UNITED STATES
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 April 2, 2000
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.)
3131 Jay Street
Santa Clara, California 95054
(Address of principal executive offices)
(408) 855-6000
(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 16, 2000, there were 30,460,857 shares of the Registrant's
common stock outstanding.
<PAGE>
<TABLE>
CYLINK CORPORATION
FORM 10-Q FOR THE QUARTER ENDED APRIL 2, 2000
INDEX
<CAPTION>
Page
<S> <C> <C>
Index 1
Part I Financial information
Item 1 Financial Statements and Supplementary Data
a) Condensed Consolidated Balance Sheets at April 2, 2000 and
December 31, 1999 2
b) Condensed Consolidated Statements of Operations for the three
months ended April 2, 2000 and March 28, 1999 3
c) Condensed Consolidated Statement of Cashflows for the three months
ended April 2, 2000 and March 28, 1999 4
d) Notes to Condensed Consolidated Financial Statements 5
Item 2 Management's discussion and analysis of financial condition and
results of operations 6
Part II Other Information 15
Signature 17
Exhibit Exhibit 27.1, Financial Data Schedule 18
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1
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data; unaudited)
<CAPTION>
Apr 2, Dec 31,
2000 1999
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 27,863 $ 33,170
Accounts receivable, net of allowances of $847 and $941 17,399 16,130
Inventories 10,850 6,745
Deferred income taxes 4,371 4,367
Other current assets 2,373 1,648
--------- ---------
Total current assets 62,856 62,060
Restricted cash 1,400 1,400
Property and equipment, net 10,234 10,038
Acquired technology, goodwill and other intangibles, net 2,469 3,188
Notes receivable from employees or former employees 3,227 3,165
Other assets 1,375 1,438
--------- ---------
$ 81,561 $ 81,289
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 17 $ 24
Accounts payable 7,677 6,635
Accrued liabilities 9,863 9,082
Income taxes payable 1,027 1,062
Deferred revenue 2,825 2,395
--------- ---------
Total current liabilities 21,409 19,198
--------- ---------
Capital lease obligations and long-term debt 113 112
--------- ---------
Commitments and Contingencies (Note 5)
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;
30,441,000 and 29,877,000 shares issued and outstanding 304 299
Additional paid-in capital 131,002 126,896
Deferred compensation related to stock options (1,606) (1,790)
Accumulated other comprehensive loss (62) (82)
Accumulated deficit (69,599) (63,344)
--------- ---------
Total shareholders' equity 60,039 61,979
--------- ---------
$ 81,561 $ 81,289
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
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CYLINK CORPORATION)
<TABLE>
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended
--------------------------
Apr 2, Mar 28,
2000 1999
--------- ---------
<S> <C> <C>
Revenue $ 17,378 $ 11,885
Cost of revenue 6,101 4,112
--------- ---------
Gross profit 11,277 7,773
--------- ---------
Operating expenses:
Research and development, net 4,430 3,553
Selling and marketing 8,469 5,419
General and administrative 4,219 2,613
Amortization of purchased intangibles 720 680
--------- ---------
Total operating expenses 17,838 12,265
--------- ---------
Loss from operations (6,561) (4,492)
Other income:
Interest income, net 287 308
Royalty and other income, net 27 119
--------- ---------
314 427
--------- ---------
Loss before income taxes (6,247) (4,065)
Provision for income taxes 8 --
--------- ---------
Net loss $ (6,255) $ (4,065)
========= =========
Net loss per share - basic and diluted $ (0.21) $ (0.14)
========= =========
Shares used in per share calculation - basic and diluted 30,051 29,117
========= =========
<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
(Dollars in thousands; unaudited)
<CAPTION>
Three Months Ended
--------------------------
April 2, March 28,
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (6,255) $ (4,065)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 811 635
Amortization of intangibles 799 683
Deferred income taxes (4) --
Amortization of imputed interest on note receivable (62) (66)
Deferred compensation 184 87
Changes in assets and liabilities
Accounts receivable (1,269) (2,408)
Inventories (4,105) 2,354
Other assets (742) (40)
Accounts payable 1,042 (893)
Accrued liabilities 782 (209)
Income taxes payable (35) (6)
Deferred revenue 430 451
--------- ---------
Net cash used in operating activities (8,424) (3,477)
--------- ---------
Cash flows from investing activities:
Acquisition of property and equipment (1,007) (191)
--------- ---------
Net cash used in investing activities (1,007) (191)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 4,111 28
Other (7) (39)
--------- ---------
Net cash provided by (used in) financing activities 4,104 (11)
--------- ---------
Effect of exchange rate changes on
cash and cash equivalents 20 (12)
--------- ---------
Net decrease in cash and cash equivalents (5,307) (3,691)
Cash and cash equivalents at beginning of year 33,170 46,575
--------- ---------
Cash and cash equivalents at end of period $ 27,863 $ 42,884
========= =========
<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 state fairly 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, 1999. Interim results of operations are not necessarily
indicative of the results to be expected for the full year.
2. Inventories
April 2, December 31,
2000 1999
------------------------
(in thousands)
Raw materials $ 5,383 $ 2,412
Work in process and subassemblies 2,345 1,610
Finished goods 3,122 2,723
------- -------
$10,850 $ 6,745
======= =======
3. Loss Per Share
Basic loss per share is based on the weighted-average number of common
shares outstanding, excluding shares in escrow. Diluted loss per share is based
on the weighted-average number of shares outstanding and dilutive potential
common shares outstanding excluding contingent shares held in escrow. The
Company's only potentially dilutive securities are stock options. All
potentially dilutive securities have been excluded from the computation of
diluted loss per share as their effect is anti-dilutive on the net loss for the
periods presented.
As of April 2, 2000 and March 28, 1999, the Company had 6,917,500 and
5,898,000 stock options outstanding with a weighted average exercise price of
$6.06 and $5.21, respectively. These options expire on various dates beginning
in 2000 through 2008.
4. Comprehensive Loss
The components of comprehensive loss are as follows:
Three Months Ended
------------------------
April 2, December 31,
2000 1999
------------------------
(in thousands)
Net loss $(6,255) $(4,065)
Foreign currency translation gain loss 20 (12)
------- -------
Total comprehensive loss $(6,235) $(4,077)
======= =======
5. Contingencies
Cylink is currently engaged in litigation. See Part II, Item 1. "Legal
Proceedings."
5
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Report on Form 10-Q includes statements that reflect Cylink's belief
concerning future events and financial performance. Statements which are not
purely historical in nature are called "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. We sometimes identify forward-looking
statements with such words as "expects", "anticipates", "intends", "believes" or
similar words concerning future events.
You should not rely on these forward-looking statements. They are subject
to certain risks and uncertainties that may cause actual results to differ
materially from past results or Cylink's predictions. For a description of these
risks see the reasons described in Item 2 "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 Cylink's Reports on Form
10-K, 10-Q, and 8-K.
All forward-looking statements included in this document are based on
information available to Cylink as of the date of this Report on Form 10-Q, and
Cylink 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.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of operations
data as a percentage of revenue for the periods indicated:
Three months ended
------------------
April 2, 2000 March 28, 1999
------------- --------------
Revenue 100.0 % 100.0 %
Cost of revenue 35.1 34.6
----- -----
Gross profit 64.9 65.4
----- -----
Operating expenses:
Research and development, net 25.5 29.9
Selling and marketing 48.7 45.6
General and administrative 24.3 22.0
Amortization of purchased intangibles 4.1 5.7
----- -----
Total operating expenses 102.6 103.2
----- -----
Loss from operations (37.7) (37.8)
Other income, net 1.8 3.6
----- -----
Loss before income taxes (35.9) (34.2)
Provision for income taxes -- --
----- -----
Net loss (35.9) % (34.2) %
===== =====
Revenue. Revenue increased 46% from $11.9 million for the three months
ended March 28, 1999 to $17.4 million for the three months ended April 2, 2000.
The increase is attributable to increases in unit shipments of existing
products, shipment of products with higher average selling prices, increased
revenues associated with maintenance and support services, and the introduction
of revenues from professional service consulting. International revenue was 41%
and 40% of total revenue for the first quarter of 2000 and 1999, respectively.
The Company's revenue is derived primarily from sales of its family of
commercial network security products, and to a lesser extent, from the license
of software products and from professional services, including customer support
and consulting. Fees for maintenance and support services of hardware products
are charged separately from product
6
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revenue. Revenues derived from the sale or license of the Company's products are
recognized in accordance with the applicable accounting standards, including
Statement of Position No. 97-2, "Software Revenue Recognition." Revenue is
recognized when persuasive evidence of a sale arrangement exists, such as
receipt of a contract or purchase order, the product has been shipped, the sales
price is fixed and determinable, collection is probable, and vendor-specific
objective evidence exists to allocate a portion of the total fee to any
undelivered elements of the arrangement. Such undelivered elements typically
consist of maintenance and support, which are deferred and amortized over the
applicable period, usually twelve months. Vendor specific objective evidence of
the value of maintenance and support is generally based on the annual renewal
rate. Concurrent with sales, a provision is made for estimated costs to repair
or replace products under warranty arrangements. Consulting revenues, which to
date have been immaterial, are recognized on a time-and-materials or percentage
of completion basis in accordance with the provisions of Accounting Research
Bulletin-45, "Long-Term Construction-Type Contracts," depending on the contract.
Gross Profit. Gross profit increased from $7.8 million for the three months
ended March 28, 1999 to $11.3 million for the three months ended April 2, 2000.
The increase in dollars was primarily a result of the increase in revenue. As a
percentage of sales, gross profit was approximately 65% for both quarters.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel related expenses, depreciation of
development equipment, facilities and supplies. Gross research and development
expenses increased 13% from $4.0 million for the three months ended March 28,
1999 to $4.5 million for the three months ended April 2, 2000. Gross research
and development expenses as a percentage of revenue were 34% for the first
quarter of 1999 and 26% for the first quarter 2000. The dollar increase resulted
from increased spending for development costs of new products, offset by reduced
spending and related reimbursements for externally funded contracts. The
decrease in expense as a percentage of revenue is due to the increased revenue
base.
From time to time the Company receives engineering funding for development
of projects to apply or enhance the Company's technology to a particular
customer's need. The amounts recognized under these research and development
contracts are offset against research and development expenses. Amounts
recognized under non-recurring engineering contracts totaled $0.4 million for
the first quarter of 1999 and $0.1 million for the three months ended April 2,
2000.
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 56% from $5.4 million for the three months ended March 28, 1999 to
$8.5 million for the three months ended April 2, 2000. Selling and marketing
expenses as a percentage of revenue were 46% and 49% for the first quarter of
1999 and 2000, respectively. Sales expenses increased for the first quarter of
2000 primarily due to the addition of 23 employees, commissions and
payroll-related costs associated with the increased revenue and the management
of indirect sales channels through the use of value-added resellers. Marketing
expenses increased due to the addition of 9 employees, consulting, advertising,
trade shows and other marketing costs associated with new marketing initiatives
and a Cylink awareness promotional campaign. Selling and marketing expenses,
expressed as a percentage of revenue, increased due to programs to staff our
Internet sales force and marketing initiatives in advance of new product
introduction.
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 61% from $2.6 million for the three months
ended March 28, 1999 to $4.2 million for the three months ended April 2, 2000.
General and administrative expenses as a percentage of revenue were 22% and 24%
for the first quarter of 1999 and 2000, respectively. The dollar increase in the
first quarter of 2000 were primarily due to increases in information technology
support related to our new E.R.P. system, in legal fees for litigation defense,
in recruiting and relocation costs to recruit a growing employment base in a
very competitive job market, and in administrative costs associated with our new
professional services organization. The increase as a percentage of revenue is
due primarily to technology support of our worldwide E.R.P. system.
Amortization of Goodwill and Other Intangibles. Amortization relating to
goodwill and other intangibles was $0.7 million in each period presented and
relates to the acquisition of Algorithmic Research, Ltd ("ARL") in September
1997, and the acquisition of S.D.I. in the third quarter of 1999.
Provision for Income Taxes. No significant provision for or benefit from
income taxes was recognized in the quarter ended April 2, 2000 as the Company
incurred a net operating loss for income tax purposes and the tax benefit
therefrom was offset by an increase in the valuation allowance on the deferred
tax asset.
7
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Other Income (Expense), Net. Other income (expense), net consists primarily
of interest income and interest expense and royalty income. Other income, net
decreased from $0.4 million for the first three months of 1999 to $0.3 million
for the first three months of 2000, principally due to the decrease in cash and
cash equivalents and reduced royalty income.
LIQUIDITY AND CAPITAL RESOURCES
At April 2, 2000, the Company had cash and cash equivalents of $27.9
million, working capital of $41.4 million and minimal long-term obligations. For
the three months ended April 2, 2000, the Company recorded a net loss of $6.3
million. Net cash used in operating activities for the first quarter of 2000 was
$8.4 million consisting primarily of the loss from operations, an increase in
accounts receivable of $1.3 million, an increase in inventories of $4.1 million,
offset in part by increases in accounts payable and accrued liabilities of $1.8
million and an increase in deferred revenue of $0.4 million. The increase in
accounts receivable was due to higher than average shipments during the last
month of the quarter and recording, late in the quarter, of a receivable from
one large contract. The revenue from this contract has been deferred, accounting
for the increase in deferred revenue. The increase in inventories was the result
of orders built late in the quarter for shipment early in the next quarter,
advanced purchases of critical components to avoid stock shortages, and
pre-production component purchases for a soon-to-be-released new product. The
increases in accounts payable and accrued liabilities resulted from the increase
in inventory purchasing. Net cash used in continuing operating activities for
the first quarter of 1999 was $3.5 million consisting primarily of the loss from
continuing operations of $4.1 million and an increase in accounts receivable of
$2.4 million, offset in part by a decrease in inventories of $2.4 million. Both
the increase in accounts receivable and the decrease in inventories were the
result of increased sales over the previous quarter.
Cash used in investing activities for the three months ended April 2, 2000
and March 28, 1999 was $1.0 million and $0.2 million, respectively, primarily to
fund the acquisition of property, plant and equipment.
Cash provided by financing activities for the three months ended April 2,
2000 was $4.1 million, resulting from proceeds from the sale of 564,000 shares
of stock pursuant to the exercise of stock options. Cash provided by financing
activities for the three months ended March 29, 1999 was not material.
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 next twelve
months. 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 or debt 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.
8
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RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We have a history of losses and expect this to continue for the foreseeable
future.
We incurred losses from continuing operations in 1999 and for each of the
prior four years. We expect to continue to incur net losses through 2000. We
might not increase or maintain our revenue or be profitable on a quarterly or an
annual basis in the future.
Our quarterly operating results may vary in the future, which could cause our
stock price to drop.
We have historically experienced significant fluctuations in our operating
results on a quarterly basis and could experience such fluctuations in the
future. Our operating results are affected by a number of factors, many of which
are outside of our control, including the following:
o the timing of the introduction by us or by our competitors of new or
enhanced products;
o market acceptance of our new products and those of our competitors;
o the timing, cancellation or delay of customer orders, including
cancellation or delay in anticipation of new product introductions or
enhancements or resulting from uncertainty relating to intellectual
property claims;
o changes in our pricing policies or those of our competitors;
o 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;
o delays in manufacturing due to shortages in components or unanticipated
revisions in product design;
o delays in software development;
o expenses incurred in seeking to obtain, enforce and defend claims with
respect to intellectual property rights;
o changes in the revenue mix from products or services sold;
o changes in the percentage of products sold through our direct sales
force versus indirect channels;
o changes in the percentage of products sold in the U.S. versus
international markets;
o loss of an important customer;
o failure to grow our customer base in accordance with market
expectations;
o customer discounts and credits; and
o our limited ability to reduce expenses rapidly to offset any unexpected
shortfall in revenue growth or decrease in revenue.
We expect to introduce a number of new products during the remainder of
2000. The delay in product availability and/or failure of any such products to
achieve market acceptance when anticipated, or at all, would materially and
adversely affect our financial condition and results of operations.
Pending Litigation
See Part II, Item 1. "Legal Proceedings."
Our sales cycles are long and unpredictable, which makes period-to-period
revenues difficult to predict.
Sales of our 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 our
products is typically lengthy and subject to a number of significant risks over
which we have little or no control. We are often required to ship products
shortly after we receive orders and, consequently, order backlog at the
9
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beginning of any period has, at times in the past, represented only a small
portion of that period's expected revenue. As a result, product revenue in any
period has been and will continue to be substantially dependent on orders booked
and shipped in that period. We typically plan our 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 at times in the past, our financial
condition and results of operations would be materially and adversely affected.
In addition, our operating expenses are based on anticipated revenue levels and
a high percentage of our 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. It is possible that in the
future our 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 our
business or the market sector in which we operate, the price of our Common Stock
would likely be adversely affected.
These factors make it difficult to predict our financial performance. As
our quarterly results fluctuate, they may fall below the expectations of public
market analysts or investors. If this occurs, the price of our common stock may
drop.
We are dependent on recently introduced and new network security products.
Our future results of operations will be highly dependent on the successful
completion of the design, development, introduction, marketing and manufacture
of the NetAuthority and NetHawk products, as well as successful marketing and
manufacture of the Cylink Link Encryptors, PrivaCy Manager, PrivateWire and
Cylink Frame Encryptor products. To date, we have made only limited commercial
shipments of certain of such products and, in some cases, no commercial
shipments of certain of such products. Our development engineers employed by ARL
in Israel delivered NetHawk in January for beta testing with customers in the
United States, and our ability to commence production at our Santa Clara
facilities depends on the availability and delivery schedules for components, or
suitable alternatives, selected by our design engineers. NetAuthority is based
on a pilot system delivered for the first time in mid-1999 under a development
contract with the United States Postal Service. These products may require
additional development work, enhancement, and testing or further refinement
before they can be introduced and made commercially available by us or achieve
market acceptance. If such new and/or other recently introduced products have
performance, reliability, quality or other shortcomings, such products could
fail to achieve market acceptance. The failure by our new or existing products
to achieve or enjoy market acceptance, whether for these or other reasons, could
cause us 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 our business,
financial condition and results of operations. We also rely on a third party
original equipment manufacturer to supply our ATM Encryptor product, and we have
no assurance this contract will be renewed. Should this third party supplier
experience a change of control or cease operations, we may experience a
temporary reduction in product availability and related ATM revenues pending
successful renegotiation of an alternate supply contract or re-engineering of
the product to be manufactured by Cylink.
Competition
Competition is intense among providers of network security systems, and we
expect such competition to increase in the future. Significant competitive
factors in these markets include:
o the development of new products and features;
o product quality and performance;
o the quality and experience of sales, marketing and service
organizations;
o product price;
o name recognition;
o perception of our stability and long-term viability; and
o adoption of embedded security solutions in other vendors' hardware and
software products.
Many of these factors are beyond our control.
10
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Our 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.,
Information Resource Engineering, Inc., Network Associates, Inc., Secure
Computing Corporation, Zaxus Limited (formerly Racal-Guardata, Inc.), and RSA
Security, Inc. Our PKI product, NetAuthority, will be competing with numerous
PKI products offered by other vendors, including Baltimore Technologies, Entrust
Technologies, Inc., and VeriSign Inc., that already have numerous customers and
significantly greater market recognition than the Company. When it is released,
our NetHawk VPN appliance will face competition from numerous other products,
including those offered or under development by Cisco Systems, Inc., Newbridge
Networks Corporation, Netscreen Technologies, Inc. and Nokia Corp. Our
professional services business competes with very large consulting organizations
such as Andersen Consulting, PricewaterhouseCoopers and other entities which
have formidable resources to market and support their security consulting
businesses. Our original equipment manufacturer ("OEM") supplier of its ATM
Encryptor product also competes with us through other channels, for sales of
this product. Our smart cards compete with numerous vendors, including Gemplus,
S.A and Schlumberger Ltd. A number of significant vendors, including Microsoft
Corporation, America On Line, Inc. 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 our products, our products may no longer be required by customers to
attain network security.
Certicom Corporation and RSA Security, Inc., 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 in most of the Company's products. Although we have 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 us, to the exclusion of our
methods, sales of our existing and planned products in that market segment may
be adversely impacted, which could have a material adverse effect on our
financial condition and results of operations.
Many of our competitors have substantially greater financial, technical,
marketing, distribution and other resources, greater name recognition and longer
standing relationships with customers than we possess. Competitors with greater
financial resources are better able to engage in more aggressive marketing
campaigns and sustained price reductions in order to gain market share. Any
period of sustained price reductions would have a material adverse effect on our
financial condition and results of operations. We may not be able to compete
successfully in the future and competitive pressures may result in price
reductions, loss of market share or otherwise have a material adverse effect on
our financial condition and results of operations.
We face the risks from tort and warranty claims that may be made against us.
Customers rely on our network security products to prevent unauthorized
access to their networks and data transmissions. A malfunction or the inadequate
design of our products could result in tort or warranty claims. A breach of a
customer's network by an unauthorized party, which is attributable to an alleged
defect in our products, may cause substantial damages due to loss or compromise
of the customer's valuable information. Furthermore, there is inadequate legal
precedent for allocating responsibility for such losses caused by the wrongful
acts of third parties. Although we attempt to reduce the risk of such losses
through warranty disclaimers and liability limitation clauses in our sales and
license agreements and by maintaining product liability insurance, there can be
no assurance that such measures will be effective in limiting our liability for
any such damages. Any liability for damages resulting from security breaches
could be substantial and could have a material adverse effect on our 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 our
products in particular, regardless of whether such breach is attributable to our
products. This could result in a decline in demand for our products, which would
have a material adverse effect on our business, financial condition and results
of operations.
We may be unable to retain our executive officers and key personnel that are
critical to our business.
In late 1998 Mr. William C. Crowell, formerly Vice President of Product
Strategy, was promoted to President and Chief Executive Officer, and Mr. Roger
A. Barnes became our Chief Financial Officer. Our future success will depend in
large part on the abilities of Mr. Crowell and the contributions by our other
executive officers, key management and technical personnel. The loss of the
services of one or more of our 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 our
business and operating results.
11
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We may not be able to hire and retain sufficient technical, marketing and
management personnel that we need to succeed because these people are limited in
number and in high demand.
We recently experienced, and may continue to experience, substantial
fluctuations in the number of employees and the scope of our operations in the
network security business, resulting in increased responsibilities for
management. To manage our business effectively, we will need to continue to
improve our operational, financial and management information systems and to
hire, train, motivate and manage our employees. Competition is intense for
qualified technical, marketing and management personnel. 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.
We have experienced delays in filling positions for engineering and marketing
personnel and expect to experience continued difficulty in filling our need for
qualified engineers and other personnel. There can be no assurance that we will
be able effectively to achieve or manage any future growth, and our failure to
do so could delay product development cycles or otherwise have a material
adverse effect on our financial condition and results of operations.
Any inability to protect our intellectual property could reduce our competitive
advantage, divert management attention, require additional intellectual property
to be developed or cause us to incur expenses to enforce our rights.
We rely on patents, trademarks, copyrights, licenses and trade secret law
to establish and preserve our intellectual property rights. We own a number of
U.S. patents covering certain aspects of our network security product designs,
and have additional U.S. patent applications pending. There can be no assurance
that any patent, trademark, copyright or license owned or held by us will not be
invalidated, circumvented or challenged, that the rights granted thereunder will
provide competitive advantages to us or that any of our pending or future patent
applications will be issued with the scope of the claims sought by us, if at
all. Further, there can be no assurance that others will not develop
technologies that are similar or superior to our technology, duplicate our
technology or design around the patents owned by us. We 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 our products are or may be developed, manufactured or sold
may not protect our products and intellectual property rights to the same extent
as the laws of the United States. Our inability to protect our intellectual
property adequately could have a material adverse effect on our 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, we have received communications from third
parties asserting that our patents, features or content of certain of our
products infringe upon the intellectual property rights held by third parties,
and we may receive such communications in the future. There can be no assurance
that third parties will not assert claims against us that result in litigation.
Any litigation, whether or not determined in our favor, could result in
significant expense to us and could divert management and other resources. In
the event of an adverse ruling in any litigation involving intellectual
property, we 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 us on reasonable terms or at all. In the event
of a successful claim against us and our failure to develop or license a
substitute technology on commercially reasonable terms, our 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 our financial condition and results of operations.
If we are unable to adapt our services to rapidly changing technology, or if the
market for network security fails to develop, our business and operating results
could suffer.
The market for our network security products is characterized by rapidly
changing technology, emerging industry standards, new product introductions and
changes in customer requirements and preferences. Our future success will depend
in part upon end-users' demand for network security products in general, and
upon our ability to enhance our existing products and to develop and introduce
new products and technologies that meet customer requirements. We face
continuing challenges to educate customers as to the value of our security
products and security consulting services. We believe that many potential
customers do not appreciate the need for security products unless and until
12
<PAGE>
they have faced a major security breach. Many potential customers prefer not to
disclose significant security breaches of their networks or are reluctant to
invest in the development of a professional security architecture to protect
their networks. This market resistance is compounded by our limited resources to
invest in marketing campaigns for our products and services.
If we are unable successfully to educate potential customers as to the
value of, and thereby obtain broad market acceptance for, our products and
services, we will continue to rely primarily on selling new and existing
products to our base of existing customers, which will significantly limit any
opportunity for growth. In addition, any significant advance in technologies for
attacking cryptographic systems could render some or all of our existing and new
products obsolete or unmarketable. To the extent that a specific method other
than ours is adopted as the standard for implementing network security in any
segment of the network security market, sales of our existing and planned
products in that market segment may be adversely impacted, which could have a
material adverse effect on our business, financial condition and results of
operations. Also, network security-related products or technologies developed by
others may adversely affect our competitive position or render our products or
technologies noncompetitive or obsolete.
In addition, a portion of the sales of our network security products will
depend upon a robust industry and infrastructure for providing access to public
switched networks, such as the Internet. The infrastructure or complementary
products necessary to make these networks into viable commercial marketplaces
may not be fully developed, and once developed, these networks may not become
viable commercial marketplaces.
If our research and development activities are unsuccessful, we will not be able
to market new products and services and our business operations and financial
results could be harmed.
The markets for our products are characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in part upon our ability to continue to enhance
our existing products and to develop, manufacture and market new products. As a
result, we expect to continue to make a significant investment in engineering,
research and development. We may not be able to develop and introduce new
products or enhancements to our existing products in a timely manner which
satisfy customer needs, achieve market acceptance or address technological
changes in our target markets. If we fail to develop products and introduce them
successfully and in a timely manner, this could adversely affect our competitive
position, financial condition and results of operations.
We face risks associated with international operations.
We plan to continue to expand our 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 our foreign sales are denominated in U.S.
dollars, our 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.
Our ability to compete successfully in foreign countries is dependent in
part on our ability to obtain and retain reliable and experienced in-country
distributors and other strategic partners. We do not have long-term
relationships with many of our value-added resellers and distributors and,
therefore, have no assurance of a continuing relationship within a given market.
Due to U.S. and Israeli government regulations restricting the export of
cryptographic devices and software, including sales to foreign governments of
certain of our network security products, we are often at a disadvantage in
competing for international sales compared to companies located outside the
United States and Israel that are not subject to such restrictions. Although the
Department of Commerce recently relaxed the export control laws as they apply to
sales of our products to our commercial customers, we still face considerable
export controls on sales to foreign governments and transfers of our technology
to foreign partners. In particular, these controls frequently hinder the close
cooperation between our engineering departments, with resulting delays in
product developments and releases of products, such as NetHawk, for
manufacturing in the United States.
13
<PAGE>
We face risks from our dependence on third party subcontractors and suppliers.
Our ability to deliver our products in a timely manner is dependent upon
the availability of quality components and subsystems used in these products. We
depend in part upon subcontractors to manufacture, assemble and deliver certain
items in a timely and satisfactory manner. We obtain certain components and
subsystems from single, or a limited number of, sources. We rely on a single OEM
supplier for our ATM Encryptor, which we offer to our customers with our own
management solution. A significant delay in obtaining a source of supply for
components selected by our design engineers or interruption in the delivery of
such items could have a material adverse effect on our financial condition and
results of operations.
Revisions in accounting estimates could adversely affect the calculation of our
future operating results.
In connection with the acquisition of ARL in September 1997, we allocated
$63.9 million of the purchase price to in-process research and development
("IPR&D"), and in accordance with generally accepted accounting principles
recorded an immediate charge off of that amount on the date of acquisition. The
amount allocated to IPR&D was determined in a manner consistent with widely
recognized appraisal practices.
In a letter dated September 15, 1998, to the American Institute of
Certified Public Accountants, the Chief Accountant of the Securities and
Exchange Commission ("SEC") indicated the SEC Staff's concerns related to
certain appraisal practices generally employed in determining the fair value of
IPR&D. As a result, it is possible that the SEC staff may require that any
enterprise that recorded an IPR&D charge revise its estimate of the value of the
IPR&D. To the extent we are required by the SEC Staff retroactively to revise
our estimate of the value of IPR&D, such revision could result in the
capitalization of additional goodwill, the amortization of which would reduce
future operating results.
14
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of April 2, 2000, we held a total of $27.9 million of cash and cash
equivalents. These securities consist primarily of money market funds and
high-grade, short-term corporate obligations. Certain of these securities are
subject to interest rate risk and will decline in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10 percent from levels as of April 2, 2000, the decline in fair value of the
portfolio would not be material.
We transact substantially all of our revenues and costs in U.S. dollars and
our results of operations would not be materially affected by fluctuations in
foreign exchange rates. Accordingly, to date, we have not used material amounts
of derivative financial instruments. As of April 2, 2000, we had no fixed rate
obligations except for capitalized leases and long-term debt of approximately
$130,000. As such, the fair value of our fixed rate obligations is not subject
to a material adverse impact from changes in interest rates.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On September 14, 1998, Cylink announced that its earnings for the third
quarter would be below consensus estimates. On November 5, 1998, Cylink
announced that, with the assistance of its independent accountants, it was
reviewing its revenue recognition practices, and Cylink 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 ended 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. Cylink has filed
amended Forms 10-Q for the first and second quarters of 1998 and an amended Form
10-K for 1997. Between November 6, 1998 and December 14, 1998, several
securities class action complaints were filed against Cylink and certain of its
current and former directors and officers in federal courts in California. These
complaints allege, among other things, that Cylink's previously issued financial
statements were materially false and misleading and that the defendants knew or
should have known that these financial statements caused Cylink'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.
The securities class action lawsuits have been ordered consolidated into a
single action pending in the United States District Court for the Northern
District of California, captioned In Re Cylink Securities Litigation, No.
C98-4292 (VRW). Plaintiffs have not yet filed an amended consolidated complaint.
Cylink 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, Cylink's business, financial condition, cash flows and results of
operations could be materially adversely affected.
15
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Index:
Exhibit
Number Description of Exhibit
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
None
Items 3, 4 and 5 are not applicable and have been omitted.
16
<PAGE>
SIGNATURE
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: May 16, 2000 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)
17
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