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 September 27, 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 January 11, 1999, there were 29,104,567 shares of the Registrant's Common
Stock outstanding.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data; unaudited)
<CAPTION>
September 27, December 31,
1998 1997
--------- ---------
Assets (restated -Note 1)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 49,241 $ 22,977
Accounts receivable, net of allowances of $457 and $278 13,483 13,914
Note receivable 3,545 --
Inventories 9,826 6,224
Net assets of discontinued operations -- 11,299
Deferred income taxes 1,629 1,533
Other current assets 2,432 2,190
--------- ---------
Total current assets 80,156 58,137
Property and equipment, net 5,884 6,003
Acquired technology, goodwill and other intangibles, net 5,979 8,017
Notes receivable from employees 5,762 3,473
Other assets 211 925
--------- ---------
$ 97,992 $ 76,555
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 156 $ 210
Accounts payable 3,163 2,238
Accrued liabilities 8,984 6,194
Accrued liabilities related to discontinued operations 3,634 --
Income taxes payable -- 1,304
Deferred revenue 1,378 206
--------- ---------
Total current liabilities 17,315 10,152
--------- ---------
Capital lease obligations and long-term debt 164 256
--------- ---------
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;
29,090,000 and 28,695,000 shares issued and outstanding 291 287
Additional paid-in capital 122,564 120,092
Deferred compensation related to stock options (188) (250)
Cumulative translation adjustment (27) (63)
Accumulated deficit (42,140) (53,932)
--------- ---------
Total shareholders' equity 80,500 66,134
--------- ---------
$ 97,992 $ 76,555
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
1
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
---------------------------- --------------------------
September 27, September 26, September 27, September 26,
1998 1997 1998 1997
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenue $ 12,130 $ 13,129 $ 32,555 $ 34,065
Cost of revenue 5,924 3,826 12,545 10,021
-------- -------- -------- --------
Gross profit 6,206 9,303 20,010 24,044
-------- -------- -------- --------
Operating expenses:
Research and development, net 6,222 3,394 12,037 9,365
Selling and marketing 6,170 4,006 17,950 10,720
General and administrative 2,452 2,268 5,782 6,291
Amortization of purchased intangibles 679 133 2,038 133
Purchased in-process technology -- 63,920 -- 63,920
-------- -------- -------- --------
Total operating expenses 15,523 73,721 37,807 90,429
-------- -------- -------- --------
Loss from operations (9,317) (64,418) (17,797) (66,385)
Other income:
Interest income, net 542 663 1,381 2,479
Royalty and other income (expense), net 32 76 (83) 402
-------- -------- -------- --------
Loss from continuing operations before income taxes (8,743) (63,679) (16,499) (63,504)
Benefit for income taxes 3,060 -- 5,774 --
-------- -------- -------- --------
Loss from continuing operations (5,683) (63,679) (10,725) (63,504)
Income (loss) from discontinued operations, net of
income tax expense (benefit) of $335, $(139) and $1,333,
as restated (Note 1) -- 796 (259) 2,951
Gain on disposal of discontinued operations,
net of income tax expense of $12,358, as restated (Note 1) -- -- 22,776 --
-------- -------- -------- --------
Net income (loss) $ (5,683) $(62,883) $ 11,792 $(60,553)
======== ======== ======== ========
Earnings (loss) per share - basic:
Continuing operations $ (0.20) $ (2.40) $ (0.37) $ (2.44)
Discontinued operations, as restated (Note 1) -- 0.03 0.78 0.12
-------- -------- -------- --------
Net income (loss) $ (0.20) $ (2.37) $ 0.41 $ (2.32)
======== ======== ======== ========
Earnings (loss) per share - diluted:
Continuing operations $ (0.20) $ (2.40) $ (0.37) $ (2.44)
Discontinued operations, as restated (Note 1) -- 0.03 0.78 0.12
-------- -------- -------- --------
Net income (loss) $ (0.20) $ (2.37) $ 0.41 $ (2.32)
======== ======== ======== ========
Shares used in per share calculation - basic 29,082 26,514 28,971 26,046
======== ======== ======== ========
Shares used in per share calculation - diluted 29,082 26,514 28,971 26,046
======== ======== ======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<CAPTION>
Nine Months Ended
-------------------------------
September 27, September 26,
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Loss from continuing operations $(10,725) $(63,504)
Adjustments to reconcile loss to net
cash used in continuing operations:
Write-off of investment in unaffiliated company 3,000
Purchased in-process technology -- 63,920
Depreciation and amortization 3,695 1,513
Deferred compensation related to stock options 62 62
Deferred income taxes (96) --
Changes in assets and liabilities:
Accounts receivable 431 (4,412)
Inventories (3,602) (287)
Other assets 472 (921)
Accounts payable 925 (1,165)
Accrued liabilities (10,971) 1,611
Deferred revenue 1,172 (8)
-------- --------
Net cash used in continuing operations (15,637) (3,191)
Net cash used in discontinued operations (7,173) (762)
-------- --------
Net cash used in operating activities (22,810) (3,953)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (2,157) (2,803)
Loans to employees in exchange for notes receivable (2,289) (3,473)
Purchase of Algorithmic Research, net of cash acquired -- (44,350)
Proceeds from sale of discontinued operations 54,879 --
Acquisition of preferred stock of unaffiliated company (3,000) --
-------- --------
Net cash provided by (used in) investing activities 47,433 (50,626)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 1,751 731
Payment of notes receivable from shareholders -- 301
Repayment of capital lease obligations and long-term debt (146) (109)
-------- --------
Net cash provided by financing activities 1,605 923
-------- --------
Effect of exchange rate changes on cash and cash equivalents 36 (104)
-------- --------
Net increase (decrease) in cash and cash equivalents 26,264 (53,760)
Cash and cash equivalents at beginning of period 22,977 78,849
-------- --------
Cash and cash equivalents at end of period $ 49,241 $ 25,089
======== ========
Supplemental disclosures:
Cash paid for income taxes $ 8,215 $ 31
Cash paid for interest 55 78
Equity issued and liabilities incurred for
purchase of Algorithmic Research -- 30,056
Note Receivable from disposition of Wireless Group, as restated (Note 1) 12,424 --
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
3
<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.
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. The Company will file
an amended Form 10-K for 1997, and amended Forms 10-Q for the first and
second quarters 1998.
2. Discontinued Operations
On March 28, 1998, the Company sold its Wireless Communications Group
("Wireless") to P-Com, Inc. for an originally reported $60.5 million ($46.0
million in cash and an 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 reduced the gain on disposal. Pursuant to the
restatement referred to in Note 1, 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. On July 14,
1998, P-Com made a partial payment of $9.7 million on its promissory note
and is disputing the remaining balance of the note and certain other
amounts the Company believes are receivable from P-Com. See Part II, Item 1
"Legal Proceedings." Wireless revenues were $7.4 million and $20.9 million
in the third quarter and first nine months of 1997, respectively, and were
$4.0 million in 1998 through the date of disposal.
3. Notes Receivable From Employees
Pursuant to their employment agreements and related promissory notes,
through September 27, 1998, the Company had loaned certain employees $5.8
million towards the purchase of their principal residences. Of this amount,
$5.2 million was receivable from officers or former officers of the
Company. The notes are generally 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. Subsequent to September 27, 1998, certain loan agreements were
amended and the Company applied certain accrued compensation amounts
against $1.6 million of the outstanding loan balance. Maturity dates for
4
<PAGE>
the remaining notes receivable, all of which are due from current or former
officers of the Company, are as follows: $1.0 million in 1999, $1.0 million
in 2002, $1.4 million in 2003, and $0.8 million thereafter.
4. Inventories
September 27, December 31,
1998 1997
------- -------
(in thousands)
Raw materials $ 3,115 $ 2,191
Work in process and subassemblies 2,213 1,858
Finished goods 4,498 2,175
------- -------
$ 9,826 $ 6,224
======= =======
<TABLE>
5. Earnings Per Share
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- ---------------------------
September 27, September 26, September 27, September 26,
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) 29,082 26,514 28,971 26,046
Incremental common shares attributable to assumed
exercise of dilutive stock options - - - -
------ ------ ------ ------
Shares used to compute diluted earnings per share 29,082 26,514 28,971 26,046
====== ====== ====== ======
Antidilutive stock options 5,735 5,325 4,321 4,077
====== ====== ====== ======
</TABLE>
All options to purchase common stock have been excluded from the
computation of diluted earnings per share as their effect is antidilutive
on the loss from continuing operations.
On December 11 and 14, 1998, the Company canceled options to purchase
2.6 million shares of common stock with exercise prices ranging from $4.19
to $23.50 previously granted to employees and certain current officers, and
reissued all such options at $4.25 to $4.63, the fair market value of the
stock on the dates of reissuance. The reissued options have a six-year term
and vest over three years from the date of issuance.
6. Recent Accounting Pronouncements
<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 Nine Months Ended
---------------------------- ----------------------------
September 27, September 26, September 27, September 26,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(in thousands)
<S> <C> <C> <C> <C>
Net income (loss) $ (5,683) $ (62,883) $ 11,792 $ (60,553)
Other comprehensive income (loss) 35 (58) 36 (104)
-------- --------- -------- ---------
Total comprehensive income (loss) $ (5,648) $ (62,941) $ 11,828 $ (60,657)
======== ========= ======== =========
</TABLE>
5
<PAGE>
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("FAS 131"). 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, and include 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, the Company's expectation that it will introduce a number of new
products in 1998 and 1999 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.
RECENT EVENTS
As publicly announced on November 5, 1998, the Company and its
independent accountants, together with legal counsel, on that date initiated a
review of the Company's revenue recognition practices. During the review,
certain facts became known indicating errors had been made in the application of
revenue recognition policies in various prior periods. The Company also
announced that all three quarters of 1998 were expected to show substantial
losses from continuing operations. On December 16, 1998, the Company released
restated financial results for the fourth quarter and year ended December 31,
1997 and first and second quarters of 1998 which resulted in the Company
recognizing substantial losses from continuing operations in the 1998 periods.
Additionally, a substantial loss from continuing operations is expected for the
fourth quarter of 1998 and the year ended December 31, 1998.
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
$12.4 million unsecured note receivable due 100 days after closing, subject to
closing adjustments. The sale resulted in an after tax gain of approximately
$22.8 million. See Note 2 of Notes to Condensed Consolidated Financial
Statements and Part II, Item 1 "Legal Proceedings." Except where noted, the
following comments are associated with the continuing network security business.
BUSINESS ACQUISITION
On September 8, 1997, the Company acquired Algorithmic Research, Ltd.
("ARL"), an Israeli company. ARL is an information security company providing
remote access network security products and smart-card technology focusing on
the market for Internet-based (TCP/IP) communications. ARL also provides
security products to broadcast networks. The total acquisition price of
approximately $76.3 million was funded from a combination of the Company's
existing working capital, newly issued common stock and options to purchase
common stock. Approximately $63.9 million of the total purchase price
represented the value of in-process technology that had not yet reached
technological feasibility, had no alternative future uses and was charged to the
Company's operations in the third quarter ended September 26, 1997. The
amortization of capitalized intangibles amounting to approximately $.7 million
per quarter subsequent to the third quarter of 1997 and the charge resulting
from in-process technology are not deductible for income tax purposes. The
acquisition was accounted for under the purchase method of accounting; and
accordingly, the results of operations of ARL are included in the consolidated
financial statements from the date of acquisition.
7
<PAGE>
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 when 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. In connection with the Company's recent
restatement of financial results, the Company undertook a review of its revenue
recognition practices to ensure that they are in accordance with the policies
described above. See "Recent Events" above.
The Company's revenue decreased by 8% from $13.1 million for the three
months ended September 26, 1997 to $12.1 million for the three months ended
September 27, 1998, and decreased by 4% from $34.1 million for the nine months
ended September 26, 1997 to $32.6 million for the nine months ended September
27, 1998. The decrease is attributable to decreases in both the average selling
prices and unit shipments of existing products.
Gross Profit. Gross profit decreased by 33% from $9.3 million for the
three months ended September 26, 1997 to $6.2 million for the three months ended
September 27, 1998, and decreased by 17% from $24.0 million for the nine months
ended September 26, 1997 to $20.0 million for the nine months ended September
27, 1998. As a percentage of revenue, gross profit was 71% and 51% for the third
quarter of 1997 and 1998, respectively, and 71% and 61% for the first nine
months of 1997 and 1998, respectively. The decrease in gross margin for the
third quarter and first nine months of 1998 compared with the corresponding
periods in 1997 was primarily due to an increased percentage of revenues from
lower margin products, particularly those products that are provided by OEM
suppliers, and to an overall decrease in average selling prices for other
product lines. Additionally, in the third quarter of 1998, the Company recorded
a charge to cost of revenue of approximately $1.1 million primarily related to
excess and obsolete inventory and to the write off of certain prepaid royalties.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel related expenses, depreciation of
development equipment, facilities and supplies. Research and development
expenses for the third quarter of 1998 included a one-time charge of $3.0
million related to the write off of an investment in an unaffiliated company.
Excluding this one-time charge, gross research and development expenses
increased 12% from $3.4 million for the three months ended September 26, 1997 to
$3.8 million for the three months ended September 27, 1998, and decreased 4%
from $10.5 million for the nine months ended September 26, 1997 to $10.0 million
for the nine months ended September 27, 1998. Excluding the one-time charge,
gross research and development expenses as a percentage of revenue were 26% and
31% for the third quarter of 1997 and 1998, respectively, and were 31% for the
first nine months of both 1997 and 1998 respectively. 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 for the third quarter of 1998, and
$1.1 million and $1.0 million for the first nine months of 1997 and 1998,
respectively. No engineering funding was recognized during the third 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 54% from $4.0 million for the three months ended September
26, 1997 to $6.2 million for the three months ended September 27, 1998, and
increased 67% from $10.7 million for the nine months ended September 26, 1997 to
$18.0 million for the nine months ended September 27, 1998. Selling and
marketing expenses as a percentage of revenue were 31% and 51% for the third
quarter of 1997 and 1998, respectively, and 31% and 55% for the first nine
months of 1997 and 1998, respectively. Selling and marketing expenses increased
from the third quarter and first nine months of 1997 primarily to support the
launch of new or enhanced products, as well as due to continued expansion of the
Company's direct field operations, product line management, marketing
development and international operations. Additionally, sales and marketing
expenses increased due to integration expenses resulting from the acquisition of
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 increased 8% from $2.3 million for the three months
ended September 26, 1997 to $2.5 million for the three months ended September
27, 1998, and decreased 8% from $6.3 million for the nine months ended September
26, 1997
8
<PAGE>
to $5.8 million for the nine months ended September 27, 1998. General and
administrative expenses as a percentage of revenue were 17% and 20% for the
third quarter of 1997 and 1998, respectively, and were 18% for the first nine
months of both 1997 and 1998, respectively.
As a result of the aforementioned restatement of financial results,
during the fourth quarter of 1998 the Company has incurred substantial fees for
professional services. Additionally, the Company has reached severance
agreements with several former officers. Total fourth quarter pretax charges
related to these matters may approach $4 million.
Other Income. Other income consists primarily of interest income.
Interest income, net, decreased from $0.7 million for the third quarter of 1997
to $0.5 million for the third quarter of 1998, and decreased from $2.5 million
for the first nine months of 1997 to $1.4 million for the comparable period in
1998. The decrease was principally due to the decrease in average cash and cash
equivalents resulting from cash used in investing activities and for working
capital requirements.
LIQUIDITY AND CAPITAL RESOURCES
At September 27, 1998, the Company had cash and cash equivalents of
$49.2 million, working capital of $62.8 million and minimal long-term
obligations. For the nine months ended September 27, 1998, the Company recorded
net income of $11.8 million, largely due to the $22.8 million net gain on the
sale of Wireless. Net cash used in continuing operating activities for the nine
months of 1998 of $15.6 million resulted primarily from losses from continuing
operations, increased inventories and estimated income tax payments related to
the gain on sale of Wireless.
Cash provided by investing activities for the nine months ended
September 27, 1998 was $47.4 million, of which $54.9 million was attributable to
the sale of Wireless. The funds attributable to the Wireless sale were partially
offset by expenditures for property and equipment of $2.2 million, long-term
loans to employees of $2.3 million, and a $3.0 million investment in the
preferred stock in an unaffiliated company.
See Part II, Item 1 "Legal Proceedings." The Company believes it has
meritorious defenses to these actions and intends to defend itself vigorously.
However, it is not feasible to predict or determine the final outcome of these
proceedings, and if the outcome were to be unfavorable, the Company's business,
financial condition and results of operations could be materially adversely
affected.
See comments regarding year 2000 readiness under "Risk Factors That May
Affect Future Results."
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 1999. 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 substantial losses from continuing operations in
1994, 1995, 1996, 1997 and the first nine months of 1998. 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 have been and continue to be 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
9
<PAGE>
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 introduced a number
of new products in 1998 and expects to introduce a number of new products in
1999. 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
The Company's business, results of operations and financial condition
could be adversely impacted by any of a number of pending or threatened
litigation matters. See Part II, Item 1. "Legal Proceedings."
Dependence on Key Personnel
On November 4, 1998, the Company accepted the resignation of Mr.
Fernand B. Sarrat as a Director, President and Chief Executive Officer, along
with the resignation of Mr. John Daws, Chief Financial Officer, and Mr. Tom
Butler, Vice President of Sales. On November 4, Mr. William C. Crowell, formerly
Vice President of Product Strategy, was promoted to President and Chief
Executive Officer, and on November 16, Mr. Roger A. Barnes became the Company's
Chief Financial Officer. The Company's future success will depend on the
abilities of Mr. Crowell and the contributions by its other 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. Retention and attraction of such qualified
personnel may become even more difficult for the Company following the Company's
recent restatement of its financial statements and recently determined losses.
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, as it has in times in the past, 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, as they did during the first nine months of 1998. As a result,
on September 14, 1998, the Company announced that its earnings for the third
quarter of 1998 would be below consensus estimates. It is possible that in the
future the Company's operating results will again be below the expectations of
securities analysts and investors. In such an event, or in the event that
adverse conditions prevail or are perceived to prevail generally or with respect
to the Company's business, the price of the Company's Common Stock would likely
be materially adversely affected.
Dependence on Recently Introduced and New Information Security Products
The Company's future results of operations will be highly dependent on
the successful completion of the design, development, introduction, marketing
and manufacture of the 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
10
<PAGE>
acceptance. If such new and recently introduced products have performance,
reliability, quality or other shortcomings, then such products could fail to
achieve market acceptance. The failure by the Company's new or existing products
to achieve or enjoy market acceptance, whether for these or other reasons, could
cause the Company to 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 business, 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, name recognition and
perception of Company stability and long term viability. Many of these factors
are beyond the Company's control. In addition, some factors, such as the
perception of the Company's stability and viability over the long term may have
been adversely affected by the recent restatement of the Company's financials,
which could materially adversely impact the Company's ability to compete.
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 from (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 from 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 result in price reductions, loss of market share or otherwise have a
material adverse effect on 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, financial condition 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 business, financial condition and results of operations.
11
<PAGE>
Year 2000
The "Year 2000 Issue" refers generally to the problems that some
software, including firmware embedded in the Company's products, may have in
determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures or the
creation of erroneous results
The Company has developed a Year 2000 readiness plan for the current
versions of its products. The plan includes development of corporate awareness,
assessment, implementation (including remediation, upgrading and replacement of
certain product versions), validation testing, and contingency planning. The
Company continues to respond to customer concerns about prior versions of its
products on a case-by-case basis.
The Company has largely completed all phases of its plan, except for
contingency planning, with respect to the current versions of all of its
products. As a result, the current versions of each of its products currently
offered for sale are "Year 2000 Compliant" as defined below (with the exception
of final documentation of compliance for several such products), when configured
and used in accordance with the related documentation, and provided that the
underlying operating system of the host machine and any other software used with
or in the host machine or the Company's products are also Year 2000 Compliant.
In some cases, the Company's products require an upgrade provided by the Company
either as a complete substitute or as a kit sold with the product in order to be
Year 2000 Compliant.
The Company has defined "Year 2000 Compliant" as the ability to: (i)
correctly handle date information needed for the December 31, 1999 to January 1,
2000 date change; (ii) function according to the product documentation provided
for this date change, without changes in operation resulting from the advent of
a new century, assuming correct configuration; (iii) where appropriate, respond
to two-digit date input in a way that resolves the ambiguity as to century in a
disclosed, defined, and predetermined manner, such as in certificate based
products, or in accordance with the Company's Year 2000 Compliant test plan; and
(iv) recognize year 2000 as a leap year. The Company has not tested its products
on all platforms or all versions of operating systems that it currently supports
and has advised its customers to verify that their platforms and operating
systems support the transition to the year 2000.
The Company has not specifically tested software obtained from third
parties (license software, shareware, and freeware) that is incorporated into
its products, but the Company's test plan was designed to reveal Year 2000
deficiencies with third party software incorporated in the Company's products.
Despite testing by the Company and current and potential customers, and
any assurances from developers of products incorporated into the Company's
products, the Company's products may contain undetected errors or defects
associated with Year 2000 date functions. Also, certain prior versions of the
Company's product are not fully Year 2000 Compliant, and the Company is working
to address these issues by offering upgrades to compliant versions. Known or
unknown errors or defects in the Company's products could result in delay or
loss of revenue, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which could
materially adversely affect the Company's business, operating results, or
financial condition.
Some commentators have predicted significant litigation regarding Year
2000 compliance issues. Because of the unprecedented nature of such litigation,
it is uncertain whether or to what extent the Company may be affected by it.
The Company has initiated a review of its material internal information
systems (including the third-party software for its management information
systems, networks and desktop applications, and its hardware telecommunications
technology). The Company expects to complete that review by mid 1999. To the
extent that the Company is not able to test the technology provided by
third-party vendors, the Company is purchasing upgrades for versions which have
been certified by their vendors as compliant. Although the Company is not
currently aware of any material operational issues or costs associated with
preparing its internal information systems for the Year 2000, the Company may
experience material unanticipated problems and costs caused by undetected errors
or defects in the technology used in its information systems.
12
<PAGE>
The Company does not currently have any information concerning the Year
2000 compliance status of its customers. If the Company's current or future
customers suspend investments in securing their existing networks while they
achieve Year 2000 compliance, or if they divert technology expenditures
(especially technology expenditures that are reserved for enterprise security
products) to address Year 2000 compliance problems, the Company's business,
results of operations, or financial condition could be materially adversely
affected.
The Company has funded its Year 2000 plan from operating cash. While
the Company does not expect such costs to be material, the Company will incur
additional amounts related to the Year 2000 plan for administrative personnel to
manage the Company's readiness plans, technical support for its product
engineering and customer satisfaction. The Company may experience material
problems and costs with Year 2000 compliance that could adversely affect the
Company's business, results of operations, and financial condition.
The Company has not developed a comprehensive contingency plan to
address situations that may result if the Company is unable to achieve Year 2000
readiness of its critical operations. The cost of developing and implementing
such a plan may itself be material. Finally, the Company is also subject to
external forces that might generally affect industry and commerce, such as
utility or transportation company Year 2000 compliance failures and related
service interruptions.
Management of Growth And Reduction In Employees
The Company has recently and may continue to experience substantial
fluctuations in the number of employees and the scope of its operations in the
network security business, resulting in increased responsibilities for
management. To manage its business effectively, the Company will need to
continue to improve its operational, financial and management information
systems and to hire, train, motivate and manage its 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, especially given the recent
announcement regarding the restatement of its financial results and associated
issues. 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, the uncertainty created
by the Company's recently announced restatements of its financial results, the
initiation of highly publicized class actions securities litigation against the
Company, and the 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 Algorithmic Research, Ltd.
("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. To date, the Company's efforts to market ARL's products through the
Company's direct sales channel have not met the Company's expectations due to
differences between the sales expertise required for selling the ARL products
and that required for the Company's other products. Consequently, the Company
has recently reorganized the management of ARL to strengthen ARL's
13
<PAGE>
responsibility for marketing and sales of its products. In addition, ARL's
improvements and development of new products have been delayed by inadequate
coordination between engineering departments located in Sunnyvale, CA and Tel
Aviv, Israel. This inadequate coordination to date is due to differing
engineering practices concerning development planning and restrictions imposed
by U.S. export control laws governing the transfer of cryptographic expertise.
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 principal offices in
Israel, a country which is vulnerable to disruption due to the sudden outbreak
of hostilities with its neighbors and various indigenous factions. 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; Market Acceptance Risks
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. The
Company faces continuing challenges to educate customers as to the value of its
security products. The Company believes that many potential customers do not
appreciate the need for high-end security products unless and until they have
faced a major security breach. If the Company is unable to successfully educate
potential customers as to the value of, and thereby obtain broad market
acceptance for, its products, it will continue to rely primarily on selling new
and existing products to its base of existing customers, which will
significantly limit any opportunity for growth. In addition, any significant
14
<PAGE>
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 business, financial condition and results of operations.
See "Competition." 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 continue to be
developed, or that, once developed, 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 is often 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 deliver its products in a timely manner 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.
15
<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 former 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 mediation efforts in October,
1998, the plaintiff in CV767448 accepted a settlement and dismissed his
complaint with prejudice. The remaining plaintiffs subsequently dismissed, with
prejudice, all of the outside Directors except the Chairman. On December 4,
1998, and December 18, 1998 the Court granted the Company's motions for summary
judgement and for dismissal, respectively, of numerous claims in CV764647.
Discovery with respect to the remaining claims is continuing, with trial
currently scheduled for mid 1999. 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. Based on the Court's decisions and
discovery in the matter to date, the Company believes the terminations were
lawful, and in the best interest of the Company, and intends to continue
defending 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 $9.7 million on its
promissory note dated April 1, 1998. The Company is presently evaluating the
merits of the balance of P-Com's deductions and, failing an amicable resolution
of P-Com's contentions, the matter will proceed to litigation. See Note 2 of
Notes to Condensed Consolidated Financial Statements.
On September 3, 1998, P-Com put the Company on notice that certain
shipments in the fourth quarter of 1997 and the first quarter of 1998 by the
Company's former Wireless division and having an invoice value of approximately
$3.7 million had been seized by an agency of the United States Department of the
Treasury and that P-Com intends to hold the Company responsible for the
consequences of this event. P-Com is currently petitioning for release of the
goods. Based on the Company's investigation to date, the Company believes either
that the grounds for the seizure are unfounded or that P-Com itself is
responsible for this action. The Company has no reason at this time to believe
that it is the subject of any official investigation and the Company has been
informed that P-Com is presently petitioning for the release of the seized
goods. A failure by P-com to obtain release of the shipment due to a violation
of law by the Company might adversely affect the amount collected from P-Com on
its outstanding obligations under the promissory note, including payment of any
relevant fines or penalties.
On September 14, 1998, the Company announced that its earnings for the
third quarter would be below consensus estimates. On November 5, 1998, the
Company announced that, with the assistance of its independent accountants, it
was reviewing its revenue recognition practices, and the Company announced that
its first and second quarter earnings would have to be restated and that it
would have operating losses for each of the three quarters for the period ending
September 27, 1998. 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. The
Company will file an amended Form 10-K for 1997, and amended Forms 10-Q for the
first and second quarters 1998. Between November 6 and November 25, 1998,
several securities class action complaints were filed against the Company and
certain of its current and former directors and officers in federal courts in
California and New Jersey. These complaints allege, among other things, that the
Company's previously issued financial statements were materially false and
misleading and that the defendants knew or should have known that these
financial statements caused the Company's common stock price to rise
artificially. The actions variously allege violations of Section 10(b) of the
Securities Exchange Act of 1934 (the "Exchange Act"), as amended, and SEC Rule
10b-5 promulgated thereunder, and Section 20 of the Exchange Act.
16
<PAGE>
The Company believes it has meritorious defenses to these actions and
intends to defend itself vigorously. However, it is not feasible to predict or
determine the final outcome of these proceedings, and if the outcome were to be
unfavorable, the Company's business, financial condition and results of
operations could be materially adversely affected.
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
17
<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: January 14, 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 and
Accounting Officer)
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 9/27/98
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> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-27-1998
<CASH> 49241
<SECURITIES> 0
<RECEIVABLES> 13940
<ALLOWANCES> 457
<INVENTORY> 9826
<CURRENT-ASSETS> 80156
<PP&E> 12616
<DEPRECIATION> 6732
<TOTAL-ASSETS> 97992
<CURRENT-LIABILITIES> 17315
<BONDS> 0
<COMMON> 291
0
0
<OTHER-SE> 80209
<TOTAL-LIABILITY-AND-EQUITY> 97992
<SALES> 32555
<TOTAL-REVENUES> 32555
<CGS> 12545
<TOTAL-COSTS> 12545
<OTHER-EXPENSES> 37807
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 48
<INCOME-PRETAX> (16499)
<INCOME-TAX> (5774)
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11792
<EPS-PRIMARY> 0.41
<EPS-DILUTED> 0.41
</TABLE>
