-----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, N+2m1GPRB18Q45Xgb+pbQ2W3eT7ZRZyzJJqY4QMIjp1xahqg7lmLI8jQRJ5eNLZf 2MlRrIPujoi5tIGksbcyag== 0000950005-98-000443.txt : 19980514 0000950005-98-000443.hdr.sgml : 19980514 ACCESSION NUMBER: 0000950005-98-000443 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980329 FILED AS OF DATE: 19980513 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: 953891600 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27742 FILM NUMBER: 98618143 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 FORM 10-Q 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 March 29, 1998 Commission File No. 0-27742 CYLINK CORPORATION (Exact name of registrant as specified in its charter) California 95-3891600 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 910 Hermosa Court Sunnyvale, California 94086 (Address of principal executive offices) (408) 735-5800 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of May 7, 1998, there were 28,984,346 shares of the Registrant's common stock outstanding. 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements CYLINK CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data; unaudited)
March 29, December 31, 1998 1997 --------- --------- Assets Current assets: Cash and cash equivalents $ 58,078 $ 22,977 Accounts receivable, net of allowances of $309 and $278 21,840 15,557 Inventories 5,955 6,224 Net assets of discontinued operations 14,500 13,218 Deferred income taxes 1,760 1,533 Other current assets 2,323 2,190 --------- --------- Total current assets 104,456 61,699 Property and equipment, net 6,041 6,003 Acquired technology, goodwill and other intangibles, net 7,338 8,017 Notes receivable from employees 4,318 3,473 Other assets 3,989 925 --------- --------- $ 126,142 $ 80,117 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Current portion of lease obligations and long-term debt $ 196 $ 210 Accounts payable 2,936 2,238 Accrued liabilities 6,435 6,194 Accrued liabilities related to discontinued operations 6,773 -- Income taxes payable 14,405 1,898 Deferred revenue 839 206 --------- --------- Total current liabilities 31,584 10,746 --------- --------- Capital lease obligations and long-term debt 215 256 --------- --------- Deferred income taxes 13 13 --------- --------- Shareholders' equity: Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued and outstanding -- -- Common stock, $0.01 par value; 40,000,000 shares authorized; 28,887,000 and 28,695,000 shares issued and outstanding 289 287 Additional paid-in capital 121,575 120,092 Deferred compensation related to stock options (229) (250) Cumulative translation adjustment (47) (63) Accumulated deficit (27,258) (50,964) --------- --------- Total shareholders' equity 94,330 69,102 --------- --------- $ 126,142 $ 80,117 ========= ========= See accompanying notes to Condensed Consolidated Financial Statements.
2 CYLINK CORPORATION CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except share and per share data; unaudited)
Three Months Ended ------------------------------ March 29, March 28, 1998 1997 -------- -------- Revenue $ 15,829 $ 9,352 Cost of revenue 3,611 2,810 -------- -------- Gross profit 12,218 6,542 -------- -------- Operating expenses: Research and development, net 3,045 3,018 Selling and marketing 5,573 2,782 General and administrative 1,408 1,900 Amortization of purchased intangibles 679 -- -------- -------- Total operating expenses 10,705 7,700 -------- -------- Income (loss) from operations 1,513 (1,158) Other income: Interest income, net 152 942 Royalty and other income (expense), net -- 131 -------- -------- Income (loss) from continuing operations before income taxes 1,665 (85) Provision for income taxes 583 -- -------- -------- Income (loss) from continuing operations 1,082 (85) Income (loss) from discontinued operations, net of income tax expense (benefit) of $(89) and $474 (166) 1,192 Gain on disposal of discontinued operations, net of income tax expense of $12,358 22,790 -- -------- -------- Net income $ 23,706 $ 1,107 ======== ======== Earnings per share - basic: Continuing operations $ 0.04 $ -- Discontinued operations 0.78 0.04 -------- -------- Net income $ 0.82 $ 0.04 ======== ======== Earnings per share - diluted: Continuing operations $ 0.04 $ -- Discontinued operations 0.74 0.04 -------- -------- Net income $ 0.78 $ 0.04 ======== ======== Shares used in per share calculation - basic 28,820 25,701 ======== ======== Shares used in per share calculation - diluted 30,440 25,701 ======== ======== See accompanying notes to Condensed Consolidated Financial Statements.
3 CYLINK CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands; unaudited)
Three Months Ended ----------------------------- March 29, March 28, 1998 1997 -------- -------- Cash flows from operating activities: Income (loss) from continuing operations $ 1,082 $ (85) Adjustments to reconcile income (loss) to net cash used in continuing operations: Depreciation and amortization 988 384 Deferred compensation related to stock options 21 21 Deferred income taxes (227) -- Changes in assets and liabilities: Accounts receivable (6,283) (58) Inventories 269 (513) Other assets (197) (1,281) Accounts payable 698 (434) Accrued liabilities 241 389 Deferred revenue 633 (19) -------- -------- Net cash used in continuing operations (2,775) (1,596) Net cash provided by (used in) discontinued operations (4,293) 326 -------- -------- Net cash used in operating activities (7,068) (1,270) -------- -------- Cash flows from investing activities: Acquisition of property and equipment (707) (1,029) Loans to employees in exchange for notes receivable (845) (3,473) Proceeds from sale of discontinued operations 46,000 -- Acquisition of preferred stock of Syndata Technologies (3,000) -- -------- -------- Net cash provided by (used in) investing activities 41,448 (4,502) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock, net 760 129 Payment of notes receivable from shareholders -- 301 Repayment of capital lease obligations and long-term debt (55) (53) -------- -------- Net cash provided by financing activities 705 377 -------- -------- Effect of exchange rate changes on cash and cash equivalents 16 (83) -------- -------- Net increase (decrease) in cash and cash equivalents 35,101 (5,478) Cash and cash equivalents at beginning of period 22,977 78,849 -------- -------- Cash and cash equivalents at end of period $ 58,078 $ 73,371 ======== ======== Supplemental disclosures: Cash paid for income taxes $ 39 $ 6 Cash paid for interest 15 21 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, 1997. Interim results of operations are not necessarily indicative of the results to be expected for the full year. Beginning in 1998, the Company's interim quarters end on the last Sunday preceding the calendar quarter end. Previously, the Company's interim quarters ended on the last Friday preceding the calendar quarter end. 2. Discontinued Operations On March 28, 1998, the Company sold its Wireless Communications Group ("Wireless") to P-Com, Inc. for $60.5 million ($46.0 million in cash and an unsecured promissory note in the amount of $14.5 million due 100 days after closing, subject to closing adjustments). As a result, the operations of Wireless have been classified as discontinued operations in the accompanying Condensed Consolidated Financial Statements and related Notes. Accrued expenses in the amount of approximately $6.8 million, primarily for professional services, anticipated excess facilities expenses, and certain other transaction related accruals were charged to discontinued operations and offset against the gain on disposal. Wireless revenues were $6.8 and $4.5 million in the first quarter of 1997 and 1998, respectively. Net assets of discontinued operations at March 29, 1998, relate primarily to accounts receivable. 3. Notes Receivable From Employees Pursuant to their employment agreements and related promissory notes, during the first quarter of 1997 and 1998 the Company loaned certain employees $3,473,000 and $845,000, respectively, towards the purchase of their principal residences. Of these amounts, $3,688,000 is receivable from officers of the Company. The notes are interest free and are due five years from the dates of the related notes, at which time the notes must be repaid or convert into, and become subject to, the terms of a standard, interest-bearing commercial loan. The notes are secured by deeds of trust on the residences. The loan agreements provide for accelerated payment in the event of termination of employment under certain conditions and, in one instance, under certain circumstances will be forgiven to the extent of any decrease in the value of the related residence. Subsequent to March 29, 1998, the Company loaned officers an additional $1,400,000 towards the purchase of principle residences under substantially similar terms. 4. Inventories March 29, December 31, 1998 1997 ------ ------ (in thousands) Raw materials $3,038 $2,191 Work in process and subassemblies 2,026 1,858 Finished goods 891 2,175 ------ ------ $5,955 $6,224 ====== ====== 5 5. Earnings Per Share Basic earnings per share amounts were calculated by dividing net income (loss) by the weighted average number of common shares outstanding. For the first quarter of 1998, diluted earnings per share amounts were based on the same reported earnings but assumed the issuance of 1,620,000 shares of common stock upon exercise of outstanding stock options using the treasury stock method. For the first quarter of 1998, weighted-average unexercised stock options to purchase 225,000 shares of common stock were excluded from the computation of diluted earnings per share as the options exercise prices were greater than the average market price of the Company's common stock and were, therefore, antidilutive. For the first quarter of 1997, all 3,647,000 weighted-average outstanding stock options were excluded from the computation of earnings per share as they were antidilutive. 6. Change in Accounting Policy Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting comprehensive income and its components in an annual financial statement that is displayed with the same prominence as other financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from nonowner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gain/loss on available-for-sale securities. Annual financial statements for prior periods will be reclassified, as required. The Company's total comprehensive earnings were as follows: Three Months Ended ---------------------- March 29, March 28, 1998 1997 ------- ------- (in thousands) Net income $23,706 $ 1,107 Other comprehensive income (loss) 16 (83) ------- ------- Total comprehensive income $23,722 $ 1,024 ======= ======= In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has not yet determined the impact of adopting this new standard. The disclosures prescribed by FAS 131 are effective for 1998, and are not required for interim periods. The Company does not expect this pronouncement to have a material impact on its financial statements. 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 1998 and continue to make a significant investment in engineering, research and development, its intention to expand its foreign sales channels and enter additional international markets, and the Company's intention to protect itself from liability arising out of "year 2000 errors." All forward-looking statements included in this document are based on information available to the Company as of the date of 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. BUSINESS ACQUISITION Pursuant to an asset purchase agreement dated March 27, 1998, the Company sold its Wireless business for approximately $46.0 million in cash and a $14.5 million unsecured note receivable due 100 days after closing, subject to closing adjustments. See Note 2 of Notes to Condensed Consolidated Financial Statements. The sale resulted in an after tax gain of approximately $22.8 million. Except where noted, the following comments are associated with the continuing network security business. RESULTS OF OPERATIONS Revenue. The Company's revenue is derived primarily from sales of its family of commercial network security products. Fees for maintenance and support services are charged separately. Revenue from product sales is recognized upon shipment to the customer. Concurrently, a provision is made for estimated costs to repair or replace products under warranty arrangements. Revenue from sales to distributors is recognized upon shipment; no right of return, stock rotation or price protection is given. Revenue from sales to value added resellers is recognized upon shipment and concurrently a provision for estimated returns is recorded. The Company's revenue increased by 69% from $9.4 million for the three months ended March 28, 1997 to $15.8 million for the three months ended March 29, 1998. Approximately 50% of the increased revenue resulted from sales of recently introduced PrivateWire products, with the remainder due to increased shipments of the Company's Link Encryption and SecureFrame products. International revenue was 41% and 34% of total revenue for the first quarter of 1997 and 1998, respectively. Gross Profit. Gross profit increased by 87% from $6.5 million for the three months ended March 28, 1997 to $12.2 million for the three months ended March 29, 1998. The increase in dollars was primarily a result of the significant increase in revenue. As a percentage of sales, gross profit was 70% and 77% for the first quarter of 1997 and 1998, respectively. The increase in gross margin resulted primarily from the increased percentage of total revenue represented by software and software-intensive products, such as PrivateWire, which generally have higher gross margins than hardware-intensive products. To a lesser degree, the increase in gross margin was due to lower average unit costs for existing 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 decreased 17% from $3.6 million for the three months ended March 28, 1997 to $3.0 million for the three months ended March 29, 1998. Gross research and development expenses as a percentage of revenue were 38% and 19% for the first quarter of 1997 and 1998, respectively. The percentage decrease resulted primarily from the Company's increased revenue base. The dollar decrease resulted from reduced contract and other variable expenses related to externally funded development and to cost containment efforts. From time to time the Company 7 receives engineering funding for development of projects to apply or enhance the Company's technology to a particular customer's need. The amounts recognized under these research and development contracts are offset against research and development expenses. No engineering funding was recognized during the first quarter of 1998. The amounts recognized under non-recurring engineering contracts totaled $0.6 million for the first quarter of 1997. Selling and Marketing. Selling and marketing expenses consist primarily of personnel expenses, including sales commissions, and expenses for advertising, public relations, seminars and trade shows. Selling and marketing expenses increased 100% from $2.8 million for the three months ended March 28, 1997 to $5.6 million for the three months ended March 29, 1998. Selling and marketing expenses as a percentage of revenue were 30% and 35% for the first quarter of 1997 and 1998, respectively. Sales and marketing expenses increased from the first quarter of 1997 primarily to support the launch of new or enhanced products, as well as due to continued expansion of the Company's direct sales operations, product line management, marketing development and international operations. Additionally, sales and marketing expenses increased due to integration expenses resulting from the acquisition of Algorithmic Research ("ARL") in September 1997. General and Administrative. General and administrative expenses consist primarily of personnel and related costs, recruitment expenses, information systems costs, and audit, legal and other professional service fees. General and administrative expenses decreased 26% from $1.9 million for the three months ended March 28, 1997 to $1.4 million for the three months ended March 29, 1998 General and administrative expenses as a percentage of revenue were 20% and 9% for the first quarter of 1997 and 1998, respectively. The dollar decrease from the first quarter of 1997 was primarily due to decreases in consulting expenses, recruiting and relocation expenses related to senior management transition and legal fees. Other Income (Expense), Net. Other income (expense), net, consists primarily of interest income and interest expense. Interest income, net, decreased from $0.9 million for the first three months of 1997 to $0.2 million for the first three months of 1998, principally due to the decrease in cash and cash equivalents resulting from investing activities and working capital requirements. LIQUIDITY AND CAPITAL RESOURCES At March 29, 1998, the Company had cash and cash equivalents of $58.1 million, working capital of $72.9 million and minimal long-term obligations. For the three months ended March 29, 1998, the Company recorded net income of $23.7 million, largely due to the gain on sale of Wireless. Net cash used in continuing operating activities for the first quarter of 1998 of $2.5 million consisted primarily of increases in accounts receivable, partially offset by income from continuing operations and an increase in current liabilities. Cash provided by investing activities for the three months ended March 29, 1998 was $41.4 million, of which $46.0 million was attributed to the sale of Wireless. The funds attributable to the Wireless sale were partially offset by expenditures for property and equipment of $0.7 million, long-term loans to employees of $0.8 million, and a $3.0 million investment in the preferred stock of Syndata Technologies, Inc. The Company is currently engaged in litigation. See Part II, Item 1 "Legal Proceedings." Management believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. The Company believes that existing cash balances and cash generated from operations, if any, will be sufficient to fund necessary purchases of capital equipment and to provide working capital through at least the remainder of 1998. However, the Company may require additional funds to support its working capital requirements or for other purposes and may seek to raise such additional funds through public or private equity financing or from other sources. No assurance can be given that additional financing will be available or that, if available, will be on terms favorable to the Company or its shareholders. 8 RISK FACTORS THAT MAY AFFECT FUTURE RESULTS Recent Losses; Potential Fluctuations in Operating Results, Future Operating Results Uncertain. The Company incurred losses from continuing operations in 1994, 1995, 1996 and 1997. There can be no assurances that the Company will increase or maintain its revenue or be profitable on a quarterly or an annual basis in the future. The Company has historically experienced significant fluctuations in its operating results on an annual and a quarterly basis and could experience such fluctuations in the future. The Company's operating results are affected by a number of factors, many of which are outside of the Company's control, including: the timing of the introduction of new or enhanced products by the Company or its competitors; market acceptance of new products of the Company, its customers and its competitors; the timing, cancellation or delay of customer orders, including cancellation or delay in anticipation of new product introduction or enhancement or resulting from uncertainty related to intellectual property claims; competitive factors, including pricing pressures; changes in operating expenses, including those resulting from changes in available production capacity of independent foundries and other suppliers and the availability of raw materials; expenses associated with obtaining, enforcing and defending claims with respect to intellectual property rights; the mix of products sold; changes in the percentage of products sold through the Company's direct sales force; personnel changes; general economic conditions; and fluctuations in foreign currency exchange rates. The Company expects to introduce a number of new products in 1998. The failure of such new products to achieve market acceptance at the time anticipated by the Company, or at all, would materially and adversely affect the Company's financial condition and results of operations. Pending Litigation See Part II, Item 1. "Legal Proceedings." Dependence on Key Personnel On November 13, 1996, the Company announced the appointment of Fernand B. Sarrat as President and Chief Executive Officer, and during the first half of 1997 the Company hired a number of executives to senior management positions within the Company. The Company's future success will depend on the abilities of Mr. Sarrat and the contributions by its executive officers, key management and technical personnel. The loss of the services of one or more of the Company's executive officers or key personnel, or the inability to continue to attract and retain qualified personnel, could delay product development cycles or otherwise have a material adverse effect on the Company's business and operating results. Lengthy Sales Cycle Sales of the Company's products generally involve a significant commitment of capital by customers, with the attendant delays frequently associated with large capital expenditures. For these and other reasons, the sales cycle associated with the Company's products is typically lengthy and subject to a number of significant risks over which the Company has little or no control. The Company is often required to ship products shortly after it receives orders and, consequently, order backlog at the beginning of any period has in the past represented only a small portion of that period's expected revenue. As a result, product revenue in any period is substantially dependent on orders booked and shipped in that period. The Company typically plans its production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. If revenue falls significantly below anticipated levels, the Company's financial condition and results of operations would be materially and adversely affected. In addition, the Company's operating expenses are based on anticipated revenue levels and a high percentage of the Company's expenses are generally fixed in the short term. Based on these factors, a small fluctuation in the timing of sales can cause operating results to vary significantly from period to period. In addition, it is possible that in the future the Company's operating results will be below the expectations of securities analysts and investors. In such an event, or in the event that adverse conditions prevail or are perceived to prevail generally or with respect to the Company's business, the price of the Company's Common Stock would likely be materially adversely affected. Dependence on Recently Introduced and New Information Security Products The Company's future results of operations will be highly dependent on the successful completion of the design, development, introduction, marketing and manufacture of the PrivateWire and PrivaCy Manager products, portions of which are under development, and SecureLink, SecureFrame, SecureDomain and PrivateWire products, which were recently introduced. To date, the Company has made only limited commercial shipments of certain of such 9 products and no commercial shipments of the remainder of such products. No assurance can be given that any of such products will not require additional development work, enhancement, testing or further refinement before they can be introduced and made commercially available by the Company or that they will achieve market acceptance. If such new and recently introduced products have performance, reliability, quality or other shortcomings, then such products could fail to achieve market acceptance and the Company may experience reduced orders, higher manufacturing costs, delays in collecting accounts receivable and additional warranty and service expenses, which in each case could have a material adverse effect on the Company's financial condition and results of operations. Competition Competition is intense among providers of network security systems, and the Company expects such competition to increase in the future. Significant competitive factors in these markets include the development of new products and features, product quality and performance, the quality and experience of sales, marketing and service organizations, product price and name recognition. Many of these factors are beyond the Company's control. The Company's competitors in the information security markets, including companies that offer products similar to or as an alternative to the Company's products, include Axent Technologies, Inc., Checkpoint Software Technologies, Ltd., Network Associates, Inc., SecureComputing Corporation, Security Dynamics Technologies, Inc., Racal-Guardata, Inc., and Information Resource Engineering, Inc. In addition, Northern Telecom Limited, AT&T, Motorola Corporation, Digital Equipment Corporation and Sun Microsystems, Inc. offer certain information security products as part of their overall networking solutions. A number of significant vendors, including Microsoft Corporation, Netscape Communications Corporation and Cisco Systems, Inc., have embedded security solutions in their software. To the extent that these embedded or optional security capabilities provide all or a portion of the functionality provided by the Company's products, the Company's products may no longer be required by customers to attain network security. Certicom Corporation and RSA Data Security, Inc., a subsidiary of Security Dynamics, ("RSA DSI") license various methods of implementing public key cryptography, including some that are different than (and incompatible with) the method of implementing public key cryptography currently used by the Company in most of its products. Although Cylink has a license to use all of the public key methods promoted by Certicom and RSA DSI, to the extent significant segments of the network security market adopt technical standards different than those currently used by the Company, to the exclusion of the Company's methods, sales of the Company's existing and planned products in that market segment may be adversely impacted, which could have a material adverse effect on the Company's financial condition and results of operations. Many of the Company's competitors have substantially greater financial, technical, marketing, distribution and other resources, greater name recognition and longer standing relationships with customers than the Company. Competitors with greater financial resources are better able to engage in sustained price reductions in order to gain market share. Any period of sustained price reductions would have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressures will not materially and adversely affect the Company's financial condition and results of operations. Product Liability Risks Customers rely on the Company's network security products to prevent unauthorized access to their networks and data transmissions. A malfunction or the inadequate design of the Company's products could result in tort or warranty claims. Although the Company attempts to reduce the risk of such losses through warranty disclaimers and liability limitation clauses in its sales and license agreements and by maintaining product liability insurance, there can be no assurance that such measures will be effective in limiting the Company's liability for any such damages. Any liability for damages resulting from security breaches could be substantial and could have a material adverse effect on the Company's business and results of operations. 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. 10 Year 2000 Although the company believes that it has identified all risks of "year 2000 errors" ("YK2 Errors") in its products, and is taking steps to repair, replace or end-of-life all products which contain YK2 Errors, there is a continuing risk that some YK2 Errors will go undetected until after December 31, 1999. The Company intends to attempt to protect itself from liability with appropriate disclaimers in its terms and conditions of sale, by encouraging customers to upgrade their products to those that have proven to be YK2 compliant, and by discouraging continued use of those products known to have YK2 Errors. However, the Company may be met with unanticipated liabilities for undiscovered YK2 Errors which cannot be limited by any of the foregoing preventive actions, and conceivably could include an allegation of damages which exceeds the terms or the amount of the Company's insurance policies covering product liability. The Company is in the process of evaluating and implementing changes, as necessary, to its information systems and, accordingly, does not anticipate any material YK2 Errors from its own information systems, databases or programs. However, the Company's financial position and results of operations could be adversely impacted by YK2 Errors faced by distributors, suppliers, customers, vendors and financial service organizations with which the Company interacts. Management of Growth And Reduction In Employees The Company has recently experienced and may continue to experience substantial growth in the number of employees and the scope of its operations in the network security business, resulting in increased responsibilities for management. To manage growth effectively, the Company will need to continue to improve its operational, financial and management information systems and to hire, train, motivate and manage a growing number of employees. Competition is intense for qualified technical, marketing and management personnel, particularly highly skilled engineers. In particular, the current availability of qualified engineers is quite limited, and competition among companies, academic institutions, government entities and other organizations for skilled and experienced engineering personnel is very intense. The Company has experienced delays in filling positions for engineering personnel and the Company expects to experience continued difficulty in filling its needs for qualified engineers and other personnel. There can be no assurance that the Company will be able to effectively achieve or manage any future growth, and its failure to do so could delay product development cycles or otherwise have a material adverse effect on the Company's financial condition and results of operations. With the sale of its Wireless business, the Company has experienced a significant reduction in employees, including the Company's former Chief Technical Officer, Dr. Jim Omura. The sale of Wireless, along with occasional reductions in specific engineering programs in the network security business, may create a risk of instability within the existing employee population resulting in departures of key employees critical to sustaining growth in the Company's network security business. Furthermore, sudden reductions on the number of the Company's employees places greater demands on the remaining employees which may distract them from fulfilling their responsibilities necessary to accomplishing the Company's financial goals. In September 1997, the Company acquired ARL and assumed responsibility for management of its worldwide operations of approximately sixty employees. The Company is heavily dependent on ARL's success in continuing to develop marketable technology and products, such as the PrivateWire family, including PrivateSafe and PrivateCard, toolkits and other components. Key factors which will determine ARL's success include whether the Company can integrate ARL's management, employee culture and organizational practices into the Company, whether the Company can adequately fund ARL's development objectives, whether the Company can can provide accurate information for ARL to focus its technology on significant market opportunities, and whether the Company can predict the most attractive features and functions for ARL's products. The Company's success in realizing the anticipated return from its investment in ARL also will be determined by the Company's ability to position and introduce ARL's products into the Company's markets and channels, and the Company's ability to provide adequate sales and customer support for ARL's products. The Company and ARL's successful working relationship may be hindered significantly by differences between the two organizations created by time, distance, language and culture. ARL operates from its principle offices in Israel, a country which is vulnerable to disruption due to the sudden outbreak of hostilities with its neighbors and various indigenous factors. Many of ARL's employees have extensive commitments to the country's military organizations which may require a loss of their services on the Company's behalf in times of political instability. 11 Intellectual Property and Other Proprietary Rights The Company relies on patents, trademarks, copyrights, licenses and trade secret law to establish and preserve its intellectual property rights. The Company owns six U.S. patents covering certain aspects of its network security product designs, and has additional U.S. patent applications pending. There can be no assurance that any patent, trademark, copyright or license owned or held by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all. Further, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology or design around the patents owned by the Company. The Company may be subject to or may initiate interference proceedings in the U.S. Patent Office, which can require significant financial and management resources. In addition, the laws of certain countries in which the Company's products are or may be developed, manufactured or sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. The inability of the Company to protect its intellectual property adequately could have a material adverse effect on its financial condition and results of operations. The computer, communications, software and network security industries are characterized by substantial litigation regarding patent and other intellectual property rights. From time to time, the Company has received communications from third parties asserting that the Company's patents, features or content of certain of the Company's products infringe upon the intellectual property rights held by third parties, and the Company may receive such communications in the future. There can be no assurance that third parties will not assert claims against the Company that result in litigation. Any litigation, whether or not determined in favor of the Company, could result in significant expense to the Company and could divert management and other resources. In the event of an adverse ruling in any litigation involving intellectual property, the Company might be required to discontinue the use of certain processes, cease the manufacture, use and sale of infringing products, expend significant resources to develop non-infringing technology or obtain licenses to the infringing technology and may suffer significant monetary damages, which could include treble damages. There can be no assurance that under such circumstances a license would be available to the Company on reasonable terms or at all. In the event of a successful claim against the Company and the Company's failure to develop or license a substitute technology on commercially reasonable terms, the Company's financial condition and results of operations would be adversely affected. There can be no assurance that existing claims or any other assertions (or claims for indemnity from customers resulting from infringement claims) will not materially and adversely affect the Company's financial condition and results of operations. Evolving Network Security Market The market for the Company's network security products is only beginning to emerge. This market is characterized by rapidly changing technology, emerging industry standards, new product introductions and changes in customer requirements and preferences. The Company's future success will depend in part upon end users' demand for network security products in general, and upon the Company's ability to enhance its existing products and to develop and introduce new products and technologies that meet customer requirements. Any significant advance in technologies for attacking cryptographic systems could render some or all of the Company's existing and new products obsolete or unmarketable. To the extent that a specific method other than the Company's is adopted as the standard for implementing network security in any segment of the network security market, sales of the Company's existing and planned products in that market segment may be adversely impacted, which could have a material adverse effect on the Company's financial condition and results of operations. There can be no assurance that network security-related products or technologies developed by others will not adversely affect the Company's competitive position or render its products or technologies noncompetitive or obsolete. In addition, a portion of the sales of the Company's network security products will depend upon a robust industry and infrastructure for providing access to public switched networks, such as the Internet. There can be no assurance that the infrastructure or complementary products necessary to make these networks into viable commercial marketplaces will be developed, or, if developed, that these networks will become viable commercial marketplaces. Rapid Technological Change The markets for the Company's products are characterized by rapidly changing technologies, extensive research and new product introductions. The Company believes that its future success will depend in part upon its ability to continue to enhance its existing products and to develop, manufacture and market new products. As a result, 12 the Company expects to continue to make a significant investment in engineering, research and development. There can be no assurance that the Company will be able to develop and introduce new products or enhancements to its existing products in a timely manner which satisfy customer needs, achieve market acceptance or address technological changes in its target markets. The failure of the Company to develop products and introduce them successfully and in a timely manner could adversely affect the Company's competitive position, financial condition and results of operations. Risks Associated with International Sales; Reliance Upon Local Partners; Restrictions on Export The Company plans to continue to expand its foreign sales channels and to enter additional international markets, both of which will require significant management attention and financial resources. International sales are subject to a number of risks, including unexpected changes in regulatory requirements, tariffs and other trade barriers, political and economic instability in foreign markets, difficulties in the staffing, management and integration of foreign operations, longer payment cycles, greater difficulty in collecting accounts receivable, currency fluctuations and potentially adverse tax consequences. Since most of the Company's foreign sales are denominated in U.S. dollars, the Company's products become less price competitive in countries in which local currencies decline in value relative to the U.S. dollar. The uncertainty of monetary exchange values has caused, and may in the future cause, some foreign customers to delay new orders or delay payment for existing orders. The long-term impact of such devaluation, including any possible effect on the business outlook in other developing countries, cannot be predicted. The Company's ability to compete successfully in foreign countries is dependent in part on the Company's ability to obtain and retain reliable and experienced in-country distributors and other strategic partners. The Company does not have long-term relationships with any of its value added resellers and distributors and, therefore, has no assurance of a continuing relationship within a given market. Due to U.S. government regulations restricting the export of cryptographic devices and software, including certain of the Company's network security products, the Company may be at a disadvantage in competing for international sales compared to companies located outside the United States that are not subject to such restrictions. Dependence on Component Availability, Subcontractor Performance and Key Suppliers The Company's ability to timely deliver its products is dependent upon the availability of quality components and subsystems used in these products. The Company depends in part upon subcontractors to manufacture, assemble and deliver certain items in a timely and satisfactory manner. The Company obtains certain components and subsystems from single, or a limited number of, sources. A significant interruption in the delivery of such items could have a material adverse effect on the Company's financial condition and results of operations. PART II. OTHER INFORMATION Item 1. Legal Proceedings On March 7, 1997, ten former employees of the Company filed suit in action No. CV764647 in the Superior Court of California, County of Santa Clara, against the Company, each of its Directors and its General Counsel, asserting claims for wrongful termination, fraud, libel, slander, age discrimination, invasion of privacy, and violation of the federal RICO statute. On July 11, 1997, an eleventh employee filed suit in action no. CV767448 in the Superior Court of California, County of Santa Clara, alleging similar claims against the Company and its Chief Executive Officer. The Company removed CV764647 to the Federal District Court for the Northern District of California and, after the Company obtained an order dismissing certain of the plaintiff's claims, including the claims of libel and RICO violations, the Court remanded the action back to the Santa Clara Superior Court. Following the remand, the Company then obtained an order consolidating CV764647 with CV767448 for purposes of discovery and trial. Both matters are currently in the discovery phase, with trial scheduled for December 1998. Although the Company has placed its insurers on notice of these claims, all of its insurers have reserved their rights and defenses under their policies, and the extent of the insurers' liability under their respective policies is undetermined. The Company believes the terminations were lawful, in the best interest of the Company, and intends to defend the matter vigorously. The defense of this matter may divert a material amount of management's attention and require the expenditure of significant legal fees and costs. An unfavorable outcome which exceeds the Company's insurance coverage, if any, could also result in a material adverse effect on the Company's financial condition. 13 Item 2. Changes in Securities (c) The Company's Registration Statement Form S-1 was declared effective by the Securities and Exchange Commission on February 15, 1996 (Reg. No. 33-80719). In February and March 1996 the Company issued 5,750,000 shares of its common stock to the public at a price of $15 per share. The Company received approximately $78.9 million net of underwriting discounts and commissions of $6.0 million and other offering expenses of $1.4 million. Through the period ended March 29, 1998, the net proceeds have been used as follows (in thousands): Purchase and installation of equipment $ 7,308 Acquisition of Algorithmic Research 45,913 Acquisition of preferrred stock of Syndata Technologies 3,000 Repayment of indebtedness 1,000 Working capital 15,843 Temporary investment in money market accounts 5,800 ------- $78,864 ======= None of the net proceeds or expenses of issuance and distribution of the securities have been, either directly or indirectly, paid to or invested with any related party or shareholder of the Company. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Index: Exhibit Number Description of Exhibit ------ ---------------------- 27.1 Financial Data Schedule (b) The Company filed a report on Form 8-K on April 13, 1998 reporting under Item 2 the disposition of the Company's Wireless Communications Group effective March 28, 1998. 14 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: May 13, 1998 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) 15 EX-27 2 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 3/29/97 CONDENSED CONSOLIDATED BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE THREE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 3-MOS DEC-31-1998 JAN-01-1998 MAR-26-1998 58,078 0 22,149 309 5,955 104,456 12,798 6,757 126,142 31,584 0 289 0 0 94,041 126,142 15,829 15,829 3,611 3,611 10,705 0 15 1,665 583 1,082 22,624 0 0 23,706 0.82 0.78
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