SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 1997
Commission File No. 0-27742
CYLINK CORPORATION
(Exact name of registrant as specified in its charter)
California 95-3891600
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
910 Hermosa Court
Sunnyvale, California 94086
(Address of principal executive offices)
(408) 735-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
As of August 7, 1997, there were 25,973,394 shares of the Registrant's Common
Stock outstanding.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data; unaudited)
<CAPTION>
June 27, December 31,
1997 1996
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 68,966 $ 78,849
Accounts receivable, net of allowance
for doubtful accounts of $409 and $644 17,242 12,682
Inventories 10,163 8,828
Deferred income taxes 1,432 1,432
Other current assets 1,755 1,351
--------- ---------
Total current assets 99,558 103,142
Property and equipment, net 4,896 3,760
Notes receivable from employees 3,473 --
Other assets 940 186
--------- ---------
$ 108,867 $ 107,088
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of capital lease obligations $ 167 $ 167
Accounts payable 2,320 3,954
Accrued liabilities 5,566 5,150
Deferred revenue 244 353
--------- ---------
Total current liabilities 8,297 9,624
--------- ---------
Capital lease obligations, long-term 165 241
--------- ---------
Deferred income taxes 12 12
--------- ---------
Shareholders' equity:
Preferred stock, $0.01 par value;
5,000,000 shares authorized; none issued and outstanding -- --
Common stock, $0.01 par value; 40,000,000 shares authorized;
25,948,000 and 25,597,000 shares issued and outstanding 259 257
Additional paid-in capital 90,330 89,772
Notes receivable from shareholders (5) (301)
Deferred compensation related to stock options (292) (334)
Cumulative translation adjustment (42) 4
Retained earnings 10,143 7,813
--------- ---------
Total shareholders' equity 100,393 97,211
--------- ---------
$ 108,867 $ 107,088
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended Six Months Ended
------------------------- -------------------------
June 27, June 28, June 27, June 28,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 18,269 $ 12,286 $ 34,451 $ 20,769
Cost of revenue 5,847 4,954 11,722 8,831
-------- -------- -------- --------
Gross profit 12,422 7,332 22,729 11,938
-------- -------- -------- --------
Operating expenses:
Research and development, net 3,879 3,037 7,787 5,639
Selling and marketing 5,635 3,389 9,663 6,116
General and administrative 2,232 1,526 4,209 2,661
-------- -------- -------- --------
Total operating expenses 11,746 7,952 21,659 14,416
-------- -------- -------- --------
Income (loss) from operations 676 (620) 1,070 (2,478)
Other income (expense):
Interest income, net 875 935 1,816 1,299
Royalty and other income (expense), net 196 70 442 (304)
-------- -------- -------- --------
Income (loss) before income taxes 1,747 385 3,328 (1,483)
Provision (benefit) for income taxes 524 131 998 (504)
-------- -------- -------- --------
Net income (loss) $ 1,223 $ 254 $ 2,330 $ (979)
======== ======== ======== ========
Net income (loss) per share $ 0.05 $ 0.01 $ 0.09 $ (0.04)
======== ======== ======== ========
Shares used to compute net income (loss)
per share 26,610 26,605 26,567 24,519
======== ======== ======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
3
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<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<CAPTION>
Six Months Ended
--------------------
June 27, June 28,
1997 1996
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 2,330 $ (979)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Write-down of short-term investments -- 441
Depreciation and amortization 937 647
Deferred compensation related to stock options 42 42
Deferred income taxes -- (653)
Changes in assets and liabilities:
Accounts receivable (4,560) (1,044)
Inventories (1,335) (1,991)
Other assets (1,158) 114
Accounts payable (1,634) 2,082
Accrued liabilities 416 992
Deferred revenue (109) (932)
-------- --------
Net cash used in operating activities (5,071) (1,281)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (2,073) (679)
Loans to employees in exchange for notes receivable (3,473) --
-------- --------
Net cash used in investing activities (5,546) (679)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 555 78,990
Payment of notes receivable from shareholders 301 --
Repayment of capital lease obligations (76) (204)
Repayment of borrowings under bank line of credit -- (1,000)
-------- --------
Net cash provided by financing activities 780 77,786
-------- --------
Effect of exchange rate changes on cash and cash equivalents (46) 8
-------- --------
Net increase (decrease) in cash and cash equivalents (9,883) 75,834
Cash and cash equivalents at beginning of period 78,849 3,240
-------- --------
Cash and cash equivalents at end of period $ 68,966 $ 79,074
======== ========
Supplemental disclosures:
Cash paid for income taxes $ 26 $ --
Cash paid for interest 44 81
Equipment acquired under capital lease obligations -- 247
Common stock issued for notes receivable 5 --
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
4
<PAGE>
CYLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements included
herein contain all adjustments, consisting only of normal recurring
adjustments which, in the opinion of management, are necessary to
fairly state the consolidated financial position, results of operations
and cash flows of Cylink Corporation ("Cylink" or the "Company") for
the periods presented. These financial statements should be read in
conjunction with the Company's audited financial statements included in
the Company's Annual Report on Form 10-K for the year ended December
31, 1996. Interim results of operations are not necessarily indicative
of the results to be expected for the full year.
2. Notes Receivable From Employees
Pursuant to their employment agreements, during the first quarter of
1997 the Company loaned certain employees $3,473,000 towards the
purchase of their principal residences. Of this amount, $2,843,000 is
receivable from officers of the Company. The notes are interest free
and are due five years from the dates of the related notes, at which
time the notes must be repaid or convert into, and become subject to,
the terms of a standard, interest-bearing commercial loan. The notes
are secured by deeds of trust on the residences. The loan agreements
provide for accelerated payment in the event of termination of
employment under certain conditions and, in one instance, under certain
circumstances will be forgiven to the extent of any decrease in the
value of the related residence.
3. Inventory
June 27, December 31,
1997 1996
------- -------
(in thousands)
Inventories:
Raw materials $ 4,623 $ 4,126
Work in process and subassemblies 3,340 3,196
Finished goods 2,200 1,506
------- -------
$10,163 $ 8,828
======= =======
4. Recent Accounting Pronouncement
<TABLE>
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 ("FAS 128"),
"Earnings Per Share." This statement redefines earnings per share under
generally accepted accounting principles. Under the new standard,
primary earnings per share is replaced by basic earnings per share and
fully diluted earnings per share is replaced by diluted earnings per
share. The Company is required to adopt the new standard in the fourth
calendar quarter of 1997. The following table sets forth primary
earnings per share as reported and unaudited pro forma basic and
diluted earnings per share assuming FAS 128 had been applied during the
periods presented:
<CAPTION>
Three Months Ended Six Months Ended
------------------ ------------------
June 27, June 28, June 27, June 28,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Primary earnings per share as reported $0.05 $0.01 $0.09 $(0.04)
Pro forma basic net income per share 0.05 0.01 0.09 (0.04)
Pro forma diluted net income per share 0.05 0.01 0.09 (0.04)
</TABLE>
5
<PAGE>
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income." FAS
130 establishes standards for reporting comprehensive income and its
components in a financial statement that is displayed with the same
prominence as other financial statements. Comprehensive income as
defined includes all changes in equity (net assets) during a period
from nonowner sources. Examples of items to be included in
comprehensive income, which are excluded from net income, include
foreign currency translation adjustments and unrealized gain/loss on
available for sale securities. The disclosure prescribed by FAS 130
must be made beginning with the first quarter of calendar 1998.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131 ("FAS 131"), "Disclosures about Segments of an
Enterprise and Related Information." This statement establishes
standards for the way companies report information about operating
segments in annual financial statements. It also establishes standards
for related disclosures about products and services, geographic areas,
and major customers. The Company has not yet determined the impact, if
any, of adopting this new standard. The disclosures prescribed by FAS
131 are effective for calendar 1998.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The statements contained in this Report on Form 10-Q that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including statements regarding Cylink's expectations, hopes,
intentions, beliefs or strategies regarding the future. Forward-looking
statements include: the Company's statements in Part I, Item 2 "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
regarding the sufficiency of the Company's existing liquidity and capital
resources, management's belief that resolution of certain litigation described
in Part II, Item 1 "Legal Proceedings" will not have a material adverse effect
on the Company's financial position and results of operations, the Company's
expectation that it will introduce a number of new products in 1997 and continue
to make a significant investment in engineering, research and development, and
its intention to expand its foreign sales channels and enter additional
international markets. All forward-looking statements included in this document
are based on information available to the Company as of the date of this Report
on Form 10-Q, and the Company assumes no obligation to update any such
forward-looking statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements. It is important
to note that the Company's actual results could differ materially from those in
such forward-looking statements for the reasons detailed in "Risk Factors That
May Affect Future Results" and other sections of this Report on Form 10-Q. You
should also consult the risk factors listed from time to time in the Company's
Reports on Form 10-Q, 8-K, 10-K and Annual Reports to the Shareholders.
RESULTS OF OPERATIONS
Revenue. The Company's revenue is derived primarily from sales of its
family of commercial information security products and its medium speed spread
spectrum radio products. Fees for maintenance and support services are charged
separately. Revenue from product sales is recognized upon shipment to the
customer. Concurrently, a provision is made for estimated cost to repair or
replace products under warranty arrangements. Revenue from sales to distributors
is recognized upon shipment; no right of return, stock rotation or price
protection is given. Revenue from sales to value added resellers is recognized
upon shipment and concurrently a provision for estimated returns is recorded.
The Company's revenue increased by 49% from $12.3 million for the three
months ended June 28, 1996 to $18.3 million for the three months ended June 27,
1997, and increased by 66% from $20.8 million for the six months ended June 28,
1996 to $34.5 million for the six months ended June 27, 1997. Sales of
information security products increased by 106% from $5.6 million for the second
quarter of 1996 to $11.6 million for the second quarter of 1997, and increased
by 111% from $9.9 million for the first half of 1996 to $20.9 million for the
first half of 1997. The increase in information security product revenue
resulted primarily from increased product shipments in the SecureWan, SecureLan
and SecureAccess encryption product lines, which are used in public and private
linked networks. Sales of wireless communications products were $6.7 million for
both the second quarter of 1996 and 1997. Wireless communications revenues
increased 24% from $10.9 million for the first half of 1996 to $13.5 million for
the first half of 1997. This increase was primarily due to higher unit sales,
particularly for the Company's AirLink S-Band radios.
International revenue was 53% and 45% of total revenue for the second
quarter of 1996 and 1997, respectively, and was 55% and 51% of total revenue for
the first half of 1996 and 1997, respectively. The decrease in international
product revenue as a percentage of total revenue from 1996 to 1997 was due
primarily to the increased percentage of total revenue represented by
information security products, which are mostly sold in the United States.
Gross Profit. Gross profit increased by 69% from $7.3 million for the
three months ended June 28, 1996 to $12.4 million for the three months ended
June 27, 1997, and increased by 90% from $11.9 million for the six months ended
June 28, 1996 to $22.7 million for the six months ended June 27, 1997. The
increase in dollars was primarily a result of the significant increase in
revenue. As a percentage of sales, gross profit was 60% and 68% for the second
quarter of 1996 and 1997, respectively, and 57% and 66% for the first half of
1996 and 1997, respectively. The increase in gross margin resulted from the
increased percentage of total revenue represented by information security
products, which generally have higher gross margins than wireless communications
products. In addition, the increase in gross margin was due to lower average
unit costs and higher average selling prices for the
7
<PAGE>
Company's wireless communications products, and a decrease in expenses for
maintenance and support services related to the Company's information security
products.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel related expenses, depreciation of
development equipment, facilities and supplies. Gross research and development
expenses increased 5% from $4.2 million for the three months ended June 28, 1996
to $4.4 million for the three months ended June 27, 1997, and increased 12% from
$7.9 million for the six months ended June 28, 1996 to $8.9 million for the six
months ended June 27, 1997. Gross research and development expenses as a
percentage of revenue were 34% and 24% for the second quarter of 1996 and 1997,
respectively, and 38% and 26% for the first half of 1996 and 1997, respectively.
The dollar increases resulted from the Company's expanded product development
efforts, partially offset by reduced contract and other variable expenses
related to externally funded research and development. From time to time the
Company receives engineering funding for development of projects to apply or
enhance the Company's technology to a particular customer's need. The amounts
recognized under these research and development contracts are offset against
research and development expenses. Amounts recognized under non-recurring
engineering contracts totaled $1.2 million and $0.6 million for the second
quarter of 1996 and 1997, respectively, and $2.3 million and $1.1 million for
the first half of 1996 and 1997, respectively.
Selling and Marketing. Selling and marketing expenses consist primarily
of personnel expenses, including sales commissions, and expenses for
advertising, public relations, seminars and trade shows. Selling and marketing
expenses increased 66% from $3.4 million for the three months ended June 28,
1996 to $5.6 million for the three months ended June 27, 1997, and increased 58%
from $6.1 million for the six months ended June 28, 1996 to $9.7 million for the
six months ended June 27, 1997. Selling and marketing expenses as a percentage
of revenue were 28% and 31% for the second quarter of 1996 and 1997,
respectively, and 29% and 28% for the first half of 1996 and 1997, respectively.
The dollar increases were due to expenses associated with expansion of the
Company's direct sales force, personnel increases in the marketing group, and
increased expenses associated with advertising, public relations and trade
shows.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, recruitment expenses, information
system costs, and audit, legal and other professional service fees. General and
administrative expenses increased 46% from $1.5 million for the three months
ended June 28, 1996 to $2.2 million for the three months ended June 27, 1997,
and 56% from $2.7 million for the six months ended June 28, 1996 to $4.2 million
for the six months ended June 27, 1997. General and administrative expenses as a
percentage of revenue were 12% for both the second quarter of 1996 and 1997, and
13% and 12% for the first half of 1996 and 1997, respectively. The dollar
increases were primarily due to increased staffing and professional fees
necessary to manage and support the Company's recent growth and provide
infrastructure required for a public company.
Other Income (Expense), Net. Other income (expense), net, primarily
consists of royalties, interest income, interest expense and investment gains
and losses. Interest income, net, increased from $1.3 million for the first half
of 1996 to $1,8 million for the first half of 1997, principally due to interest
income resulting from funds derived from the Company's initial public offering
in February and March of 1996. In the first quarter of 1997, the Company
recorded a benefit of $632,000 primarily related to the reversal of an allowance
provided on the receivable related to the Company's interest in the residual
value of a former partnership known as Public Key Partners ("PKP"). Management
considers the uncertainty regarding ultimate collection to have been resolved as
a result of the settlement agreement between the Company and RSA Data Security,
Inc., a subsidiary of Security Dynamics ("RSA DSI"). The assets of the former
partnership, consisting primarily of cash, are being held in trust pending the
resolution of certain litigation described in Part II, Item 1 "Legal
Proceedings." Management does not believe that the ultimate resolution of this
matter will have a material adverse effect on the Company's financial position
or results of operations. The first quarter of 1996 includes a $441,000 write
down of the Company's short-term investments as management concluded the decline
in value was permanent. These investments were sold at an actual loss of
$432,000 in the third quarter of 1996. The Company also experienced a decline in
royalty income during the six months ended June 27, 1997 as compared to the same
period in 1996.
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 1997, the Company had cash and cash equivalents of $69.0
million, working capital of $91.3 million and minimal long-term obligations. Net
cash used in operating activities consisted primarily of increases in current
assets other than cash and a decrease in accounts payable, partially offset by
net income and an increase in accrued liabilities.
8
<PAGE>
The Company made capital expenditures of approximately $2.1 million in
the six months ended June 27, 1997. The Company also made long-term loans to
employees of approximately $3.5 million.
The Company is currently engaged in litigation and has certain assets
subject to litigation. See Part II, Item 1 "Legal Proceedings." Management
believes that the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
The Company believes that existing cash balances and cash generated
from operations, if any, will be sufficient to fund necessary purchases of
capital equipment and to provide working capital through at least the remainder
of 1997. However, the Company may require additional funds to support its
working capital requirements or for other purposes and may seek to raise such
additional funds through public or private equity financing or from other
sources. No assurance can be given that additional financing will be available
or that, if available, will be available on terms favorable to the Company or
its shareholders.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Recent Losses; Potential Fluctuations in Operating Results, Future Operating
Results Uncertain.
Due primarily to increased research and development, sales and
marketing, and litigation expenses, the Company incurred losses in 1994 and 1995
and the first six months of 1996. There can be no assurances that the Company
will increase or maintain its revenue or be profitable on a quarterly or an
annual basis in the future.
The Company has historically experienced significant fluctuations in
its operating results on an annual and a quarterly basis and could experience
such fluctuations in the future. The Company's operating results are affected by
a number of factors, many of which are outside of the Company's control,
including: the timing of the introduction of new or enhanced products by the
Company or its competitors; market acceptance of new products of the Company,
its customers and its competitors; the timing, cancellation or delay of customer
orders, including cancellation or delay in anticipation of new product
introduction or enhancement or resulting from uncertainty relating to
intellectual property claims; competitive factors, including pricing pressures;
changes in operating expenses, including those resulting from changes in
available production capacity of independent foundries and other suppliers and
the availability of raw materials; expenses associated with obtaining, enforcing
and defending claims with respect to intellectual property rights; the mix of
products sold; changes in the percentage of products sold through the Company's
direct sales force; personnel changes; general economic conditions; and
fluctuations in foreign currency exchange rates. The Company expects to
introduce a number of new products in 1997. The failure of such new products to
achieve market acceptance at the time anticipated by the Company, or at all,
would materially and adversely affect the Company's financial condition and
results of operations.
Potential Volatility of Stock Price
The trading of the Company's Common Stock has been and may continue to
be subject to wide fluctuations in response to quarter to quarter variations in
operating results, announcements of technological innovations or new products by
the Company or its competitors, developments with respect to patents or
proprietary rights, general conditions in the information security systems and
wireless communications industries, changes in earnings estimates by analysts,
or other events or factors. In addition, the stock market has experienced
extreme price and volume fluctuations, which have particularly affected the
market prices of many technology companies and which have often been unrelated
to the operating performance of such companies. The Company's sales or operating
results in future quarters may be below the expectations of public market
securities analysts and investors. In such event, the price of the Company's
Common Stock would likely decline, perhaps substantially. These Company-specific
factors or broad market fluctuations may materially adversely affect the market
price of the Company's Common Stock.
Pending Litigation
See Part II, Item 1. "Legal Proceedings."
9
<PAGE>
Dependence on Key Personnel
The Company's future success will depend to a large extent on the
abilities and successful contributions of its executive officers, key management
and technical personnel. The Company has been able to recruit several senior
managers in the last year and its future is closely linked to the ability to
successfully integrate these key employees into the Company, and to maintain and
extend its base of talented management, technical and other personnel.
Competition for highly-skilled business, product development, technical and
other personnel is intense, and the loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel, could delay product development cycles or otherwise
have a material adverse effect on the Company's financial position and results
of operations.
Lengthy Sales Cycle
Sales of the Company's products generally involve a significant
commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures. For these and other reasons, the
sales cycle associated with the Company's products is typically lengthy and
subject to a number of significant risks over which the Company has little or no
control. The Company is often required to ship products shortly after it
receives orders and, consequently, order backlog at the beginning of any period
has in the past represented only a small portion of that period's expected
revenue. As a result, product revenue in any period is substantially dependent
on orders booked and shipped in that period. The Company typically plans its
production and inventory levels based on internal forecasts of customer demand,
which are highly unpredictable and can fluctuate substantially. If revenue falls
significantly below anticipated levels, the Company's financial condition and
results of operations would be materially and adversely affected. In addition,
the Company's operating expenses are based on anticipated revenue levels and a
high percentage of the Company's expenses are generally fixed in the short term.
Based on these factors, a small fluctuation in the timing of sales can cause
operating results to vary significantly from period to period. In addition, it
is possible that in the future the Company's operating results will be below the
expectations of securities analysts and investors. In such an event, or in the
event that adverse conditions prevail or are perceived to prevail generally or
with respect to the Company's business, the price of the Company's Common Stock
would likely be materially adversely affected.
Dependence on Recently Introduced and New Information Security Products
The Company's future results of operations will be highly dependent on
the successful completion of the design, development, introduction, marketing
and manufacture of the SecureManager products, some of which are under
development, and the SecureGate, SecureTraveler, SecureFrame and SecureDomain
products, which were recently introduced. To date, the Company has made only
limited commercial shipments of certain of such products. No assurance can be
given that any of such products will not require additional development work,
enhancement, testing or further refinement before they can be introduced and
made commercially available by the Company or that they will achieve market
acceptance. If such new and recently introduced products have performance,
reliability, quality or other shortcomings, then such products could fail to
achieve market acceptance and the Company may experience reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and additional
warranty and service expenses, which in each case could have a material adverse
effect on the Company's financial condition and results of operations.
Competition
Competition is intense among providers of information security systems
and wireless communications equipment and systems, and the Company expects such
competition to increase in the future. Significant competitive factors in these
markets include the development of new products and features, product quality
and performance, the quality and experience of sales, marketing and service
organizations, product price and name recognition. Many of these factors are
beyond the Company's control.
The Company's competitors in the information security markets include
Security Dynamics, Semaphore, Cray Research, Racal-Guardata, Inc., and
Information Resource Engineering, Inc. Northern Telecom Limited, AT&T, Motorola
Corporation, Digital Equipment Corporation and Sun Microsystems, Inc. offer
certain information security products as part of their overall networking
solutions. In addition, a number of significant vendors, including Microsoft
Corporation, Netscape Communications Corporation and Cisco Systems have embedded
security solutions in their software. To the extent that these embedded or
optional security capabilities provide all or a
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portion of the functionality provided by the Company's products, the Company's
products may no longer be required by customers to attain information security.
Several vendors including RSA DSI license various methods of
implementing cryptographic technology, including some that are different than
(and incompatible with) the method of implementing cryptography currently used
by the Company in most of its products. Although Cylink has a license to use all
of the leading methods promoted by the Company and RSA DSI, to the extent
relevant industries impose technical standards different than those currently
used by the Company in any segment of the information security market, sales of
the Company's existing and planned products in that market segment may be
adversely impacted, which could have a material adverse effect on the Company's
financial condition and results of operations.
The Company competes with a large number of companies in the wireless
communications markets, including U.S. local exchange carriers and foreign
telephone companies. The most significant competition for sub-T1 rate AirLink
products in the wireless market is from telephone companies that offer leased
line data services. The Company also competes with other suppliers of wireless
products such as Digital Wireless, Utilicom, Western Multiplex and California
Microwave, Inc.
Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer standing relationships with customers than the Company. Competitors
with greater financial resources are better able to engage in sustained price
reductions in order to gain market share. Any period of sustained price
reductions would have a material adverse effect on the Company's financial
condition and results of operations. There can be no assurance that the Company
will be able to compete successfully in the future or that competitive pressures
will not materially and adversely affect the Company's financial condition and
results of operations.
Product Liability Risks
Customers rely on the Company's information security products to
prevent unauthorized access to their networks and data transmissions. A
malfunction or the inadequate design of the Company's products could result in
tort or warranty claims. Although the Company attempts to reduce the risk of
such losses through warranty disclaimers and liability limitation clauses in its
sales agreements and by maintaining product liability insurance, there can be no
assurance that such measures will be effective in limiting the Company's
liability for any such damages. Any liability for damages resulting from
security breaches could be substantial and could have a material adverse effect
on the Company's business and results of operations. In addition, a
well-publicized actual or perceived security breach could adversely affect the
market's perception of security products in general, or the Company's products
in particular, regardless of whether such breach is attributable to the
Company's products. This could result in a decline in demand for the Company's
products, which would have a material adverse effect on the Company's financial
condition and results of operations.
Management of Growth
The Company has recently experienced and may continue to experience
substantial growth in the number of its employees and the scope of its
operations, resulting in increased responsibilities for management. To manage
growth effectively, the Company will need to continue to improve its
operational, financial and management information systems and to hire, train,
motivate and manage a growing number of employees. Competition is intense for
qualified technical, marketing and management personnel, particularly highly
skilled engineers. In particular, the current availability of qualified
engineers is quite limited, and competition among companies, academic
institutions, government entities and other organizations for skilled and
experienced engineering personnel is very intense. The Company is currently
attempting to hire a number of engineering personnel and has experienced delays
in filling such positions. The Company expects to experience continued
difficulty in filling its needs for qualified engineers and other personnel.
There can be no assurance that the Company will be able to effectively achieve
or manage any future growth, and its failure to do so could delay product
development cycles or otherwise have a material adverse effect on the Company's
financial condition and results of operations.
Intellectual Property and Other Proprietary Rights
The Company relies on patents, trademarks, copyrights, licenses and
trade secret law to establish and preserve its intellectual property rights. The
Company owns twelve U.S. patents covering certain aspects of its
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<PAGE>
product designs and has one additional U.S. patent application pending. The
Company also has the exclusive right to sublicense certain patents that were
granted to Stanford University with respect to the original Public Key methods
(the "Stanford Patents"), which expire in the United States in the third quarter
of 1997. There can be no assurance that any patent, trademark, copyright or
license owned or held by the Company will not be invalidated, circumvented or
challenged, that the rights granted thereunder will provide competitive
advantages to the Company or that any of the Company's pending or future patent
applications will be issued with the scope of the claims sought by the Company,
if at all. Further, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology, duplicate
the Company's technology or design around the patents owned by the Company. The
Company may be subject to or may initiate interference proceedings in the U.S.
Patent Office, which can require significant financial and management resources.
In addition, the laws of certain countries in which the Company's products are
or may be developed, manufactured or sold may not protect the Company's products
and intellectual property rights to the same extent as the laws of the United
States. The inability of the Company to protect its intellectual property
adequately could have a material adverse effect on its financial condition and
results of operations.
The network information security and wireless communications industries
in which the Company sells its products are characterized by substantial
litigation regarding patent and other intellectual property rights. From time to
time, the Company has received communications from third parties asserting that
the Company's patents, features or content of certain of the Company's products
infringe upon the intellectual property rights held by third parties, and the
Company may receive such communications in the future. The Company is not aware
that any of the features or content of its products wrongfully infringe on any
valid intellectual property rights of others. There can be no assurance that
third parties will not assert claims against the Company that result in
litigation. Any litigation, whether or not determined in favor of the Company,
could result in significant expense to the Company and could divert management
and other resources. In the event of an adverse ruling in any litigation
involving intellectual property, the Company might be required to discontinue
the use of certain processes, cease the manufacture, use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to the infringing technology and may suffer significant monetary
damages, which could include treble damages. There can be no assurance that
under such circumstances a license would be available to the Company on
reasonable terms or at all. In the event of a successful claim against the
Company and the Company's failure to develop or license a substitute technology
on commercially reasonable terms, the Company's financial condition and results
of operations would be adversely affected. There can be no assurance that
existing claims or any other assertions (or claims for indemnity from customers
resulting from infringement claims) will not materially and adversely affect the
Company's financial condition and results of operations.
Evolving Information Security Market
The market for the Company's information security products is only
beginning to emerge. This market is characterized by rapidly changing
technology, emerging industry standards, new product introductions and changes
in customer requirements and preferences. The Company's future success will
depend in part upon end users' demand for information security products in
general, and upon the Company's ability to enhance its existing products and to
develop and introduce new products and technologies that meet customer
requirements. Any significant advance in technologies for attacking
cryptographic systems could render some or all of the Company's existing and new
products obsolete or unmarketable. To the extent that a specific method other
than the Company's is adopted as the standard for implementing information
security in any segment of the information security market, sales of the
Company's existing and planned products in that market segment may be adversely
impacted, which could have a material adverse effect on the Company's financial
condition and results of operations. There can be no assurance that information
security-related products or technologies developed by others will not adversely
affect the Company's competitive position or render its products or technologies
noncompetitive or obsolete.
In addition, a portion of the sales of the Company's information
security products will depend upon a robust industry and infrastructure for
providing access to public switched networks, such as the Internet. There can be
no assurance that the infrastructure or complementary products necessary to make
these networks into viable commercial marketplaces will be developed, or, if
developed, that these networks will become viable commercial marketplaces.
12
<PAGE>
Rapid Technological Change
The markets for the Company's products are characterized by rapidly
changing technologies, extensive research and new product introductions. The
Company believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop, manufacture and market
new products. As a result, the Company expects to continue to make a significant
investment in engineering, research and development. There can be no assurance
that the Company will be able to develop and introduce new products or
enhancements to its existing products in a timely manner which satisfy customer
needs, achieve market acceptance or address technological changes in its target
markets. The failure of the Company to develop products and introduce them
successfully and in a timely manner could adversely affect the Company's
competitive position, financial condition and results of operations.
Wireless Communications Industry Regulatory Environment
Wireless communications are subject to regulations by United States and
foreign laws and international treaties. In the United States, the Company's
wireless communications products are subject to various regulations of the
Federal Communications Commission ("FCC"). Current FCC regulations permit
license-free operation of certain FCC certified wireless products. The future of
remote wireless communications is highly volatile, due in part to ongoing
uncertainty regarding telecommunications deregulation and the status of
initiatives relating to the auction of licenses for personal communications
service ("PCS") frequencies. Regulatory changes, including changes in the
allocation of available frequencies, could significantly affect the Company's
operations by diverting the Company's development efforts, making current
products obsolete or increasing the opportunity for additional competition.
There can be no assurance that new regulations will not be promulgated which
could have a material adverse effect on the Company's financial condition and
results of operations.
The Company also is subject to regulatory requirements in foreign
markets. Equipment can be marketed in a country only if permitted by suitable
frequency allocations and regulations, and only if such equipment has received
type approval by the country in question. The process of complying with new
regulations and of obtaining type approval is often complex and lengthy and can
result in significant expense and delays in the introduction of products in new
countries.
Changes in, or the failure by the Company to comply with, applicable
domestic and international regulations could have a material adverse effect on
the Company's business and operating results. There can be no assurance that the
Company will be able to comply with regulations in any particular country.
Risks Associated with International Sales; Reliance Upon Local Partners;
Restrictions on Export
International product sales represented approximately 35%, 47%, 59% and
51% of revenue in 1994, 1995, 1996 and for the six months ended June 27, 1997,
respectively. In particular, sales of the Company's wireless communications
products are currently concentrated in developing countries. The Company plans
to continue to expand its foreign sales channels and to enter additional
international markets, both of which will require significant management
attention and financial resources. International sales are subject to a number
of risks, including unexpected changes in regulatory requirements, tariffs and
other trade barriers, political and economic instability in foreign markets,
difficulties in the staffing, management and integration of foreign operations,
longer payment cycles, greater difficulty in collecting accounts receivable,
currency fluctuations and potentially adverse tax consequences. Since most of
the Company's foreign sales are denominated in U.S. dollars, the Company's
products become less price competitive in countries in which local currencies
decline in value relative to the U.S. dollar. The uncertainty of monetary
exchange values has caused, and may in the future cause, some foreign customers
to delay new orders or delay payment for existing orders. The long-term impact
of such devaluation, including any possible effect on the business outlook in
other developing countries, cannot be predicted.
The Company's ability to compete successfully in foreign countries is
dependent in part on the Company's ability to obtain and retain reliable and
experienced in-country distributors and other strategic partners. The Company
does not have long-term relationships with any of its value added resellers and
distributors and, therefore, has no assurance of a continuing relationship
within a given market.
United States government regulations restrict the export of certain
cryptographic devices, including certain of the Company's information security
products. As a result, the Company may be at a disadvantage in competing
13
<PAGE>
for international sales compared to companies located outside the United States
that are not subject to such restrictions.
Dependence on Component Availability, Subcontractor Performance and Key
Suppliers
The Company's ability to timely deliver its products is dependent upon
the availability of quality components and subsystems used in these products.
The Company depends in part upon subcontractors to manufacture, assemble and
deliver certain items in a timely and satisfactory manner. The Company obtains
certain components and subsystems from single, or a limited number of, sources.
A significant interruption in the delivery of such items could have a material
adverse effect on the Company's financial condition and results of operations.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On September 6, 1995, the Company obtained an arbitration award
dissolving a former partnership, known as PKP, between the Company's
wholly-owned subsidiary, Caro-Kann Corporation, and RSA DSI. Although various
claims between the Company and RSA DSI were settled on December 31, 1996, a
third party continues to pursue various claims against PKP and RSA DSI for
wrongful business practices in action C-94-20512 SW before the United States
District Court for the Northern District of California. An unfavorable outcome
might affect the residual value the Company may receive from the former
partnership.
On March 7, 1997, ten former employees of the Company filed suit in
action No. CV764647 in the Superior Court of California, County of Santa Clara,
against the Company, each of its Directors and its General Counsel, asserting
claims for wrongful termination, fraud, libel, slander, age discrimination,
invasion of privacy, and violation of the federal RICO statute. The Company has
removed the action to the United States District Court, Northern District of
California, No. C-97-20331 PVT. On July 23, 1997, one additional former employee
served a summons and complaint in action No. CV767448 in the Superior Court of
the State of California, County of Santa Clara, against the Company and one
additional defendant alleging grounds similar to those asserted by the ten
pending plaintiffs. Although the Company has placed its insurers on notice of
these claims, only some of them have admitted coverage with reservation of
certain rights and defenses. The Company believes the terminations were lawful
and intends to defend the matter vigorously. The defense of this matter may
divert a material amount of management's attention and require the expenditure
of significant legal fees and costs. An unfavorable outcome which exceeds the
Company's insurance coverage, if any, could also result in a material adverse
effect on the Company's financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Registrant's Annual Meeting of Shareholders was held on May 22, 1997.
(b) The following directors were elected at the Meeting:
For Withheld
--- --------
Fernand B. Sarrat 23,690,338 162,877
Jimmy K. Omura 23,691,988 161,227
Leo A. Guthart 23,690,838 162,377
James H. Simons 23,691,488 161,727
Howard L. Morgan 23,691,488 161,727
Elwyn Berlecamp 23,668,305 184,910
William W. Harris 23,690,238 162,977
King W.W. Harris 23,690,688 162,527
(c) Other matters voted on at the Meeting were the following:
(i) Approval and ratification of the Cylink Corporation 1994 Flexible
Stock Incentive Plan, as Amended, which (i) increases the maximum
aggregate number of shares available for the grant of incentive
stock options to 5,950,000, (ii) provides for discretionary awards
to the Company's Non-Employee Directors, and (iii)
14
<PAGE>
increases the maximum number of shares with respect to which options
and stock appreciation rights may be granted to any employee to
1,000,000.
For 14,539,614
Against 1,846,491
Abstain 48,913
Broker non-votes 7,418,197
(ii) Approval of an amendment to the Company's bylaws granting the Board
of Directors the authority to approve loans to, and guarantee
obligations of, officers of the Company and to ratify a loan for
approximately $2,000,000 made to the Company's President and Chief
Executive Officer.
For 15,689,549
Against 670,775
Abstain 74,694
Broker non-votes 7,418,197
(iii) Ratification of the appointment of Price Waterhouse LLP as the
Company's independent auditors for the fiscal year ending December
31, 1997.
For 23,708,626
Against 92,668
Abstain 51,921
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Index:
Exhibit
Number Description of Exhibit
------ ----------------------
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended June 27, 1997.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: August 11, 1997 CYLINK CORPORATION
By: /s/ JOHN H. DAWS
-----------------------------------------
John H. Daws
Vice President of Finance
and Administration and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
16
<TABLE> <S> <C>
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<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
6/27/97 CONDENSED CONSOLIDATED BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR
THE SIX MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-27-1997
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<ALLOWANCES> 409
<INVENTORY> 10163
<CURRENT-ASSETS> 99558
<PP&E> 10328
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<TOTAL-ASSETS> 108867
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<CGS> 11722
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