-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LzPDCwi+ruJpB+k5azLKZlVh3wMeTlVZpCrB7zxy4U03UjlECMOf4nmqErApashl ACWQBznDR2dSdL+Zp2xssw== 0000950005-97-000684.txt : 19970812 0000950005-97-000684.hdr.sgml : 19970812 ACCESSION NUMBER: 0000950005-97-000684 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970627 FILED AS OF DATE: 19970811 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CYLINK CORP /CA/ CENTRAL INDEX KEY: 0001005230 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 952891600 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27742 FILM NUMBER: 97655813 BUSINESS ADDRESS: STREET 1: 910 HERMOSA COURT CITY: SUNNYVALE STATE: CA ZIP: 94086-4103 BUSINESS PHONE: 4087355800 MAIL ADDRESS: STREET 1: 910 HERMOSA CT CITY: SUNNYVALE STATE: CA ZIP: 94086-4103 10-Q 1 QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 27, 1997 Commission File No. 0-27742 CYLINK CORPORATION (Exact name of registrant as specified in its charter) California 95-3891600 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 910 Hermosa Court Sunnyvale, California 94086 (Address of principal executive offices) (408) 735-5800 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- As of August 7, 1997, there were 25,973,394 shares of the Registrant's Common Stock outstanding. PART I. FINANCIAL INFORMATION Item 1. Financial Statements CYLINK CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data; unaudited)
June 27, December 31, 1997 1996 --------- --------- Assets Current assets: Cash and cash equivalents $ 68,966 $ 78,849 Accounts receivable, net of allowance for doubtful accounts of $409 and $644 17,242 12,682 Inventories 10,163 8,828 Deferred income taxes 1,432 1,432 Other current assets 1,755 1,351 --------- --------- Total current assets 99,558 103,142 Property and equipment, net 4,896 3,760 Notes receivable from employees 3,473 -- Other assets 940 186 --------- --------- $ 108,867 $ 107,088 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Current portion of capital lease obligations $ 167 $ 167 Accounts payable 2,320 3,954 Accrued liabilities 5,566 5,150 Deferred revenue 244 353 --------- --------- Total current liabilities 8,297 9,624 --------- --------- Capital lease obligations, long-term 165 241 --------- --------- Deferred income taxes 12 12 --------- --------- 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; 25,948,000 and 25,597,000 shares issued and outstanding 259 257 Additional paid-in capital 90,330 89,772 Notes receivable from shareholders (5) (301) Deferred compensation related to stock options (292) (334) Cumulative translation adjustment (42) 4 Retained earnings 10,143 7,813 --------- --------- Total shareholders' equity 100,393 97,211 --------- --------- $ 108,867 $ 107,088 ========= ========= See accompanying notes to Condensed Consolidated Financial Statements.
2 CYLINK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data; unaudited)
Three Months Ended Six Months Ended ------------------------- ------------------------- June 27, June 28, June 27, June 28, 1997 1996 1997 1996 -------- -------- -------- -------- Revenue $ 18,269 $ 12,286 $ 34,451 $ 20,769 Cost of revenue 5,847 4,954 11,722 8,831 -------- -------- -------- -------- Gross profit 12,422 7,332 22,729 11,938 -------- -------- -------- -------- Operating expenses: Research and development, net 3,879 3,037 7,787 5,639 Selling and marketing 5,635 3,389 9,663 6,116 General and administrative 2,232 1,526 4,209 2,661 -------- -------- -------- -------- Total operating expenses 11,746 7,952 21,659 14,416 -------- -------- -------- -------- Income (loss) from operations 676 (620) 1,070 (2,478) Other income (expense): Interest income, net 875 935 1,816 1,299 Royalty and other income (expense), net 196 70 442 (304) -------- -------- -------- -------- Income (loss) before income taxes 1,747 385 3,328 (1,483) Provision (benefit) for income taxes 524 131 998 (504) -------- -------- -------- -------- Net income (loss) $ 1,223 $ 254 $ 2,330 $ (979) ======== ======== ======== ======== Net income (loss) per share $ 0.05 $ 0.01 $ 0.09 $ (0.04) ======== ======== ======== ======== Shares used to compute net income (loss) per share 26,610 26,605 26,567 24,519 ======== ======== ======== ======== See accompanying notes to Condensed Consolidated Financial Statements.
3 CYLINK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands; unaudited)
Six Months Ended -------------------- June 27, June 28, 1997 1996 -------- -------- Cash flows from operating activities: Net income (loss) $ 2,330 $ (979) Adjustments to reconcile net income (loss) to net cash used in operating activities: Write-down of short-term investments -- 441 Depreciation and amortization 937 647 Deferred compensation related to stock options 42 42 Deferred income taxes -- (653) Changes in assets and liabilities: Accounts receivable (4,560) (1,044) Inventories (1,335) (1,991) Other assets (1,158) 114 Accounts payable (1,634) 2,082 Accrued liabilities 416 992 Deferred revenue (109) (932) -------- -------- Net cash used in operating activities (5,071) (1,281) -------- -------- Cash flows from investing activities: Acquisition of property and equipment (2,073) (679) Loans to employees in exchange for notes receivable (3,473) -- -------- -------- Net cash used in investing activities (5,546) (679) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock, net 555 78,990 Payment of notes receivable from shareholders 301 -- Repayment of capital lease obligations (76) (204) Repayment of borrowings under bank line of credit -- (1,000) -------- -------- Net cash provided by financing activities 780 77,786 -------- -------- Effect of exchange rate changes on cash and cash equivalents (46) 8 -------- -------- Net increase (decrease) in cash and cash equivalents (9,883) 75,834 Cash and cash equivalents at beginning of period 78,849 3,240 -------- -------- Cash and cash equivalents at end of period $ 68,966 $ 79,074 ======== ======== Supplemental disclosures: Cash paid for income taxes $ 26 $ -- Cash paid for interest 44 81 Equipment acquired under capital lease obligations -- 247 Common stock issued for notes receivable 5 -- See accompanying notes to Condensed Consolidated Financial Statements.
4 CYLINK CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The unaudited condensed consolidated financial statements included herein contain all adjustments, consisting only of normal recurring adjustments which, in the opinion of management, are necessary to fairly state the consolidated financial position, results of operations and cash flows of Cylink Corporation ("Cylink" or the "Company") for the periods presented. These financial statements should be read in conjunction with the Company's audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. Interim results of operations are not necessarily indicative of the results to be expected for the full year. 2. Notes Receivable From Employees Pursuant to their employment agreements, during the first quarter of 1997 the Company loaned certain employees $3,473,000 towards the purchase of their principal residences. Of this amount, $2,843,000 is receivable from officers of the Company. The notes are interest free and are due five years from the dates of the related notes, at which time the notes must be repaid or convert into, and become subject to, the terms of a standard, interest-bearing commercial loan. The notes are secured by deeds of trust on the residences. The loan agreements provide for accelerated payment in the event of termination of employment under certain conditions and, in one instance, under certain circumstances will be forgiven to the extent of any decrease in the value of the related residence. 3. Inventory June 27, December 31, 1997 1996 ------- ------- (in thousands) Inventories: Raw materials $ 4,623 $ 4,126 Work in process and subassemblies 3,340 3,196 Finished goods 2,200 1,506 ------- ------- $10,163 $ 8,828 ======= ======= 4. Recent Accounting Pronouncement In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 128 ("FAS 128"), "Earnings Per Share." This statement redefines earnings per share under generally accepted accounting principles. Under the new standard, primary earnings per share is replaced by basic earnings per share and fully diluted earnings per share is replaced by diluted earnings per share. The Company is required to adopt the new standard in the fourth calendar quarter of 1997. The following table sets forth primary earnings per share as reported and unaudited pro forma basic and diluted earnings per share assuming FAS 128 had been applied during the periods presented:
Three Months Ended Six Months Ended ------------------ ------------------ June 27, June 28, June 27, June 28, 1997 1996 1997 1996 -------- -------- -------- -------- Primary earnings per share as reported $0.05 $0.01 $0.09 $(0.04) Pro forma basic net income per share 0.05 0.01 0.09 (0.04) Pro forma diluted net income per share 0.05 0.01 0.09 (0.04)
5 In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income." FAS 130 establishes standards for reporting comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income as defined includes all changes in equity (net assets) during a period from nonowner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gain/loss on available for sale securities. The disclosure prescribed by FAS 130 must be made beginning with the first quarter of calendar 1998. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has not yet determined the impact, if any, of adopting this new standard. The disclosures prescribed by FAS 131 are effective for calendar 1998. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding Cylink's expectations, hopes, intentions, beliefs or strategies regarding the future. Forward-looking statements include: the Company's statements in Part I, Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding the sufficiency of the Company's existing liquidity and capital resources, management's belief that resolution of certain litigation described in Part II, Item 1 "Legal Proceedings" will not have a material adverse effect on the Company's financial position and results of operations, the Company's expectation that it will introduce a number of new products in 1997 and continue to make a significant investment in engineering, research and development, and its intention to expand its foreign sales channels and enter additional international markets. All forward-looking statements included in this document are based on information available to the Company as of the date of this Report on Form 10-Q, and the Company assumes no obligation to update any such forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements. It is important to note that the Company's actual results could differ materially from those in such forward-looking statements for the reasons detailed in "Risk Factors That May Affect Future Results" and other sections of this Report on Form 10-Q. You should also consult the risk factors listed from time to time in the Company's Reports on Form 10-Q, 8-K, 10-K and Annual Reports to the Shareholders. RESULTS OF OPERATIONS Revenue. The Company's revenue is derived primarily from sales of its family of commercial information security products and its medium speed spread spectrum radio products. Fees for maintenance and support services are charged separately. Revenue from product sales is recognized upon shipment to the customer. Concurrently, a provision is made for estimated cost to repair or replace products under warranty arrangements. Revenue from sales to distributors is recognized upon shipment; no right of return, stock rotation or price protection is given. Revenue from sales to value added resellers is recognized upon shipment and concurrently a provision for estimated returns is recorded. The Company's revenue increased by 49% from $12.3 million for the three months ended June 28, 1996 to $18.3 million for the three months ended June 27, 1997, and increased by 66% from $20.8 million for the six months ended June 28, 1996 to $34.5 million for the six months ended June 27, 1997. Sales of information security products increased by 106% from $5.6 million for the second quarter of 1996 to $11.6 million for the second quarter of 1997, and increased by 111% from $9.9 million for the first half of 1996 to $20.9 million for the first half of 1997. The increase in information security product revenue resulted primarily from increased product shipments in the SecureWan, SecureLan and SecureAccess encryption product lines, which are used in public and private linked networks. Sales of wireless communications products were $6.7 million for both the second quarter of 1996 and 1997. Wireless communications revenues increased 24% from $10.9 million for the first half of 1996 to $13.5 million for the first half of 1997. This increase was primarily due to higher unit sales, particularly for the Company's AirLink S-Band radios. International revenue was 53% and 45% of total revenue for the second quarter of 1996 and 1997, respectively, and was 55% and 51% of total revenue for the first half of 1996 and 1997, respectively. The decrease in international product revenue as a percentage of total revenue from 1996 to 1997 was due primarily to the increased percentage of total revenue represented by information security products, which are mostly sold in the United States. Gross Profit. Gross profit increased by 69% from $7.3 million for the three months ended June 28, 1996 to $12.4 million for the three months ended June 27, 1997, and increased by 90% from $11.9 million for the six months ended June 28, 1996 to $22.7 million for the six months ended June 27, 1997. The increase in dollars was primarily a result of the significant increase in revenue. As a percentage of sales, gross profit was 60% and 68% for the second quarter of 1996 and 1997, respectively, and 57% and 66% for the first half of 1996 and 1997, respectively. The increase in gross margin resulted from the increased percentage of total revenue represented by information security products, which generally have higher gross margins than wireless communications products. In addition, the increase in gross margin was due to lower average unit costs and higher average selling prices for the 7 Company's wireless communications products, and a decrease in expenses for maintenance and support services related to the Company's information security products. Research and Development. Research and development expenses consist primarily of salaries and other personnel related expenses, depreciation of development equipment, facilities and supplies. Gross research and development expenses increased 5% from $4.2 million for the three months ended June 28, 1996 to $4.4 million for the three months ended June 27, 1997, and increased 12% from $7.9 million for the six months ended June 28, 1996 to $8.9 million for the six months ended June 27, 1997. Gross research and development expenses as a percentage of revenue were 34% and 24% for the second quarter of 1996 and 1997, respectively, and 38% and 26% for the first half of 1996 and 1997, respectively. The dollar increases resulted from the Company's expanded product development efforts, partially offset by reduced contract and other variable expenses related to externally funded research and development. 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 $1.2 million and $0.6 million for the second quarter of 1996 and 1997, respectively, and $2.3 million and $1.1 million for the first half of 1996 and 1997, respectively. Selling and Marketing. Selling and marketing expenses consist primarily of personnel expenses, including sales commissions, and expenses for advertising, public relations, seminars and trade shows. Selling and marketing expenses increased 66% from $3.4 million for the three months ended June 28, 1996 to $5.6 million for the three months ended June 27, 1997, and increased 58% from $6.1 million for the six months ended June 28, 1996 to $9.7 million for the six months ended June 27, 1997. Selling and marketing expenses as a percentage of revenue were 28% and 31% for the second quarter of 1996 and 1997, respectively, and 29% and 28% for the first half of 1996 and 1997, respectively. The dollar increases were due to expenses associated with expansion of the Company's direct sales force, personnel increases in the marketing group, and increased expenses associated with advertising, public relations and trade shows. General and Administrative. General and administrative expenses consist primarily of personnel and related costs, recruitment expenses, information system costs, and audit, legal and other professional service fees. General and administrative expenses increased 46% from $1.5 million for the three months ended June 28, 1996 to $2.2 million for the three months ended June 27, 1997, and 56% from $2.7 million for the six months ended June 28, 1996 to $4.2 million for the six months ended June 27, 1997. General and administrative expenses as a percentage of revenue were 12% for both the second quarter of 1996 and 1997, and 13% and 12% for the first half of 1996 and 1997, respectively. The dollar increases were primarily due to increased staffing and professional fees necessary to manage and support the Company's recent growth and provide infrastructure required for a public company. Other Income (Expense), Net. Other income (expense), net, primarily consists of royalties, interest income, interest expense and investment gains and losses. Interest income, net, increased from $1.3 million for the first half of 1996 to $1,8 million for the first half of 1997, principally due to interest income resulting from funds derived from the Company's initial public offering in February and March of 1996. In the first quarter of 1997, the Company recorded a benefit of $632,000 primarily related to the reversal of an allowance provided on the receivable related to the Company's interest in the residual value of a former partnership known as Public Key Partners ("PKP"). Management considers the uncertainty regarding ultimate collection to have been resolved as a result of the settlement agreement between the Company and RSA Data Security, Inc., a subsidiary of Security Dynamics ("RSA DSI"). The assets of the former partnership, consisting primarily of cash, are being held in trust pending the resolution of certain litigation described in Part II, Item 1 "Legal Proceedings." Management does not believe that the ultimate resolution of this matter will have a material adverse effect on the Company's financial position or results of operations. The first quarter of 1996 includes a $441,000 write down of the Company's short-term investments as management concluded the decline in value was permanent. These investments were sold at an actual loss of $432,000 in the third quarter of 1996. The Company also experienced a decline in royalty income during the six months ended June 27, 1997 as compared to the same period in 1996. LIQUIDITY AND CAPITAL RESOURCES At June 27, 1997, the Company had cash and cash equivalents of $69.0 million, working capital of $91.3 million and minimal long-term obligations. Net cash used in operating activities consisted primarily of increases in current assets other than cash and a decrease in accounts payable, partially offset by net income and an increase in accrued liabilities. 8 The Company made capital expenditures of approximately $2.1 million in the six months ended June 27, 1997. The Company also made long-term loans to employees of approximately $3.5 million. The Company is currently engaged in litigation and has certain assets subject to litigation. See Part II, Item 1 "Legal Proceedings." Management believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. The Company believes that existing cash balances and cash generated from operations, if any, will be sufficient to fund necessary purchases of capital equipment and to provide working capital through at least the remainder of 1997. However, the Company may require additional funds to support its working capital requirements or for other purposes and may seek to raise such additional funds through public or private equity financing or from other sources. No assurance can be given that additional financing will be available or that, if available, will be available on terms favorable to the Company or its shareholders. RISK FACTORS THAT MAY AFFECT FUTURE RESULTS Recent Losses; Potential Fluctuations in Operating Results, Future Operating Results Uncertain. Due primarily to increased research and development, sales and marketing, and litigation expenses, the Company incurred losses in 1994 and 1995 and the first six months of 1996. There can be no assurances that the Company will increase or maintain its revenue or be profitable on a quarterly or an annual basis in the future. The Company has historically experienced significant fluctuations in its operating results on an annual and a quarterly basis and could experience such fluctuations in the future. The Company's operating results are affected by a number of factors, many of which are outside of the Company's control, including: the timing of the introduction of new or enhanced products by the Company or its competitors; market acceptance of new products of the Company, its customers and its competitors; the timing, cancellation or delay of customer orders, including cancellation or delay in anticipation of new product introduction or enhancement or resulting from uncertainty relating to intellectual property claims; competitive factors, including pricing pressures; changes in operating expenses, including those resulting from changes in available production capacity of independent foundries and other suppliers and the availability of raw materials; expenses associated with obtaining, enforcing and defending claims with respect to intellectual property rights; the mix of products sold; changes in the percentage of products sold through the Company's direct sales force; personnel changes; general economic conditions; and fluctuations in foreign currency exchange rates. The Company expects to introduce a number of new products in 1997. The failure of such new products to achieve market acceptance at the time anticipated by the Company, or at all, would materially and adversely affect the Company's financial condition and results of operations. Potential Volatility of Stock Price The trading of the Company's Common Stock has been and may continue to be subject to wide fluctuations in response to quarter to quarter variations in operating results, announcements of technological innovations or new products by the Company or its competitors, developments with respect to patents or proprietary rights, general conditions in the information security systems and wireless communications industries, changes in earnings estimates by analysts, or other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations, which have particularly affected the market prices of many technology companies and which have often been unrelated to the operating performance of such companies. The Company's sales or operating results in future quarters may be below the expectations of public market securities analysts and investors. In such event, the price of the Company's Common Stock would likely decline, perhaps substantially. These Company-specific factors or broad market fluctuations may materially adversely affect the market price of the Company's Common Stock. Pending Litigation See Part II, Item 1. "Legal Proceedings." 9 Dependence on Key Personnel The Company's future success will depend to a large extent on the abilities and successful contributions of its executive officers, key management and technical personnel. The Company has been able to recruit several senior managers in the last year and its future is closely linked to the ability to successfully integrate these key employees into the Company, and to maintain and extend its base of talented management, technical and other personnel. Competition for highly-skilled business, product development, technical and other personnel is intense, and the loss of the services of one or more of the Company's executive officers or key personnel, or the inability to continue to attract qualified personnel, could delay product development cycles or otherwise have a material adverse effect on the Company's financial position and results of operations. Lengthy Sales Cycle Sales of the Company's products generally involve a significant commitment of capital by customers, with the attendant delays frequently associated with large capital expenditures. For these and other reasons, the sales cycle associated with the Company's products is typically lengthy and subject to a number of significant risks over which the Company has little or no control. The Company is often required to ship products shortly after it receives orders and, consequently, order backlog at the beginning of any period has in the past represented only a small portion of that period's expected revenue. As a result, product revenue in any period is substantially dependent on orders booked and shipped in that period. The Company typically plans its production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. If revenue falls significantly below anticipated levels, the Company's financial condition and results of operations would be materially and adversely affected. In addition, the Company's operating expenses are based on anticipated revenue levels and a high percentage of the Company's expenses are generally fixed in the short term. Based on these factors, a small fluctuation in the timing of sales can cause operating results to vary significantly from period to period. In addition, it is possible that in the future the Company's operating results will be below the expectations of securities analysts and investors. In such an event, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to the Company's business, the price of the Company's Common Stock would likely be materially adversely affected. Dependence on Recently Introduced and New Information Security Products The Company's future results of operations will be highly dependent on the successful completion of the design, development, introduction, marketing and manufacture of the SecureManager products, some of which are under development, and the SecureGate, SecureTraveler, SecureFrame and SecureDomain products, which were recently introduced. To date, the Company has made only limited commercial shipments of certain of such products. No assurance can be given that any of such products will not require additional development work, enhancement, testing or further refinement before they can be introduced and made commercially available by the Company or that they will achieve market acceptance. If such new and recently introduced products have performance, reliability, quality or other shortcomings, then such products could fail to achieve market acceptance and the Company may experience reduced orders, higher manufacturing costs, delays in collecting accounts receivable and additional warranty and service expenses, which in each case could have a material adverse effect on the Company's financial condition and results of operations. Competition Competition is intense among providers of information security systems and wireless communications equipment and systems, and the Company expects such competition to increase in the future. Significant competitive factors in these markets include the development of new products and features, product quality and performance, the quality and experience of sales, marketing and service organizations, product price and name recognition. Many of these factors are beyond the Company's control. The Company's competitors in the information security markets include Security Dynamics, Semaphore, Cray Research, Racal-Guardata, Inc., and Information Resource Engineering, Inc. Northern Telecom Limited, AT&T, Motorola Corporation, Digital Equipment Corporation and Sun Microsystems, Inc. offer certain information security products as part of their overall networking solutions. In addition, a number of significant vendors, including Microsoft Corporation, Netscape Communications Corporation and Cisco Systems have embedded security solutions in their software. To the extent that these embedded or optional security capabilities provide all or a 10 portion of the functionality provided by the Company's products, the Company's products may no longer be required by customers to attain information security. Several vendors including RSA DSI license various methods of implementing cryptographic technology, including some that are different than (and incompatible with) the method of implementing cryptography currently used by the Company in most of its products. Although Cylink has a license to use all of the leading methods promoted by the Company and RSA DSI, to the extent relevant industries impose technical standards different than those currently used by the Company in any segment of the information security market, sales of the Company's existing and planned products in that market segment may be adversely impacted, which could have a material adverse effect on the Company's financial condition and results of operations. The Company competes with a large number of companies in the wireless communications markets, including U.S. local exchange carriers and foreign telephone companies. The most significant competition for sub-T1 rate AirLink products in the wireless market is from telephone companies that offer leased line data services. The Company also competes with other suppliers of wireless products such as Digital Wireless, Utilicom, Western Multiplex and California Microwave, Inc. Many of the Company's competitors have substantially greater financial, technical, marketing, distribution and other resources, greater name recognition and longer standing relationships with customers than the Company. Competitors with greater financial resources are better able to engage in sustained price reductions in order to gain market share. Any period of sustained price reductions would have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressures will not materially and adversely affect the Company's financial condition and results of operations. Product Liability Risks Customers rely on the Company's information security products to prevent unauthorized access to their networks and data transmissions. A malfunction or the inadequate design of the Company's products could result in tort or warranty claims. Although the Company attempts to reduce the risk of such losses through warranty disclaimers and liability limitation clauses in its sales agreements and by maintaining product liability insurance, there can be no assurance that such measures will be effective in limiting the Company's liability for any such damages. Any liability for damages resulting from security breaches could be substantial and could have a material adverse effect on the Company's business and results of operations. In addition, a well-publicized actual or perceived security breach could adversely affect the market's perception of security products in general, or the Company's products in particular, regardless of whether such breach is attributable to the Company's products. This could result in a decline in demand for the Company's products, which would have a material adverse effect on the Company's financial condition and results of operations. Management of Growth The Company has recently experienced and may continue to experience substantial growth in the number of its employees and the scope of its operations, resulting in increased responsibilities for management. To manage growth effectively, the Company will need to continue to improve its operational, financial and management information systems and to hire, train, motivate and manage a growing number of employees. Competition is intense for qualified technical, marketing and management personnel, particularly highly skilled engineers. In particular, the current availability of qualified engineers is quite limited, and competition among companies, academic institutions, government entities and other organizations for skilled and experienced engineering personnel is very intense. The Company is currently attempting to hire a number of engineering personnel and has experienced delays in filling such positions. The Company expects to experience continued difficulty in filling its needs for qualified engineers and other personnel. There can be no assurance that the Company will be able to effectively achieve or manage any future growth, and its failure to do so could delay product development cycles or otherwise have a material adverse effect on the Company's financial condition and results of operations. Intellectual Property and Other Proprietary Rights The Company relies on patents, trademarks, copyrights, licenses and trade secret law to establish and preserve its intellectual property rights. The Company owns twelve U.S. patents covering certain aspects of its 11 product designs and has one additional U.S. patent application pending. The Company also has the exclusive right to sublicense certain patents that were granted to Stanford University with respect to the original Public Key methods (the "Stanford Patents"), which expire in the United States in the third quarter of 1997. There can be no assurance that any patent, trademark, copyright or license owned or held by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all. Further, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology or design around the patents owned by the Company. The Company may be subject to or may initiate interference proceedings in the U.S. Patent Office, which can require significant financial and management resources. In addition, the laws of certain countries in which the Company's products are or may be developed, manufactured or sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. The inability of the Company to protect its intellectual property adequately could have a material adverse effect on its financial condition and results of operations. The network information security and wireless communications industries in which the Company sells its products are characterized by substantial litigation regarding patent and other intellectual property rights. From time to time, the Company has received communications from third parties asserting that the Company's patents, features or content of certain of the Company's products infringe upon the intellectual property rights held by third parties, and the Company may receive such communications in the future. The Company is not aware that any of the features or content of its products wrongfully infringe on any valid intellectual property rights of others. There can be no assurance that third parties will not assert claims against the Company that result in litigation. Any litigation, whether or not determined in favor of the Company, could result in significant expense to the Company and could divert management and other resources. In the event of an adverse ruling in any litigation involving intellectual property, the Company might be required to discontinue the use of certain processes, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology and may suffer significant monetary damages, which could include treble damages. There can be no assurance that under such circumstances a license would be available to the Company on reasonable terms or at all. In the event of a successful claim against the Company and the Company's failure to develop or license a substitute technology on commercially reasonable terms, the Company's financial condition and results of operations would be adversely affected. There can be no assurance that existing claims or any other assertions (or claims for indemnity from customers resulting from infringement claims) will not materially and adversely affect the Company's financial condition and results of operations. Evolving Information Security Market The market for the Company's information security products is only beginning to emerge. This market is characterized by rapidly changing technology, emerging industry standards, new product introductions and changes in customer requirements and preferences. The Company's future success will depend in part upon end users' demand for information security products in general, and upon the Company's ability to enhance its existing products and to develop and introduce new products and technologies that meet customer requirements. Any significant advance in technologies for attacking cryptographic systems could render some or all of the Company's existing and new products obsolete or unmarketable. To the extent that a specific method other than the Company's is adopted as the standard for implementing information security in any segment of the information security market, sales of the Company's existing and planned products in that market segment may be adversely impacted, which could have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that information security-related products or technologies developed by others will not adversely affect the Company's competitive position or render its products or technologies noncompetitive or obsolete. In addition, a portion of the sales of the Company's information security products will depend upon a robust industry and infrastructure for providing access to public switched networks, such as the Internet. There can be no assurance that the infrastructure or complementary products necessary to make these networks into viable commercial marketplaces will be developed, or, if developed, that these networks will become viable commercial marketplaces. 12 Rapid Technological Change The markets for the Company's products are characterized by rapidly changing technologies, extensive research and new product introductions. The Company believes that its future success will depend in part upon its ability to continue to enhance its existing products and to develop, manufacture and market new products. As a result, the Company expects to continue to make a significant investment in engineering, research and development. There can be no assurance that the Company will be able to develop and introduce new products or enhancements to its existing products in a timely manner which satisfy customer needs, achieve market acceptance or address technological changes in its target markets. The failure of the Company to develop products and introduce them successfully and in a timely manner could adversely affect the Company's competitive position, financial condition and results of operations. Wireless Communications Industry Regulatory Environment Wireless communications are subject to regulations by United States and foreign laws and international treaties. In the United States, the Company's wireless communications products are subject to various regulations of the Federal Communications Commission ("FCC"). Current FCC regulations permit license-free operation of certain FCC certified wireless products. The future of remote wireless communications is highly volatile, due in part to ongoing uncertainty regarding telecommunications deregulation and the status of initiatives relating to the auction of licenses for personal communications service ("PCS") frequencies. Regulatory changes, including changes in the allocation of available frequencies, could significantly affect the Company's operations by diverting the Company's development efforts, making current products obsolete or increasing the opportunity for additional competition. There can be no assurance that new regulations will not be promulgated which could have a material adverse effect on the Company's financial condition and results of operations. The Company also is subject to regulatory requirements in foreign markets. Equipment can be marketed in a country only if permitted by suitable frequency allocations and regulations, and only if such equipment has received type approval by the country in question. The process of complying with new regulations and of obtaining type approval is often complex and lengthy and can result in significant expense and delays in the introduction of products in new countries. Changes in, or the failure by the Company to comply with, applicable domestic and international regulations could have a material adverse effect on the Company's business and operating results. There can be no assurance that the Company will be able to comply with regulations in any particular country. Risks Associated with International Sales; Reliance Upon Local Partners; Restrictions on Export International product sales represented approximately 35%, 47%, 59% and 51% of revenue in 1994, 1995, 1996 and for the six months ended June 27, 1997, respectively. In particular, sales of the Company's wireless communications products are currently concentrated in developing countries. The Company plans to continue to expand its foreign sales channels and to enter additional international markets, both of which will require significant management attention and financial resources. International sales are subject to a number of risks, including unexpected changes in regulatory requirements, tariffs and other trade barriers, political and economic instability in foreign markets, difficulties in the staffing, management and integration of foreign operations, longer payment cycles, greater difficulty in collecting accounts receivable, currency fluctuations and potentially adverse tax consequences. Since most of the Company's foreign sales are denominated in U.S. dollars, the Company's products become less price competitive in countries in which local currencies decline in value relative to the U.S. dollar. The uncertainty of monetary exchange values has caused, and may in the future cause, some foreign customers to delay new orders or delay payment for existing orders. The long-term impact of such devaluation, including any possible effect on the business outlook in other developing countries, cannot be predicted. The Company's ability to compete successfully in foreign countries is dependent in part on the Company's ability to obtain and retain reliable and experienced in-country distributors and other strategic partners. The Company does not have long-term relationships with any of its value added resellers and distributors and, therefore, has no assurance of a continuing relationship within a given market. United States government regulations restrict the export of certain cryptographic devices, including certain of the Company's information security products. As a result, the Company may be at a disadvantage in competing 13 for international sales compared to companies located outside the United States that are not subject to such restrictions. Dependence on Component Availability, Subcontractor Performance and Key Suppliers The Company's ability to timely deliver its products is dependent upon the availability of quality components and subsystems used in these products. The Company depends in part upon subcontractors to manufacture, assemble and deliver certain items in a timely and satisfactory manner. The Company obtains certain components and subsystems from single, or a limited number of, sources. A significant interruption in the delivery of such items could have a material adverse effect on the Company's financial condition and results of operations. PART II. OTHER INFORMATION Item 1. Legal Proceedings On September 6, 1995, the Company obtained an arbitration award dissolving a former partnership, known as PKP, between the Company's wholly-owned subsidiary, Caro-Kann Corporation, and RSA DSI. Although various claims between the Company and RSA DSI were settled on December 31, 1996, a third party continues to pursue various claims against PKP and RSA DSI for wrongful business practices in action C-94-20512 SW before the United States District Court for the Northern District of California. An unfavorable outcome might affect the residual value the Company may receive from the former partnership. On March 7, 1997, ten former employees of the Company filed suit in action No. CV764647 in the Superior Court of California, County of Santa Clara, against the Company, each of its Directors and its General Counsel, asserting claims for wrongful termination, fraud, libel, slander, age discrimination, invasion of privacy, and violation of the federal RICO statute. The Company has removed the action to the United States District Court, Northern District of California, No. C-97-20331 PVT. On July 23, 1997, one additional former employee served a summons and complaint in action No. CV767448 in the Superior Court of the State of California, County of Santa Clara, against the Company and one additional defendant alleging grounds similar to those asserted by the ten pending plaintiffs. Although the Company has placed its insurers on notice of these claims, only some of them have admitted coverage with reservation of certain rights and defenses. The Company believes the terminations were lawful and intends to defend the matter vigorously. The defense of this matter may divert a material amount of management's attention and require the expenditure of significant legal fees and costs. An unfavorable outcome which exceeds the Company's insurance coverage, if any, could also result in a material adverse effect on the Company's financial condition. Item 4. Submission of Matters to a Vote of Security Holders (a) The Registrant's Annual Meeting of Shareholders was held on May 22, 1997. (b) The following directors were elected at the Meeting: For Withheld --- -------- Fernand B. Sarrat 23,690,338 162,877 Jimmy K. Omura 23,691,988 161,227 Leo A. Guthart 23,690,838 162,377 James H. Simons 23,691,488 161,727 Howard L. Morgan 23,691,488 161,727 Elwyn Berlecamp 23,668,305 184,910 William W. Harris 23,690,238 162,977 King W.W. Harris 23,690,688 162,527 (c) Other matters voted on at the Meeting were the following: (i) Approval and ratification of the Cylink Corporation 1994 Flexible Stock Incentive Plan, as Amended, which (i) increases the maximum aggregate number of shares available for the grant of incentive stock options to 5,950,000, (ii) provides for discretionary awards to the Company's Non-Employee Directors, and (iii) 14 increases the maximum number of shares with respect to which options and stock appreciation rights may be granted to any employee to 1,000,000. For 14,539,614 Against 1,846,491 Abstain 48,913 Broker non-votes 7,418,197 (ii) Approval of an amendment to the Company's bylaws granting the Board of Directors the authority to approve loans to, and guarantee obligations of, officers of the Company and to ratify a loan for approximately $2,000,000 made to the Company's President and Chief Executive Officer. For 15,689,549 Against 670,775 Abstain 74,694 Broker non-votes 7,418,197 (iii) Ratification of the appointment of Price Waterhouse LLP as the Company's independent auditors for the fiscal year ending December 31, 1997. For 23,708,626 Against 92,668 Abstain 51,921 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Index: Exhibit Number Description of Exhibit ------ ---------------------- 27.1 Financial Data Schedule (b) No reports on Form 8-K were filed during the quarter ended June 27, 1997. 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 11, 1997 CYLINK CORPORATION By: /s/ JOHN H. DAWS ----------------------------------------- John H. Daws Vice President of Finance and Administration and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 6/27/97 CONDENSED CONSOLIDATED BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE SIX MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 6-MOS DEC-31-1997 JAN-01-1997 JUN-27-1997 68966 0 17651 409 10163 99558 10328 5432 108867 8297 0 259 0 0 100134 108867 34451 34451 11722 11722 21659 0 23 3328 998 2330 0 0 0 2330 0.09 0.09
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