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 July 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 August 14, 2000, there were 30,837,000 shares of the Registrant's
common stock outstanding.
<PAGE>
CYLINK CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JULY 2, 2000
INDEX
Page
----
Index 1
Part I Financial information
Item 1 Financial Statements and Supplementary Data
a) Condensed Consolidated Balance Sheets at July 2, 2000
and December 31, 1999 2
b) Condensed Consolidated Statements of Operations for
the three and six months ended July 2, 2000 and June 27, 1999 3
c) Condensed Consolidated Statements of Cashflows for the
six months ended July 2, 2000 and June 27, 1999 4
d) Notes to Condensed Consolidated Financial Statements 5
Item 2 Management's discussion and analysis of financial condition
and results of operations 7
Part II Other Information 16
Signature 19
Exhibit Exhibit 27.1, Financial Data Schedule 20
1
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<TABLE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data; unaudited)
<CAPTION>
July 2, Dec 31,
2000 1999
--------- ---------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 18,907 $ 33,170
Accounts receivable, net of allowances of $1,012 and $941 19,510 16,130
Inventories 12,998 6,745
Deferred income taxes 4,371 4,367
Other current assets 1,911 1,648
--------- ---------
Total current assets 57,697 62,060
Restricted cash 1,400 1,400
Property and equipment, net 10,558 10,038
Acquired technology, goodwill and other intangibles 1,746 3,188
Notes receivable from employees or former employees 3,284 3,165
Other assets 1,312 1,438
--------- ---------
$ 75,997 $ 81,289
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 39 $ 24
Accounts payable 6,050 6,635
Accrued liabilities 9,858 9,082
Income taxes payable 1,030 1,062
Deferred revenue 3,653 2,395
--------- ---------
Total current liabilities 20,630 19,198
--------- ---------
Capital lease obligations and long-term debt, less current portion 106 112
--------- ---------
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; 55,000,000 shares authorized; 308 299
30,751,000 and 29,877,000 shares issued and outstanding
Additional paid-in capital 132,117 126,896
Deferred compensation related to stock options (1,421) (1,790)
Accumulated other comprehensive loss (51) (82)
Accumulated deficit (75,692) (63,344)
--------- ---------
Total shareholders' equity 55,261 61,979
--------- ---------
$ 75,997 $ 81,289
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
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<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended Six Months Ended
------------------------ ------------------------
July 2, June 27, July 2, June 27,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 18,005 $ 15,209 $ 35,383 $ 27,094
Cost of revenue 6,433 4,769 12,679 8,881
-------- -------- -------- --------
Gross profit 11,572 10,440 22,704 18,213
-------- -------- -------- --------
Operating expenses:
Research and development, net 5,269 3,940 9,912 7,493
Selling and marketing 9,114 6,218 17,225 11,637
General and administrative 3,009 3,303 7,228 5,916
Amortization of purchased intangibles 720 680 1,440 1,360
-------- -------- -------- --------
Total operating expenses 18,112 14,141 35,805 26,406
-------- -------- -------- --------
Loss from operations (6,540) (3,701) (13,101) (8,193)
Other income (expense):
Interest income, net 540 628 827 936
Royalty and other income (expense), net (93) 19 (66) 138
-------- -------- -------- --------
447 647 761 1,074
-------- -------- -------- --------
Loss before income taxes (6,093) (3,054) (12,340) (7,119)
Provision for income taxes -- -- 8 --
-------- -------- -------- --------
Net loss $ (6,093) $ (3,054) $(12,348) $ (7,119)
======== ======== ======== ========
Net loss per share - basic: $ (0.20) $ (0.10) $ (0.41) $ (0.24)
======== ======== ======== ========
Net loss per share - diluted: $ (0.20) $ (0.10) $ (0.41) $ (0.24)
======== ======== ======== ========
Shares used in per share calculation - basic 30,511 29,127 30,258 29,122
======== ======== ======== ========
Shares used in per share calculation - diluted 30,511 29,127 30,258 29,122
======== ======== ======== ========
<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>
Six Months Ended
-----------------------------
July 2, June 27,
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(12,348) $ (7,119)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation 1,636 1,238
Amortization of purchased intangibles 1,440 1,360
Deferred income taxes (4) 26
Amortization of imputed interest on note receivable (119) (132)
Deferred compensation related to stock options 369 42
Deferred compensation related to employee notes receivable -- 251
Changes in assets and liabilities:
Accounts receivable (3,380) (3,650)
Inventories (6,253) 4,425
Other assets (132) 1,059
Accounts payable (585) 416
Accrued liabilities 776 (777)
Income taxes payable (3) (6)
Deferred revenue 1,258 (2)
-------- --------
Net cash used in operating activities (17,345) (2,869)
Net cash used in discontinued operations -- (527)
-------- --------
Net cash used in operating activities (17,345) (3,396)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (2,159) (1,333)
-------- --------
Net cash used in investing activities (2,159) (1,333)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 5,230 62
Other (20) (63)
-------- --------
Net cash provided by (used in) financing activities 5,210 (1)
-------- --------
Effect of exchange rate changes on
cash and cash equivalents 31 (48)
-------- --------
Net decrease in cash and cash equivalents (14,263) (4,778)
Cash and cash equivalents at beginning of year 33,170 46,575
-------- --------
Cash and cash equivalents at end of year $ 18,907 $ 41,797
======== ========
Supplemental disclosures
Income tax refund -- $ 2,500
<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
July 2, Dec. 31,
2000 1999
------- -------
(in thousands)
Raw materials $ 6,505 $ 2,412
Work in process and subassemblies 3,239 1,610
Finished goods 3,254 2,723
------- -------
$12,998 $ 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 July 2, 2000 and June 27, 1999, the Company had 6,717,000 and
6,422,000 stock options outstanding with a weighted average exercise price of
$6.61 and $4.74, respectively. These options expire on various dates beginning
in 2000 through 2008.
4. Comprehensive Loss
<TABLE>
The components of comprehensive loss are as follows:
<CAPTION>
Three Months Ended Six Months Ended
---------------------------- ----------------------------
July 2, June 27, July 2, June 27,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss $ (6,093) $ (3,054) $(12,348) $ (7,119)
Other comprehensive income (loss) 11 (36) 31 (48)
-------- -------- -------- --------
Total comprehensive loss $ (6,082) $ (3,090) $(12,317) $ (7,167)
======== ======== ======== ========
</TABLE>
5. Recently issued accounting pronouncements
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," which provides the SEC staff's views on selected revenue
recognition issues. The guidance in SAB 101 must be adopted during the fourth
quarter of 2000, and the effects, if any, are required to be recorded through a
retroactive, cumulative-effect adjustment as of the beginning of the year, with
a
5
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restatement of all prior interim quarters in the year. Management is evaluating
the effects, if any, that SAB 101 may have on the Company's income statement
presentation, operating results or financial position.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement, which is effective for the year beginning January 1, 2001,
establishes accounting and reporting standards for derivative instruments and
for hedging activities. SFAS No. 133 was amended by SFAS No. 138 in June 2000.
SFAS No. 133 requires a company to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. Management is evaluating the impact this statement may have on
the company's financial statements.
6. Contingencies
Cylink is currently engaged in litigation. See Part II, Item 1. "Legal
Proceedings."
7. Subsequent Events
Working capital loan. On July 27, 2000, Cylink received a commitment
for a $10.0 million working capital loan secured by all of Cylink's tangible
assets from a bank. The revolving loan provides for loan advances up to 80% of
Cylink's eligible accounts receivable, bears interest at a rate not exceeding
the Bank's prime rate of interest, and is due July 31, 2001.
Acquisitions. On July 27, 2000, Cylink entered into an agreement to
acquire all the outstanding shares of Celotek Corporation, a developer of
high-performance Asynchronous Transfer Mode network security appliances for
approximately $21,500,000 less certain expenses. The consideration will be paid
by the issuance of that number of shares of common stock to be based on the
average price twenty days preceding the closing, but in any event not to be less
than $11.50 nor greater than $15.00 per share. The acquisition is expected to
close no later than August 31, 2000, is subject to customary closing conditions
and will be treated for accounting purposes as a purchase.
6
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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
<TABLE>
The following table sets forth certain consolidated statement of
operations data as a percentage of revenue for the periods indicated:
<CAPTION>
Three months ended Six months ended
------------------ -------------------
July 2, June 27, July 2, June 27,
2000 1999 2000 1999
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 35.7 31.4 35.8 32.8
----- ----- ----- -----
Gross profit 64.3 68.6 64.2 67.2
----- ----- ----- -----
Operating expenses:
Research and development, net 29.3 25.9 28.0 27.7
Selling and marketing 50.6 40.9 48.7 43.0
General and administrative 16.7 21.7 20.4 21.8
Amortization of purchased intangibles 4.0 4.5 4.1 5.0
----- ----- ----- -----
Total operating expenses 100.6 93.0 101.2 97.5
----- ----- ----- -----
Loss from operations (36.3) (24.4) (37.0) (30.3)
Other income, net 2.5 4.3 2.1 4.0
----- ----- ----- -----
Loss before income taxes (33.8) (20.1) (34.9) (26.3)
Provision for income taxes -- -- -- --
----- ----- ----- -----
Net loss (33.8)% (20.1)% (34.9)% (26.3)%
===== ===== ===== =====
</TABLE>
Revenue. Revenue increased 18% from $15.2 million for the three months
ended June 27, 1999 to $18.0 million for the three months ended July 2, 2000,
and increased 31% from $27.1 million for the six months ended June 27, 1999 to
$35.4 million for the six months ended July 2, 2000. The increase is
attributable to increases in unit shipments of existing products, the
introduction of new products late in the 2nd quarter of 2000, shipment of
products with higher average selling prices, increased revenues from our
Algorithmic Research, Ltd. subsidiary, increased
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revenues associated with maintenance and support services, and the introduction
of revenues from professional service consulting in the latter half of 1999.
International revenue was 34% and 47% of total revenue for the second 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 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," and Statement of Position 81-1:
"Accounting for Performance of Construction-type and Certain Production-type
Contracts" depending on the contract.
Gross Profit. Gross profit increased from $10.4 million for the three
months ended June 27, 1999 to $11.6 million for the three months ended July 2,
2000, and increased from $18.2 million for the six months ended June 27, 1999 to
$22.7 million for the six months ended July 2, 2000. The increase in dollars was
primarily a result of the increase in revenue. As a percentage of sales, gross
profit was approximately 69% and 64% for the quarters ended June 27, 1999 and
July 2, 2000, respectively. The decrease in gross profit as a percentage of
revenue was due to a higher percentage of revenues derived from our OEM-based
ATM encryptor business which historically has lower gross margins and greater
revenue contribution from lower margin customer service business.
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 26% from $4.4 million for the three months ended June 27,
1999 to $5.6 million for the three months ended July 2, 2000, and increased 20%
from $8.4 million for the six months ended June 27, 1999 to $10.1 million for
the six months ended July 2, 2000. Gross research and development expenses as a
percentage of revenue were 29% for the second quarter of 1999 and 31% for the
second quarter 2000, and 31% for the first half of 1999 and 29% for the first
half of 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 increase in expense as a
percentage of revenue for the second quarters is due to the greater growth in
spending due to new product introductions and lower development project
reimbursements than the rate of revenue growth.
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 $0.5
million for the second quarter of 1999 and $0.1 million for second quarter of
2000.
Selling and Marketing. Selling and marketing expenses consist primarily
of personnel expenses, including sales commissions and bonuses, and expenses for
advertising, public relations, seminars and trade shows. Selling and marketing
expenses increased 47% from $6.2 million for the three months ended June 27,
1999 to $9.1 million for the three months ended July 2, 2000, and increased 48%
from $11.6m for the six months ended June 27, 1999 to $17.2 million for the six
months ended July 2, 2000. Selling and marketing expenses as a percentage of
revenue were 41% and 51% for the second quarter of 1999 and 2000, respectively,
and 43% and 49% for the first half of 1999 and 2000, respectively. Sales
expenses increased for the second quarter of 2000 primarily due to the addition
of 12 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 11
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 as a result of the above factors in advance of incremental revenues
generated by new product introductions.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, recruitment expenses, information
systems costs, and audit, legal and other professional service fees. General and
administrative expenses decreased 9% from $3.3 million for the three months
ended June 27, 1999 to $3.0 million for the three months ended July 2, 2000, and
increased 22% from $5.9 million for the first half of 1999 to $7.2 million
8
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for the first half of 2000. General and administrative expenses as a percentage
of revenue were 22% and 17% for the second quarter of 1999 and 2000,
respectively, and 22% and 20% for the first half of 1999 and 2000, respectively.
The dollar decrease in the second quarter of 2000 versus the second quarter of
1999 was primarily due to the recovery of legal costs under our insurance policy
with respect to the class action litigation, a one-time telecommunication
billing error recovery , the elimination of executive bonuses, offset in part by
increased spending in the information technology area to support the Oracle ERP
system. The decrease as a percentage of revenue is due primarily to the decrease
in overall costs measured against an increasing revenue base.
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 July 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.
Other Income (Expense), Net. Other income (expense), net consists
primarily of interest income and interest expense, foreign exchange gains or
losses, and royalty income. Other income, net decreased from $0.6 million for
the second three months of 1999 to $0.4 million for the second three months of
2000, principally due to decreased cash and cash equivalents and reduced royalty
and other income.
LIQUIDITY AND CAPITAL RESOURCES
At July 2, 2000, the Company had cash and cash equivalents of $18.9
million, working capital of $37.1 million and minimal long-term obligations. For
the three months ended July 2, 2000, the Company recorded a net loss of $6.1
million. Net cash used in operating activities for the first half of 2000 was
$17.3 million consisting primarily of the loss from operations, an increase in
accounts receivable of $3.4 million, an increase in inventories of $6.3 million,
an increase in accounts payable and accrued liabilities of $.1m, offset in part
by an increase deferred revenue of $1.3 million. The increase in accounts
receivable was due to higher than average shipments during the last month of the
quarter. The increase in inventories was the result of advanced purchases of
critical components to avoid stock shortages, and pre-production component
purchases for a soon-to-be-released new product. The decrease in accounts
payable resulted from payment cycles which are shorter than inventory turn
cycles. The increase in accrued liabilities was due principally to sales
commission accruals and amounts due under Cylink's Employee Stock Purchase Plan
that was introduced in the first quarter of 2000. Net cash used in continuing
operating activities for the first half of 1999 was $2.9 million consisting
primarily of the loss from continuing operations of $7.1 million and an increase
in accounts receivable of $3.7 million, offset in part by a decrease in
inventories of $4.4 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 six months ended July 2, 2000
and June 27, 1999 was $2.2 million and $1.3 million, respectively, primarily to
fund the acquisition of property, plant and equipment.
Cash provided by financing activities for the six months ended July 2,
2000 was $5.2 million, resulting from proceeds from the sale of 875,000 shares
of stock pursuant to the exercise of stock options. Cash provided by financing
activities for the six months ended June 27, 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. Cylink has secured a $10 million revolving line of credit at
favorable terms with a leading Silicon Valley bank to assure that we can meet
any working capital requirements. 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 in the future. 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.
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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 introduced a number of new products during the first half of 2000,
and we expect to introduce other 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
10
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control. We are often required to ship products shortly after we receive orders
and, consequently, order backlog at the 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, Cylink ATM Encryptors and Cylink Frame Encryptor products. To date,
we have made only limited commercial shipments of certain of these products. Our
development engineers employed by ARL in Israel delivered NetHawk in January
2000 for beta testing with customers in the United States, and our production at
our Santa Clara facilities depends on the continued availability and delivery
schedules for components, or suitable alternatives, selected by our design
engineers. NetAuthority is based on a pilot system delivered in mid-1999 under a
development contract with the United States Postal Service, which we upgraded
with our first commercial release during July 2000. 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. On July 27, 2000, we entered into
a contract to acquire the third party original equipment manufacturer of our ATM
Encryptor product. Should this contract fail to close, we have no assurance that
our supply contract will be renewed and in the event of a change of control or
termination of 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.
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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
Data Security, Inc. Our PKI product, NetAuthority, competes 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. Our NetHawk VPN
appliance competes with 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 and, in the event we fail to
close our agreement to acquire our OEM, this competition will continue. 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 Data 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 principal 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
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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.
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, including claims that may arise out of our ATM encryptor business we
are in the process of acquiring. 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
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services. We believe that many potential customers do not appreciate the need
for security products unless and until 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.
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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. In the event we fail to close our pending
contract to acquire this OEM supplier, our dependence on this sole source of
production will continue for the foreseeable future. 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.
We face risks associated with our pending acquisition.
On July 27, 2000 we agreed to acquire Celotek Corporation, a privately
held company in the ATM encryption business, in exchange for $21,500,000 of our
Common Stock minus certain expenses. The shares to be issued in this acquisition
will increase the number of shares of our common stock outstanding, and
therefore will result in earnings per share dilution unless we are able to
realize sufficient financial benefits from the transaction. While we believe we
will achieve financial benefits that will offset the dilution, acquisitions
inherently involve risks and uncertainties. These include potential costs and
management distractions associated with integrating the operations of the two
companies, the potential loss of key employees of the acquired company, the
potential loss of key customers, and potential operational challenges that the
acquired company may have and which are sometimes unforeseeable. Any such
circumstances could result in the acquisition not rendering financial benefits
to offset the cost of the acquisition.
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.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of July 2, 2000, we held a total of $18.9 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 July 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 July 2, 2000, we had no fixed
rate obligations except for capitalized leases and long-term debt of
approximately $145,000. 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 recently filed an amended consolidated complaint
and our motion to dismiss the complaint is pending before the Court.
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.
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Item 4. Submission of Matters to a Vote of Security Holders
(a) The Registrant's Annual Meeting of Shareholders was held May 17, 2000.
The vote of holders of record of 30,440,642 shares of Cylink's common
stock outstanding at the close of business on March 31, 2000 was
solicited by proxy pursuant to Regulation 14A under the Securities Act
of 1934.
(b) The following persons were elected Directors of Cylink at the Annual
Meeting:
Votes Votes
Name of Director For Withheld
---------------- --- --------
Howard L. Morgan 26,607,890 69,185
William W. Harris 26,601,590 75,485
William P. Crowell 26,606,061 71,014
(c) The shareholders approved Cylink's 2000 Employee Stock Purchase Plan
Votes Votes Votes
For Against Withheld
--- ------- --------
25,757,999 880,539 38,537
(d) The shareholders amended the Articles of Incorporation to increase the
authorized number of Common Stock the Company may issue by 15,000,000
shares to a total of 55,000,000 shares.
Votes Votes Votes
For Against Withheld
--- ------- --------
26,496,032 153,209 27,834
(e) The shareholders ratified the appointment of Deloitte & Touche LLP as
Cylink's independent auditor for the fiscal year ending December 31,
2000.
Votes Votes Votes
For Against Withheld
--- ------- --------
26,642,048 28,235 6,792
(f) There were no other matters voted on at the meeting.
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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:
On August 4, 2000, Cylink filed a report on Form 8-K dated July 31,
2000 as required by Item 2 of Form 8-K with respect to an Agreement and
Plan of Reorganization to acquire Celotek Corporation for a value of
$21,5000,000 in Cylink Common Stock minus certain expenses.
Items 2, 3 and 5 are not applicable and have been omitted.
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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: August 15, 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)
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