SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q/A
(restated)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 29, 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 May 7, 1998, there were 28,984,346 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>
March 29, December 31,
1998 1997
--------- ---------
Assets (restated-see Note 2) (restated-see Note 2)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 58,078 $ 22,977
Accounts receivable, net of allowances of $309 and $278 12,756 13,914
Inventories 6,935 6,224
Net assets of discontinued operations 12,424 11,299
Deferred income taxes 1,760 1,533
Other current assets 2,323 2,190
--------- ---------
Total current assets 94,276 58,137
Property and equipment, net 6,041 6,003
Acquired technology, goodwill and other intangibles, net 7,338 8,017
Notes receivable from employees 4,318 3,473
Other assets 3,989 925
--------- ---------
$ 115,962 $ 76,555
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 196 $ 210
Accounts payable 2,936 2,238
Accrued liabilities 6,505 6,194
Accrued liabilities related to discontinued operations 6,773 --
Income taxes payable 11,361 1,304
Deferred revenue 1,165 206
--------- ---------
Total current liabilities 28,936 10,152
--------- ---------
Capital lease obligations and long-term debt 215 256
--------- ---------
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;
28,887,000 and 28,695,000 shares issued and outstanding 289 287
Additional paid-in capital 121,575 120,092
Deferred compensation related to stock options (229) (250)
Cumulative translation adjustment (47) (63)
Accumulated deficit (34,790) (53,932)
--------- ---------
Total shareholders' equity 86,798 66,134
--------- ---------
$ 115,962 $ 76,555
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
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<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended
-------------------------------
March 29, March 28,
1998 1997
-------- --------
(restated-see Note 2)
<S> <C> <C>
Revenue $ 8,062 $ 9,352
Cost of revenue 2,631 2,810
-------- --------
Gross profit 5,431 6,542
-------- --------
Operating expenses:
Research and development, net 3,045 3,018
Selling and marketing 5,573 2,782
General and administrative 1,478 1,900
Amortization of purchased intangibles 679 --
-------- --------
Total operating expenses 10,775 7,700
-------- --------
Loss from operations (5,344) (1,158)
Other income:
Interest income, net 167 942
Royalty and other income (expense), net (15) 131
-------- --------
Loss from continuing operations before income taxes (5,192) (85)
Benefit for income taxes (1,817) --
-------- --------
Loss from continuing operations (3,375) (85)
Income (loss) from discontinued operations,
net of income tax expense (benefit) of $(139) and $474 (259) 1,192
Gain on disposal of discontinued operations,
net of income tax expense of $12,358 22,776 --
-------- --------
Net income $ 19,142 $ 1,107
======== ========
Earnings (loss) per share - basic:
Continuing operations $ (0.12) $ --
Discontinued operations 0.78 0.04
-------- --------
Net income $ 0.66 $ 0.04
======== ========
Earnings (loss) per share - diluted:
Continuing operations $ (0.12) $ --
Discontinued operations 0.78 0.04
-------- --------
Net income $ 0.66 $ 0.04
======== ========
Shares used in per share calculation - basic 28,820 25,701
======== ========
Shares used in per share calculation - diluted 28,820 25,701
======== ========
<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>
Three Months Ended
-----------------------------
March 29, March 28,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities: (restated-see Note 2)
Loss from continuing operations $ (3,375) $ (85)
Adjustments to reconcile loss to net
cash used in continuing operations:
Depreciation and amortization 988 384
Deferred compensation related to stock options 21 21
Deferred income taxes (227) --
Changes in assets and liabilities:
Accounts receivable 1,158 (58)
Inventories (711) (513)
Other assets (197) (1,281)
Accounts payable 698 (434)
Accrued liabilities 311 389
Income taxes payable (2,450) --
Deferred revenue 959 (19)
-------- --------
Net cash used in continuing operations (2,825) (1,596)
Net cash provided by (used in) discontinued operations (4,243) 326
-------- --------
Net cash used in operating activities (7,068) (1,270)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (707) (1,029)
Loans to employees in exchange for notes receivable (845) (3,473)
Proceeds from sale of discontinued operations 46,000 --
Acquisition of preferred stock of an unaffiliated company (3,000) --
-------- --------
Net cash provided by (used in) investing activities 41,448 (4,502)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 760 129
Payment of notes receivable from shareholders -- 301
Repayment of capital lease obligations and long-term debt (55) (53)
-------- --------
Net cash provided by financing activities 705 377
-------- --------
Effect of exchange rate changes on cash and cash equivalents 16 (83)
-------- --------
Net increase (decrease) in cash and cash equivalents 35,101 (5,478)
Cash and cash equivalents at beginning of period 22,977 78,849
-------- --------
Cash and cash equivalents at end of period $ 58,078 $ 73,371
======== ========
Supplemental disclosures:
Cash paid for income taxes $ 39 $ 6
Cash paid for interest 15 21
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
4
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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. Restatement of Financial Results
On November 5, 1998, the Company publicly announced that it and its
independent accountants had initiated a review of revenue recognition
practices which would result in a restatement of previously issued first
and second quarter 1998 results and that all three quarters of 1998 were
expected to show substantial operating losses. During the review, certain
facts became known indicating errors had been made in the application of
revenue recognition policies which also impacted the fourth quarter of
1997, and as a result, 1997 full-year results have been restated along with
first and second quarter 1998 results. These restated results were
announced in a press release dated December 16, 1998.
This Quarterly Report on Form 10-Q/A amends items 1 and 2 of Part I of
the Company's Quarterly Report on Form 10-Q previously filed for the
quarterly period ended March 29, 1998. This Quarterly Report on Form 10-Q/A
is filed in connection with the Company's restatement of its financial
statements for the quarterly period ended March 29, 1998. Financial
statement information and related disclosures included in this amended
filing reflect, where appropriate, changes as a result of the restatements.
Except as otherwise noted, information contained in this Quarterly Report
on Form 10-Q/A is as of March 29, 1998.
As a result of the restatement, the statements of operations and financial
position have been restated as follows:
Three Months Ended
March 29, 1998
-------------------------
As Originally
Reported As Restated
-------- --------
(in thousands)
Sales $ 15,829 $ 8,062
Operating expenses 10,705 10,775
Income (loss) from
continuing operations 1,082 (3,375)
Net income (loss) $ 23,706 $ 19,142
======== ========
5
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Three Months Ended
March 29, 1998
---------------------
As Originally
Reported As Restated
--------- ---------
Earnings (loss) per share - diluted
Continuing operations $ 0.04 $(0.12)
Discontinued operations 0.74 0.78
--------- ---------
Net Income $ 0.78 $ 0.66
========= =========
as of March 29, 1999
---------------------
Accumulated Deficit $ (27,258) $ (34,790)
========= =========
The restatement of results for the fourth quarter of 1997 resulted in a
reduction of previously reported amounts at December 31, 1997 for accounts
receivable of $1.6 million, net assets of discontinued operations of $1.9
million and income taxes payable of $0.6 million, and a corresponding
increase in the previously reported accumlated deficit of $3.0 million,
resulting in a restated accumulated deficit of $53.9 million.
3. 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. Pursuant to the restatement
referred to in Note 2, certain revenues of Wireless previously recognized
in the fourth quarter of 1997 and the first quarter of 1998 were adjusted.
Based on the net assets of Wireless as of March 28, 1998, after
restatement, the sales proceeds would have been approximately $58.4 million
resulting in a note receivable of approximately $12.4 million (a reduction
of $2.1 million in the initial note receivable). Wireless revenues were
$6.8 million and $4.5 million in the first quarter of 1997 and 1998,
respectively. Net assets of discontinued operations at March 29, 1998,
relate primarily to accounts receivable.
4. Notes Receivable From Employees
Pursuant to their employment agreements and related promissory notes,
during the first quarter of 1997 and 1998 the Company loaned certain
employees $3,473,000 and $845,000, respectively, towards the purchase of
their principal residences. Of these amounts, $3,688,000 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. Subsequent to March 29,
1998, the Company loaned officers an additional $1,400,000 towards the
purchase of a principle residences under substantially similar terms.
5. Inventories
March 29, December 31,
1998 1997
------ ------
(restated-see Note 2)
(in thousands)
Raw materials $3,038 $2,191
Work in process and subassemblies 2,026 1,858
Finished goods 1,871 2,175
------ ------
$6,935 $6,224
====== ======
6
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<TABLE>
6. Earnings (Loss) Per Share
<CAPTION>
Three Months Ended
-----------------------------
March 29, March 28,
1998 1997
------ ------
(restated-See Note 2)
(in thousands)
<S> <C> <C>
Shares used to compute basic earnings (loss) per share
(weighted average number of common shares
outstanding during the period) 28,820 25,701
Incremental common shares attributable to assumed
exercise of dilutive stock options -- --
------ ------
Shares used to compute diluted earnings (loss) per share 28,820 25,701
====== ======
Antidilutive stock options 4,965 3,647
====== ======
</TABLE>
7. Comprehensive Income
<TABLE>
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 income was as follows:
<CAPTION>
Three Months Ended
-----------------------------
March 29, March 28,
1998 1997
------- -------
(restated-See Note 2)
(in thousands)
<S> <C> <C>
Net income $19,142 $ 1,107
Other comprehensive income (loss) 16 (83)
------- -------
Total comprehensive income $19,158 $ 1,024
======= =======
</TABLE>
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.
8. Recent Accounting Pronouncement
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.
7
<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/A 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 the original Report on Form 10-Q (May 13, 1998), 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/A. You should also consult the risk
factors listed from time to time in the Company's Reports on Form 10-Q, 10-Q/A,
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, 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 decreased by 14% from $9.4 million for the three
months ended March 28, 1997 to $8.1 million for the three months ended March 29,
1998. The decrease is attributable to decreases in both the average selling
prices and unit shipments of existing products. International revenue was 41%
and 50% of total revenue for the first quarter of 1997 and 1998, respectively.
Gross Profit. Gross profit decreased by 17% from $6.5 million for the
three months ended March 28, 1997 to $5.4 million for the three months ended
March 29, 1998. The decrease in dollars was primarily a result of the decrease
in revenue. As a percentage of sales, gross profit was 70% and 67% for the first
quarter of 1997 and 1998, respectively. The decrease in gross margin resulted
primarily from decreased average selling prices.
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 decreased 17% from $3.6 million for the three months ended March 28,
1997 to $3.0 million for the three months ended March 29, 1998. Gross research
and development expenses as a percentage of revenue were 38% for both the first
quarters of 1997 and 1998. The dollar decrease resulted from reduced contract
and other variable expenses related to externally funded development and to 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. No
engineering funding was recognized during the first quarter of
8
<PAGE>
1998. The amounts recognized under non-recurring engineering contracts totaled
$0.6 million for the first quarter of 1997.
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 100% from $2.8 million for the three months ended March 28,
1997 to $5.6 million for the three months ended March 29, 1998. Selling and
marketing expenses as a percentage of revenue were 30% and 69% for the first
quarter of 1997 and 1998, respectively. Sales and marketing expenses increased
from the first quarter 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 22% from $1.9 million for the three months
ended March 28, 1997 to $1.5 million for the three months ended March 29, 1998.
General and administrative expenses as a percentage of revenue were 20% and 18%
for the first quarter of 1997 and 1998, respectively. The dollar decrease from
the first quarter of 1997 was primarily due to decreases in consulting expenses,
recruiting and relocation expenses related to senior management transition and
legal fees.
Other Income (Expense), Net. Other income (expense), net, consists
primarily of interest income and interest expense. Interest income, net,
decreased from $0.9 million for the first three months of 1997 to $0.2 million
for the first three months of 1998, principally due to the decrease in cash and
cash equivalents resulting from investing activities and working capital
requirements.
LIQUIDITY AND CAPITAL RESOURCES
At March 29, 1998, the Company had cash and cash equivalents of $58.1
million, working capital of $65.3 million and minimal long-term obligations. For
the three months ended March 29, 1998, the Company recorded net income of $19.1
million, due to the gain on sale of Wireless. Net cash used in continuing
operating activities for the first quarter of 1998 of $2.8 million consisted
primarily of the loss from continuing operations and an increase in income taxes
payable, offset by a decrease in accounts receivable.
Cash provided by investing activities for the three months ended March
29, 1998 was $41.4 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 $0.7 million, long-term loans to
employees of $0.8 million, and a $3.0 million investment in the preferred stock
of an unaffiliated company.
The Company is currently engaged in 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 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.
9
<PAGE>
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 the first half of
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 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
10
<PAGE>
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 SecureLink, SecureFrame, SecureDomain 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, Digital Equipment 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 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.
11
<PAGE>
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 on 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 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.
12
<PAGE>
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 six 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 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
13
<PAGE>
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, 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.
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,
14
<PAGE>
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
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 financial
condition.
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 March 29, 1998, the net proceeds have been used as
follows (in thousands):
Purchase and installation of equipment $ 7,308
Acquisition of Algorithmic Research 45,913
Acquisition of preferrred stock of Syndata Technologies 3,000
Repayment of indebtedness 1,000
Working capital 15,843
Temporary investment in money market accounts 5,800
-------
$78,864
=======
None of the net proceeds or expenses of issuance and distribution of
the securities have been, either directly or indirectly, paid to or
invested with any related party or shareholder of the Company.
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: February 11, 1999 CYLINK CORPORATION
By: /s/ ROGER A. BARNES
--------------------------
Roger A. Barnes
Vice President of Finance
and Administration and
Chief Financial Officer
(Duly Authorized Officer
and Principal Financial
Officer as of
November 16, 1998)
16
<TABLE> <S> <C>
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<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
3/29/98 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>
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<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-29-1998
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