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 28, 1998
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 10, 1998, there were 29,074,990 shares of the Registrant's Common
Stock outstanding.
1
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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 28, December 31,
1998 1997
--------- ---------
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 46,052 $ 22,977
Accounts receivable, net of allowances of $384 and $278 28,430 15,557
Note receivable 14,500 --
Inventories 6,957 6,224
Net assets of discontinued operations -- 13,218
Deferred income taxes 1,640 1,533
Other current assets 2,464 2,190
--------- ---------
Total current assets 100,043 61,699
Property and equipment, net 6,105 6,003
Acquired technology, goodwill and other intangibles, net 6,659 8,017
Notes receivable from employees 5,703 3,473
Other assets 3,469 925
--------- ---------
$ 121,979 $ 80,117
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 194 $ 210
Accounts payable 1,958 2,238
Accrued liabilities 8,442 6,194
Accrued liabilities related to discontinued operations 3,850 --
Income taxes payable 9,469 1,898
Deferred revenue 939 206
--------- ---------
Total current liabilities 24,852 10,746
--------- ---------
Capital lease obligations and long-term debt 178 256
--------- ---------
Deferred income taxes 13 13
--------- ---------
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;
29,044,000 and 28,695,000 shares issued and outstanding 290 287
Additional paid-in capital 122,442 120,092
Deferred compensation related to stock options (208) (250)
Cumulative translation adjustment (62) (63)
Accumulated deficit (25,526) (50,964)
--------- ---------
Total shareholders' equity 96,936 69,102
--------- ---------
$ 121,979 $ 80,117
========= =========
<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 28, June 27, June 28, June 27,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 18,035 $ 11,584 $ 33,864 $ 20,936
Cost of revenue 4,472 3,385 8,083 6,195
-------- -------- -------- --------
Gross profit 13,563 8,199 25,781 14,741
-------- -------- -------- --------
Operating expenses:
Research and development, net 2,770 2,953 5,815 5,971
Selling and marketing 6,207 3,932 11,780 6,714
General and administrative 1,822 2,123 3,230 4,023
Amortization of purchased intangibles 680 -- 1,359 --
-------- -------- -------- --------
Total operating expenses 11,479 9,008 22,184 16,708
-------- -------- -------- --------
Income (loss) from operations 2,084 (809) 3,597 (1,967)
Other income:
Interest income, net 687 874 839 1,816
Royalty and other income (expense), net (115) 195 (115) 326
-------- -------- -------- --------
Income from continuing operations before income taxes 2,656 260 4,321 175
Provision for income taxes 924 -- 1,507 --
-------- -------- -------- --------
Income from continuing operations 1,732 260 2,814 175
Income (loss) from discontinued operations, net of
income tax expense (benefit) of $524, $(89) and $998 -- 963 (166) 2,155
Gain on disposal of discontinued operations,
net of income tax expense of $12,358 -- -- 22,790 --
-------- -------- -------- --------
Net income $ 1,732 $ 1,223 $ 25,438 $ 2,330
======== ======== ======== ========
Earnings per share - basic:
Continuing operations $ 0.06 $ 0.01 $ 0.10 $ 0.01
Discontinued operations -- 0.04 0.78 0.08
-------- -------- -------- --------
Net income $ 0.06 $ 0.05 $ 0.88 $ 0.09
======== ======== ======== ========
Earnings per share - diluted:
Continuing operations $ 0.06 $ 0.01 $ 0.09 $ 0.01
Discontinued operations -- 0.04 0.75 0.08
-------- -------- -------- --------
Net income $ 0.06 $ 0.05 $ 0.84 $ 0.09
======== ======== ======== ========
Shares used in per share calculation - basic 29,011 25,921 28,916 25,811
======== ======== ======== ========
Shares used in per share calculation - diluted 30,435 26,609 30,437 26,155
======== ======== ======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<CAPTION>
Six Months Ended
-----------------------------
June 28, June 27,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Income (loss) from continuing operations $ 2,814 $ 175
Adjustments to reconcile income (loss) to net
cash used in continuing operations:
Depreciation and amortization 2,215 878
Deferred compensation related to stock options 42 42
Deferred income taxes (107) --
Changes in assets and liabilities:
Accounts receivable (12,873) (3,147)
Inventories (733) (1,016)
Other assets 182 (1,158)
Accounts payable (280) (1,560)
Accrued liabilities (2,688) 407
Deferred revenue 733 (109)
-------- --------
Net cash used in continuing operations (10,695) (5,488)
Net cash provided by (used in) discontinued operations (6,957) 417
-------- --------
Net cash used in operating activities (17,652) (5,071)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (1,578) (2,073)
Loans to employees in exchange for notes receivable (2,230) (3,473)
Proceeds from sale of discontinued operations 46,000 --
Acquisition of preferred stock of Syndata Technologies (3,000) --
-------- --------
Net cash provided by (used in) investing activities 39,192 (5,546)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 1,628 555
Payment of notes receivable from shareholders -- 301
Repayment of capital lease obligations and long-term debt (94) (76)
-------- --------
Net cash provided by financing activities 1,534 780
-------- --------
Effect of exchange rate changes on cash and cash equivalents 1 (46)
-------- --------
Net increase (decrease) in cash and cash equivalents 23,075 (9,883)
Cash and cash equivalents at beginning of period 22,977 78,849
-------- --------
Cash and cash equivalents at end of period $ 46,052 $ 68,966
======== ========
Supplemental disclosures:
Cash paid for income taxes $ 6,054 $ 26
Cash paid for interest 30 44
<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, 1997. Interim results
of operations are not necessarily indicative of the results to be expected
for the full year.
Beginning in 1998, the Company's interim quarters end on the last
Sunday preceding the calendar quarter end. Previously, the Company's
interim quarters ended on the last Friday preceding the calendar quarter
end.
2. Discontinued Operations
On March 28, 1998, the Company sold its Wireless Communications Group
("Wireless") to P-Com, Inc. for $60.5 million ($46.0 million in cash and
unsecured promissory note in the amount of $14.5 million due 100 days after
closing, subject to closing adjustments). As a result, the operations of
Wireless have been classified as discontinued operations in the
accompanying Condensed Consolidated Financial Statements and related Notes.
Accrued expenses in the amount of approximately $6.8 million, primarily for
professional services, anticipated excess facilities expenses, and certain
other transaction related accruals were charged to discontinued operations
and offset against the gain on disposal. Wireless revenues were $6.7
million and $13.5 million in the second quarter and first half of 1997,
respectively, and were $4.5 million in 1998 through the date of disposal.
On July 14, 1998, P-Com made a partial payment of $9.4 million on its
promissory note and is disputing the remaining balance. See Part II, Item 1
"Legal Proceedings."
3. Notes Receivable From Employees
Pursuant to their employment agreements and related promissory notes,
the Company has loaned certain employees $5.7 million towards the purchase
of their principal residences. Of this amount, $5.1 million is receivable
from officers of the Company. The notes are interest free and are secured
by deeds of trust on the related 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. Maturity dates are as follows: $1.6 million in 2002, $1.7
million in 2003, and $2.4 million thereafter.
4. Inventories
June 28, December 31,
1998 1997
------ ------
(in thousands)
Raw materials $2,965 $2,191
Work in process and subassemblies 2,256 1,858
Finished goods 1,736 2,175
------ ------
$6,957 $6,224
====== ======
5
<PAGE>
<TABLE>
5. Earnings Per Share
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
June 28, June 27, June 28, June 27,
1998 1997 1998 1997
------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C>
Shares used to compute basic earnings per share
(weighted average number of common shares
outstanding during the period) 29,011 25,921 28,916 25,811
Incremental common shares attributable to assumed
exercise of dilutive stock options 1,424 688 1,521 344
------ ------ ------ ------
Shares used to compute diluted earnings per share 30,435 26,609 30,437 26,155
====== ====== ====== ======
Antidilutive stock options 160 3,396 192 3,611
====== ====== ====== ======
</TABLE>
6. Recent Accounting Pronouncements
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income." This
Statement establishes standards for reporting comprehensive income and its
components in an annual 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.
Annual financial statements for prior periods will be reclassified, as
required. The Company's total comprehensive earnings were as follows:
Three Months Ended Six Months Ended
------------------ ----------------
June 28, June 27, June 28, June 27,
1998 1997 1998 1997
------- ------- ------- -------
(in thousands)
Net income $ 1,732 $ 1,223 $25,438 $ 2,330
Other comprehensive income (loss) (15) 37 1 (46)
------- ------- ------- -------
Total comprehensive income $ 1,717 $ 1,260 $25,439 $ 2,284
======= ======= ======= =======
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 of adopting this new standard. The
disclosures prescribed by FAS 131 are effective for 1998, and are not
required for interim periods. The Company does not expect this
pronouncement to have a material impact on its financial statements.
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 1998 and continue
to make a significant investment in engineering, research and development, its
intention to expand its foreign sales channels and enter additional
international markets, and the Company's intention to protect itself from
liability arising out of "year 2000 errors." 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.
DISCONTINUED OPERATIONS
Pursuant to an asset purchase agreement dated March 27, 1998, the
Company sold its Wireless business for approximately $46.0 million in cash and a
$14.5 million unsecured note receivable due 100 days after closing, subject to
closing adjustments. See Note 2 of Notes to Condensed Consolidated Financial
Statements. The sale resulted in an after tax gain of approximately $22.8
million. Except where noted, the following comments are associated with the
continuing network security business.
RESULTS OF OPERATIONS
Revenue. The Company's revenue is derived primarily from sales of its
family of commercial network security 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 costs
to repair or replace products under warranty arrangements. Revenue from sales to
distributors is recognized upon shipment; no right of return or price protection
is given. A provision is recorded for any estimated reduction in gross profit
due to limited stock rotation privileges. 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 56% from $11.6 million for the three
months ended June 27, 1997 to $18.0 million for the three months ended June 28,
1998, and increased by 62% from $20.9 million for the six months ended June 27,
1997 to $33.9 million for the six months ended June 28, 1998. Approximately 50%
of the increased revenue resulted from sales of recently introduced PrivateWire
products, with the remainder due to increased shipments of the Company's Link
Encryption and SecureFrame products. International revenue was 29% and 31% of
total revenue for the second quarter of 1997 and 1998, respectively.
Gross Profit. Gross profit increased by 65% from $8.2 million for the
three months ended June 27, 1997 to $13.6 million for the three months ended
June 28, 1998, and increased by 75% from $14.7 million for the six months ended
June 27, 1997 to $25.8 million for the six months ended June 28, 1998. The
increase in dollars was primarily a result of the significant increase in
revenue. As a percentage of sales, gross profit was 71% and 75% for the second
quarter of 1997 and 1998, respectively, and 70% and 76% for the first half of
1997 and 1998, respectively. The increase in gross margin resulted primarily
from the increased percentage of total revenue represented by software and
software-intensive products, such as PrivateWire, which generally have higher
gross margins than hardware-intensive products. To a lesser degree, the increase
in gross margin was due to lower average unit costs for existing 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
7
<PAGE>
development expenses decreased 11% from $3.6 million for the three months ended
June 27, 1997 to $3.2 million for the three months ended June 28, 1998, and
decreased 13% from $7.1 million for the first half of 1997 to $6.2 million for
the first half of 1998. Gross research and development expenses as a percentage
of revenue were 31% and 18% for the second quarter of 1997 and 1998,
respectively, and 34% and 18% for the first half of 1997 and 1998 respectively.
The decrease in expenses as a percentage of revenue resulted primarily from the
Company's increased revenue base. The dollar decrease resulted from reduced
contract and other variable expenses related to externally funded development
and from cost containment efforts. 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. The amounts recognized under non-recurring engineering
contracts totaled $0.6 million and $0.4 million for the second quarter of 1997
and 1998, respectively, and $1.1 million and $0.4 million for the first half of
1997 and 1998, 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 58% from $3.9 million for the three months ended June 27,
1997 to $6.2 million for the three months ended June 28, 1998, and increased 75%
from $6.7 million for the six months ended June 27, 1997 to $11.8 million for
the six months ended June 28, 1998. Selling and marketing expenses as a
percentage of revenue were 34% for the second quarter of both 1997 and 1998, and
32% and 35% for the first half of 1997 and 1998, respectively. Sales and
marketing expenses increased from the second quarter and first half of 1997
primarily to support the launch of new or enhanced products, as well as due to
continued expansion of the Company's direct sales operations, product line
management, marketing development and international operations. Additionally,
sales and marketing expenses increased due to integration expenses resulting
from the acquisition of Algorithmic Research ("ARL") in September 1997.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, recruitment expenses, information
systems costs, and audit, legal and other professional service fees. General and
administrative expenses decreased 14% from $2.1 million for the three months
ended June 27, 1997 to $1.8 million for the three months ended June 28, 1998,
and decreased 20% from $4.0 million for the six months ended June 27, 1997 to
$3.2 million for the six months ended June 28, 1998. General and administrative
expenses as a percentage of revenue were 18% and 10% for the second quarter of
1997 and 1998, respectively, and 19% and 10% for the fist half of 1997 and 1998,
respectively. The dollar decrease from the second quarter and first half of 1997
was primarily due to decreases in consulting expenses, recruiting and relocation
expenses related to senior management transition and legal fees.
Other Income. Other income consists primarily of interest income.
Interest income, net, decreased from $0.9 million for the second quarter of 1997
to $0.7 million for the second quarter of 1998, and decreased from $1.8 million
for the first half of 1997 to $0.8 million for the first half of 1998. The
decrease is principally due to the decrease in average cash and cash equivalents
resulting from investing activities and working capital requirements.
LIQUIDITY AND CAPITAL RESOURCES
At June 28, 1998, the Company had cash and cash equivalents of $46.1
million, working capital of $75.1 million and minimal long-term obligations. For
the six months ended June 28, 1998, the Company recorded net income of $25.4
million, largely due to the gain on sale of Wireless. Net cash used in
continuing operating activities for the first half of 1998 of $10.7 million
consisted primarily of increases in accounts receivable resulting from increased
foreign sales into new areas and to more liberal payment terms.
Cash provided by investing activities for the six months ended June 28,
1998 was $39.2 million, of which $46.0 million was attributed to the sale of
Wireless. The funds attributable to the Wireless sale were partially offset by
expenditures for property and equipment of $1.6 million, long-term loans to
employees of $2.2 million, and a $3.0 million investment in the preferred stock
of Syndata Technologies, Inc.
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.
8
<PAGE>
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 1998. 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 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.
The Company incurred losses from continuing operations in 1994, 1995,
1996 and 1997. 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 related 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 1998. 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.
Pending Litigation
See Part II, Item 1. "Legal Proceedings."
Dependence on Key Personnel
On November 13, 1996, the Company announced the appointment of Fernand
B. Sarrat as President and Chief Executive Officer, and during 1997 the Company
hired a number of executives to senior management positions within the Company.
The Company's future success will depend on the abilities of Mr. Sarrat and the
contributions by its executive officers, key management and technical personnel.
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 and retain qualified
personnel, could delay product development cycles or otherwise have a material
adverse effect on the Company's business and operating results.
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
9
<PAGE>
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 PrivateWire and PrivaCy Manager products, portions of
which are under development, and Link Encryptors NRZ, SecureFrame and
PrivateWire products, which were recently introduced. To date, the Company has
made only limited commercial shipments of certain of such products and no
commercial shipments of the remainder 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 network security 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,
including companies that offer products similar to or as an alternative to the
Company's products, include Axent Technologies, Inc., Checkpoint Software
Technologies, Ltd., Network Associates, Inc., SecureComputing Corporation,
Security Dynamics Technologies, Inc., Racal-Guardata, Inc., and Information
Resource Engineering, Inc. In addition, Northern Telecom Limited, AT&T, Motorola
Corporation, and Sun Microsystems, Inc. offer certain information security
products as part of their overall networking solutions. A number of significant
vendors, including Microsoft Corporation, Netscape Communications Corporation
and Cisco Systems, Inc., have embedded security solutions in their software. To
the extent that these embedded or optional security capabilities provide all or
a portion of the functionality provided by the Company's products, the Company's
products may no longer be required by customers to attain network security.
Certicom Corporation and RSA Data Security, Inc., a subsidiary of
Security Dynamics, ("RSA DSI") license various methods of implementing public
key cryptography, including some that are different than (and incompatible with)
the method of implementing public key cryptography currently used by the Company
in most of its products. Although Cylink has a license to use all of the public
key methods promoted by Certicom and RSA DSI, to the extent significant segments
of the network security market adopt technical standards different than those
currently used by the Company, to the exclusion of the Company's methods, 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.
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 network 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 and license
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
10
<PAGE>
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.
Year 2000
Although the company believes that it has identified all risks of "year
2000 errors" ("YK2 Errors") in its products, and is taking steps to repair,
replace or end-of-life all products which contain YK2 Errors, there is a
continuing risk that some YK2 Errors will go undetected until after December 31,
1999. The Company intends to attempt to protect itself from liability with
appropriate disclaimers in its terms and conditions of sale, by encouraging
customers to upgrade their products to those that have proven to be YK2
compliant, and by discouraging continued use of those products known to have YK2
Errors. However, the Company may be met with unanticipated liability for an
undiscovered YK2 Error which cannot be limited by any of the foregoing
preventive actions, and conceivably could include an allegation of damages which
exceeds the terms or the amount of the Company's insurance policies covering
product liability.
The Company is in the process of evaluating and implementing changes,
as necessary, to its information systems and accordingly does not anticipate any
material YK2 Errors from its own information systems, databases or programs.
However, the Company's financial position and results of operations could be
adversely impacted by YK2 Errors faced by distributors, suppliers, customers,
vendors and financial service organizations with which the Company interacts.
Management of Growth And Reduction In Employees
The Company has recently experienced and may continue to experience
substantial growth in the number of employees and the scope of its operations in
the network security business, 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 has
experienced delays in filling positions for engineering personnel and 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.
With the sale of its Wireless business, the Company has experienced a
significant reduction in employees, including the Company's former Chief
Technical Officer, Dr. Jim Omura. The sale of Wireless, along with occasional
reductions in specific engineering programs in the network security business,
may create a risk of instability within the existing employee population
resulting in departures of key employees critical to sustaining growth in the
Company's network security business. Furthermore, sudden reductions in the
number of the Company's employees places greater demands on the remaining
employees which may distract them from fulfilling their responsibilities
necessary to accomplishing the Company's financial goals.
In September 1997, the Company acquired ARL and assumed responsibility
for management of its worldwide operations of approximately sixty employees. The
Company is heavily dependent on ARL's success in continuing to develop
marketable technology and products, such as the PrivateWire family, including
PrivateSafe and PrivateCard, toolkits and other components. Key factors which
will determine ARL's success include whether the Company can integrate ARL's
management, employee culture and organizational practices into the Company,
whether the Company can adequately fund ARL's development objectives, whether
the Company can provide accurate information for ARL to focus its technology on
significant market opportunities, and whether the Company can predict the most
attractive features and functions for ARL's products. The Company's success in
realizing the
11
<PAGE>
anticipated return from its investment in ARL also will be determined by the
Company's ability to position and introduce ARL's products into the Company's
markets and channels, and the Company's ability to provide adequate sales and
customer support for ARL's products. The Company and ARL's successful working
relationship may be hindered significantly by differences between the two
organizations created by time, distance, language and culture. ARL operates from
its principle offices in Israel, a country which is vulnerable to disruption due
to the sudden outbreak of hostilities with its neighbors and various indigenous
factors. Many of ARL's employees have extensive commitments to the country's
military organizations which may require a loss of their services on the
Company's behalf in times of political instability.
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 a number of U.S. patents covering certain aspects of its network
security product designs, and has additional U.S. patent applications pending.
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 computer, communications, software and network security industries
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. 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 Network Security Market
The market for the Company's network 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 network 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 network security in any segment of the
network 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
12
<PAGE>
that network 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 network 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.
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.
Risks Associated with International Sales; Reliance Upon Local Partners;
Restrictions on Export
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, export control laws, 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.
Due to U.S. government regulations restricting the export of
cryptographic devices and software, including certain of the Company's network
security products, the Company may be at a disadvantage in competing for
international sales compared to companies located outside the United States that
are not subject to such restrictions.
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.
13
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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. On July 11,
1997, an eleventh employee filed suit in action no. CV767448 in the Superior
Court of California, County of Santa Clara, alleging similar claims against the
Company and its Chief Executive Officer. The Company removed CV764647 to the
Federal District Court for the Northern District of California and, after the
Company obtained an order dismissing certain of the plaintiff's claims,
including the claims of libel and RICO violations, the Court remanded the action
back to the Santa Clara Superior Court. Following the remand, the Company then
obtained an order consolidating CV764647 with CV767448 for purposes of discovery
and trial. Both matters are currently in the discovery phase, with trial
currently scheduled for December 1998. Although the Company has placed its
insurers on notice of these claims, all of its insurers have reserved their
rights and defenses under their policies, and the extent of the insurers'
liability under their respective policies is undetermined. The Company believes
the terminations were lawful, in the best interest of the Company, 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 results.
After asserting certain deductions arising under the contract dated
March 27, 1998, for the purchase of the Company's Wireless division, P-Com made
a partial payment on July 14, 1998, in the amount of $9.4 million on its
promissory note dated April 1, 1998. The Company is presently evaluating the
merits of P-Com's deductions and, failing an amicable resolution of P-Com's
contentions, the matter will proceed to litigation.
Item 2. Changes in Securities
(c) The Company's Registration Statement Form S-1 was declared effective by
the Securities and Exchange Commission on February 15, 1996 (Reg. No.
33-80719). In February and March 1996 the Company issued 5,750,000 shares
of its common stock to the public at a price of $15 per share. The Company
received approximately $78.9 million net of underwriting discounts and
commissions of $6.0 million and other offering expenses of $1.4 million.
Through the period ended June 28, 1998, the net proceeds have been used as
follows (in thousands):
Purchase and installation of equipment $ 8,179
Acquisition of Algorithmic Research 45,913
Acquisition of preferrred stock of Syndata Technologies 3,000
Repayment of indebtedness 1,000
Working capital 20,772
-------
$78,864
=======
None of the net proceeds or expenses of issuance and distribution of
the securities were, either directly or indirectly, paid to or invested
with any related party or shareholder of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Registrant's Annual Meeting of Shareholders was held on May 22, 1998.
14
<PAGE>
(b) The following directors were elected at the Meeting:
For Withheld
---------- --------
Leo A. Guthart 22,604,270 101,729
William J. Perry 22,603,970 102,029
James H. Simmons 22,605,770 100,229
William W. Harris 22,605,470 100,529
Howard L. Morgan 22,602,470 103,529
Fernand B. Sarrat 22,603,770 102,229
Elwyn Berlekamp 22,605,330 100,669
King W.W. Harris 22,602,370 103,629
Yossi Tulpan 22,607,030 98,969
(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, (the "Plan") which (i) increases
the number of shares of Common Stock reserved for issuance
thereunder to 8,050,000, and (ii) provides that as of January 1 of
each year the number of Common Shares reserved for issuance under
the Plan will be increased, in the discretion of the Board of
Directors, by up to 4% of the number of shares outstanding as of
December 31 of the immediately preceding year.
For 14,038,141
Against 949,686
Abstain 60,652
Broker non-votes 7,657,520
(ii) Ratification of the appointment of Price Waterhouse LLP as the
Company's independent auditors for the fiscal year ending December
31, 1998.
For 22,656,025
Against 17,335
Abstain 32,639
Item 5. Other Information
Any shareholder proposal submitted with respect to the Company's 1999
Annual Meeting of Shareholders, which proposal is submitted outside the
requirements of Rule 14a-8 under the Securities Exchange Act of 1934, will be
considered untimely for purposes of Rule 14a-4 and 14a-5 if notice thereof is
received by the Company after March 9, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Index:
Exhibit
Number Description of Exhibit
27.1 Financial Data Schedule
(b) The Company filed a report on Form 8-K on April 13, 1998 reporting under
Item 2 the disposition of the Company's Wireless Communications Group
effective March 28, 1998.
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 12, 1998 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>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
6/28/98 CONDENSED CONSOLIDATED BALANCE SHEET AND THE STATEMENT OF
OPERATIONS FOR THE THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-28-1998
<CASH> 46,052
<SECURITIES> 0
<RECEIVABLES> 28,814
<ALLOWANCES> 384
<INVENTORY> 6,957
<CURRENT-ASSETS> 100,043
<PP&E> 12,037
<DEPRECIATION> 5,932
<TOTAL-ASSETS> 121,979
<CURRENT-LIABILITIES> 24,852
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0
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<COMMON> 290
<OTHER-SE> 96,646
<TOTAL-LIABILITY-AND-EQUITY> 121,979
<SALES> 18,035
<TOTAL-REVENUES> 18,035
<CGS> 4,472
<TOTAL-COSTS> 4,472
<OTHER-EXPENSES> 11,479
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15
<INCOME-PRETAX> 2,656
<INCOME-TAX> 924
<INCOME-CONTINUING> 1,732
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