integrated solution for all Web and non-Web applications and resources. With rapid deployment capabilities that leverage and protect existing technology and infrastructure investments, these components allow business units or organizations to respond quickly to opportunities that require electronic access to data by customers, partners, or suppliers.

     Mykotronx Products

          SafeNet Mykotronx is a manufacturer of high-grade INFOSEC and COMSEC devices for use in space and other sensitive digital communication environments.

          Space Communications Security: SafeNet Mykotronx offers a wide variety of cryptographic ASIC solutions for both space and commercial voice and data applications. For voice and data applications, our single chip cryptographic solutions include the MYK-82A (“Capstone”), Krypton, and MYK-85 Key Management Unit. For network server acceleration, we offer FastMAP and NSOC3 integrated circuits which provide the most advanced performance features for public-key cryptography and IPSec processing. And for space applications, SafeNet Mykotronx ASIC products include:

          Cryptographic Cards: Addressing Type 2 Encryption/ Decryption, Secure Hash, and Key Exchange, the SafeNet Mykotronx FORTEZZA^tm Crypto Card implements cryptographic security and authentication methods in a PCMCIA hardware token for Government and commercial applications. The Card provides portable security, together with on-board storage of user credentials, keys, and digital certificates. Fully FORTEZZA^tmcompliant, the card incorporates the National Security Agency-certified CAPSTONE RISC-based cryptographic processor. It is the hardware crypto token chosen to secure the Defense Messaging System (DMS).

               A breakthrough in PCMCIA Technology and used by the Government to protect top secret information, the FORTEZZA^tm Plus Cryptocard is the solution for both current and evolving INFOSEC applications. MISSI compatible and PC CARD 95, 16-bit data I/ O compliant, the FORTEZZA^tm Plus Cryptocard is the cryptographic engine for the Secure Terminal Equipment (STE). The size of a credit card, FORTEZZA^tm Plus takes advantage of such commercial network technologies as ISDN to deliver high quality secure digital voice/data services. In addition, the card incorporates the National Security Agency-certified Krypton 4C RISC-based cryptographic processor. On March 14, 2005 SafeNet announced that it was awarded a $7.7 million contract from the Department of Defense (DOD) to develop the Enhanced Crypto Card (ECC), the next-generation version of SafeNet’s FORTEZZA Plus Crypto Card.

          Network Security: The KIV-7M is among the first products available that are fully compliant with the U.S. Government’s Cryptographic Modernization Program administered by the National Security Agency. Through this Program, the U.S. Government has the ability to upgrade the security infrastructure of its communication architectures to meet present and future security needs. The KIV-7M has been in development during the last two years and meets the requirements of the NSA’s Link Encryptor Family Interoperability Specification (LEFIS), which mandates modes of operation to provide interoperability. The KIV-7M is a multichannel, multifunction encryptor and facilitates users to interoperate with a number of legacy devices in a single-unit reducing user operating costs and saving valuable space and weight aboard vehicles, ships and aircraft. It is fully reprogrammable permitting it to be reconfigured for new security features as they are developed, and it is network-capable by the addition of an optional HAIPE-compliant interface card.

          The SafeNet Mykotronx WLA-7HS Wireline Interface Adapter Module was developed specifically to interface communications equipment with field wire at data rates from 1.2 kbps to 2.048 Mbps at distances up to 4 kilometers. A user-friendly, menu-driven operator interface simplifies programming of all operational features. The standard EIA-530 ciphertext interface supports direct connection to the KIV-7HS and the entire KIV-7 family of products. It also facilitates connections with other communications equipment requiring connectivity to field wire.

          Embedded Solutions.

          We provide integrated security solutions for networking and communications OEMs. Our security platforms are deployed by the leading global telecommunications, enterprise/SOHO, wireless and semiconductor vendors for their next-generation networking and communications solutions.

We provide security systems, including QuickSec VPN security software, SafeXcel security processors, and silicon-proven semiconductor IP that deliver protection while reducing cost and time to market for our customers.

Sentinel Rights Management Suite

      SafeNet’s Rights Management suite, featuring Sentinel anti-piracy and license management products, enable application developers and appliance manufacturers to defend against the revenue leakage and market erosion caused by piracy and licensing non-compliance and consists of the following products:

          Our portfolio of VPN security products is based on SecureIP Technology^TM. SecureIP Technology is the intellectual property underlying the building blocks of security applications that enable entities to securely use the Internet and other shared networks. SecureIP Technology is implemented in our CGX Library, a library of more than 60 cryptographic commands, processes and interfaces that provides a flexible and secure application that is portable across many processors and operating systems. The CGX Library is embedded in our chips, accelerator cards, and software clients, forming a seamless suite of readily embeddable products for our OEM customers. In addition, we apply our security technologies at each layer of the enterprise; not only the embedded technologies, but also in the designs of the gateways and the systems resulting in integrated enterprise security systems with high level performance.

          The majority of our customers are U.S. government agencies, financial institutions and many of the leading OEMs.

          Our significant end-user (Enterprise) customers include:

          We provide customer support through a staff of support engineers knowledgeable in both our network security systems and products, and complex computer networks. In addition to supporting customers, this group of engineers performs system level quality assurance testing of new products and product enhancements. We provide customer telephone support, including 24 hour a day “hot line” support. In addition, we offer on-site training, installation and trouble-shooting services, generally on a fee basis.

          We provide limited warranties on our hardware products for periods of ninety days up to two years upon delivery of the product. After warranty expiration, clients may purchase an extended warranty support contract. This contract extends warranty service for an additional one-year period, providing repair or replacement of defective products and telephone support. We also offer support on a time and materials basis.

       Our marketing department is dedicated to marketing communications, developing sales tools and sales support programs, public relations, product launch support, events and partner programs. Our marketing efforts focus on building brand recognition and developing leads for our sales force.

       To achieve these objectives, our marketing program includes:

       Some of our network security products contain encryption algorithms that are subject to the export restrictions administered by the Bureau of Industry and Security, U.S. Department of Commerce. These restrictions permit the export of encryption products based on country, algorithm and class of end-user. They prohibit the export of encryption products to some countries and to business entities that are not included in a range of end-users.

      We have assembled a team of engineers with experience in the fields of computing, network systems design, Internet routing protocols, security standards and software. Our engineering team has experience in developing and delivering hardware, software, encryption and authentication technology, accelerator cards and integrated custom silicon chips.

      We believe strong product development capabilities are essential to our strategy of enhancing our core technology, developing additional product functionality and maintaining the competitiveness of our products. Our current significant initiatives include:

          We will continue to devote resources to the latest security technology and to meet the increasing demands of our customers and the market. Our internal research and development expenses were $31.2 million on a historical basis for the year ended December 31, 2005, $23.8 million for the year ended December 31, 2004 and $14.7 million for the year ended December 31, 2003.

          Orders for our products are usually placed by customers on an as-needed basis and we typically ship products within five days to 10 weeks of receipt of a customer’s firm purchase order. Our backlog consists of all orders received, where the anticipated shipping date is typically within six months. Because of the possibility of customer changes in delivery schedules or cancellations of orders, our backlog as of any particular date may not be indicative of sales in any future period. We seldom maintain long-term contracts with our customers that require them to purchase our products. Our backlog as of December 31, 2005 was approximately $48.3 million, which we expect to realize in 2006.

          SafeNet designs and develops or participates in the design and development of all key components of our appliances, software and silicon chips, which are fabricated by contract manufacturers and chip foundries. Our silicon chips are primarily manufactured by Analog Devices, Samsung, Toshiba, LSI, Cypress Semiconductor and Philips Semiconductor. We outsource the manufacturing of our appliance and token products primarily to ISO 9001 / 2000 registered privately-held contract manufacturers. Where we have high volume operations, SafeNet employees reside at the contract manufacturer on a full time basis to assure our quality levels are maintained and we are allocated appropriate levels of capacity to meet our on time delivery targets. The outsourced operations include engineering prototypes, pre-production runs, full turnkey box-builds and product drop shipments. We also design, specify and monitor all the testing required to meet our internal and external quality control guidelines. Outsourcing allows us to reduce fixed overhead and personnel costs and provides greater flexibility to match product and market demands. In order to maintain control over costs, we have manufacturing service agreements with all key appliance and token contract manufacturers and have negotiated contract pricing with all chip foundries. However, the unavailability of the contract manufacturers and foundries we utilize could substantially decrease our control of the cost, quality and timeliness of the manufacturing process.

          The network security market is highly competitive and subject to rapid technological changes. We expect to face increasing competitive pressures from competitors as network security becomes more prevalent. We currently compete against companies that have substantially greater financial resources, sales and marketing organizations, market penetration and research and development capabilities, as well as broader product offerings and greater market presence and name recognition. There are also a number of other hardware and software data encryption methods and security technologies on the market that compete with our products.

          We believe that the principal competitive factors affecting the network security market include standards compliance, product quality and reliability, technical features, network compatibility, ease of use, client service and support, distribution and price. Although we believe our technology and products currently compete favorably with respect to such factors, there can be no assurance that we can maintain our competitive position against current and potential competitors.

          We face numerous competitors. Our key OEM competitive threat comes from potential customers electing to develop internal capabilities similar to those provided by our products rather than buying solutions from us or another outside vendor. The key enterprise competitive threat is that customers select vendors with greater financial, research and marketing resources.

          Competitors for our Enterprise Security Division include:

          Competitors for our Embedded Security Division include:

          Our success and ability to compete is dependent, in part, upon our ability to maintain the proprietary nature of our technologies. We rely on a combination of patent, trade secret, copyright and trademark law, and nondisclosure agreements to protect our intellectual property. We own 87 United States and foreign patents and have additional pending foreign and domestic patent applications. Our patents and patent applications protect various aspects of our network security technology and have expiration dates ranging from 2006 to 2022.

          We seek to protect the source codes to our computer software programs, which are essential elements of our products, by means of copyright and trade secrets laws. The protection of our intellectual property and information we develop will be limited to such protection as we may be able to secure pursuant to trade secret or copyright laws or under any confidentiality agreements into which we may enter. We own federally registered trademarks for the SafeNet name as well as the names of certain of our products. However, we cannot make assurances as to the validity, enforceability or lack of infringement of these trademarks.

          At present, we have confidentiality agreements with our officers, directors and employees. There can be no assurance that the scope of any such protection we are able to secure will be adequate to protect our intellectual property or that we will have the financial resources to engage in litigation against parties who may infringe upon such intellectual property. In addition, we cannot be assured that others will not develop similar technology independent of us.

          We believe that our products do not infringe upon the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims in the future.

          As of December 31, 2005, we had 1,043 employees, of whom 109 are engaged in production and quality control, 185 in administration and financial control, 469 in engineering, development, and client support, and 280 in sales and marketing. We employ 538 employees in the United States and 505 employees internationally.

       Set forth below are the risks that we believe are material to our investors. This section contains forward-looking statements. You should refer to the explanation of the qualifications and limitations on forward-looking statements set forth at the beginning of Item 1 of this Annual Report on Form 10-K.

We have a history of losses and if we fail to execute our growth strategy, our business could be materially and adversely affected.

          We historically have experienced substantial net losses, as reported in accordance with generally accepted accounting principles in the United States (GAAP), of $6.1 million in 2003 and net income of $2.2 million, and $3.0 million in 2004 and 2005, respectively. As of December 31, 2005, we had an accumulated deficit of approximately $21.1 million. We intend to maintain or increase our expenditures in all areas in order to execute our business plan. As a result, we may continue to incur substantial net losses in the future. The likelihood of our success must be considered in light of the problems, expenses and delays frequently encountered in connection with new technologies, the design and manufacture of information technology security solutions, and the competitive environment in which we operate. You should not consider our historical results and recent growth as being indicative of future revenue levels or operating results. We can neither give assurance that we will operate profitably in the future nor that profitability will be sustained if it is achieved.

The loss of significant customers could have a material adverse effect on our business and results of operations.

          We were dependent on five customers that represented 38% of our consolidated revenue for the year ended December 31, 2005. We have one enterprise customer, a major U.S. Federal Agency, that accounted for 26% of our consolidated revenue for 2005. If our sales to our significant customers decline, our business, financial condition and results of operations could suffer. Any loss of governmental customers could have a material adverse effect on our business and prospects. In addition, we regularly license some of our products to customers who compete with us in other product categories. This potential conflict may deter existing and potential future customers from purchasing or licensing some of our products.

We may not be able to successfully execute our growth strategy through acquisitions

          One of our key strategies is to grow our business by selectively pursuing acquisitions. There has been substantial consolidation in the information security industry, and we expect this consolidation to continue in the foreseeable future. As a result of this consolidation, we expect to increasingly compete against larger competitors with broader product offerings and greater resources, including software vendors, network providers and manufacturers of networking and computer equipment and communications devices. In order to remain competitive, we have acquired and intend to continue acquiring businesses that complement or expand our existing business, including acquisitions that could be material in size and scope. Although we believe we have been successful with this strategy in the past, we may not be able to successfully grow our business in the future through acquisitions for a number of reasons including:

  Our failure to successfully execute our growth strategy through acquisitions could have a material adverse effect on our business and future prospects.

Growing our business through acquisitions involves the risk that we may not successfully integrate the business or assets acquired or that we may not achieve the expected benefits from the acquisition.

     There are potential risks associated with growing our business through acquisitions, including the failure to successfully integrate and realize the expected benefits of an acquisition. With any past or future acquisition, there is the possibility that:

     We cannot assure you that our acquisitions will be successful and will not materially adversely affect our business, operating results, or financial condition. We must also manage any growth resulting from such acquisitions effectively. Failure to manage growth effectively and successfully integrate the acquired company’s operations could have a material adverse effect on our business and operating results.

Our quarterly operating results may fluctuate and our future revenues and profitability are uncertain.

     We have experienced significant fluctuations in our quarterly operating results during the last five years and anticipate continued substantial fluctuations in our future operating results. A number of factors have contributed to these quarterly fluctuations including, but not limited to:

     It is likely that our operating results will fall below our expectations and the expectations of securities analysts or investors in some future quarter and the market price of our common stock could be materially adversely affected.

If our subsidiary, Mykotronx, Inc., were to lose its eligibility as a small business under the rules of the Small Business Administration, it would incur additional costs and charges relating to disclosure, accounting and reporting to the U.S. government.

     We do not believe Mykotronx’s status as a small business has had a material effect on SafeNet’s business. However, the loss of small business status may result in the company incurring additional charges and costs related to disclosure, accounting and reporting requirements applicable to a government contractor (either as a prime or subcontractor) not qualified as a small business. In addition, Mykotronx would no longer be eligible for small business set asides, which could make it more difficult for Mykotronx to pursue certain contract opportunities.

Our industry is highly competitive and becoming increasingly consolidated, which may result in our losing customers and declining revenue.

     Our industry is relatively new, highly competitive and subject to rapid technological changes. Our future financial performance will depend, in large part, on our ability to establish and maintain an advantageous market position in the increasingly consolidated information security industry. We currently compete with companies that have substantially greater financial resources, sales and marketing organizations, market penetration and research and development capabilities, as well as broader product offerings and greater market presence and name recognition. For example, current competitors of our Enterprise Security Division include General Dynamics, L-3 Communications, Juniper Networks, Check Point Software, Cisco Systems and Nortel Networks. Current competitors of our Embedded Security Division include Broadcom, HiFn, Cavium and Certicom.

     The competitive risk will increase to the extent that competitors begin to include software vendors, network providers, and manufacturers of networking and computer equipment and communications devices who may be in a better position than us to develop information security products in anticipation of developments in their products and networks. Competitive factors in the information security industry include:

     Our failure to successfully compete in any of these areas could have a material adverse effect on our results of operations and financial condition.

We may not be able to protect our proprietary technologies.

          Our success and ability to compete is dependent, in part, upon our ability to maintain the proprietary nature of our technologies. We rely on a combination of patent, trade secret, copyright and trademark law and nondisclosure agreements to protect our intellectual property. We own 76 United States and foreign patents and have additional pending foreign and domestic patent applications. Our patents and patent applications protect various aspects of our network security technology and have expiration dates ranging from 2006 to 2022. Although we hold several patents and have several pending patent applications that cover aspects of our technology, these patents and patent applications do not protect some of our security products and services. In addition, we may not receive patents for our current and future patent applications.

          Confidentiality, other non-disclosure agreements and other methods upon which we rely to protect our trade secrets, proprietary information and rights may not be adequate to protect such proprietary rights. Litigation to defend and enforce our intellectual property rights could result in substantial costs and diversion of resources and could have a material adverse effect on our financial condition and results of operations regardless of the final outcome of such litigation. Despite our efforts to safeguard and maintain our intellectual property, we may not be successful in doing so or the steps taken by us in this regard may not be adequate to deter misappropriation of our technology or prevent an unauthorized third party from copying or otherwise obtaining and using our products, technology or other information that we regard as proprietary. In addition, others may independently develop similar technologies or duplicate any technology developed by us. We may also be subject to additional risks as we enter into transactions in countries where intellectual property laws are not well developed or are poorly enforced. Legal protections of our rights may be ineffective in such countries, and technology developed in such countries may not be protected in jurisdictions where protection is ordinarily available. Our inability to protect our intellectual property would have a material adverse effect on our results of operations and financial condition.

Due to the nature of the information security industry and our products, our products and technologies could infringe on the intellectual property rights of others, which may cause us to engage in costly litigation and, if we are not successful, could cause us to pay substantial damages and prohibit us from selling our products.

          The information security products we sell are complex by nature and incorporate a variety of technologies and methods. The use of these technologies and methods increases the risk that third parties may challenge the patents issued or licensed to us and the risk that a third party may claim our products infringe that third party’s intellectual property rights. We may not be able to successfully challenge these infringement claims or defend the validity of our patents and could have to pay substantial damages, possibly including treble damages, for past infringement if it is ultimately determined that our products infringe a third party’s upon patents. Further, we may be prohibited from selling our products before we obtain a license, which, if available at all, may require us to pay substantial royalties. Even if infringement claims against us are without merit, or if we challenge the validity of issued patents, lawsuits take significant time, may be expensive and may divert management attention from other business concerns.

We may not be able to maintain effective product distribution channels, which could result in decreased revenue.

          We rely on both our direct sales force and an indirect channel distribution strategy for the sale and marketing of our products. Our sales and marketing organization may be unable to successfully compete against more extensive and well-funded sales and marketing operations of certain of our competitors. Additionally, we may be unable to attract integrators and resellers that can market our products effectively and provide timely and cost-effective customer support and service. Further, our distributors, integrators and resellers may carry competing lines of products. The loss of important sales personnel, distributors, integrators or resellers could adversely affect us.

Delays in product development could adversely affect market acceptance of our products.

          We may experience schedule overruns in product development triggered by factors such as insufficient staffing or the unavailability of development-related software, hardware or technologies. Further, when developing new security products, our development schedules may be altered as a result of the discovery of software bugs, performance problems or changes to the product specification in response to customer requirements, technology developments or self-initiated changes. All of these factors can cause a product to enter the market behind schedule, which may adversely affect market acceptance of the product or place it at a disadvantage to a competitor’s product that has already gained market share or market acceptance during the delay.

We may be subject to product liability or other claims that could adversely affect our reputation with existing and potential customers and expose us to significant liability.

          The sale and installation of our systems and products entails a risk of product failure, product liability or other claims. An actual or perceived breach of network or data security, regardless of whether such breach is attributable to our products or services, could adversely affect our reputation and financial condition or results of operations. The complex nature of our products and services can make the detection of errors or failures difficult during the development process. If errors or failures are subsequently discovered, this may result in delays and lost revenues during the correction process. In addition, a malfunction or the inadequate design of our products could result in product liability claims.

          We attempt to reduce the risk of such losses by including warranty disclaimers and liability limitation clauses in our contracts with customers. However, we may not have obtained adequate contractual protection against liability in all instances.

          We currently maintain product liability insurance. However, our insurance coverage may not be adequate and any product liability claim for damages resulting from security breaches could be substantial. In the event of product liability litigation, insufficient insurance coverage could have a material adverse effect on our results of operations and financial condition. Further, some of our customers and future customers may require minimum product liability insurance coverage as a condition to purchasing our products. Failure to satisfy these insurance requirements could impede our ability to sell products and services to these customers, which could have a material adverse effect on our financial condition and results of operations. We cannot assure you that that insurance will be available to us at a reasonable cost or will be sufficient to cover all possible liabilities.

We rely on single or limited sources for the manufacture and supply of our products.

          We rely upon a single or a limited number of sources for the manufacture and supply of our products. Our silicon chips are primarily manufactured by Analog Devices, Samsung, Toshiba, LSI, Cypress Semiconductor and Philips Semiconductor. We outsource the manufacturing of our appliance and token products primarily to ISO 9001/2000 registered, privately-held contract manufacturers. Because we depend on third party manufacturers and suppliers, we do not directly control product delivery schedules or product quality. In addition, we cannot assure you that we will be able to maintain satisfactory contractual relations with our manufacturers and suppliers. A significant delay in delivering products to our customers, whether from unforeseen events such as natural disasters or otherwise, could have a material adverse effect on our results of operations and financial condition. If we lose any of our manufacturers or suppliers, we expect that it would take from three to six months for a new manufacturer or supplier to begin full-scale production of one of our products. The delay and expense associated with qualifying a new manufacturer or

supplier and commencing production could result in a material loss of revenue and reduced operating margins and harm our relationships with customers. While we have not experienced any significant supply problems or problems with the quality of the manufacturing process of our suppliers and there have been no materially late deliveries of components or parts, it is possible that in the future we may encounter problems in the manufacturing process or shortages in parts, components, or other elements vital to the manufacture, production and sale of our products.

We rely on key technical and management employees and if such employees become unavailable, our business could be adversely affected.

          The information security industry is highly specialized and the competition for qualified employees is intense. We expect this to remain so for the foreseeable future. We believe our success depends upon a number of key employees, such as our Chairman and Chief Executive Officer, our President and Chief Operating Officer and key technical personnel, and upon our ability to retain and hire additional key personnel. Several members of our management team have joined us in the last 18 months. It may be difficult for us to integrate these new employees into our existing management team. Further additions of new employees and departures of existing employees, particularly in key positions, can be disruptive and can result in further departures of our personnel. The loss of the services of key personnel or the inability to attract additional qualified personnel could materially and adversely affect our results of operations and product development efforts. We may be unable to achieve our revenue and operating performance objectives unless we can attract and retain technically qualified and highly skilled engineers, sales, technical, marketing, and management personnel.

          In 2001, we entered into a five-year employment agreement with Anthony A. Caputo, our Chairman and Chief Executive Officer. In 2004, the employment agreement was amended to extend the original term from five to seven years. Also, in 2004 we entered into five-year employment agreements with our President and Chief Operating Officer, Carole D. Argo, and our Senior Vice President and Chief Financial Officer, Kenneth Mueller, and in 2005, we entered into a three-year employment agreement with our Senior Vice President and General Manager of our Enterprise Security Division, Chris Fedde. However, we have not historically entered into employment agreements with our other employees. This may adversely impact our ability to attract and retain the necessary technical, management and other key personnel to successfully run our business.

Management has identified a material weakness in our internal control over financial reporting that will require significant resources to remediate and could adversely affect our ability to report our financial results accurately.

     In connection with the evaluation of our internal controls over finanical reporting as of December 31, 2005, management identified a material weakness in internal control over financial reporting and concluded that they were not effective as of that date. The material weakness pertains to insufficient staffing and technical expertise in our accounting and financial reporting functions. The inadequate level of staffing and technical expertise results in certain accounting processes and controls around the financial statement close and financial reporting processes, the processes for accounting for non-routine tranactions and judgmental reserves, as well as certain controls over transactions processing, not being performed correctly, or on a timely basis. The lack of sufficient staffing and technical expertise has reduced the effectiveness of the existing accounting and financial reporting function, thereby increasing the risk of a financial statement misstatement. As a result, we were required to restate our financial statements for the three and six month periods ended June 30, 2005 and the three and nine month periods ended September 30, 2005.

     We have taken steps to address this material weakness, including hiring two new accountants with relevant accounting experience and creating and filling the position of Director of Recognition of Revenue. In addition, we are seeking to fill positions in a newly created corporate controller group to review the consolidation of the worldwide operations and to provide a review function for financial information reported from our regional operation centers. We intend to hire approximately four accountants during 2006 with relevant accounting experience for this group, including a seasoned leader to manage this group. However, we cannot provide assurance that we will be able to hire qualified persons for these new positions or that the new positions we have established and the persons we hire to fill those positions will be sufficient to remediate the material weakness management has identified.

     The remediation of this material weakness will require us to expend significant resources and management time, which could adversely affect our results of operations. Also, if we are unable to successfully remediate this material weakness, we may not be able to report our financial results accurately, which may cause investors to lose confidence in our reported financial information and have an adverse effect on the trading price of our common stock.

Our future success will depend upon our ability to anticipate and keep pace with technological changes and introduce new products and services in a timely manner.

          Our industry is characterized by rapid changes, including evolving industry standards, frequent introduction of new products and services, continuing advances in technology and changes in customer requirements and preferences. We expect technological developments to continue at a rapid pace in our industry. Accordingly, we cannot assure you that technological changes implemented by competitors, developers of operating or networking systems or persons seeking to breach network security will not cause

our technology to be rendered obsolete or non-competitive. Technology changes, software bugs, performance problems or customer requirements may also cause the development cycle for our new products to be significantly longer than our historical product development cycle, resulting in higher development costs or a loss in market share.

          Failure to develop and introduce new products and services and improve current products and services in a timely fashion could adversely affect us. Because of the complexity of our products and services or shortages of development personnel, we have from time to time experienced delays in introducing new and enhanced products and services. These products may require additional development work, enhancement and testing to achieve commercial success. If these or other new or recently introduced products have performance, reliability, quality or other shortcomings, such products could fail to achieve adequate market acceptance. The failure of our new or existing products to achieve or maintain market acceptance, whether for these or other reasons, could cause us to experience reduced orders, which in each case could have a material adverse effect on our business, financial condition and results of operations.

Prolonged economic weakness in the Internet infrastructure, network security and related markets may decrease our revenues and margins.

          The market for our products and services depends on economic conditions affecting the broader Internet infrastructure, network security and related markets. Prolonged weakness in these markets has caused in the past and may cause in the future enterprises and carriers to delay or cancel security projects, reduce their overall or security-specific information technology budgets or reduce or cancel orders for our products. In this environment, our customers may experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and services. This, in turn, may lead to longer sales cycles, delays in purchase decisions, payment and collection, and may also result in price pressures, causing us to realize lower revenues and operating margins. In addition, general economic uncertainty caused by potential hostilities involving the United States, terrorist activities and the general decline in capital spending in the information technology sector make it difficult to predict changes in the information security requirements of our customers and the markets we serve. In light of these events, some businesses may curtail or eliminate capital spending on information technology. These factors may cause our revenues and operating margins to decline.

If our products and services do not interoperate with our end-users’ networks, installations could be delayed or cancelled, which could significantly reduce our revenues.

          Our products are designed to interface with our end-users’ existing networks, each of which has different specifications and utilizes multiple protocol standards. Many of our end-users’ networks contain multiple generations of products that have been added over time as these networks have grown and evolved. Our products and services must interoperate with all of the products and services within these networks as well as with future products and services that might be added to these networks to meet our end-users’ requirements. If we find errors in the existing software used in our end-users’ networks, we may elect to modify our software to fix or overcome these errors so that our products will interface with their existing software and hardware. If our products do not interface with those within our end-users’ networks, customer installations could be delayed or orders for our products could be cancelled, which could significantly reduce our revenues.

A decrease of average selling prices for our products and services could adversely affect our business.

          The average selling prices for our products and services may decline due to product introductions by our competitors, price pressures from significant customers and other factors. The market for our embedded products is dominated by a few large OEM vendors, who have considerable pricing power over

our company. In addition, with the general economic slowdown and decrease of information technology capital spending budgets, our customers often seek the lowest price for their security needs. To sell our products and services at higher prices, we must continue to develop and introduce new products and services that incorporate new technologies or high-performance features. If we experience pricing pressures or fail to develop new products, our revenues and gross margins could decline, which could harm our business, financial condition and results of operations.

We face risks associated with our international business activities.

          International sales accounted for approximately 29% of our consolidated revenue for the year ended December 31, 2005. International sales are subject to risks related to imposition of governmental controls, export license requirements, restrictions on the export of critical technology, general economic conditions, fluctuations in currency values, translation of foreign currencies into U.S. dollars, foreign currency exchange controls, tariffs, quotas, trade barriers and other restrictions, compliance with applicable foreign laws and other economic and political uncertainties.

     Some of our information security products contain encryption algorithms that are subject to the export restrictions administered by the Bureau of Industry and Security, U.S. Department of Commerce. These restrictions permit the export of encryption products based on country, algorithm and class of end- user. They prohibit the export of encryption products to some countries and to business entities that are not included in a range of end-users. These restrictions may provide a competitive advantage to foreign competitors facing less stringent controls on their products and services. In addition, the list of countries, products and users for which export approval is required, and regulatory policies with respect thereto, could become more restrictive, and laws limiting the domestic use of encryption could be enacted. Our foreign distributors may also be required to secure licenses or formal permission before encryption products can be imported. Compliance with export restrictions has resulted in delays in shipping our products to certain end users in the past and may result in such delays in the future.

A breach of network security could harm public perception of our products and services, which could cause us to lose revenue.

          If an actual or perceived breach of network security occurs in one of our end-users’ network systems, regardless of whether the breach is attributable to our products or services, the market perception of the effectiveness of our products and services could be harmed. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. Failure to anticipate new techniques or otherwise prevent breaches of network security could cause us to lose current and potential customers and revenues.

Because a significant portion of our net assets is represented by goodwill that is subject to mandatory annual impairment evaluations, we could be required to write-off some or all of this goodwill, which may adversely affect our financial condition and results of operations.

          We account for all acquisitions using the purchase method of accounting. Under purchase method accounting, a portion of the purchase price for a business is allocated to identifiable tangible and intangible assets and assumed liabilities based on estimated fair values at the date of consummation. Any excess purchase price, which is very likely to constitute a significant portion of the purchase price, will be allocated to goodwill. In accordance with the Financial Accounting Standards Board’s Statement No. 142, Goodwill and Other Intangible Assets, goodwill is not amortized but is reviewed annually, or more frequently if impairment indicators arise, for impairment. At December 31, 2005 our reported goodwill of $339.8 million represented 58% of our reported net assets. When we perform future impairment tests, it is possible that the carrying value of this goodwill could exceed its implied fair value and therefore would require adjustment. Such adjustment would result in a charge to operating income in that period. Once adjusted, there can be no assurance that there will not be further adjustments for impairment in future periods.

The conversion of our 2.50% convertible subordinated notes could adversely affect our available cash.

          Under the terms of our 2.50% convertible subordinated notes that we issued in December 2005, upon conversion of the notes, we are required to pay the principal amount in cash, provided that we are not in default under any senior debt outstanding at such time. Assuming we have enough cash to pay the principal amount of the notes upon conversion, such payment may adversely affect our available cash, which could adversely affect our ability to conduct our operations, service any other debt or borrow money. The conversion price of the notes is $41.30 and the holders’ conversion rights are triggered when the closing price of our common stock over certain periods of time is more than $49.56.

Anti-takeover provisions in our charter documents and under Delaware law and certain provisions of our 2.50% convertible subordinated notes could discourage an acquisition of us by a third party.

          Our restated certificate of incorporation provides for the issuance of “blank check” preferred stock, which may have the effect of delaying, deferring or preventing a change in control of our company without further action by the stockholders and may adversely affect the voting and other rights of the holders of common stock. In addition, our bylaws provide that our stockholders may call a special meeting of stockholders only upon a written request of stockholders owning a majority of our capital stock. In addition, certain provisions under Delaware law restrict business combinations between a corporation and an owner of 15% or more of the outstanding voting stock of the corporation for a three-year period. These provisions of our restated certificate of incorporation and bylaws and Delaware law could discourage, delay or prevent a third party from acquiring or merging with us, even if such action was beneficial to our stockholders and, in turn, the holders of the notes.

          Certain provisions of our 2.50% convertible subordinated notes could make it more difficult or more expensive for a third party to acquire us. Upon the occurrence of certain transactions constituting a change of control of us, holders of the notes will have the right, at their option, to require us to repurchase all of their notes or any portion of the principal amount of such notes in integral multiples of $1,000. We may also be required to issue additional shares upon conversion or provide for conversion into the acquirer’s capital stock in the event of certain transactions constituting a change of control.

The price of our common stock may be volatile.

     In the past, the price of our common stock has experienced volatility due to a number of factors, some of which are beyond our control. The price of our common stock may continue to experience volatility in the future from time to time. Among the factors that could affect our stock price are:

     The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.

     We lease approximately 62,800 square feet in Belcamp, Maryland, for our corporate and administrative facilities. This space is used for our executive headquarters, Enterprise research and development and the SafeNet Trusted Services facility. The lease, which expires in December 2013, has an initial annual lease commitment of approximately $1.3 million with annual increases.

     We assumed Rainbow’s lease of approximately 57,400 square feet in Ottawa, Canada. This space was previously used for product development and product management. The lease, which expires in December 2010 requires annual rent of approximately $1.4 million. There is a sublease for the entire space, which expires in December 2010, and provides annual rental income of approximately $0.7 million.

     We assumed Mykotronx’s lease of approximately 49,159 square feet in Torrance, California. This space is used for corporate headquarters, sales, product development and finance. The lease, which expires in April 2008, requires annual rent of approximately $0.7 million.

     We assumed Cylink’s lease of approximately 46,700 square feet in Santa Clara, California. This space is subleased. The lease, which expires in August 2009, requires annual rent payments of approximately $1.4 million with annual increases. The sublease of the entire area, which expires in August 2009, provides annual rent of approximately $0.5 million.

     We lease approximately 156,100 square feet at 9 additional locations globally which support product development, product management, sales and support, customer support, and finance business functions. The leases for these locations expire in years 2006 through 2011. The aggregate annual lease commitments for these locations is approximately $3.2 million.

          We are not involved in any material legal proceedings, other than ordinary routine litigation incidental to our business and other nonmaterial proceedings.

None.

30

          The selected financial data set forth below as of and for each of the five years ended December 31, 2005 is derived from our audited financial statements. The selected financial data is qualified by and should be read in conjunction with the consolidated financial statements, included in Item 8 of this Form 10-K and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this Form 10-K.

          The following is a summary of the quarterly results of operations for the years ended December 3l, 2005 and 2004.

During the fourth quarter of fiscal year 2005 and subsequent to December 31, 2005, the Company identified certain adjustments to its financial statements that impacted the results of operations that were previously reported in its quarterly reports on Form 10-Q. The Company previously reflected certain adjustments to its previously issued financial statements for the three and nine month periods ended September 30, 2005 in its Form 10-Q/A and has reflected the remaining subsequently detected adjustments in the table above. The results of operations for the previously reported quarters have been adjusted and are reflected in the “as adjusted” amounts above. A summary of the significant adjustments are as follows:

Forward-Looking Statements

          This Annual Report on Form 10-K contains “forward-looking” statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. These risks and other factors include, among others, the risks described in Item 1A — Business. As a general matter, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of such terms or other comparable terminology.

          We develop, market, sell and support a portfolio of hardware and software information security products and services. Our products and services are used to create secure WANs and VPNs to prevent security breaches that could result in unauthorized access to confidential data, invasion of privacy and financial loss.

          We have two reportable business segments. Through our Enterprise Security Division, we sell high-performance security solutions to address the needs of our government, financial institution and other security-sensitive commercial customers. We also provide, through our Embedded Security Division, a broad range of network security products, including silicon chips, accelerator cards, licensed intellectual property and software products, to OEMs that embed them in their own network infrastructure and wireless products. The divisions are strategic business units that offer different products. These divisions are managed separately as they offer different products and employ different marketing strategies.

different marketing strategies (See Note 15 to the accompanying notes to our consolidated financial statements included in Item 8 of this Form 10-K).

          We periodically review and consider possible acquisitions of companies that we believe will contribute to our long-term objectives and discuss such acquisitions with the management of those companies. Such acquisitions, which may be material, may be made from time to time.

          In February 2003, we acquired Cylink Corporation, which expanded our customer base and our product offerings to include security solutions for WANs. Operations of Cylink were integrated into the Enterprise Security Division.

          In February 2003, we also acquired the assets of Raqia Networks, Inc., a development stage company that was developing content inspection technology. This transaction consisted primarily of technology-related intangible assets. The operations of Raqia have been integrated into the Embedded Security Division.

          In November 2003, we acquired substantially all of the assets and properties used in connection with the toolkit, IPVia VPN and VPN client businesses of SSH Communications Security Corp. SSH is a world-leading supplier of managed security middleware. The operations of SSH Communications Security Corp have been integrated into the Embedded Security Division.

          In March 2004, we completed the acquisition of Rainbow Technologies, Inc. Rainbow provided information security solutions for mission-critical data and applications used in business, organization, and government computing environments. This merger with Rainbow has had and will continue to have a significant impact on our operations going forward. The operations of Rainbow have been integrated into the Company and are included in both the Enterprise and Embedded Security Divisions.

          In October 2004, we acquired Datakey Inc., which expanded our customer base and product offerings to include token-based solutions that simplify enterprise-wide access and identity management. Operations of Datakey are included in our Enterprise Security Division.

          On April 4, 2005, we completed the acquisition of DMDsecure.com, B.V. in a cash transaction. DMDsecure was a leader in carrier grade server DRM software for solution providers and software vendors as well as broadcasters, broadband and mobile operators and service providers. DMDsecure broadened our Rights Management business by providing technology that protects the electronic delivery of wide ranging content. The results of operations of DMDsecure have been included in our consolidated results of operation beginning on April 4, 2005. The operations of DMDsecure are in the process of being integrated into the Embedded Security Division.

          Effective June 1, 2005, we acquired all of the issued and outstanding shares and vested stock options of MediaSentry, Inc. The results of operations of MediaSentry have been included in our consolidated results of operations beginning June 1, 2005. MediaSentry is a global provider of anti-piracy and business management services for the recording and motion picture industries. MediaSentry’s anti-piracy solutions help clients detect and deter unauthorized distribution of copyrighted content and prosecute those who engage in piracy. The operations of MediaSentry are in the process of being integrated into the Embedded Security Division.

          On December 1, 2005, we completed the acquisition of Eracom Technologies AG, a leading IT security manufacturer and pioneer of Hardware Security Modules (HSM). Eracom augmented our Borderless security offering with the addition of its Hardware Security Modules (HSM) designed for the Electronic Funds Transfer (EFT), credit card and ATM segments of the financial services market, and its POI products that encrypt data on PCs, laptops, servers, and portable media. The results of operations of Eracom Technologies AG have been included in our consolidated results of operations beginning December 1, 2005.

          Our historical operating results have been dependent on a variety of factors including, but not limited to, the length of the sales cycle, the timing of orders from and shipments to clients, product development expenses and the timing of development and introduction of new products. Our expense levels are based, in part, on expectations of future revenues. The size and timing of our historical revenues have varied substantially from quarter to quarter and year to year. Accordingly, the results of a particular period, or period to period comparisons of recorded sales and profits may not be indicative of future operating results.

Recent Development

     On February 8, 2006, we announced that we had reached an agreement with the board of directors of nCipher plc, a company incorporated under the laws of England and Wales (“nCipher”), on the terms of a recommended cash offer for the entire issued (and issuable upon exercise of options granted) ordinary share capital of nCipher, for 300 pence in cash for each nCipher share (the “Offer” and the “Offer Price”, respectively). Based on the Offer Price, the number of nCipher outstanding shares and the number of nCipher shares issuable upon exercise of options granted, the total consideration to be paid by us would be approximately £86.1 million (approximately US$150 million). nCipher provides HSM technology, disk encryption technology and other products for identity protection and management.

     The directors of nCipher have unanimously recommended that nCipher shareholders accept the Offer. In addition, we have received (1) irrevocable undertakings to accept the Offer from all of the directors of nCipher with respect to nCipher shares representing approximately 9.3% of nCipher’s outstanding ordinary share capital; (2) irrevocable undertakings to accept the Offer from certain institutional shareholders with respect to nCipher shares representing approximately 29.9% of nCipher’s outstanding ordinary share capital, which undertakings will become non-binding if the Offer lapses or is withdrawn or if an offer for nCipher shares is made by a third party at certain prices per nCipher share; and (3) non-binding letters in support of the Offer from certain other institutional shareholders with respect to nCipher shares representing approximately 12.6% of nCipher’s outstanding ordinary share capital. Also, nCipher has agreed to pay a fee to SafeNet of £860,578 (approximately US$1.5 million) if the Offer is not consummated due to certain events.

     The Offer is subject to certain conditions, including the valid acceptances of not less than 90% (or such lesser percentage as we may decide) of the nCipher shares to which the Offer relates. Upon the Offer becoming, or being declared, unconditional in all respects and sufficient acceptances being received, we intend to exercise our rights in accordance with the laws of the United Kingdom to acquire the remaining nCipher shares not tendered in the Offer. We expect the acquisition to close in the second quarter of 2006.

          The following table sets forth certain of our Consolidated Statement of Operations data as a percentage of revenues for the years ended December 31.

Revenues and Gross Margins

           Revenues increased by $61.5 million overall primarily due to $44.9 million increase in product offerings and the inclusion of the full year results of operations for the acquired Rainbow and Datakey businesses. The $8.7 million increase in service and maintenance revenue is primarily the result of the acquisition of MediaSentry and an increased level of service and maintenance contracts for new sales and renewals of existing service and maintenance contracts. License and royalties increased $7.9 million primarily as a result of increased sales of our licensed toolkit offerings.

          The revenue increase by segment for the year ended December 31, 2005 over the year ended December 31, 2004 is attributable to several factors. The Embedded Security Division added $19.1 million of revenue from increased product offerings from both internal development efforts and those acquired in business combinations during 2005 that were not available in 2004. Revenues earned by the Enterprise Security Division increased $42.4 million, due primarily to increases in our TYPE 1 and Borderless product offerings. Inclusion of a full year of results of operations for businesses acquired in 2004 also contributed to the increase.

          The revenue mix by type has not changed significantly between 2004 and 2005. Our integrated product and service offerings will continue to offer growth in all three revenue types, but we expect to remain a product-based company. These products include hardware, appliances, and product development. The revenue mix by segment should continue to be materially consistent with the most recent year, with the Embedded Security Division representing 28% to 30% of total revenues and the Enterprise Security Division representing the remainder.

          Gross margins for each type of revenue fluctuated for the year ended December 31, 2005 as compared to the year ended December 31, 2004. The decrease in product margin was due to the TYPE 1 products, which carry margins in the 20% to 25% range and represent approximately 40% of the revenues for the current period. The products and services comprising the remaining portion of the revenue base earn average margins from 70% to over 90%.

          The gross margins by segment are reflective of changes within each division. The Embedded Security Division’s gross margins increased because of the addition of higher margin products primarily through acquisitions. The Enterprise Security Division’s gross margins decreased because of the increase in product revenues over other revenue streams as a result of a full year of results of operations of the acquired Rainbow and Datakey businesses coupled with growth in the Mykotronx business. Product revenues are typically lower margin sales than service and maintenance, licenses, or royalties. The Enterprise Security Division has become primarily a product based business and thus experienced slight margin degradation based on the product sales mix. The Enterprise Security Division’s gross margins will fluctuate based on the mix of revenues from sales of TYPE 1 products and other higher margin products during the applicable reporting period.

          Research and development expenses rose due to the increase in the number of ongoing technology projects within the Company as well as the increase in the number of research and development team employees. We have added personnel through acquisitions in the last 12 to 24 months, including Rainbow and Datakey in 2004. For 2005, we added personnel from DMDsecure, MediaSentry and Eracom. The number of research and development personnel increased to 469 as of December 31, 2005 from 410 as of December 31, 2004, representing an increase of approximately 14%. As a percentage of revenue, research and development expenses have remained consistent at approximately 12% for both 2005 and 2004. The Company has been able to leverage its many research and development resources into multiple projects that have resulted in increased and continuously improving product offerings of both hardware and software.

          Sales and marketing expenses increased due to two factors. The first factor is additional headcount added throughout the year, due primarily to the DMDsecure, MediaSentry and Eracom acquisitions. The number of sales and marketing personnel increased to 280 as of December 31, 2005 from 181 as of December 31, 2004, representing an increase of approximately 55%. The second factor is increased sales, which incrementally increases selling costs, including commissions. As a percentage of revenue, sales and marketing expenses increased from 14% for 2004 to 19% for 2005. The increase in the percentage of total revenue was expected as we have expanded into new markets throughout the world.

          General and administrative expenses increased due to additional legal and professional fees, as well as increased headcount. We expect to continue to incur certain professional costs associated with compliance with the provisions of the Sarbanes-Oxley Act. In addition, we will incur additional costs associated with adding additional staffing and technical expertise in our accounting and financial reporting functions, as discussed in more detail in Item 9A of this Form 10-K. As a percentage of revenue, general and administrative expenses were consistent at approximately 8% for both 2005 and for 2004.

          Write-off of acquired in-process research and development costs increased by approximately $1.2 million. The write-off of acquired in-process research and development costs was directly attributable to the acquisition of DMDsecure assets. These write-offs represent the estimated fair value of the in-process research and development projects that have not yet reached technological feasibility at the acquisition date, and had no future alternate future use. The value assigned to acquired in-process technologies relate to the DMDmobile v2 project. The estimated fair value of this project was determined by the use of a discounted cash flow model, using a discount rate that took into account the stage of completion, and the risks surrounding the successful development and commercialization of the technology and product. There was no such write-off in 2004.

          Costs of integration of acquired companies decreased by approximately $8.5 million from the year ended December 31, 2004 to the same period in 2005. The costs in 2005 primarily reflect the integration costs related to the 2005 acquisitions of DMDsecure and MediaSentry in addition to the final amounts of integration costs related to the 2004 acquisitions of Rainbow and Datakey. The acquisitions in 2005 were considerably less in size and scope than the 2004 acquisition of Rainbow. These costs will fluctuate as we acquire companies and integrate the people, systems, products and cultures into the combined company. The fluctuation is dependent on the level of effort required in integrating the people, systems, products and cultures of any potential acquired business.

          The restructuring charges for 2005 of approximately $2.4 million primarily represent an estimated liability related to the exit of one of our leased facilities as well as significant reduction in the use of another facility. We have been able to consolidate leased facilities as we continue to integrate the businesses we acquired in 2004 and 2005.

          Amortization of intangible assets increased from $8.7 million for 2004 to $9.2 million for 2005. The amortization for the 2005 period includes a full year of amortization from the Rainbow and Datakey acquisitions completed in 2004 and the addition of partial years amortization for the DMDsecure,

MediaSentry and Eracom acquisitions. Amortization of acquired intangible assets will continue to be a significant cost for 2006 and future periods.

          Amortization of unearned compensation is a cost primarily related to the Rainbow and MediaSentry acquisitions. It reflects the amortization of the intrinsic value of the unvested portion of common stock options assumed by us in each of the acquisitions.

          The increase in interest income is due primarily to increased cash and investment balances that increased interest earned over the prior period. The gain in foreign exchange relates to increased volume of transactions of international sales and strengthening of the U.S. dollar against the currencies of our international customers. Other income increased as a result of a realized gain on the sale of a building, offset by loss on disposals of other assets. In December 2005, we issued $250 million of convertible subordinated notes that will mature on December 15, 2010. The notes bear interest at 2.5% per annum, which will generate approximately $6.3 million of interest expense in 2006, which will be offset by the interest earned. For the years ended December 31, 2005 and 2004, interest expense of $480 and $208, respectively, was incurred and has been included in interest income, net of interest expense.

          The effective income tax rate for the year ended December 31, 2005 is 50%. The overall effective rate was greater than the U.S. statutory rate primarily due to an increase in our effective state tax rate related to deferred tax liabilities established in purchase accounting for non-deductible intangible assets and net operating losses in certain foreign subsidiaries for which no tax benefit was recognized, offset by tax benefits associated with operating in lower tax rate foreign countries. In 2004, the effective income tax rate was 42%. The difference between this rate and the U.S. statutory rate was primarily due to the non-deductible write-off of in-process research and development costs and net operating losses in certain foreign subsidiaries for which no tax benefit was recognized.

Revenues and Gross Margins

          Revenues increased $135.4 million primarily due to increased product offerings that stemmed from acquisitions, primarily the Rainbow acquisition. Revenue from those product offerings accounted for $134.4 million of the increased revenue, including the related service and maintenance revenue. License and royalties decreased due to several one time sales in 2003, specifically, the execution of six new license arrangements that accounted for $5.7 million in revenue. There were also $1.5 million of new intellectual property licenses during 2003. These sales were not repeated in 2004. Service and maintenance revenue increased due to several acquired maintenance contracts from the Rainbow transaction.

          Revenue increases by segment for the year ended December 31, 2004 over the year ended December 31, 2003 are reflective of several factors. The Embedded Security Division added $37.0 million of revenue from product offerings acquired in business combinations during 2004 that were not available in 2003. Revenues earned by the Enterprise Security Division increased $98.7 million, due primarily to acquired product offerings ($97.4 million).

          The revenue mix by type has changed significantly as our acquisitions were product-based companies, particularly Rainbow Technologies with a 97% product and 3% service mix, historically. Our integrated product and service offerings will continue to offer growth in all three revenue types but we expect to remain a product-based company. These products include hardware, appliances, and customized products. The revenue mix by segment should continue to be materially consistent with the most recent quarter, with the Embedded Security Division representing 27% to 30% of total revenues and the Enterprise Security Division representing the remainder.

          Gross margins for each type of revenue fluctuated for the year ended December 31, 2004 as compared to the year ended December 31, 2003. The fluctuation in product margin was due to the secure communications business, which carries margins in the 20% to 25% range and represents over 40% of the revenues for the current period. The products and services comprising the remaining portion of the revenue base earn average margins from 70% to over 90%.

          The gross margins by segment are reflective of changes within each division. The Embedded Security Division’s gross margins as well as the Enterprise Security Division’s gross margins decreased because of the increase in product revenues over other revenue streams. Product revenues are much lower margin sales than service and maintenance, licenses, or royalties. Both divisions have become primarily product based businesses driving down margins. The Enterprise Security Division’s gross margins will fluctuate based on the mix of revenues from sales of secure communications products during the applicable reporting period.