-----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, SNN9RVEuPePLj6qIujWVD7b9YKji3tImzRL2Wa8FQislMmWmbnvW6r2HdB1qJ5MN 8JIz3ep8cp1l17J8MKrTDw== 0000950005-97-000365.txt : 19970401 0000950005-97-000365.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950005-97-000365 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 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-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-27742 FILM NUMBER: 97568788 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-K405 1 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1996 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) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock 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 ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value of voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 14, 1997, as reported by the Nasdaq National Market, was approximately $103,661,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock, based on Schedule 13G filings, have been excluded from the computation in that such persons may be deemed to be affiliates. This determination of affiliate status is not a conclusive determination for other purposes. As of March 14, 1997, there were 25,755,468 shares of the Registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Parts of the Registrant's Proxy Statement for its Annual Meeting of Shareholders (the "Proxy Statement") to be held on May 22, 1997, are incorporated by reference in Part III of this Form 10-K to the extent stated herein. PART I The statements contained in this Report on Form 10-K 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 Corporation's ("Cylink" or the "Company") expectations, hopes, intentions, beliefs or strategies regarding the future. Forward looking statements include: the Company's statements in Part I, Item 1 "Business" regarding (i) its belief that solving network security issues will increase applications accessible through public networks, (ii) its strategies for continuing to be a leading provider of enterprise-wide information security products and to establish network security standards for the secure exchange of information, (iii) its belief that it has a competitive advantage, and that its AirLink products respond to a need, in the wireless communications market for spread spectrum radio products, and its strategy for its AirLink products providing last mile and data network solutions at ranges of up to 30 miles, (iv) its plans to develop domestic and international strategic marketing and product development relationships, (v) its expected research and development expenditures for the enhancement of the Company's existing products, including its Secure Enterprise Architecture Stack and AirLink products, and for the development and introduction of new products, and (vi) the Company's intention to expand foreign sales channels and enter additional international markets; the Company's statements in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding (i) the Company's expectation that it will more likely than not realize its net deferred tax assets based on future income in the next twelve months, and (ii) the sufficiency of the Company's existing liquidity and capital resources; and, management's belief that resolution of certain litigation described in Note 10 of the Notes to Consolidated Financial Statements contained in Item 8 "Financial Statements and Supplementary Data" will not have a material adverse effect on the Company's financial position. 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-K, 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 Item 1 "Business - The Cylink Strategy, - Information Security Products, - Research and Development, and - Risk Factors That May Affect Future Results," and other sections of this Report on Form 10-K. 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. ITEM 1. BUSINESS The Company supplies network information security products that enable the secure transmission and authentication of data over local area networks ("LANs"), wide area networks ("WANs") and public packet switched networks, such as the Internet. The Company's broad line of information security products provides an integrated solution that prevents unauthorized access or manipulation of information, enables secure electronic commerce over the Internet and allows mobile users to securely access corporate networks. Cylink further offers a line of spread spectrum radio products for wireless transmission of voice and data communications which operate in the unlicensed spread spectrum bands adopted by the U.S. Federal Communications Commission ("FCC") in 1985 and subsequently adopted in many other countries throughout the world. The Company's spread spectrum radio products focus primarily on the fixed location, outdoor, wireless communications infrastructure market. The Company was formed in 1984 as a partnership and subsequently incorporated in California in 1989. In February and March of 1996, the Company completed its initial public offering and its Common Stock began trading on the Nasdaq National Market under the symbol CYLK. Through the offering, the Company sold 5,750,000 shares of its Common Stock which generated approximately $79.3 million of cash, net of underwriting discounts, commissions and other offering costs. The Company operates in one industry segment -- secure communications products. The Company's operations outside of the United States consist primarily of a sales and service office in the United Kingdom, with smaller sales offices in several other countries. See Note 11 of the Notes to Consolidated Financial Statements for geographic area information. Industry Background The demand for information security and authentication of data in computer networks has increased significantly as a result of the shift from mainframe to distributed computing and the increasing use of shared public packet switched 2 networks, such as the Internet. The increased number of users that can now share computing resources and communicate with each other over LANs, WANs and public networks raises significant new access and security issues that are more difficult to address than in mainframe-based host systems. Over the last decade, the shift from mainframe to distributed computing has increased the level of electronic information transmission. The client/server environment enables information sharing and efficient communications that are increasingly seen as competitive advantages in business. In addition, the prevalence and ease-of-use of modem-based connections have broadened the definition of a LAN, enabling users in remote locations to access the central databases and applications on the LAN. However, as organizations increasingly rely on electronic transmission of data, their information becomes increasingly vulnerable. Individuals have been able to exploit system weaknesses to gain unauthorized access to networks, network transmissions and individual network computers, and have used such access to alter or steal data or, in some cases, to launch destructive attacks on data or computers within a network. Several well-publicized attacks have brought attention to certain attackers' techniques (given colorful names such as "packet spoofing," "password sniffing," "Trojan horse," and "session hijacking"). Until 1993, the primary means by which sensitive data was transmitted between distant points within a WAN was through private leased lines. Cost and other factors have led organizations to move away from these private leased lines to public networks, such as the Internet. Compared to private leased lines, public networks offer improved support at a significantly lower user charge due to economies of scale achieved through the larger number of users sharing the network. While providing these benefits, the use of public networks increases the need to ensure the security of information transmitted over these networks. In public networks, transmitted information is exposed to others, who can, in the absence of effective security measures, gain access to, manipulate and divert the transmitted data. Public networks enable connections among home personal computer ("PC") users, remote users and corporate networks. Much of the recent growth of the Internet has been attributed to an increase in commercial access providers and organizations seeking to market products or services to users. The Internet and other public networks are enabling increasing numbers of computer users to engage in electronic commerce, such as banking, trading securities, verifying credit and purchasing products and services. These increasing levels of electronic commerce place a premium on ensuring the integrity and security of information transmission. Complete information security solutions for LANs, WANs and public networks must perform each of the following five critical functions: o Access control -- Access to a computer network must be limited only to specific authorized users. o Privacy -- An authorized user must be prevented from viewing another party's private data. o Authentication -- The receiver of the transmitted information must be able to verify the identity of the sender. o Integrity -- The receiver and the sender must know that the transmitted data has not been changed or compromised by any unauthorized manipulation. o Non-repudiation -- Both the sender and receiver must be able to verify that a data transmission has been executed and cannot be later repudiated by either party. To date, a substantial portion of the demand for information security over public networks has been addressed by only partial solutions. "Firewall" products offer access control primarily by filtering incoming information based on packet addresses. Greater access control is possible with secret passwords of various types, including the use of time-varying and challenge-response password tokens. These tokens and access control systems generally provide some level of user authentication, but no privacy, integrity or non-repudiation. Many other encryption products provide privacy, but do not perform the other security functions, nor are they easily controlled or managed from one central location. The Company believes that the use of public networks for electronic commerce and other applications has been slowed to date by concern over network security and that solving security issues will increase the types of applications that can be accessed through public networks. The Cylink Solution Through its recently introduced products and those under development, Cylink offers information security products designed to provide a comprehensive system-wide information security solution that addresses the five critical functions of access control, privacy, authentication, integrity and non-repudiation in a scaleable, centrally-managed 3 system. The Company's products incorporate the latest commercially available security technologies, including Public Key cryptography-based digital signatures, certificates and key exchange techniques, which enable the Company to offer a broad, flexible and scaleable information security solution. The Company's information security products incorporate Cylink's Secure Enterprise Architecture Stack, an integrated group of software security modules that provide the foundation for an enterprise-wide information security solution. The Cylink Strategy The Company intends to maintain its position as a leading provider of enterprise-wide information security solutions and to establish standards for the secure exchange of information among users of LANs, WANs and public networks, such as the Internet. The Company seeks to achieve these goals through the following strategies: o Offer Comprehensive Enterprise-Wide Information Security Solutions. The Company's strategy is to offer a broad, centrally manageable and flexible line of information security products that provides a virtual private network from end node to end node. The Company's recently introduced products and those under development are designed to authenticate the user (not just the IP address) and prevent unauthorized access to a network system and information within that system. o Maintain and Leverage Technology Expertise in Public Key Cryptography. The Company plans to maintain its technology expertise in the application of Public Key cryptography through a combination of internal research and development efforts, government research and development contracts and customer funded research, and partnering with strategic vendors, focusing on technologies that are critical to the proliferation of electronic commerce over public switched networks. The Company's technological achievement has resulted in the use of Cylink's products by the U.S. Federal Reserve System and Society for Worldwide Interbank Financial Telecommunications ("S.W.I.F.T."), and the development of one of the first government approved key recovery architectures. In 1996, the Company had net research and development expenses of approximately $11.3 million. o Broaden Use of Public Key Technology through Licensing. The Company seeks to proliferate its specific methods of implementing Public Key technology by licensing certain of its core technical components and its Public Key cryptographic libraries to strategic partners. To encourage the use of Public Key cryptography, the Company has licensed the Stanford Patents (defined below) to over 30 companies, including Cisco Systems, Inc. ("Cisco"), 3Com Corporation, Hughes Aircraft Company, Intel Corporation, Microsoft Corporation, Motorola, Inc., Open Market, Inc., PictureTel Corporation, Scientific-Atlanta, Inc., Sun Microsystems, Inc. and Tandem Computers, Inc. The Company's technology licensing partnership with Cygnus Solutions, Inc. enables software developers to incorporate basic Cylink information security protocols and techniques into their software products. The Company's goal is to provide a migration path that enables vendors to upgrade their systems with certain base technology which is complementary with the Company's products. o Expand into Emerging Public Network Markets. The Company intends to leverage its expertise in providing solutions for virtual private networks by introducing new information security products for public network users. Demand for information security has historically been limited to business in security-conscious industries such as banking, telecommunications, aerospace and defense. However, with the increased use of the Internet and public networks, as well as remote access to LANs and WANs, network security is of increasing concern to most businesses and other organizations that use network-based information resources. o Build and Foster Strategic Relationships. The Company intends to continue to develop strategic marketing and product development relationships with key original equipment manufacturers ("OEMs") in order to further market acceptance of the Company's products. For example, the Company has licensed to Cisco certain of its software security module protocols under its OEM agreement to provide enhanced information security solutions for Cisco's customers. Note, however, that 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 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 techniques for attacking cryptographic systems could render some or all of the Company's existing and new products obsolete or unmarketable. To the extent that the Company is unable to adopt and incorporate emerging standards for implementing information security in a market segment, sales of the Company's existing and planned products in that market segment would be significantly less than the levels currently anticipated by the Company. There can be no assurance that 4 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. See "Business - Risk Factors That May Affect Future Results -- Competition, -- Evolving Information Security Market, and -- Rapid Technological Change." Technology The Company's information security products are based on Public Key cryptography techniques, which were first developed in 1976 at Stanford University by Drs. Diffie and Hellman. The Company has the exclusive right to sublicense certain patents that were granted to Stanford with respect to the original Public Key methods (the "Stanford Patents"). The Stanford Patents issued in the United States will expire in the third quarter of 1997. See "Business - Risk Factors That May Affect Future Results -- Intellectual Property and Other Proprietary Rights." The Public Key cryptography methods adopted by the Company require that each user be assigned both a private number, which is confidential, and a mathematically related public number, which can be revealed without compromising the user's private number. Diffie-Hellman key exchange provides for two users in a data network to exchange their public numbers and then compute a shared secret number that is unique to them. This shared secret number can then be used as the secret encryption key in a conventional encryption system to maintain the privacy of the communication between two users. The Company has adopted advanced Public Key digital signature methods. An individual's digital signature is a set of unique binary numbers, which is derived from a combination of the message and the signer's private number. Any user in the network can verify this digital signature by using only the sender's public number. Digital signature methods are part of the foundation for secure electronic transactions that can scale to potentially millions of users conducting commerce on the Internet. The Company's products enable network administrators to act as certificate authorities that permit each authorized user in the network to have his or her public number validated for the purpose of establishing its authenticity to other users. The certification authority provides each authorized user with an electronic message containing that user's name, public number, unique privileges within the network and expiration date. This message is digitally signed by the network administrator to create the user's certificate, which in effect serves to notarize the user's public number and enable that user to conduct secure communications with other certified users within the network. Certificates can also be issued by a public authority, such as that contemplated by the U.S. Postal Service's pilot program, to authenticate users of public networks such as the Internet. The Company has developed an integrated set of independent software modules on which the Company's information security products are based. This software incorporates Public Key cryptography techniques in its key management system, digital signatures and certificates to provide complete, scaleable enterprise-wide security solutions. This flexible architecture includes a certification authority and a network management system that enables the network administrator to create virtual private workgroups. The Company designs application specific integrated circuits ("ASICs") and custom integrated circuits to implement its encryption algorithms and Public Key techniques in order to provide increased performance, security and functionality in its products at reduced cost. Cylink's significant technical achievements in the area of proprietary ASIC design include encryption chips with speeds up to 155 megabits per second ("Mbps") and Public Key co-processor chips that have the capability of handling 1,024 bit numbers. Cylink has developed hardware and software implementations of network interfaces, standards and protocols. Cylink information security products are designed to secure existing networks without reducing performance or requiring modifications of existing network hardware or software. The Company has developed a broad range of network interfaces for its products, which enables the Company's security products to connect to most networks in use today throughout the world. The current list of network interfaces used in Company products include: T1 (1.5 Mbps), T2 (6.2 Mbps), T3 (45 Mbps), E1 (2 Mbps), E3 (34 Mbps), X.25, V.35, X.21, Frame Relay (FRF.1, FRF.3 and FRF.4), NTT T1 (Japan), 10 Base 2, 10 Base 5, 10 Base T, HSSI, RS-232 and RS-422. Information Security Products Cylink originally entered the information security market in 1986 with hardware-based link encryptors to secure transmissions between users in WANs that were communicating over private, leased communication lines. These original products formed the foundation for Cylink's SecureWAN product line, which is a family of encryption products that 5 provide security solutions for WANs operated by government agencies, financial institutions, Fortune 1000 companies and telecommunications companies. In response to the movement of WAN users to public networks, Cylink has developed packet encryptors that enable secure transmission of packets of data between two points in X.25 and Frame Relay based public networks. Because of the proliferation of LANs, the Company developed its SecureLAN product line to manage, control and monitor information within a LAN. Cylink also developed its SecureAccess product line to allow remote and mobile users secure access to their corporate computing resources. The Company's products are designed to be modular, scaleable, configurable and easy to use. Customers can easily configure and upgrade their Cylink security systems through the purchase of Cylink products that meet their specific, evolving information security needs. Most of the Company's recently introduced products are based upon the Company's Secure Enterprise Architecture Stack and are designed to be managed as an integrated, interoperable security system by the Company's SecureManager products. The following table sets forth Cylink's principal information security products currently offered or under development: Year Product Description Introduced ------- ----------- ---------- SecureWAN Family CIDEC-HS High Speed T1 Link Encryption 1986 CIDEC-MS Medium Speed Link Encryption 1987 CIDEC-LS Low Speed Link Encryption 1987 CIDEC-VHS Very High Speed T3 Encryption 1990 CIDEC-MLS Integrated Link Cards 1993 SecureX25L Low Speed X.25 Packet Encryption 1993 SecureX25H High Speed X.25 Packet Encryption 1994 SecureFrame Frame Relay Packet Encryption 1996 SecureLAN Family SecureDomain Router Domain Packet Encryption/Access 1996 SecureNode Software PC Packet Encryption/Access * SecureNode Card Accelerator Card for SecureNode Software * SecureAccess Family SecurePhone Telephone Encryption 1989 SecureFX Group 3 Fax Encryption 1990 SecureGate Server Software for SecureAccess Family 1996 SecureTraveler Windows Software Encryption/Access 1997 SecurePocket Traveler Stand Alone Encryption/Access 1997 Trust Point Data Mail and File Encryption * SecureManager CSMS SecureX25 Network Management 1994 SecureManager Manages all SecureLAN Products 1996 - ---------- * Indicates products under development and scheduled for introduction in 1997. SecureWAN Product Family. The Company's SecureWAN product family is a complete line of link encryptors that utilize Diffie-Hellman key management techniques to support conventional encryption algorithms, such as the data encryption standard ("DES") and Cylink proprietary algorithms. Depending on the product model, the SecureWAN encryptors operate at varying data rates over private and public networks and support most widely used data link protocols. The Company's original CIDEC line of data and voice encryption products offers full encryption and access control and is available in a number of models that range from high speed T1 and T3 data transfer rates (1.54 Mbps and 45 Mbps, respectively) to low speed transfer rates (1200 bits per second to 256 kilobits per second ("kbps")). The Company believes that its CIDEC-VHS/VHX products are the fastest data link encryptors commercially available in the world today. 6 Cylink's high speed SecureX25H and low speed SecureX25L offer encryption for public switched packet networks based on X.25 packet transmission technology and support data rates up to 64 kbps and up to 512 virtual circuits. Cylink's SecureFrame product is designed to operate as a dedicated Frame Relay encryptor capable of operations on any public or private Frame Relay-based network. The SecureFrame is designed to support data rates of up to 2.048 Mbps and up to 1,024 user addresses. SecureLAN Product Family. The Company's SecureLAN product family is designed to provide packet-based security solutions for both private and public networks. The Company's SecureLAN products are designed to allow a customer to create and control access to groups within the network, known as virtual private workgroups. For example, a customer could segregate within a network certain departments, such as human resources and finance, denying employees from other departments access to files within the virtual private workgroup. Further, within a virtual private workgroup, the Company's SecureLAN products are designed to allow certain users, such as the director of human resources, greater access to files than other users. The SecureDomain product is a hardware device that resides between the router and subnet in a LAN. The SecureDomain product supports simultaneous secured TCP/IP and IPX communications among networks and subnets. The SecureDomain product is designed to allow organizations to use the Internet as part of their own secure virtual private network. Under the Company's existing licensing relationship with Cisco, Cisco is authorized to embed the SecureDomain software product in its router products as part of Cisco's IOS operating system. Cylink's SecureNode products are under development and are being designed to extend the functionality of SecureDomain to the desktop level and enable encryption at substantially faster speeds than are currently available from software-only solutions. SecureAccess Product Family. Addressing the need for secure remote access to private networks, the Company's SecureAccess product line is designed to enable secure dial-up access to a corporation's LAN or WAN. The SecureAccess products can be combined to create an access control solution that provides the network administrator with the five critical functions of network security for a virtual private network over public switched telephone networks ("PSTNs") and the Internet. The SecureAccess product line is scaleable to accommodate thousands of users and, among other applications, can enable electronic commerce over the Internet. The SecureGate Server, which physically resides between the customer's communications server and modems, can monitor and protect corporate information resources by controlling incoming and outgoing calls to and from the network. SecureGate provides centralized management and tracking of remote users and their individual security profiles, with audit trails of all system activities. SecureGate also acts as the certificate authority for the SecureAccess system. SecureTraveler for Windows is a PC-based software security client for SecureGate and responds to customers' needs to share critical information over PSTNs and the Internet. SecureTraveler is designed to operate transparently with Windows communications applications to secure end-to-end sessions in their entirety. SecurePocket Traveler is a pocket-sized, hardware security device that is inserted between a laptop PC, desktop PC or other computer device and a modem and provides security functions similar to those provided by SecureTraveler for Windows. SecureManager. The SecureManager is designed to allow the network administrator to centrally manage the security features of a secured network, subnet, host and node within a LAN, to create or dissolve secure workgroups and to monitor the performance of other Cylink products within the network. SecureManager enables the network administrator to configure, manage, install and modify all information security within a LAN or WAN from one point in the network. The Company's future results of operations will be highly dependent on the successful marketing and customer acceptance of the SecureFrame, SecureManager, SecureGate, SecureTraveler, SecurePocket Traveler and SecureDomain products, which were recently introduced. To date, the Company has made only modest commercial shipments of certain of such products and no commercial shipments of the remainder of such products. No assurance can be given that these products will not require additional development work, enhancement, testing or further refinement before they can be 7 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. See "Business - Risk Factors That May Affect Future Results -- Dependence on Recently Introduced and New Information Security Products, and -- Product Liability Risks." Sales, Marketing and Customer Support Cylink markets its information security products primarily through its direct sales force and, to a lesser extent, through distributors and OEMs. The Company's direct sales force operates from the Company's headquarters in Sunnyvale, California and from four sales offices, and directs its efforts primarily at government agencies, financial institutions, Fortune 1000 companies and telecommunication carriers. Cylink's sales force, engineers and technical personnel work closely with customers in order to design system security and network configurations that are tailored to the customers' needs. International sales of information security products are made primarily through the Company's six foreign sales offices and numerous distributors. The Company does not have long-term contractual relationships with any of its distributors and, therefore, has no assurance of a continuing relationship within a given market. To date, the customers of the Company's information security products have primarily consisted of Fortune 1000 companies, financial institutions, government agencies and telecommunication carriers who use the Company's SecureWAN products to encrypt and secure their private leased line WANs. From inception through December 31, 1996, the Company sold over $125 million of information security products in the U.S. and abroad. Demand for computer and network security has historically been limited to businesses in security-conscious industries such as banking, telecommunications, aerospace and defense. However, with the increased use of WANs, public networks and remote access to LANs and WANs, network security is of increasing concern to most businesses and other organizations that use computer- or network-based information resources. A representative list of the end users of the Company's information security products is set forth below:
Fortune 1000 Financial Government Telecommunications Companies Institutions Agencies Carriers - --------- ------------ -------- -------- Caterpillar Bank of America Department of Defense AT&T Computer Sciences Corp. Bank of China Department of Justice Bell Atlantic IBM Bankers Trust Department of Treasury MCI Communications Lockeed Martin Citibank Federal Reserve Bank Pacific Bell Motorola Credit Suisse Internal Revenue Service U.S. Sprint Lloyds Bank U.S. Postal Service S.W.I.F.T. Swiss Bank
The Company believes that customer support is essential to developing and maintaining good relationships with its customers. Cylink's support personnel are responsible for providing installation, technical training, technical support, on-site support and repair services. The Company sells end users a number of different levels of support, maintenance and service options, including extended warranties, emergency replacement services, product upgrades and on-site support. The company offers service and support from its headquarters and from service and support centers in New Jersey, the United Kingdom, Singapore, China and Russia. Telephone support is available twenty-four hours per day, seven days per week, through a toll-free hotline. Wireless Communications Product Line Cylink offers a line of spread spectrum radio products that are used for wireless transmission of voice and data communications which operate in the unlicensed spread spectrum bands adopted by the FCC in 1985 and subsequently adopted in many other countries throughout the world. In 1990, the Company began to focus on the growing market for 8 wireless communications, particularly that section of the wireless market that cannot be addressed by conventional wireless cellular solutions. During 1994, 1995 and 1996, sales of AirLink products accounted for approximately 32%, 38% and 50%, respectively, of the Company's revenue. A large portion of the demand for wireless communications products comes from developing countries where the absence of a reliable wired telecommunications infrastructure provides a significant opportunity for a wireless spread spectrum based solution to respond to the growing need for modern data communications capabilities. The Company's AirLink product line was first introduced in 1991 and has two primary applications. The first application is to provide telephone connectivity to remote locations where the limited number of users does not justify the cost of a cellular station or wired communications link. AirLink is capable of providing point-to-point communications over distances up to thirty miles. The second application is to provide a data transmission network in locations, such as developing countries, where wired telecommunications infrastructure is either unreliable or nonexistent. Cellular phone systems are designed for voice communications, and are believed by Cylink's customers to be too expensive for, and do not support sufficiently fast data transfer rates for, data communications. In addressing these two markets, the Company has positioned its AirLink product line between the full featured, point-to-point, very high speed microwave radio links and the high volume, low power spread spectrum wireless devices. The Company believes that its AirLink product line responds to a market need that exists between these two ends of the marketplace for a cost effective, ruggedized, outdoor wireless product offering that is capable of transmitting at medium data rates between 19.2 kbps and 2 Mbps. The Company offers over 20 different models of its AirLink products to specifically address a wide range of individual customer needs within this market segment. The Company's strategy for its AirLink product line is to provide last mile and data network solutions at ranges of up to 30 miles and to continue to seek feature improvements and cost reductions to enhance and maintain its position within this market segment. The Company intends to maintain its strong technical position in the wireless communications market through continued improvement of its radio frequency designs, ASIC modem chips and software modules. The following table lists the Company's current wireless communication product lines:
Year Product Description Frequency Band Introduced ------- ----------- -------------- ---------- AirLink Modem Family AirLink L-Band Data Rate: 19.2 kbps to 256 kbps 902-928 MHz 1992 Extended Temperature Operation AirLink S-Band Data Rate: 19.2 kbps to 512 kbps 2.400-2.483 GHz 1993 Meets ETSI (European) Standard AirLink VF Single Channel Voice Link 902-928 MHz 1992 AirLink Bridge Wireless Ethernet Bridge Link 2.400-2.483 GHz 1995 AirLink Data Metro Wireless Remote Access Router 2.400-2.483 GHz * AirLink Pro 64 64 kbps WAN Solution with 2.400-2.483 GHz * Network Management AirLink T1/E1 Family AirLink T1 Data Rate: 1.544 Mbps (US T1) 5.725-5.850 GHz 1995 AirLink E1 Data Rate: 2.048 Mbps (European E1) 5.725-5.850 GHz 1995 AirLink T1/E1 Pro Wireless T1/E1 with Advanced 5.725-5.850GHz * Network Management - ---------- * Indicates products under development and scheduled for introduction in 1997.
The AirLink L-Band and S-Band offer varying data rates for point-to-point communications solutions for fixed location, last mile wireless networking. The AirLink VF product is used primarily for point-to-point voice communications in last mile applications. The AirLink Bridge is a full function ethernet LAN bridge that enables a customer to establish a wireless link between separate LANs within a fifteen mile radius. The AirLink T1 and E1 products offer data transfer rates at T1 rates for the United States and E1 rates for Europe, and represent the Company's fastest and most advanced products for wireless data transmission. 9 The Company believes that it has certain core technical competencies in spread spectrum signal processing that have enabled its AirLink product line to be high performance, cost-effective solutions for its targeted applications. The Company has developed certain radio frequency ("RF") and microwave circuit designs that provide high sensitivity to weak signals while retaining the ability to reject out-of-band interference. The AirLink product line has been approved for use by over 30 foreign governments. All Cylink wireless products are based on proprietary, custom integrated circuits that permit low power operation, are cost-effective and easy to manufacture. The Company has further developed a number of wireless architecture features and algorithms and holds five U.S. patents for such features as spread spectrum correlation design, multi-user detection schemes and spread spectrum modulation and demodulation designs. The Company believes that this combination of proprietary technologies and experience in spread spectrum radio have given it a competitive advantage with respect to the breadth of data rates covered, network manageability, transmission range and ease of use. The Company directs its wireless sales and marketing efforts primarily at countries that do not have a reliable wired telecommunications infrastructure. These sales are made primarily through value added resellers ("VARs") and distributors and, to a lesser extent, directly by Cylink in certain targeted applications. Cylink intends to pursue strategic alliances with both international and domestic system integrators and other partners that would integrate AirLink products into their last mile solutions for voice and data networks. Cylink believes that this strategy will be particularly significant in developing countries where alliances with local partners can provide better access to and knowledge of these local markets. International customers for the AirLink products include Dole Fruit & Nut Co. (Central America), Pakistan Telecommunications Corp., Unicom (China), IUSAC (Mexico), Banco Popular (Puerto Rico), the post office for the Czech Republic and Chase Manhattan Bank. United States end users of AirLink products include AT&T Corp. ("AT&T"), Southwestern Bell, Cellular One, the U.S. State Department, Lockeed Martin Corporation, the U.S. Department of Energy, AirTouch Cellular, GTE MobilNet, Peek Traffic/Transyt and McCain Traffic Supply. Research and Development The Company's research and development efforts are focused on developing new products, core technologies and enhancements to existing products. For its information security products, the Company's research and development strategy has in recent periods focused on the development of modular software and hardware products that can be readily integrated and adapted to the changing standards and requirements of the communications and internetworking industries. A focus of the Company's research and development efforts in 1996 has been the development of the SecureLAN, SecureAccess and SecureManager product families. The Company expects that it will continue to devote substantial research and development resources to the enhancement of its Secure Enterprise Architecture Stack software modules for the foreseeable future. The Company's research and development efforts for its AirLink product line are focused on strengthening its position in the fixed location, outdoor, wireless communications infrastructure market. The Company's principal 1996 development effort for its AirLink products was the development and introduction of a new AirLink T1/E1 wireless system, which the Company expects will be a primary focus of its continuing product enhancement and cost reduction efforts. The Company also expects to continue development of its custom ASIC wireless components, which provide the core for the AirLink product line. In 1994, 1995 and 1996, the Company's gross research and development expenses were $8.8 million, $11.3 million and $17.4 million, respectively. From time to time, the Company receives engineering funding for development projects to apply or enhance the Company's technology to a particular customer's need. The amount recognized under these research and development contracts are offset against research and development expense. Amounts recognized under non-recurring engineering contracts totaled $0.7 million, $1.1 million and $6.1 million in 1994, 1995 and 1996, respectively. The Company believes that its ability to attract and retain qualified development personnel is essential to the success of its development programs. The market for such personnel is highly competitive and the Company's development activities could be adversely affected if the Company is unsuccessful in attracting and retaining skilled technical personnel. See "Business - Risk Factors That May Affect Future Results -- Dependence on Key Personnel, and --Management of Growth." In addition, 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 and introduce 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 10 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 in a timely manner could adversely affect the Company's competitive position, financial condition and results of operations. See "Business - Risk Factors That May Affect Future Results -- Competition, -- Dependence on Recently Introduced and New Information Security Products, -- Evolving Information Security Market, -- Rapid Technological Change, and -- Wireless Communications Industry Regulatory Environment." Regulatory Matters The Company's information security products are subject to the export restrictions recently transferred to administration by the U.S. Department of Commerce, which license the export of encryption products subject to certain technical restrictions. In addition, these U.S. export laws prohibit the export of encryption products to a number of hostile countries. Although to date the Company has been able to secure all U.S. export licenses routinely, there can be no assurance that the Company will continue to be able to secure such licenses in a timely manner in the future, or at all. In certain foreign countries, the Company's distributors are required to secure licenses or formal permission before encryption products can be imported. To date, except for certain limited cases, the Company's distributors have not been denied permission to import the Company's products. See "Business - Risk Factors That May Affect Future Results - -- Risks Associated with International Sales; Reliance Upon Local Partners; Restrictions on Export." The Company's wireless products are subject to regulations of the FCC and regulations of the telecommunications regulatory authority in each country where the Company sells its products. These regulations are in the form of general approval to sell products within a given country for operation in a given frequency band, one time equipment certification, and, at times, local approval for installation. In the United States, all Cylink wireless products are subject to FCC Part 15 rules on unlicensed spread spectrum operation. In the international markets, government regulations vary. In those countries that have accepted certain worldwide standards, such as the FCC rulings or those from the European Telecommunications Standards Institute, Cylink has not experienced significant regulatory issues in bringing its products to market. Approval in these markets involves retaining local testing agencies to verify specific product compliance. However, many developing countries, including the large markets in India and China, have not fully developed or have no frequency allocation, equipment certification or telecommunications regulatory standards. In these markets, Cylink is actively working, both directly and with industry standard bodies, to conform regulations to worldwide standards. See "Business - Risk Factors That May Affect Future Results -- Wireless Communications Industry Regulatory Environment." Backlog Orders for the Company's products are usually placed by customers on an as-needed basis and the Company has typically been able to ship products within thirty days after the customer submits a firm purchase order. The Company's backlog consists of all orders received, regardless of the anticipated shipping date. Because of the possibility of customer changes in delivery schedules or cancellation of orders, the Company's backlog as of any particular date may not be indicative of sales in any future period. The Company does not generally maintain long-term contracts with its customers that require customers to purchase the Company's products. The Company's backlog as of December 31, 1995 and 1996 was approximately $5.1 million and $6.9 million, respectively. See "Business - Risk Factors That May Affect Future Results -- Lengthy Sales Cycle." Manufacturing The Company's manufacturing operations consist primarily of component procurement, final assembly and test, and quality control of subassemblies and systems. The Company generally uses domestic independent contractors to manufacture and assemble printed circuit boards. The manufacturing process enables the Company to configure the hardware and software in combinations to meet a wide variety of customer requirements. The Company installs its software into the electronically programmable read only memory of its products to maintain quality control and security, and performs "burn-in" procedures and functional tests, as well as comprehensive inspections to assure the quality and reliability of its products. The Company's product designs are proprietary but generally incorporate industry-standard hardware components. However, certain semiconductor devices, electronic components and subassemblies are presently purchased from sole source suppliers. Certain other components are presently available or acquired from only a limited number of suppliers. 11 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. A significant interruption in the delivery of such items could have a material adverse effect on the Company's results of operations. See "Business - Risk Factors That May Affect Future Results -- Dependence on Component Availability, Subcontractor Performance and Key Suppliers." Employees As of December 31, 1996, the Company had 347 employees, of whom 119 were primarily engaged in research and development, 98 in sales, marketing and related customer support services, 26 in administration and 104 in manufacturing. Of these employees, 326 were located in the United States, 15 in Europe and 6 in Asia. None of the Company's employees is represented by a collective bargaining agreement with respect to his or her employment by the Company, nor has the Company experienced any organized work stoppage. The Company considers its relations with its existing employees to be good. 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. Pending Litigation See Item 3. "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 ("CEO"). Mr. Sarrat, 45, succeeds Lewis C. Morris, 64, who resigned in July, 1996. Dr. Jim Omura, Chief Technology Officer, had been serving as acting CEO. At this time, the Company is unable to assess the potential impact resulting from the retirement of Mr. Morris, a co-founder of the Company, and the transition to Mr. Sarrat as new CEO. The Company's future success will depend to a large extent on the abilities of and successful transition to Mr. Sarrat as the new CEO, as well as the contributions by its executive officers, key management and technical personnel. The failure to successfully integrate Mr. Sarrat into the Company, 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 business and operating results. 12 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 is 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 and SecureNode products, some of which are under development, and the SecureGate, SecureTraveler, SecurePocket Traveler, SecureFrame and SecureDomain products, which were recently introduced. To date, the Company has made only limited commercial shipments of certain of such products and no commercial shipments of the remainder of such products. No assurance can be given that any of such products will not require additional development work, enhancement, testing or further refinement before they can be introduced and made commercially available by the Company or that they will achieve market 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 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 information security. RSA Data Security, Inc., a subsidiary of Security Dynamics, ("RSA DSI") licenses 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 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. 13 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 product designs and has one additional U.S. patent application pending. The Company also has the exclusive right to sublicense 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 14 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. 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 FCC. Current FCC regulations permit license-free operation of certain FCC certified wireless products. The future of remote 15 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% and 59% of revenue in 1994, 1995 and 1996, 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 ("VARs") 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 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. ITEM 2. PROPERTIES The Company's headquarters occupies 86,000 square feet in Sunnyvale, California, the lease for which expires in June 1999. During the second quarter of 1996, the Company signed a five-year lease agreement for approximately 35,000 square feet of office and manufacturing space, also in Sunnyvale. Substantially all manufacturing activities have been moved to this site. The Company leases facilities for sales offices in New Jersey, Virginia, United Kingdom, Singapore, China, India and Pakistan. The Company believes that its current facilities are well maintained and are adequate for the 16 foreseeable future and that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. ITEM 3. LEGAL PROCEEDINGS On September 6, 1995, the Company obtained an arbitration award dissolving a former partnership, known as Public Key Partners ("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. Although the Company has placed its insurers on notice of these claims, none of them have admitted coverage. 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, may also result in a material adverse effect on the Company's financial condition. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders, through solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information concerning the executive officers of the Company as of December 31, 1996: Name Age Position - ---- --- -------- Fernand Sarrat 45 Director, Chief Executive Officer and President Jimmy K. Omura 56 Director and Chief Technical Officer John H. Daws 53 Vice President and Chief Financial Officer Robert B. Fougner 44 Secretary and General Counsel Steven Goldberg 43 Vice President and General Manager of the Wireless Communications Division Sarah L. Engel 53 Vice President, Human Resources and Organizational Development John Kalb 49 Vice President, Business Development Les Nightingill 46 Vice President, Special Projects Peter J. Slocum 41 Vice President, Engineering 17 Mr. Sarrat joined the Company as Chief Executive Officer and President in November 1996. Prior to joining the Company, Mr. Sarrat was with IBM Corporation for over 20 years, most recently as General Manager of Networking Computing Marketing & Services, and held such other positions as General Manager of the Networked Application Services Division, the Assistant General Manager of Marketing and Business Development, and General Manager of Marketing & Services in the Midwest. Dr. Omura co-founded the Company in 1984 and served as both Chairman of the Board and Vice President, Research and Development, from 1984 until December 1995. Dr. Omura is currently the Company's Chief Technical Officer and, during the period from June until November, 1996, Dr. Omura also served as the Company's acting Chief Executive Officer. Mr. Daws joined the Company as Vice President and Chief Financial Officer in September 1995. From April 1992 to August 1995, he was Vice President and Chief Financial Officer of Crosspoint Solutions, Inc., a software and semiconductor company, and from June 1988 to December 1991 he was Vice President, Finance of Rolm Computer Corporation, a software and computer company and a subsidiary of Loral Corporation. Mr. Fougner has been Secretary and General Counsel since joining the Company in December 1989. Prior to joining the Company, he was a partner in the New York law firm of Hill, Betts & Nash. Dr. Goldberg joined the Company as Vice President and General Manager of the Wireless Communications Division in March 1995. From September 1991 to March 1995, he served as Manager of the Communications Systems Group of Trimble Navigation Limited, a manufacturer of global positioning systems, and from September 1988 to September 1991, he served as a Senior Engineer at Applied Signal Technology, Inc., a manufacturer of signal processing equipment. Ms. Engel joined the Company in February 1997. Before joining the Company she was an independent consultant specializing in strategic planning, human resources and organizational development with such clients as Ford Motor Company, The Coca-Cola Company, Exxon Corporation and Harcourt General, Inc., among others. Mr. Kalb joined the Company in January 1997. Prior to joining the Company, he was with IBM Corporation for over 25 years, most recently as Vice President of Electronic Commerce, Internet Division, responsible for marketing, software development and operations relating to IBM's offerings for enabling commerce over the Internet. Mr. Nightingill joined the Company in November 1995 and, in the capacity of Director, and later Vice President of Engineering, headed development of the Company's link, voice, and fax encryption products as well as the Company's CSU and access multiplexer communication products. Prior to joining the Company, he held engineering positions at TRW Vidar, GTE Lenkurt Fiber Optics Communications Division, and California Microwave's TXR subsidiary. Mr. Slocum joined the Company in February 1997. From July 1993 to February 1997 he served as Vice President of Engineering for Octel Communications Corporation, a provider of voice messaging systems and services. Mr. Slocum served as Director of Engineering for Silicon Graphics, Inc., a computing systems company, from July 1992 to July 1993 and MIPS Computer Systems, Inc. (merged with Silicon Graphics, Inc. in July 1992) from August 1990 to July 1992. 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been traded in the over-the-counter market under the symbol CYLK since the Company's initial public offering on February 15, 1996. The following table sets forth the high and low closing prices as reported on the Nasdaq National Market during the last fiscal year: First Second Third Fourth Fiscal 1996 Quarter Quarter Quarter Quarter - ----------- ------- ------- ------- ------- High 26 1/4 23 1/2 17 1/2 15 1/16 Low 17 17 9 13/16 10 15/16 As of March 14, 1997, the Company had approximately 144 shareholders of record. The Company has never declared or paid dividends on its capital stock. The Company currently intends to reinvest its earnings in the development of its business and does not intend to pay dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA The following selected financial information has been derived from the Company's audited consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations and is qualified by reference to and should be read in conjunction with the consolidated financial statements and related notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
Year ended December 31, -------------------------------------------------------------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- (in thousands, except per share data) Revenue $ 51,958 $ 34,902 $ 26,646 $ 26,294 $ 17,209 Research and development expense, net 11,342 10,185 8,117 5,508 5,114 Net income (loss) 1,197 (1,079) (700) 1,901 932 Net income (loss) per share $ 0.05 $ (0.06) $ (0.04) $ 0.10 $ 0.05 Shares used to compute net income (loss) per share 25,761 19,572 19,351 19,901 19,255 As of December 31, -------------------------------------------------------------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- (in thousands) Cash, cash equivalents and short-term investments $ 78,849 $ 6,098 $ 6,626 $ 7,193 $ 5,819 Working capital 93,518 12,604 12,042 14,057 11,357 Total assets 107,088 22,725 20,663 19,777 15,795 Long-term obligations 241 291 -- -- -- Shareholders' equity $ 97,211 $ 14,605 $ 14,149 $ 15,481 $ 13,561
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth certain consolidated statement of operations data as a percentage of revenue for the periods indicated: Year ended December 31, -------------------------------- 1996 1995 1994 ---- ---- ---- Revenue 100.0% 100.0% 100.0% Cost of revenue 41.9 39.6 39.3 ------ ------ ------ Gross profit 58.1 60.4 60.7 ------ ------ ------ Operating expenses: Research and development, net 21.8 29.2 30.5 Selling and marketing 26.6 27.4 24.5 General and administrative 11.9 14.4 15.3 Employee severance costs 1.2 -- -- ------ ------ ------ Total operating expenses 61.5 71.0 70.3 ------ ------ ------ Income (loss) from operations (3.4) (10.6) (9.6) Other income, net 6.2 5.3 5.2 ------- ------- ------- Income (loss) before income taxes 2.8 (5.3) (4.4) Provision (benefit) for income taxes 0.5 (2.2) (1.7) ------- ------- ------- Net income (loss) 2.3% (3.1)% (2.7)% ======= ======= ======= The following table sets forth certain information regarding the Company's information security products and wireless communications products: Year ended December 31, ----------------------------- 1996 1995 1994 ---- ---- ---- (dollars in thousands) Information security product revenue $25,793 $21,534 $18,008 Information security product gross margin 62% 67% 66% Wireless communications product revenue $26,165 13,368 8,638 Wireless communications product gross margin 54% 49% 50% Revenue. The Company's revenue increased 49% from $34.9 million in 1995 to $52.0 million in 1996. Sales of information security products and wireless communications products increased by 20% and 96%, respectively, from 1995 to 1996. The increased revenue from information security products was primarily due to increased unit sales of the Company's Secure WAN, LAN and Access encryption product line, which are used in public and private linked networks. Unit sales of the Company's older CIDEC encryption product line were essentially flat in comparison with 1995. The increased revenue from wireless communications products was primarily a result of significantly increased shipments in international markets. The Company's revenue increased 31% from $26.6 million in 1994 to $34.9 million in 1995. Sales of information security products and wireless communications products increased by 20% and 55%, respectively, from 1994 to 1995. These increases were primarily due to higher unit sales of the Company's existing products. 20 International product revenue was 35%, 47% and 59% of revenue for 1994, 1995 and 1996, respectively. International product revenue as a percentage of total revenue increased for both information security and wireless communications products in 1995 and 1996, but the overall increase was primarily due to increased unit sales of wireless communications products. Gross Profit. Gross profit increased 43% from $21.1 million in 1995 to $30.2 million in 1996, but decreased slightly as a percentage of sales from 60% to 58%. As a percentage of revenue, gross profit was negatively affected by increased sales of wireless communications products, which generally have a lower gross margin than information security products. Further, gross margin on information security products declined as some of the new products have lower gross margins than the Company's older CIDEC encryption products and these new products represented an increased percentage of revenue. This decrease in gross margin was partially offset by an overall increase in wireless communication product gross margins due to increased average selling prices and reduced unit costs. Gross profit increased 31% from $16.2 million in 1994 to $21.1 million in 1995 primarily due to increased unit volume. As a percentage of revenue, gross profit decreased marginally from 1994 to 1995 due to increased sales of wireless communications 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 28% from $8.8 million in 1994 to $11.3 million in 1995 and 54% to $17.4 million in 1996. From time to time, the Company receives engineering funding for development 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 expense. Amounts recognized under non-recurring engineering contracts totaled $0.7 million, $1.1 million and $6.1 million in 1994, 1995 and 1996, respectively. Selling and Marketing. Selling and marketing expenses consist primarily of personnel costs, including sales commissions, and costs of advertising, public relations, seminars and trade shows. Selling and marketing expenses increased 47% from $6.5 million in 1994 to $9.6 million in 1995 and 44% to $13.8 million in 1996. The increases were primarily due to expenses associated with expansion of the Company's direct sales force, personnel increases in the marketing group, and increased costs 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 23% from $4.1 million in 1994 to $5.0 million in 1995 and 23% to $6.2 million in 1996. General and administrative expense as a percentage of revenue was 15%, 14% and 12% for 1994, 1995 and 1996, respectively. The dollar increases in 1995 and 1996 are 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. The decreases as a percentage of revenue in 1995 and 1996 were primarily due to general and administrative expenses allocated over a larger revenue base. Employee Severance Costs. During the fourth quarter of 1996, the Company recorded a $634,000 one-time charge related to the reorganization and replacement of several senior management positions. Other Income (Expense), Net. Other income (expense), net primarily consists of royalties, interest income and interest expense. Other income increased 33% from $1.4 million in 1994 to $1.9 million in 1995 and 73% to $3.2 million in 1996. The increase in 1995 was primarily due to an increase in royalty income partially offset by a decrease in interest and other income. Royalty income in 1994 and 1995 included royalty payments from two licensees of the Company's wireless ASIC products for cordless telephones. The increase in other income for 1996 was principally due to an increase in interest income resulting from funds derived from the Company's initial public offering in February and March 1996. The Company sustained a decrease in royalty income in 1996 from the aforementioned licensees. Additionally, the Company sold marketable securities at a loss of $432,000 in 1996. Provision (Benefit) for Income Taxes. The provision (benefit) for income taxes as a percentage of income (loss) before taxes was a benefit of 39% in 1994, a benefit of 41% in 1995 and a provision of 17% in 1996. Net deferred tax assets of $1.4 million at December 31, 1996, were based both on the Company's carryback capacity and management's determination that the Company will more likely than not realize such assets based on expected future income in the next 21 twelve months. However, there can be no assurance that the Company will be profitable in future periods. See Item I "Business - Risk Factors That May Affect Future Results -- Recent Losses; Potential Fluctuations in Operating Results, Future Operating Results Uncertain." The Company's effective tax rate for 1997 is expected to increase to approximately the federal statutory rate. Net income (loss). The Company had losses of $700,000 in 1994 and $1.1 million in 1995, and net income of $1.2 million in 1996. In 1994, the Company began a strategic research and development program designed to create new products and enhance existing products. While revenue increased in 1995, the Company incurred a net loss due to continued high levels of research and development expenses related to the Company's strategic research and development project. In 1996, increased gross profit resulting from newer information security products and international sales of wireless communications products was largely offset by higher spending for research and development, net, and selling and marketing resulting in a loss from operations. LIQUIDITY AND CAPITAL RESOURCES In February and March 1996, the Company completed its initial public offering and its Common Stock began trading on the Nasdaq National Market under the symbol CYLK. Through the offering the Company sold 5,750,000 shares of its Common Stock which generated approximately $79.3 million in cash, net of underwriting discounts, commissions and other offering costs. As of December 31, 1996, the Company had $78.8 million in cash and cash equivalents. Cash provided by operating activities in 1994 consisted primarily of a decrease in accounts receivable and increases in accrued liabilities and deferred revenue, offset in part by a net loss and an increase in inventories. Cash used in operating activities for 1995 was principally a result of a net loss and increased inventory and accounts receivable to support increased revenue, which were offset only in part by increases in accounts payable and accrued liabilities. Cash used in operating activities in 1996 was principally a result of increased inventory and accounts receivable to support increased revenue, which was offset in part by net income and increases in accounts payable and accrued liabilities. The Company made capital expenditures of approximately $1.2 million, $614,000 and $2.8 million in 1994, 1995 and 1996, respectively. Additionally, in 1995 and 1996 the Company acquired $493,000 and $256,000 of equipment financed by capital leases. These acquisitions have generally consisted of computer workstations, networking equipment, office furniture and equipment, and leasehold additions and improvements. In 1994, the Company purchased marketable securities of $2.8 million. These securities were sold in 1994 and 1996. The Company believes that existing cash balances and cash generated from operations will be sufficient to fund necessary purchases of capital equipment and to provide working capital through 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. See Item 3 "Legal Proceedings" and Item 1 "Business - Risk Factors That May Affect Future Results." 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements and Financial Statement Schedules Page ---- Financial Statements: Report of Price Waterhouse LLP, Independent Accountants 23 Consolidated Balance Sheets at December 31, 1996 and 1995 24 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 25 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 26 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 27 Notes to Consolidated Financial Statements 28 Financial Statement Schedule: Schedule II - Valuation and Qualifying Accounts 42 All other schedules are omitted because they are not required, are not applicable, or the information is included in the consolidated financial statements or notes thereto. Report of Independent Accountants To the Board of Directors and Shareholders of Cylink Corporation In our opinion, the consolidated financial statements listed in the above index present fairly, in all material respects, the financial position of Cylink Corporation and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP San Jose, California January 24, 1997 23 Cylink Corporation Consolidated Balance Sheets (dollars in thousands, except per share data)
December 31, 1996 1995 Assets Current assets: Cash and cash equivalents $ 78,849 $ 3,240 Short-term investments -- 2,858 Accounts receivable, net of allowances of $644 and $483 12,682 6,013 Inventories 8,828 6,096 Deferred income taxes 1,432 1,091 Other current assets 1,351 948 --------- --------- Total current assets 103,142 20,246 Property and equipment, net 3,760 2,295 Other assets 186 184 --------- --------- $ 107,088 $ 22,725 ========= ========= Liabilities and Shareholders' Equity Current liabilities: Bank borrowings under line of credit $ -- $ 1,000 Current portion of lease obligations 167 144 Accounts payable 3,954 1,378 Accrued liabilities 5,090 3,741 Income taxes payable 60 90 Deferred revenue 353 1,289 --------- --------- Total current liabilities 9,624 7,642 --------- --------- Lease obligations, long-term 241 291 --------- --------- Deferred income taxes 12 187 --------- --------- Commitments and contingencies (Notes 10 and 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; 25,597,000 and 19,087,000 shares issued and outstanding 257 191 Additional paid-in capital 89,772 9,281 Notes receivable from shareholders (301) (515) Deferred compensation related to stock options (334) (417) Unrealized loss on investments -- (416) Cumulative translation adjustment 4 (135) Retained earnings 7,813 6,616 --------- --------- Total shareholders' equity 97,211 14,605 --------- --------- $ 107,088 $ 22,725 ========= ========= The accompanying notes are an integral part of these financial statements.
24 Cylink Corporation Consolidated Statements of Operations (dollars in thousands, except per share data)
Year ended December 31, 1996 1995 1994 Revenue $ 51,958 $ 34,902 $ 26,646 Cost of revenue 21,767 13,800 10,474 ------------ ------------ ------------ Gross profit 30,191 21,102 16,172 ------------ ------------ ------------ Operating expenses: Research and development, net 11,342 10,185 8,117 Selling and marketing 13,788 9,570 6,516 General and administrative 6,185 5,037 4,088 Employee severance costs 634 -- -- ------------ ------------ ------------ Total operating expenses 31,949 24,792 18,721 ------------ ------------ ------------ Income (loss) from operations (1,758) (3,690) (2,549) Other income (expense): Interest income, net 3,303 50 198 Royalty and other income (expense), net (97) 1,806 1,199 ------------ ------------ ------------ Income (loss) before income taxes 1,448 (1,834) (1,152) Provision (benefit) for income taxes 251 (755) (452) ------------ ------------ ------------ Net income (loss) $ 1,197 $ (1,079) $ (700) ============ ============ ============ Net income (loss) per share $ 0.05 $ (0.06) $ (0.04) ============ ============ ============ Shares used to compute net income (loss) per share 25,761,000 19,572,000 19,351,000 ============ ============ ============ The accompanying notes are an integral part of these financial statements.
25 Cylink Corporation Consolidated Statements of Shareholders' Equity (dollars in thousands)
Deferred Notes Compensation Additional Receivable Related to Unrealized Common Stock Paid-in from Stock Loss on Shares Amount Capital Shareholders Options Investments Balance at December 31, 1993 17,623,000 $ 176 $ 7,062 $ -- $ -- $ -- Issuance of common stock under stock option plans 14,000 -- 10 -- -- -- Tax benefit from exercise of nonqualified stock options -- -- 6 -- -- -- Repurchase of common stock (13,000) -- (15) -- -- -- Unrealized loss on investments -- -- -- -- -- (679) Translation adjustment -- -- -- -- -- -- Net loss -- -- -- -- -- -- ---------- ------- --------- ------- ------- -------- Balance at December 31, 1994 17,624,000 176 7,063 -- -- (679) Issuance of common stock under stock option plans 1,463,000 15 1,801 (515) -- -- Deferred compensation related to stock options -- -- 417 -- (417) -- Unrealized gain on investments -- -- -- -- -- 263 Translation adjustment -- -- -- -- -- -- Net loss -- -- -- -- -- -- ---------- ------- --------- ------- ------- -------- Balance at December 31, 1995 19,087,000 191 9,281 (515) (417) (416) Issuance of common stock under stock option plans 760,000 8 1,088 -- -- -- Issuance of common stock in initial public offering, net 5,750,000 58 78,806 -- -- -- Tax benefit from exercise of nonqualified stock options -- -- 597 -- -- -- Payment on notes receivable from shareholders -- -- -- 214 -- -- Amortization of deferred compensation -- -- -- -- 83 -- Reversal of unrealized loss on investments upon disposition -- -- -- -- -- 416 Translation adjustment -- -- -- -- -- -- Net income -- -- -- -- -- -- ---------- ------- --------- ------- ------- -------- Balance at December 31, 1996 25,597,000 $ 257 $ 89,772 $ (301) $ (334) $ -- ========== ======= ========= ======= ======= ========
Cumulative Translation Retained Adjustment Earnings Total Balance at December 31, 1993 $ (52) 8,395 15,481 Issuance of common stock under stock option plans -- -- 10 Tax benefit from exercise of nonqualified stock options -- -- 6 Repurchase of common stock -- -- (15) Unrealized loss on investments -- -- (679) Translation adjustment 46 -- 46 Net loss -- (700) (700) ------- ----- ------ Balance at December 31, 1994 (106) 7,695 14,149 Issuance of common stock under stock option plans -- -- 1,301 Deferred compensation related to stock options -- -- -- Unrealized gain on investments -- -- 263 Translation adjustment (29) -- (29) Net loss -- (1,079) (1,079) ------- ----- ------ Balance at December 31, 1995 (135) 6,616 14,605 Issuance of common stock under stock option plans -- -- 1,096 Issuance of common stock in initial public offering, net -- -- 78,864 Tax benefit from exercise of nonqualified stock options -- -- 597 Payment on notes receivable from shareholders -- -- 214 Amortization of deferred compensation -- -- 83 Reversal of unrealized loss on investments upon disposition -- -- 416 Translation adjustment 139 -- 139 Net income -- 1,197 1,197 ------- ----- ------ Balance at December 31, 1996 $ 4 7,813 97,211 ======= ===== ====== The accompanying notes are an integral part of these financial statements. 26 Cylink Corporation Consolidated Statements of Cash Flows (dollars in thousands)
Year ended December 31, 1996 1995 1994 Cash flows from operating activities: Net income (loss) $ 1,197 $ (1,079) $ (700) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Realized loss on sale of investments 432 -- -- Depreciation and amortization 1,350 919 728 Deferred compensation related to stock options 83 -- -- Deferred income taxes (516) (383) (202) Changes in assets and liabilities: Accounts receivable (6,669) (1,269) 879 Inventories (2,732) (1,451) (763) Other assets (405) 573 (830) Accounts payable 2,576 252 502 Accrued liabilities 1,349 414 1,130 Income taxes payable (30) (314) (217) Deferred revenue (936) (77) 815 -------- -------- -------- Net cash provided by (used in) operating activities (4,301) (2,415) 1,342 -------- -------- -------- Cash flows from investing activities: Acquisition of property and equipment (2,815) (614) (1,234) Purchase of short-term investments -- -- (2,775) Proceeds from sale of short-term investments 2,842 -- 974 -------- -------- -------- Net cash provided by (used in) investing activities 27 (614) (3,035) -------- -------- -------- Cash flows from financing activities: (Repayment) borrowings under bank line of credit (1,000) 1,000 -- Proceeds from issuance of common stock, net 79,960 1,301 10 Repurchase of common stock -- -- (15) Payment on notes receivable from shareholders 214 -- -- Repayment of capital lease obligations (27) (58) -- Tax benefit from exercise of stock options 597 -- -- -------- -------- -------- Net cash provided by (used in) financing activities 79,744 2,243 (5) -------- -------- -------- Effect of exchange rate changes on cash and cash equivalents 139 (5) 9 -------- -------- -------- Net increase (decrease) in cash and cash equivalents 75,609 (791) (1,689) Cash and cash equivalents at beginning of year 3,240 4,031 5,720 -------- -------- -------- Cash and cash equivalents at end of year $ 78,849 $ 3,240 $ 4,031 ======== ======== ======== Supplemental disclosures: Cash paid for income taxes $ 18 $ 58 $ 707 Cash paid for interest 110 32 -- Equipment acquired under capital lease obligations 256 493 -- Common stock issued for notes receivable -- 515 -- The accompanying notes are an integral part of these financial statements.
27 Cylink Corporation Notes to Consolidated Financial Statements 1. The Company and a Summary of its Significant Accounting Policies The Company Cylink Corporation (the "Company") was incorporated in California in October 1989 to engage in the development, manufacture, license and marketing of electronic encryption devices and in 1990 began developing wireless communication products. The Company's operations outside of the United States consist primarily of a sales office in the United Kingdom. Basis of presentation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company's interim quarters end on the Friday nearest the calendar quarter end. The Company's year end is December 31. Foreign currency The functional currencies of the Company's foreign subsidiaries are the local currencies. The balance sheet accounts are translated into United States dollars at the exchange rate prevailing at the balance sheet date. Revenues, costs and expenses are translated into United States dollars at average rates for the period. Gains and losses resulting from translation are presented as a component of shareholders' equity. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statement of operations and were not significant during any of the periods presented. Cash equivalents and short-term investments Cash equivalents consist of highly liquid investment instruments with a maturity at the time of purchase of three months or less. The Company's short-term investments are classified as available-for-sale and therefore are reported at fair value with unrealized gains and losses as a separate component of shareholders' equity. Inventories Inventories are stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market. Other assets Patent acquisition costs are amortized using the straight-line method over 10 years. Patents, net of amortization, of $18,000 and $27,000 are included in other assets as of December 31, 1996 and 1995, respectively. Property and equipment Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally five years. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the remaining lease term. 28 Revenue recognition Revenue is recognized upon shipment to customers. 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. Royalty income of $1,308,000, $1,772,000 and $866,000 for the years ended December 31, 1996, 1995 and 1994, respectively, is included in other income and is generally recognized upon the reported sale of products subject to royalties. Research and development Research and development costs are charged to operations as incurred. The Company on occasion receives nonrecurring engineering funding for development projects to apply or enhance the Company's technology to a particular customer's needs. Non-refundable receipts are recognized over the term of the respective contract using the percentage of completion method. Receipts, which are refundable pending the achievement of certain results, are deferred and recognized upon acceptance by the customer. Amounts billed on contracts and collected prior to being earned are recorded as deferred revenue. At the time of recognition, amounts received under research and development contracts are offset against research and development expenses. Software development costs are included in research and development and are expensed as incurred. Statement of Financial Accounting Standards No. 86 (SFAS 86) requires the capitalization of certain software development costs once technological feasibility is established, which the Company defines as completion of a working model. The capitalized cost is then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever is greater. To date, the period between achieving technological feasibility and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any software development costs. Stock-based compensation The Company accounts for stock based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. The Company provides additional pro forma disclosures as required under Statement of Financial Accounting Standard No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." See Note 7. Income taxes Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts. Net income (loss) per share Net income (loss) per share is computed using the weighted average number of outstanding shares of common stock and common stock equivalents. Common stock equivalents consist of stock options (using the treasury stock method). Common stock equivalents are excluded from the computation if their effect is antidilutive, except that, pursuant to the requirements of the Securities and Exchange Commission, common stock equivalents (using the treasury stock method and the initial public offering price) issued subsequent to November 30, 1994 through February 15, 1996 have been included in the computation as if they were outstanding for all periods through the effective date of the Company's initial public offering. Off-balance sheet risk and concentrations of credit risk Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents, short-term investments, accounts receivable, and to a lesser extent currency fluctuation of balances denominated in currencies other than the United States dollar. The Company limits the amount of investment exposure to any one financial institution and financial instrument. The Company performs on-going credit evaluations and maintains reserves for potential credit losses; historically such losses have been 29 immaterial. The Company minimizes the amount of cash it maintains in local currencies by maintaining excess cash in United States dollars. No customer accounted for more than 10% of total accounts receivable at December 31, 1996 and 1995 and no customer accounted for greater than 10% of revenue in any period presented. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain amounts in the 1995 financial statements have been reclassified to conform to the 1996 presentation. Dependence on 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. 2. Initial Public Offering In February 1996, the Company completed its initial public offering and issued 5,000,000 shares of its common stock to the public at a price of $15.00 per share. In March 1996, the underwriters exercised their option to cover over-allotments and an additional 750,000 shares of common stock were issued at $15.00 per share. The Company received approximately $79 million of cash, net of underwriting discounts, commissions and other offering costs. In connection with the Company's initial public offering, the Board of Directors authorized the issuance of up to 5,000,000 shares of undesignated preferred stock and the Board has the authority to issue the undesignated preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof. No preferred stock had been issued as of December 31, 1996. 30 3. Details of Balance Sheet Components December 31, 1996 1995 (in thousands) Inventories: Raw materials $ 4,126 $ 3,042 Work in process and subassemblies 3,196 1,773 Finished goods 1,506 1,281 ------- ------- $ 8,828 $ 6,096 ======= ======= Property and equipment: Machinery and equipment $ 7,068 $ 4,995 Furniture and fixtures 624 179 Leasehold improvements 564 267 ------- ------- 8,256 5,441 Less: accumulated depreciation and amortization (4,496) (3,146) ------- ------- $ 3,760 $ 2,295 ======= ======= Accrued liabilities: Accrued compensation and benefits $ 2,116 $ 1,037 Accrued royalties 665 428 Accrued employee severance costs 634 -- Accrued distributor commissions 543 252 Accrued professional fees 235 1,365 Other accrued liabilities 897 659 ------- ------- $ 5,090 $ 3,741 ======= ======= 4. Short-term Investments The cost and fair value of the Company's short-term investments as of December 31, 1995 were as follows (in thousands): Unrealized Cost Fair Value Loss Short-term investments $3,274 $2,858 $ 416 ====== ====== ====== Short-term investments generally consisted of preferred stock and were sold during 1996 resulting in a loss of $432,000. The Company had no short-term investments as of December 31, 1996. 5. Bank Line of Credit In July 1995, the Company signed a credit agreement with a bank which provided a line of credit for working capital advances of up to $5,000,000 or a specified percentage of eligible accounts receivable, plus $2,000,000 or a specified percentage of short-term investments, respectively. Any advances under the line of credit were collaterized by certain assets and intellectual property of the Company. Interest on borrowings under the line of credit was set at the 30 day LIBOR plus 2.0%. Among other provisions, the Company was required to maintain certain financial 31 covenants. In addition, payment of cash dividends was prohibited without the bank's consent. At December 31, 1995, the Company had $1,000,000 outstanding under the line of credit which was repaid during 1996. The line of credit agreement expired in July 1996 and was not renewed by the Company. 6. Income Taxes The provision (benefit) for income taxes consists of the following: Year ended December 31, 1996 1995 1994 (in thousands) Current: Federal $ 709 $(403) $(258) State 58 (92) (58) Foreign -- 123 66 ----- ----- ----- 767 (372) (250) ----- ----- ----- Deferred: Federal (478) (348) (143) State (38) (35) (59) ----- ----- ----- (516) (383) (202) ----- ----- ----- $ 251 $(755) $(452) ===== ===== ===== Deferred tax assets (liabilities) comprise the following: December 31, 1996 1995 (in thousands) Assets: Net operating loss and credit carryforwards $ 984 $ 1,235 Unrealized capital loss 166 161 Bad debt reserve 230 162 Inventory reserves and basis differences 1,382 1,063 Accrued expenses 448 200 Deferred rent 30 22 Warranty reserve 60 33 Other 102 77 ------- ------- Total deferred tax assets 3,402 2,953 ------- ------- Liabilities: Depreciation (5) (123) Other liabilities (7) (64) ------- ------- Total deferred tax liabilities (12) (187) ------- ------- Valuation allowance (1,970) (1,862) ------- ------- Net deferred tax assets $ 1,420 $ 904 ======= ======= 32 Net deferred tax assets of $1,420,000 at December 31, 1996 were based on the Company's carryback capacity and expected future income in the next twelve months. Based on the available objective evidence, including the operating losses experienced in recent years, management cannot conclude that it is more likely than not a portion of the deferred tax assets will be realized and, therefore, the Company has recorded a partial valuation against the deferred tax assets. The provision (benefit) reconciles to the amount computed by applying the United States federal statutory rate to income before taxes as follows: Year ended December 31, 1996 1995 1994 U.S. federal statutory income tax rate 34.0% (34.0)% (34.0)% State taxes, net of federal tax benefit 0.9 (4.6) (6.7) Research and development tax credits (24.2) -- (3.0) Change in valuation allowance 7.4 -- -- Foreign losses not benefitted 5.2 -- -- Other (6.0) (2.6) 4.5 ---- ----- ----- Effective tax rate 17.3% (41.2)% (39.2)% ==== ===== ===== The Company has not provided United States federal income taxes on the undistributed earnings of foreign subsidiaries because it is the Company's intention to permanently reinvest such earnings. At December 31, 1996, 1995 and 1994, total undistributed earnings of these subsidiaries were approximately $1,846,000, $1,579,000 and $1,341,000, respectively. The Company had research and development credit carry forwards of approximately $980,000 and $1,200,000 at December 31, 1996 and 1995, respectively, which expire from 2009 to 2010. 7. Stock Option Plans The Company has adopted the 1987 Stock Option Plan and the 1994 Flexible Stock Incentive Plan (collectively known as the "Plans") which provide for the grant of incentive stock options and nonqualified stock options to executives, employees and consultants to purchase up to 2,010,000 and 3,950,000 common shares, respectively. Stock options may be granted at prices not less than 100% and 85% for incentive and nonqualified stock options, respectively, of the fair market value of the stock on the date of grant. Through December 31, 1996, all nonqualified stock options have been granted at 100% of the fair market value of the stock on the date of grant. Options granted under the Plans are exercisable at such times and under such conditions as determined by the Board of Directors, and generally vest over five years. Options expire ten years from the date of grant. Shares issued upon exercise of options are subject to certain restrictions on their transferability. The Company has the right to repurchase such shares, at a price equal to the fair market value, when the optionee is no longer associated with the Company. Shares repurchased increase the number of shares available for grant under the Plans. 33 The following table summarizes the Company's stock option activity and related weighted average exercise price within each category for each of the three years in the period ended December 31, 1996: Weighted Shares Average Available Options Exercise for grant Outstanding Price Balance at December 31, 1993 102,200 1,531,400 $ 0.93 Approved 2,750,000 -- Granted at market price (1,949,445) 1,949,445 1.84 Exercised -- (13,800) 0.73 Canceled 67,100 (67,100) 1.61 Repurchased 13,200 -- ---------- --------- Balance at December 31, 1994 983,055 3,399,945 1.44 Approved 1,200,000 -- Granted at market price (779,450) 779,450 2.60 Granted below market price (436,000) 436,000 2.02 Exercised -- (1,462,785) 1.25 Canceled 315,452 (315,452) 1.91 ---------- --------- Balance at December 31, 1995 1,283,057 2,837,158 1.89 Approved 2,000,000 -- Granted at market price (2,042,810) 2,042,810 12.53 ---------- --------- Exercised -- (760,492) 1.44 Canceled 741,723 (741,723) 4.89 ---------- --------- Balance at December 31, 1996 1,981,970 3,377,753 $ 7.72 ========= ========= Significant option groups outstanding at December 31, 1996, and related weighted average exercise price and contractual life information are as follows:
Options Outstanding Options Exercisable -------------------------------------------------------- ------------------------------ Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Prices Outstanding Contractual Life Exercise Price Outstanding Exercise Price $ 0.25 to $ 4.80 1,398,753 7.0 $ 1.78 823,342 $ 1.65 $ 6.40 to $11.00 1,172,667 9.7 10.32 26,782 6.40 $11.25 to $14.56 550,633 9.9 12.08 4,601 12.73 $17.25 to $23.50 255,700 9.3 18.92 14,584 19.28 ---------- -------- $ 0.25 to $23.50 3,377,753 8.6 $ 7.72 869,309 $ 2.15 ========== ========
The weighted average estimated grant date fair value, as defined by SFAS 123, for options granted during 1995 at market price and below market price on the dates of grant were $1.04 and $1.47, respectively. The weighted average estimated grant date fair value, as defined by SFAS 123, for options granted at market price during 1996 was $6.03. The estimated grant date fair value disclosed by the Company is calculated using the Black-Scholes model. The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely tradeable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated grant date fair value. 34 The following weighted average assumptions are included in the estimated grant date fair value calculations for the Company's stock option awards: 1996 1995 Expected life (years) 3.04 3.04 Risk-free interest rate 5.93% 6.22% Volatility 69.46% 54.89% Dividend yield 0.00% 0.00% Had the Company recorded compensation costs based on the estimated grant date fair value, as defined by SFAS 123, for awards granted under its stock option plans, the Company's net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts below for the years ended December 31, 1996 and 1995 (in thousands, except for per share amounts): 1996 1995 Net income (loss) As reported $ 1,197 $(1,079) Pro forma (325) (1,354) Net income (loss) per share As reported $ 0.05 $ (0.06) Pro forma (0.01) (0.07) The pro forma effect on net income (loss) and net income (loss) per share for 1996 and 1995 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. As of December 31, 1995, the Company had granted certain options for the purchase of common stock at less than the deemed fair market value and approximately $417,000 of compensation expense is being amortized over the five-year vesting period of the options. 8. Notes Receivable From Shareholders During November 1995, the Company made loans totaling $515,000 to certain employees pursuant to the Company's 1994 Flexible Stock Incentive Plan. The loans bear interest at 8.0% per annum and are secured by 427,000 shares of the Company's common stock. The loans were due in November 1996 or, if earlier, upon the borrower's termination of employment with the Company. During 1996, the Company extended the due dates on certain of the loans. As of December 31, 1996, the remaining balance on these loans totaled $301,000 and is due in February 1997. 9. Research and Development Contracts During the years ended December 31, 1996, 1995 and 1994, the Company performed research and development under several government funded arrangements aggregating $3,777,000, $526,000 and $297,000, respectively. These contracts provide funding (irrespective of the results) for research and development of certain cryptographic technologies which will be jointly owned by the Company and these government agencies. Amounts received under these contracts are offset against research and development expenses. The Company performed research and development under several other research and development contracts which provide for the development and transfer of technology in exchange for development funding. The Company recorded as a reduction of research and development expenses $2,363,000, $604,000 and $367,000 under such arrangements in the years ended December 31, 1996, 1995 and 1994, respectively. The funds received under contracts in progress, included in deferred revenue pending achievement of milestones, totaled $1,050,000 as of December 31, 1995. No funds had been received under such contracts in advance of the achievement of milestones as of December 31, 1996. 35 In 1991, the Company entered into an agreement with a third party to partially fund research and development related to certain cryptographic technology. The Company is required to pay royalties of 5% on sales of products developed under this research project. In connection with a contract amendment in 1993, the Company prepaid royalties of $300,000 in exchange for limitations on total royalties, not to exceed $712,000. The prepaid royalties were fully amortized as of December 31, 1995. 10. Joint Venture and Contingencies On September 6, 1995, the Company obtained an arbitration award dissolving a former partnership, known as Public Key Partners ("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. Management believes that the ultimate resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations. Subsequent event (unaudited) 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. Although the Company has placed its insurers on notice of these claims, none of them have admitted coverage. 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, may also result in a material adverse effect on the Company's financial condition. However, management believes that the ultimate resolution of this matter will not have a material adverse effect on the Company's financial position or results of operations. 36 11. Geographic Information The Company operates in one industry segment. Revenue, income (loss) from operations and identifiable assets, classified by the major geographic areas in which the Company operates, were as follows: Year ended December 31, 1996 1995 1994 (in thousands) Revenue: Sales to unaffiliated customers: United States: Customers in United States $ 21,553 $ 18,677 $ 17,425 Customers in Central and South America 9,387 5,084 3,778 Customers in Europe 7,067 2,076 1,027 Other 9,736 5,455 2,134 Europe 4,215 3,610 2,282 -------- -------- -------- $ 51,958 $ 34,902 $ 26,646 ======== ======== ======== Intercompany sales among geographic entities eliminated in consolidation $ 2,445 $ 1,950 $ 1,098 ======== ======== ======== Income (loss) from operations: United States $ (1,784) $ (4,053) $ (2,615) Europe 26 363 66 -------- -------- -------- $ (1,758) $ (3,690) $ (2,549) ======== ======== ======== December 31, 1996 1995 (in thousands) Identifiable assets: United States $ 26,026 $ 15,501 Europe 2,213 1,126 -------- -------- 28,239 16,627 General corporate assets consisting of cash, cash equivalents and short-term investments 78,849 6,098 -------- -------- $107,088 $ 22,725 ======== ======== Intercompany sales among the Company's geographic areas are recorded on the basis of intercompany prices established by the Company. At December 31, 1996 and 1995, total foreign liabilities (excluding intercompany balances) were $660,000 and $765,000, respectively. 37 12. Lease Commitments The Company leases its headquarters and manufacturing facility and sales offices under various noncancelable operating leases. These leases expire at various dates through June 2001 and certain of the leases are renewable for an additional five years. In addition to the minimum lease payments, the Company is responsible for insurance, repairs and certain other operating costs under the terms of the leases. The Company also leases certain equipment under long-term lease agreements that are classified as capital leases. These capital leases, which consist primarily of computer equipment, terminate at various dates through 2000. Total equipment acquired under these capitalized leases, which secure such borrowings, was $621,000 at cost and $445,000 at net book value as of December 31, 1996. Future minimum lease payments under all noncancelable operating and capital leases are as follows (in thousands): Operating Capital Year ending December 31, Leases Leases 1997 $ 1,177 $ 219 1998 1,175 191 1999 721 86 2000 393 8 2001 197 -- ------- ----- Total minimum payments $ 3,663 504 ======= Less: amount representing interest (96) ----- Present value of capital lease obligations 408 Less: current portion (167) ----- Lease obligations, long-term $ 241 ===== Rent expense under operating leases totaled $1,207,000, $909,000 and $708,000 during the years ended December 31, 1996, 1995 and 1994, respectively. 38 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item with respect to directors, appearing under the caption "Election of Directors" including subcaptions thereof, in the Company's Proxy Statement for the 1997 annual meeting of shareholders to be held on or about May 22, 1997 (the "Proxy Statement") and which will be filed in definitive form pursuant to Regulation 14a before the meeting date and within 120 days after the end of fiscal year 1996, is incorporated herein by reference. The information required by this Item concerning the Company's executive officers is set forth in Part I hereof under the caption "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item appearing under the caption "Executive Compensation and Other Information" in the Company's Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item appearing under the caption "Certain Transactions" in the Company's Proxy Statement is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K (a) 1. Financial Statements -- See index to Consolidated Financial Statements and Financial Statement Schedule at page 23 of this Form 10-K. 2. Financial Statement Schedule -- See Index to Consolidated Financial Statements and Financial Statement Schedule at page 23 of this Form 10-K. 3. Exhibits Index: Exhibit Number Description of Exhibit ------ ---------------------- 3.1 Amended and Restated Articles of Incorporation of the Registrant (1) and Certificate of Amendment thereto dated March 5, 1996. 3.2 Bylaws, as amended. (1) 3.3 Certificates of Amendment of Bylaws dated March 26, 1997 4.1 Reference is made to Exhibits 3.1 and 3.2. 4.2 Specimen certificate for Common Stock. (1) 39 10.1 Stockholder Agreement, dated as of September 29, 1989, between the Company and the shareholders set forth therein, and amendments thereto. (1) 10.2 Form of Indemnification Agreement between the Company and each of its executive officers and directors. (1) 10.3 Employment Agreement between the Company and Lewis C. Morris, dated April 1, 1989, and amendments thereto. (1) (2) 10.4 Employment Agreement between the Company and Jimmy K. Omura, dated as of April 1, 1989, and amendments thereto. (1) (2) 10.5 Employment Agreement between the Company and Fernand B. Sarrat, dated as of November 6, 1996. (2) 10.6 Lease Agreement between the Company and ARGOSystems, Inc., a wholly-owned subsidiary of The Boeing Company, dated May 1, 1994. (1) 10.7 License Agreement between the Company and The Board of Trustees of the Leland Stanford Junior University, dated as of August 25, 1989, the First Amendment to License Agreement, dated as of April 6, 1990, and the Second Amendment to License Agreement, dated as of July 7, 1995. (1) 10.8 Company's 1987 Non-Qualified Stock Option Plan, including forms of agreements thereunder. (1) (2) 10.9 Company's 1994 Flexible Stock Incentive Plan, including forms of agreements thereunder, and amendments thereto. (1) (2) 10.10 Loan and Security Agreement between the Company and Silicon Valley Bank dated as of July 20, 1995. (1) 11.1 Statement regarding calculation of net income (loss) per share. 21.1 Subsidiaries of the Company. (1) 23.1 Consent of Price Waterhouse LLP. 24.1 Power of Attorney. Reference is made to Page IV-2. 27.1 Financial Data Schedule. ---------- (1) Incorporated by reference from the Company's Registration Statement on Form S-1 Registration No. 33- 80719, which became effective February 15, 1996. (2) Management contract or compensatory plan or arrangement required to be filed as an exhibit to this report on Form 10-K pursuant to Item 14(a). (b) The Company did not file or amend any reports on Form 8-K during the last quarter of the fiscal year ending December 31, 1996. 40 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. CYLINK CORPORATION Date: March 21, 1997 By: /s/ FERNAND B. SARRAT ------------------- Fernand B. Sarrat President and Chief Executive Officer KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John H. Daws and Robert B. Fougner, and each of them, acting individually, as his or her attorney-in-fact, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ FERNAND B. SARRAT President and Chief Executive Officer March 21, 1997 ----------------- (Principal Executive Officer) Fernand B. Sarrat /s/ JOHN H. DAWS Vice President of Finance and Administration March 21, 1997 ------------ and Chief Financial Officer John H. Daws (Principal Financial and Accounting Officer) /s/ JIMMY K. OMURA Chief Technical Officer and Director March 21, 1997 -------------- Jimmy K. Omura /s/ LEO A. GUTHART Chairman of the Board March 21, 1997 --------------- Leo A. Guthart /s/ ELWYN BERLEKAMP Director March 21, 1997 ---------------- Elwyn Berlekamp /s/ KING W.W. HARRIS Director March 21, 1997 ---------------- King W.W. Harris /s/ WILLIAM W. HARRIS Director March 21, 1997 ----------------- William W. Harris /s/ HOWARD L. MORGAN Director March 21, 1997 ---------------- Howard L. Morgan /s/ JAMES H. SIMMONS Director March 21, 1997 ---------------- James H. Simmons
41 SCHEDULE II CYLINK CORPORATION VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1994, 1995 and 1996 (in thousands) Additions Balance at Charged to Deductions Balance Beginning Statement of from at end of Period Operations Reserves of Period --------- ---------- -------- --------- Allowance for doubtful accounts Year ended December 31, 1994 $ 175 $ 104 $ -- $ 279 Year ended December 31, 1995 $ 279 $ 210 $ (6) $ 483 Year ended December 31, 1996 $ 483 $ 269 $ 108 $ 644 42 EX-3.1 2 CERTIFICATE OF AMENDMENT EXHIBIT 3.1 CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED ARTICLES OF INCORPORATION OF CYLINK CORPORATION, a California Corporation -------------------------------- The undersigned Harold S. Yang and Robert Fougner hereby certify that: ONE:They are the duly elected and acting Vice President and Secretary, respectively, of Cylink Corporation, a California corporation (the "Corporation"). TWO:The Amended and Restated Articles of Incorporation of said Corporation are amended as follows: Article Third shall be amended in its entirety to read as follows: "THIRD: A. Classes of Stock. This Corporation is authorized to issue two classes of shares, designated "Preferred Stock" and "Common Stock." The total number of shares which the Corporation is authorized to issue is forty five million (45,000,000) shares. Forty million (40,000,000) shares shall be Common Stock, $.01 par value, (the "Common Stock") and five million (5,000,000) shares shall be Preferred Stock, $.01 par value (the "Preferred Stock"). B. Preferred Stock. The undesignated shares of Preferred Stock shall be issued from time to time in one or more series. The Board of Directors is hereby authorized, within the limitations and restrictions stated in these Articles of Incorporation, to fix or alter the individual rights, dividend rate, conversion rights, voting rights, rights and terms of redemption (including sinking fund provisions), the redemption price or prices, the liquidation preference of any wholly unissued shares of Preferred Stock, and the number of shares constituting any such series and the designation thereof, or any of them, and to increase or decrease the number of shares of any series subsequent to the issue of shares of that series, but not below the number of shares of such series then outstanding. In case the number of shares of any series shall be so decreased, the shares constituting such decrease shall resume the status which they had prior to the adoption of the resolution originally fixing the number of shares of such series." Article Sixth shall be added to read as follows: "SIXTH: A. Date Effective. This Article shall become effective only when the Corporation shall become a "listed corporation" within the meaning of Section 301.5(d) of the California Corporations Code. B. No Cumulative Voting. The election of directors by the shareholders shall not be by cumulative voting. At each election of directors by the shareholders, each shareholder entitled to vote may vote all the shares held by that shareholder for each of several nominees for director up to the number of directors to be elected. The shareholder may not cast more votes for any single nominee than the number of shares held by that shareholder." Article Seventh shall be added to read as follows: "SEVENTH: A. Date Effective. This Article shall become effective only when the Corporation shall become a "listed corporation" within the meaning of Section 301.5(d) of the California Corporations Code. B. Classified Board of Directors. For so long as the board of directors consists of at least nine directors, the directors shall be divided into three classes, designated Class I, Class II and Class III. Each class shall consist, as nearly as may be possible, of one-third (1/3) of the total number of directors constituting the entire Board of Directors. The initial classes shall be elected as follows: Class I directors shall be elected for a one-year term, Class II directors for a two-year term and Class III directors for a three-year term. At each succeeding annual meeting of shareholders, successors to the class of directors whose term expires at the annual meeting of shareholders shall be elected for three-year terms. If the number of directors is changed, any increase or decrease shall be elected for three-year terms. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent director. A director shall hold office until the annual meeting for the year in which his or her term expires and until his or her successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement, disqualification or removal from office. Except as otherwise required by law, any vacancy on the Board of Directors that results from an increase in the number of directors and any other vacancy occurring in the Board of Directors shall be filled by a majority of the directors then in office, even if less than a quorum, or by a sole remaining director. Any director elected to fill a vacancy not resulting from an increase in the number of directors shall have the same remaining term as that of his or her predecessor." THREE: The foregoing amendments of Amended and Restated Articles of Incorporation have been duly approved by the Board of Directors of the Corporation. FOUR: The foregoing amendments of Amended and Restated Articles of Incorporation were duly approved by the holders of the requisite number of shares of the Corporation in accordance with Sections 902 of the California General Corporation Law; the total number of outstanding shares entitled to vote with respect to the foregoing amendment was 19,029,490 shares of Common Stock. The number of shares voting in favor of the foregoing amendments equaled or exceeded the vote required, such required vote being a majority of the outstanding shares of Common Stock. IN WITNESS WHEREOF, the undersigned have executed this Certificate of Amendment of Amended and Restated Articles of Incorporation this 9th day of February, 1996. /s/ Harold S. Yang ---------------------------------- Harold S. Yang, Vice President /s/ Robert B. Fougner ---------------------------------- Robert B. Fougner, Secretary The undersigned certify under penalty of perjury that they have read the foregoing Certificate of Amendment of Amended and Restated Articles of Incorporation and know the contents thereof, and that the statements therein are true. Executed at Sunnyvale, California, on February 9, 1996. /s/ Harold S. Yang ---------------------------------- Harold S. Yang, Vice President /s/ Robert B. Fougner ---------------------------------- Robert B. Fougner, Secretary EX-3.3 3 CERTIFICATE OF AMENDMENT EXHIBIT 3.3 CERTIFICATE OF AMENDMENT OF THE BYLAWS OF CYLINK CORPORATION a California corporation The undersigned, Robert Fougner hereby certifies that: 1. He is the duly elected and acting Secretary of Cylink Corporation, a California corporation (the "Corporation"). 2. Effective December 13, 1995 , Section 2.9(d) was added to the Bylaws of the Corporation to read in its entirety as follows: "Section 2.9. Voting. . . . . (d) Notwithstanding any term of this Section 2.9, during any period in which (i) the corporation is a listed corporation, as "listed corporation" is defined in California Corporations Code Section 301.5(d), and (ii) its Articles of Incorporation provide that shareholders of the corporation are not entitled to cumulate their votes in elections of directors, this Section 2.9 shall not be deemed to allow shareholders of the corporation to cumulate their votes in the elections of directors, and further Section 2.9(c) hereof shall not apply with respect to voting in the election of directors." 3. Effective December 13, 1995, Article XIII, Transfer of Shares, has been repealed and deleted in its entirety from the Bylaws of the Corporation. IN WITNESS WHEREOF, the undersigned has set his hand hereto this 26th day of March, 1997. /s/ Robert B. Fougner ------------------------------------- Robert B. Fougner Secretary CERTIFICATE OF AMENDMENT OF THE BYLAWS OF CYLINK CORPORATION a California Corporation The undersigned, Robert B. Fougner, hereby certifies: 1. That he is the duly elected and acting Secretary of Cylink Corporation, a California corporation (the "Corporation"). 2. That effective October 26, 1995, Section 3.2 of the Corporation's Bylaws was amended to read as follows: "The number of directors of the corporation shall be not less than seven (7) nor more than nine (9) until changed by amendment of the Articles of Incorporation or by a Bylaw amending this Section 3.2 duly adopted by the vote or written consent of holders of a majority of the outstanding shares, provided that if the minimum number of directors is five (5) or more, any proposal to reduce the minimum number of directors to a number less then five (5) cannot be adopted if the votes cast against its adoption at a meeting, or the shares not consenting in the case of action by written consent, are equal to more than sixteen and two-thirds percent (16 2/3%) of the outstanding shares entitled to vote. The exact number of directors shall be fixed from time to time, within the limits specified in the Articles of Incorporation in this Section 3.2, by a resolution duly adopted by the vote of a majority of the shares entitled to vote represented at a duly held meeting at which a quorum is present, or by the written consent of the holders of a majority of the outstanding shares entitled to vote, or by the Board of Directors. IN WITNESS WHEREOF, the undersigned has set his hand hereto this 26th day of March, 1997. /s/ Robert B. Fougner --------------------------------------- Robert B. Fougner Secretary EX-10.5 4 AGREEMENT AGREEMENT Agreement made as of the 6th day of November, 1996, by and between Cylink Corporation, a California corporation with its principal place of business at 910 Hermosa Court, Sunnyvale, California 94086 (the "Company"), and Fernand Sarrat residing at ______________________________ (the "Executive"). W I T N E S S E T H : WHEREAS, the Company desires to employ Executive as its President and Chief Executive Officer and Executive is willing to serve in such capacity; and WHEREAS, the Company and Executive desire to set forth the terms and conditions of such employment. NOW, THEREFORE, in consideration of the premises and of the mutual covenants and agreements herein contained, the Company and Executive agree as follows: 1. Employment. The Company hereby agrees to employ Executive, and Executive agrees to be employed by the Company, on the terms and conditions herein contained, and, effective as of November 6, 1996 as its President and Chief Executive Officer ("CEO") and in such other executive capacities (not inconsistent with Executive's duties as President and CEO) with the Company and its affiliated entities as assigned from time to time by the Board of Directors of the Company (the "Board"). Executive shall report only to the Board and the Chairman of the Board. As President and CEO, Executive shall have duties, authority and responsibilities commensurate with the duties, authority and responsibilities of a president and a chief executive officer of a similar type company. During the term of Executive's employment, he shall be based at the principal office of the Company, which is currently in the Palo Alto, California area, provided, however, that Executive shall be required to travel as reasonably necessary in connection with the official business of the Company. Executive shall relocate his permanent residence and his family to the Palo Alto, California, area within one (1) year of the Effective Date. During the Employment Term, the Company shall recommend the Executive for election as a director of the Company. If so requested by the Board, Executive shall also serve on the Board of Directors of the Company and as a director and officer of its affiliated entities without additional compensation. The Executive shall devote substantially all of his business time, energy, skill and efforts to the performance of his duties hereunder and shall faithfully and 2 diligently serve the Company. The Executive shall perform his duties and responsibilities to the best of his abilities in a diligent, trustworthy, businesslike and efficient manner. The foregoing shall not prevent Executive from participating in not-for-profit activities or from managing his passive personal investments provided that these activities do not materially interfere with Executive's obligations hereunder. 2. Term of Employment. Executive's employment under this Agreement shall be for a term (the "Employment Term") commencing on November 6, 1996 (the "Effective Date") and terminating, unless otherwise terminated earlier as provided in Section 9 hereof, on December 31, 2001 (the "Original Employment Term"), provided that the Employment Term shall be extended (subject to earlier termination as provided in Section 9 hereof) for additional one (1) year periods (the "Additional Terms"), unless, at least thirty (30) days prior to the end of the Original Employment Term or any Additional Term, the Company or the Executive has notified the other in writing that the Employment Term shall terminate at the end of the then current term. If and when this Agreement is so extended, the term "Employment Term" used herein shall also refer to the 3 period of such extension. Notwithstanding anything else herein, the provisions of Section 12, 13, 14 and 16 hereof shall survive and remain in effect notwithstanding the termination of the Employment Term or a breach by the Company or Executive of this Agreement or any of its terms. 3. Compensation. (a) As compensation for his services under this Agreement, the Company shall pay Executive a salary at a rate of at least $300,000 per year ("Base Salary"). Such Base Salary shall be payable in equal installments (not less frequently than monthly) and subject to withholding in accordance with the Company's normal payroll practices. (b) Executive's Base Salary may be increased by the Board, in its sole discretion, from time to time. (c) In addition to the Base Salary, for each calendar year completed during the Employment Term, the Company shall pay to Executive an annual bonus which shall not be less than $100,000 per year, provided that the minimum annual bonus for the 1996 calendar year shall be prorated by multiplying $100,000 by a fraction the numerator of which is 4 the number of days during 1996 that the Executive was employed by the Company and the denominator of which is 365. The Company shall pay fifty percent (50%) of the minimum annual bonus in July of each calendar year of the Employment Term, with the remainder of such year's minimum annual bonus paid in January of the following calendar year. Any annual bonuses beyond the annual minimum bonus shall be discretionary with the Board or a Committee thereof (the "Committee") and, if declared and paid, shall be paid at such time as bonuses are generally paid or as otherwise determined by the Board or Committee. (d) The Company shall pay Executive a $2,000,000 special bonus in January 2001 if Executive remains continuously employed by the Company through December 31, 2000. The Company may offset against such special bonus (after any applicable taxes are withheld) any amounts owed the Company by the Executive. (e) The Company shall reimburse Executive for all reasonable expenses incurred by him in the course of performing his duties under this Agreement which are consistent with the Company's policies in effect form time to time with respect to travel, entertainment and other business expenses, subject to the Company's requirements with respect 5 to reporting and documentation of such expenses. 4. Benefits and Fringes. (a) During the Employment Term, Executive shall be entitled to (i) all benefits and fringes, if any, as are generally provided from time to time by the Company to its senior executive officers, including, without limitation, any life, medical and disability insurance plans and pension, incentive, profit-sharing, deferred compensation and other similar plans, practices, policies and programs, subject to the Executive's satisfaction of the applicable eligibility requirements and with due credit against any annual bonus plan or program for the minimum annual bonus set forth in Section 3(c) hereof, and (ii) such other benefits and fringes set forth in this Agreement. In addition, the Company shall reimburse Executive annually during each full calendar year during the Employment Term for the reasonable annual cost of a policy of term life insurance in the amount of $1,250,000, upon presentation of evidence of payment of the premiums on such policy. To the extent a commercial life insurance policy has not been obtained, the Company will self-fund the $1,250,000 life insurance policy for the sixty (60) day period commencing on the Effective Date. In addition, during the Original Employment Term, 6 the Company shall reimburse Executive annually during each full calendar year during the Employment Term for the reasonable annual cost of a policy for additional term life insurance in the amount of the lesser of (i) $2,000,000, or (ii) the outstanding principal of the Loan under Section 6 hereof (the "Additional Life Insurance"). The foregoing reimbursements for life insurance premiums shall, based on Executive's representation that he is in good health, be limited to payment of only a reasonable amount (which includes, but is not limited to, standard premium amounts). The Company shall gross-up for tax purposes the deemed income to Executive for providing life insurance under this Section 4(a) such that the economic effect to Executive is the same as if such insurance was provided to Executive on a non-taxable basis. Such gross up shall be in accordance with Section 19 hereof. The Executive shall grant the Company a first security interest through a collateral assignment in the Additional Life Insurance to secure the loan under Section 6 hereof. (b) During the Employment Term, the Company shall, in its discretion, either pay Executive a monthly automobile allowance of $500, or make available to Executive an automobile of the type provided to other senior executives of the Company for his 7 exclusive use in connection with the official business of the Company and incidental personal use. If an automobile is made available, Executive shall be responsible for all costs associated with garaging and operating any such automobile, other than those costs arising out of the official business of the Company, provided that the Company shall be responsible for maintenance and insurance. Executive shall be responsible for any income tax consequences arising from the use of the automobile under this arrangement. (c) No later than sixty (60) days after (i) the Effective Date or (ii) any required increase in coverage hereunder, and subject to Executive cooperating with the insurance company underwriting requirements and being accepted for the policy coverage at not more than reasonable premium rates (with respect to (i) above) and at no more than one hundred twenty-five percent (125%) of standard premium rates (with respect to (ii) above), the Company shall provide, during the Employment Term, a long term disability coverage policy or policies for Executive's benefit in an amount equal to at least sixty-six and two-thirds percent (66 and 2/3%) of the greater of (A) $500,000 per annum, or (B) the sum of Executive's then current Base Salary and minimum annual bonus, provided that the amounts in (A) or (B) above and/or the percentage 8 above shall be limited or reduced to the extent that the Company after good faith effort is unable to obtain such policy. The long term disability policy shall be based upon the same waiting period (which shall be no longer than six (6) months) and substantially the same terms as the Company's current long term disability policies for its executives. (d) The Company agrees to reimburse Executive for (i) all reasonable expenses incurred by Executive in moving any items of personal property owned by Executive and his family from Connecticut to California, (ii) the reasonable cost of up to three (3) one-person round trip airfare trips per month from Connecticut to California (coach class), which may be used by Executive, his spouse, or any of his children, until Executive relocates his family to California, but in no event for more than one (1) year after the Effective Date, and (iii) the reasonable cost of three (3) round trip airfare trips for Executive's family from Connecticut to California during the same period as specified in (ii). In addition, during the period prior to his relocation (but in no event for more than one (1) year from the Effective Date), the Company shall provide a suitable apartment for Executive's use when he is at the Company's headquarters. The Company shall also reimburse Executive for the following reasonable costs: 9 (i) All reasonable transaction costs associated with Executive purchasing his new residence in the area of the Company's current headquarters, including, but not limited to, closing costs, inspections, title insurance, reasonable legal expenses (other than for any litigation) and statutory expenses; and (ii) All reasonable transaction costs associated with Executive selling his current principal residence, including, but not limited to, standard brokerage commissions, closing costs, legal expenses (other than for any litigation) and statutory fees, but not any costs of repairing, changing or decorating the residence prior to, or as a condition of, selling or any costs to pay off or bond any liens or judgments. In addition, the Company shall gross up for tax purposes any deemed income arising pursuant to the benefits provided under this Section 4(d), including this sentence, so that the economic benefit is the same as if such benefits were provided on a non-taxable basis. Such gross up shall be in accordance with Section 19 hereof. 5. Stock Options. On November 6, 1996, the Compensation Committee of the Board (the "Compensation Committee") granted Executive non-qualified options to purchase 1,000,000 10 shares of Company common stock at an exercise price of $11.00 per share, pursuant and subject to the Company's 1994 Flexible Stock Incentive Plan (the "Plan"), provided that options to purchase 250,000 shares of such common stock were conditioned on shareholder approval of an amendment to the Plan, adopted at the Board meeting held on November 6, 1996, increasing the number of shares permitted to be issued under the Plan and the number permitted to be issued to any individual. The terms of the Options, which will be set forth in an Option agreement, substantially in the form as set forth in the Option agreement, annexed as Exhibit A hereto (as specifically modified by this Section 5), include that the Options (i) shall fully vest upon the occurrence of a Change in Control of the Company (as such term is currently defined in the Plan), (ii) shall be for a maximum ten (10) year term, and (iii) shall vest and become exercisable ratably over a five (5) year period on the last day of each month during such period, if the Executive is employed on each vesting date, provided that the initial twenty percent (20%) of the Options shall not vest and be exercisable until the first anniversary of the grant. In addition, the Options will provide that in the event of a termination of Executive's employment (i) prior to the second anniversary of the Effective Date without Cause or for Good Reason, or (ii) as a result of 11 the Executive's death or Disability, in addition to any Options which are already vested and exercisable, the Executive's Options shall vest, and become immediately exercisable for a period of three (3) months after such termination (except in the case of a death or Disability termination, in which case, the period will be one (1) year), but in no event beyond the original Option term, with respect to 200,000 Options, or in the case of Disability, 100,000 Options. Upon any other termination, the periods of exercise are those set forth in the annexed form agreement. 6. Relocation Loan; etc. (a) In connection with the transfer of Executive's principal place of employment to California from Connecticut, the Company shall provide Executive with a five (5) year interest-free mortgage loan in the amount of up to $2,400,000 for purposes of Executive's acquisition of a new principal residence (the "Loan"). The Loan shall not be for more than the purchase price of the residence and shall promptly be reduced to $2,000,000 upon sale by Executive of his residence in Connecticut (or, if Executive does not sell such residence, within two (2) years after the making of the Loan). The Loan shall be subject to, and governed by, the terms and conditions of a loan agreement and mortgage between the Executive and the 12 Company, which the parties shall enter into at the time the Executive purchases the new residence. The Company shall retain a first mortgage security interest in the residence during the term of the Loan. The Loan is intended to satisfy the requirements of Temporary Treasury Regulation Section 1.7872-5T(c)(1) and the parties hereto agree to execute such documents as are necessary to comply therewith. (b) In the event the Original Employment Term is renewed, (i) the Loan, which shall be evidenced by a promissory note, shall be converted to, or substituted with, an interest-bearing loan (secured by the first mortgage) with a thirty (30) year amortization schedule and with a rate of interest equal to the lesser of (i) the rate then charged by Bank of America for similar mortgages, or (ii) the lesser of (A) eight percent (8%), or (B) the percentage equal to the number determined by dividing the difference between the sum of Executive's then current Base Salary and minimum annual bonus less $400,000 by $10,000 (provided that if originally (B) is the lower amount, as (B) increases a new calculation under (ii) shall be made and the rate of interest adjusted accordingly. 13 (c) Notwithstanding anything else herein, the Loan shall become due and payable in full upon the earliest of (i) sale or other transfer of the residence securing the Loan, (ii) uncured breach of the term of the mortgage (which shall have normal commercial default provisions) or (iii) one hundred twenty (120) days after Executive commenced other substantially full-time employment or consulting. In addition, the Loan shall be promptly reduced by the after-tax amount of the bonus referred to in Section 3(d) hereof upon receipt by Executive of such bonus. (d) The Loan referred to in (a) above shall be forgiven in the Specified Amount (as defined below), and, to the extent the Specified Amount exceeds the outstanding balance of the Loan, the Company shall pay Executive such excess in the event (i) Executive is still employed at the end of the Original Employment Term, (ii) terminated theretofore for Good Reason, or (iii) is terminated theretofore by the Company without Cause. In the case of (i) the Specified Amount is the amount by which the Appraised Value of his residence secured by the mortgage at the end of the Original Employment Term is less than his purchase cost of the residence (or, if the residence costs more than $2.4 million, the relative percentage of the 14 difference based on the ratio of $2.4 million to the actual purchase price), but in no event more than $2,000,000. Appraisal shall be determined by an appraisal obtained from an appraiser mutually agreed upon by Executive and the Company (paid for by the Company) and, if they cannot agree on an appraiser, the average appraisal obtained from three (3) appraisers appointed by the AAA in accordance with its procedures (paid for by the Company). In the event of (ii) or (iii), the same terms shall apply, but the Appraisals shall occur at the time of termination and, if those Appraisals show a Specified Amount, another Appraisal shall occur at the time the Loan becomes due. If the second appraisal occurs and shows a Specified Amount, then the amount due shall be based on the lesser of the two Specified Amounts. If the first appraisal shows a difference, no payment shall be made, but Interest on the Loan thereafter shall be paid only on principal of the then remaining amount on the Loan less the aforesaid difference (subject to the limitation). In the event of termination of the Employment Term, the following provisions shall apply: (A) In the event of termination by the Company for Cause, the Loan shall become due and payable in full one (l) year after the termination, provided that, if such 15 termination is in the Original Employment Term, the Loan shall be converted to, or be substituted by, an Interest (as defined herein) bearing similarly secured loan, with quarterly amortization on a 30-year amortization basis during such one year period. (B) In the event of voluntary termination by the Executive other than for Good Reason or in the event of the Executive's death, the Loan shall become immediately due and payable in full. (C) In the event of termination for Disability, by the Company without Cause or by the Executive for Good Reason, the Loan shall become due and payable in full three (3) years after the Termination, provided that, if such Termination is in the Original Employment Term, the Loan shall be converted to, or be substituted by, an Interest bearing similarly secured loan, with quarterly payments of Interest (as defined herein) only. (e) During the Original Employment Term, the Company shall reimburse Executive's property taxes and reasonable home owner's insurance (building and furnishings only) including, without limitation, fire, flood, earthquake, and mudslide coverage for the new residence in the Palo Alto, California area (the "Residence Reimbursement"). The Residence 16 Reimbursement shall be made promptly upon presentation of invoices or notices of the amount due. The Residence Reimbursement shall not exceed $42,000 for any calendar year. Notwithstanding the foregoing, in the event Executive's employment is terminated by the Company for Cause or by the Executive without Good Reason, Executive will promptly refund to the Company the portion of any Residence Reimbursement received or made on behalf of expenses which are allocable to the period subsequent to the date of termination. The Residence Reimbursement (and the amounts payable under this sentence) shall be grossed up in such manner than the economic effect to Executive is the same as the Residence Reimbursement was provided to Executive on a nontaxable basis. The gross up shall be in accordance with Section 19 hereof. (f) Interest shall mean the lower of (i) the prevailing commercial mortgage rates of Bank of America, N.A. for mortgages of similar amounts, periods and terms, and (ii) eight (8%) percent per annum. 7. Child's Medical and Schooling Expenses. 17 Certain benefits as set forth below shall be conferred upon Executive with respect to Executive's child who is currently in a special program (the "Child"), provided Executive complies with the provisions of this Section 7. The Company agrees to pay for the Executive up to $60,000 per calendar year for COBRA coverage and supplemental medical and schooling expenses (until the earlier of the end of the Original Employment Term or the Child completing high school) incurred by the Child in a facility equivalent to the facility in which the Child is enrolled as of the Effective Date, provided Executive uses his best efforts to mitigate such expenses through any available programs (including governmental programs) or other medical coverage (including available spousal or COBRA coverage). The Executive will provide the Company with information and documentation to support such expenses consistent with the Company's requirements with respect to reporting and documentation of expenses. In addition, the Company shall gross-up for tax purposes any income arising pursuant to the benefits provided under this Section 7, including this sentence, so that the economic effect to Executive is the same as if such benefits were provided in a non-taxable basis. Such gross up shall be in accordance with Section 19 hereof. 18 8. Vacation. During the Employment Term, Executive shall be entitled to four (4) weeks paid vacation in each full calendar year (prorated for any partial year) to be taken at such times as mutually agreed by the Executive and the Chairman of the Board or the Board. Unused vacation in any calendar year shall be lost and not carried over from year to year. 9. Termination. (a) Executive's employment under this Agreement shall terminate prior to December 31, 2001 upon the occurrence of any of the following events: (i) Automatically on the date of Executive's death. (ii) Upon written notice by the Company to the Executive, if the Executive (as determined by the Board in good faith) fails to regularly perform the material duties hereunder by reason of mental or physical illness or incapacity for an aggregate period of more than 180 days during any 365 day period (a "Disability"), provided that, during the Employment Term prior to such termination, the Company's obligations hereunder shall be reduced by any payments being received by Executive under any long-term disability program. (iii) Upon written notice by the Company to the Executive for Cause. Cause shall mean (A) the Executive being convicted of (or pleading nolo contendere to) a felony (other than a traffic-related offense); (B) the barring of the Executive by any regulatory 19 authority from holding his positions or any limitations imposed on the Company by any regulatory agency if the Executive continued to hold his positions; (C) willful refusal by the Executive to attempt to properly perform his material obligations under this Agreement, or attempt to follow any direction of the Board consistent with this Agreement, which in either case is not remedied within ten (10) business days (with appropriate reasonable adjustment if Executive is at the time of notice away on vacation) after receipt by the Executive of written notice from the Company specifying the details thereof, provided the refusal to follow a direction shall not be Cause if the Executive in good faith believes that such direction is not legal and promptly notifies the Board in writing of such belief; (D) the Executive's willful misconduct or material gross negligence with regard to the business, assets or employees of the Company or its affiliated entities (including as willful misconduct, without limitation, the Executive's willful breach of any fiduciary duty he may owe to the Company or its affiliates under applicable law or this agreement but not de minimis personal use of Company assets or reasonable good faith expense account disputes), (E) the Executive's theft, dishonesty or fraud with regard to the Company or its affiliates which is intended to enrich the Executive or another person or entity but not de minimis personal use of Company assets or reasonable good faith expense account disputes, or (F) any other material breach by the Executive of this Agreement that remains uncured for twenty (20) days after written notice thereof is given to the Executive. During any period in which the Executive is charged with committing a crime covered by (A) above, the Company may suspend Executive from his titles, duties and authority herein pending resolution of his status under applicable law; such suspension shall be with pay for up to six (6) months and thereafter shall be without pay. 20 (iv) Immediately upon written notice to the Executive by the Company without Cause. A termination of this Agreement by virtue of the Company notifying Executive that the Agreement shall not automatically extend pursuant to Section 2 hereof shall constitute a termination of Executive by the Company other than for Cause as of the end of the Employment Term. (v) Upon the voluntary termination of the Executive without Good Reason upon thirty (30) days prior written notice to the Company (which the Company may, in its sole discretion, make effective earlier). A notice by Executive of non-renewal of the Employment Term shall be deemed a voluntary termination by Executive. (vi) Upon written notice by the Executive for Good Reason stating with specificity the details of the Good Reason, if the stated Good Reason is not cured within twenty (20) days of the giving of such notice. Any notice for Good Reason shall be given within ninety (90) days of the later of (i) the occurrence of the triggering event, or (ii) the date upon which Executive could be reasonably expected to know of such event. "Good Reason" shall mean (A) any material reduction in authority, duties or responsibilities (except temporarily in connection with a suspension as set forth in (iii) above or during any period of physical or mental illness); (B) any reduction, in Executive's title or level of reporting; (C) the relocation of the Executive to a facility or a location more than fifty (50) miles from the Executive's then 21 present location, without the Executive's written consent; or (D) any other material breach of any provision of this Agreement by the Company, including without limitation, a reduction by the Company in the Base Salary or minimum annual bonus of the Executive as in effect; immediately prior to such reduction. In addition, the Executive may terminate employment by written notice given to the Company within the thirty (30) day period following the first anniversary of a Change in Control of the Company (as currently defined in the Plan) and have such termination treated as a termination for Good Reason. (b) Upon such earlier termination of the Employment Term, the Executive shall be promptly paid any unpaid salary and accrued vacation through his date of termination, a prorated portion of his unpaid annual minimum bonus for the calendar year of his termination, reimbursed for any expenses incurred in connection with the business of the Company prior to his date of termination which he would be otherwise entitled to reimbursement for in accordance with the Company's policies on the reimbursement of business expenses, receive any benefits or fringes due under any benefit or fringe plan or arrangement in accordance with the terms of said plan or arrangement due for the period prior to such termination. In 22 addition, if the termination is pursuant to Section 9(a)(iv) or (a)(vi) above and prior to the Executive's sixty-fifth birthday, the Executive shall receive in full settlement of all amounts owed him, provided he signs a release running to the Company and its related entities and their respective officers, directors and employees of all claims, relating to his employment and termination thereof (other than any right to indemnification under the Company's Articles of Incorporation or By-Laws or the Indemnification Agreement annexed as Exhibit B hereto, which shall survive) in such form as reasonably requested by the Company, (i) twelve (12) monthly installments of severance pay each in an amount equal to the greater of $41,375 or one-twelfth of the then sum of his Base Salary and minimum annual bonus, subject to the offset of any amounts due under Section 6 hereof, and (ii) payment by the Company of the premiums for Executive's and his dependents' COBRA coverage for the Company's health insurance plan that generally applies to executives for the period in which Executive is receiving severance pursuant to (i) above or, if earlier, until Executive and his dependents cease to be eligible for such COBRA coverage. In addition, in the event Executive's employment is terminated prior to December 31, 2000 pursuant to Section 9(a)(iv) or 9(a)(vi), the Company shall pay, provided Executive (or, in 23 the case of his death, his executors) executes the release of claim described above, the special bonus in Section 3(d) hereof (subject to the same rights of offset as set forth therein). The Company's payment obligations under this Section 9(b) (other than those in the first sentence) shall immediately cease in the event Executive materially breaches any of his obligations under Sections 12, 13 or 14 of this Agreement. (c) If the Employment Term ends early pursuant to Section 9(a)(ii) hereof on account of Disability, and Executive executes the release of claim set forth in subsection (b) above, the Company shall pay to Executive monthly, until the second anniversary of the date of the termination for Disability, the amount of $27,750, less any payments to which Executive is entitled for such month under any disability benefit plan or the like sponsored, or contributed to, by the Company (including, without limitation, Social Security); provided, however, that in the event of Executive's death during the payment period, the Company shall not be obligated to pay any such amounts subsequent to the date of Executive's death. In addition, in the event Executive is terminated for Disability prior to December 31, 2000 and such Disability is a "Total and Permanent Disability" within the meaning of Section 72(m)(7) of the Internal 24 Revenue Code of 1986, as amended (the "Code"), the Company shall pay (subject to Executive's execution of the release of claim described in subsection (b) above and the right to offset as provided in Section 3(d)), the special bonus payable under Section 3(d) hereof. The Company's payment obligations under this Section 9(c) shall immediately cease in the event Executive materially breaches any of his obligations under Sections 12, 13 or 14 of this Agreement. After the end of such two (2) year period, Executive shall only be entitled to receive amounts as he may be entitled to under any disability policy specified in Section 4(c) hereof or otherwise sponsored by the Company. (d) If the Employment Term ends early pursuant to Section 9 hereof for any reason, except as expressly provided in this Section 9, Executive shall cease to have any rights to salary, bonus or benefits other than: (i) salary or bonus which has accrued but is unpaid as of the end of the Employment Term, and (ii) but only to the extent provided in any benefit or equity plan or arrangement in which Executive has participated as an employee of the Company, any benefits or rights which by their specific terms extend beyond termination of Executive's employment. 25 (e) All aforesaid amounts in this Section 9 shall be subject to required withholding. The Company and its affiliated entities shall have no other obligations to the Executive upon a termination except as specifically provided in this Agreement. 10. Special Tax Provision. (a) Anything in this Agreement to the contrary notwithstanding, in the event that any amount or benefit paid, payable, or to be paid, or distributed, distributable, or to be distributed to or with respect to Executive (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any person whose actions result in a change of ownership or effective control covered by Section 280G(b)(2) of the Code or any person affiliated with the Company or such person) as a result of a change in ownership or effective control of the Company or a direct or indirect parent (within the meaning of Section 280G of the Code) thereof (or the assets of any of the foregoing) covered by Code Section 280G(b)(2) (collectively, the "Covered Payments") is or becomes subject to the excise tax imposed by or under Section 4999 of the Code (or any similar tax that may hereafter be imposed), and/or any interest or penalties with respect to such excise tax (such excise tax, 26 together with such interest and penalties, is hereinafter collectively referred to as the "Excise Tax"), the Company shall pay to Executive an additional amount (the "Tax Reimbursement Payment") such that after payment by Executive of all taxes (including, without limitation, any interest or penalties and any Excise Tax imposed on or attributable to the Tax Reimbursement Payment itself), Executive retains an amount of the Tax Reimbursement Payment equal to the sum of (i) the amount of the Excise Tax imposed upon the Covered Payments, and (ii) without duplication, an amount equal to the product of (A) any deductions disallowed for federal, state or local income tax purposes because of the inclusion of the Tax Reimbursement Payment in Executive's adjusted gross income, and (B) the highest applicable marginal rate of federal, state or local income taxation, respectively, for the calendar year in which the Tax Reimbursement Payment is made or is to be made. The intent of this Section 10 is that after Executive pays federal, state and local income tax and any payroll taxes, Executive will be in the same position as if Executive were not subject to the Excise Tax under Section 4999 of the Code and did not receive the extra payments pursuant to this Section 10 and this Section 10 shall be interpreted accordingly. 27 (b) Except as otherwise provided in Section 10(a), for purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax, such Covered Payments will be treated as "parachute payments" (within the meaning of Section 280G(b)(2) of the Code) and such payments in excess of the Code Section 280G(b)(3) "base amount" shall be treated as subject to the Excise Tax, unless, and except to the extent that, the Company's independent certified public accountants appointed prior to the change in ownership covered by Code Section 280G(b)(2) or legal counsel (reasonably acceptable to Executive) appointed by such public accountants (or, if the public accountants decline such appointment and decline appointing such legal counsel, such independent certified public accountants as promptly mutually agreed on in good faith by the Company and Executive) (the "Accountant"), deliver a written opinion to Executive, reasonably satisfactory to Executive's legal counsel, that, in the event such reporting position is contested by the Internal Revenue Service, there will be a more likely than not chance of success with respect to a claim that the Covered Payments (in whole or in part) do not constitute "parachute payments," represent reasonable compensation for services actually rendered (within the meaning of Section 28 280G(b)(4) of the Code) in excess of the "base amount" allocable to such reasonable compensation, or such "parachute payments" are otherwise not subject to such Excise Tax (with appropriate legal authority, detailed analysis and explanation provided therein by the Accountant); and the value of any Covered Payments which are non-cash benefits or deferred payments or benefits shall be determined by the Accountant in accordance with the principles of Section 280G of the Code. (c) For purposes of determining the amount of the Tax Reimbursement Payment, Executive shall be deemed: to pay federal, state and/or local income taxes at the highest applicable marginal rate of income taxation for the calendar year in which the Tax Reimbursement Payment is made or is to be made, and to have otherwise allowable deductions for federal, state and local income tax purposes at least equal to those disallowed due to the inclusion of the Tax Reimbursement Payment in Executive's adjusted gross income. (d)(i)(A) In the event that prior to the time Executive has filed any of Executive's tax returns for the calendar year in which the change in ownership event covered by Code Section 280G(b)(2) occurred, the Accountant determines, for any reason whatsoever, the 29 correct amount of the Tax Reimbursement Payment to be less than the amount determined at the time the Tax Reimbursement Payment was made, Executive shall repay to the Company, at the time that the amount of such reduction in Tax Reimbursement Payment is determined by the Accountant, the portion of the prior Tax Reimbursement Payment attributable to such reduction (including the portion of the Tax Reimbursement Payment attributable to the Excise Tax and federal, state and local income tax imposed on the portion of the Tax Reimbursement Payment being repaid by Executive, using the assumptions and methodology utilized to calculate the Tax Reimbursement Payment (unless manifestly erroneous)), plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. (B) In the event that the determination set forth in (A) above is made by the Accountant after the filing by Executive of any of Executive's tax returns for the calendar year in which the change in ownership event covered by Code Section 280G(b)(2) occurred but prior to one (1) year after the occurrence of such change in ownership, Executive shall file at the request of the Company an amended tax return in accordance with the Accountant's determination, but no portion of the Tax Reimbursement Payment shall be required 30 to be refunded to the Company until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed the interest received or credited to Executive by such tax authority for the period it held such portion (less any tax Executive must pay on such interest and which Executive is unable to deduct as a result of payment of the refund). (C) In the event Executive receives a refund pursuant to (B) above and repays such amount to the Company, Executive shall thereafter file for any refunds or credits that may be due to Executive by reason of the repayments to the Company. Executive and the Company shall mutually agree upon the course of action, if any, to be pursued (which shall be at the expense of the Company) if Executive's claim for such refund or credit is denied. (ii) In the event that the Excise Tax is later determined by the Accountant or the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalties payable with respect to such excess) once the amount of such excess is finally determined. (iii) In the event of any controversy with the Internal Revenue Service (or other taxing authority) under this Section 10, subject to the second sentence of 31 subpart (i)(C) above, Executive shall permit the Company to control issues related to this Section 10 (at its expense), provided that such issues do not potentially materially adversely affect Executive, but Executive shall control any other issues. In the event the issues are interrelated, Executive and the Company shall in good faith cooperate so as not to jeopardize resolution of either issue, but if the parties cannot agree Executive shall make the final determination with regard to the issues. In the event of any conference with any taxing authority as to the Excise Tax or associated income taxes, Executive shall permit the representative of the Company to accompany Executive, and Executive and his representative shall cooperate with the Company and its representative. (iv) With regard to any initial filing for a refund or any other action required pursuant to this Section 10 (other than by mutual agreement) or, if not required, agreed to by the Company and Executive, Executive shall cooperate fully with the Company, provided that the foregoing shall not apply to actions that are provided herein to be at Executive's sole discretion. (e) The Tax Reimbursement Payment, or any portion thereof, payable by the Company shall be paid not later than the fifth day following the determination by the Accountant, and any payment made after such fifth day shall bear interest at the rate provided in Code Section 1274(b)(2)(B). The Company shall use its best efforts to cause the Accountant to 32 promptly deliver the initial determination required hereunder and, if not delivered, within ninety (90) days after the change in ownership event covered by Section 280G(b)(2) of the Code, the Company shall pay Executive the Tax Reimbursement Payment set forth in an opinion from counsel recognized as knowledgeable in the relevant areas selected by Executive, and reasonably acceptable to the Company, within five (5) days after delivery of such opinion. In accordance with Section 9(e), the Company may withhold from the Tax Reimbursement Payment and deposit into applicable taxing authorities such amounts as they are required to withhold by applicable law. To the extent that Executive is required to pay estimated or other taxes on amounts received by Executive beyond any withheld amounts, Executive shall promptly make such payments. The amount of such payment shall be subject to later adjustment in accordance with the determination of the Accountant as provided herein. (f) The Company shall be responsible for (i) all charges of the Accountant, (ii) if (e) is applicable, the reasonable charges for the opinion given by Executive's counsel, and (iii) all reasonable charges in connection with the preparation and filing of any amended tax returns on behalf of the Executive requested by the Company, required hereunder, 33 or required by applicable law. The Company shall gross-up for tax purposes any income to Executive arising pursuant to this subsection (f) so that the economic effect to Executive is the same as if the benefits were provided on a non-taxable basis. Such gross-up shall be in accordance with Section 19 hereof. (g) Executive and the Company shall mutually agree on and promulgate further guidelines in accordance with this Section 10 to the extent, if any, necessary to effect the reversal of excessive or shortfall Tax Reimbursement Payments. The foregoing shall not in any way be inconsistent with Section 10(d)(i)(C) hereof. 11. No Duty to Mitigate/Set-Off. The Company's obligation to make payments provided under Section 9 of this Agreement, other than as specifically set forth in this Agreement, shall not be affected by any set-off, counterclaim, recoupment, defense, or other claim, right or action which the Company may have against the Executive or others. The Company agrees that if Executive's employment with the Company is terminated during the Employment Term, Executive shall not be required to seek other employment or to attempt in any way to reduce any amounts payable to Executive by 34 the Company pursuant to this Agreement. Further, the amount of any payment or benefit provided for in this Agreement shall not be reduced by any compensation earned by Executive or benefit provided to Executive as the result of employment by another employer or otherwise. Any amounts due under Section 9 are inclusive, and in lieu of, any amounts payable under any other salary continuation or cash severance arrangement of the Company and to the extent paid or provided under any other such arrangement shall be offset from the amount due under Section 9. 12. Inventions and Other Intellectual Property. The Company and Executive agree to promptly execute the Proprietary Information and Invention Agreement, annexed as Exhibit C hereto. 13. Confidential Information. Executive acknowledges that the information, observations and data obtained by him while employed by the Company pursuant to this Agreement concerning the business or affairs of the Company or any of its subsidiaries or affiliates or any predecessor thereof ("Confidential Information") are the property of the Company or such subsidiary or affiliate. 35 Executive agrees that he shall not disclose to any unauthorized person or use for his own account any Confidential Information without the prior written consent of the Chairman of the Board or the Board unless and except to the extent that the aforementioned matters become generally known to and available for use by the public other than as a result of Executive's acts or omissions to act or, while employed, he discloses based on his good faith determination that to do so is in the best interests of the Company. If Executive receives legal process, he may comply with it provided he promptly notifies the Company and cooperates with the Company in obtaining a protective order. Executive shall deliver to the Company at the termination of the Employment Term, or at any other time the Company may request, all memoranda, notes, plans, records, reports, computer tapes and software and other documents and data (and copies thereof) relating to the Confidential Information, the Work Product or the business of the Company or any of its subsidiaries or affiliates which he may then possess or have under his control. 14. Non-Compete, Non-Solicitation. (a) Executive acknowledges that in the course of his employment with the Company pursuant to this Agreement he will become familiar with trade secrets of and other 36 Confidential Information concerning the Company and its subsidiaries and affiliates and predecessors thereof and that his services will be of special, unique and extraordinary value to the Company. (b) During the Employment Term and for two (2) years thereafter, Executive shall not enter into Competition with the Company or its affiliates to the extent such Competition requires Executive to divulge, disclose or communicate to any third party any Company "trade secret" as that term is defined under California law. For purposes of this Agreement, Competition shall mean participating, directly or indirectly, as an individual proprietor, partner, stockholder, officer, employee, director, joint venturer, investor, lender, consultant or in any capacity whatsoever (within the United States or in any foreign country where the Company or its affiliates do business) in a business in competition with any business conducted by the Company or its affiliates with regard to which Executive worked or otherwise had responsibilities or had access to material Confidential Information while employed by the Company or its affiliates; provided, however, that such participation shall not include (i) the mere ownership of not more than two percent (2%) of the total outstanding stock of a publicly 37 held company, (ii) the performance of services for any enterprise to the extent such services are not performed, directly or indirectly, for a business in the aforesaid competition, (iii) any activity engaged in with the prior written approval of the Chairman of the Board, or (iv) Executive's employment by a non Competitive division (or other business unit) of a company which is in Competition with the Company so long as Executive is not involved with the competitive division (or other business unit). Notwithstanding anything else in this Section 14(b) to the contrary, subsequent to the termination of Executive's employment hereunder, Executive may, in his sole discretion, passively invest in any entity, provided Executive does not divulge, disclose or communicate any Company "trade secrets" or Confidential Information to such company or its affiliates, employees, officers, consultants, directors, lenders, or investors and further provided Executive does not render services to such company in violation of this Section 14 or otherwise violates this Section 14 (other than by making such passive investments). (c) During the Employment Term and for two (2) years thereafter, Executive shall not directly or indirectly solicit for Competitive products or induce any customer of the Company or its affiliates to terminate, or otherwise to cease, reduce, or diminish in any 38 way its relationship with the Company or its affiliates. (d) During the Employment Term and the one (1) year thereafter, Executive shall not recruit, solicit or induce any nonclerical employees of the Company or its affiliates to terminate their employment with, or otherwise cease their relationship with, the Company or its affiliates or hire or assist another person or entity to hire any nonclerical employee of the Company or its affiliates or any person who within six (6) months before had been a nonclerical employee of the Company or any of its affiliates. Notwithstanding the foregoing, if requested by any entity with which Executive is not affiliated, Executive may serve as a reference for any person who at the time of the request is not an employee of the Company or any of its affiliates. (e) If, at the time of enforcement of this Section 14, a court holds that the restrictions stated herein are unreasonable under circumstances then existing, the parties hereto agree that the maximum period, scope or geographical area reasonable under such circumstances shall be substituted for the stated period, scope or area and that the court shall be allowed to revise the restrictions contained herein to cover the maximum period, scope and area 39 permitted by law. 15. Enforcement. Because Executive's services are unique and because Executive has access to Confidential Information and intellectual properties of the Company and its affiliates, the parties hereto agree that money damages would be an inadequate remedy for any breach of this Agreement. Therefore, in the event a breach or threatened breach of this Agreement, the Company or its successors or assigns may, in addition to other rights and remedies existing in their favor, apply to any court of competent jurisdiction for specific performance and/or injunctive or other relief in order to enforce, or prevent any violations of, the provisions hereof (without posting a bond or other security). 16. Indemnification. Executive shall be entitled to be indemnified for his activities as an officer or director to the full extent provided in the Articles of Incorporation and By-Laws of the Company and in accordance with the Indemnification Agreement annexed as Exhibit B hereto, which the Company and Executive agree to promptly execute. In addition, the Company shall cover 40 Executive under Directors and Officers Liability Insurance both during and, for six (6) years after, the Employment Term in the same amount and to the same extent as the Company covers its other officers and directors. 17. Executive Representations. Executive represents and warrants to the Company that (i) the execution, delivery and performance of this Agreement by Executive does not and will not conflict with, breach, violate or cause a default under any contract, agreement, instrument, order, judgment or decree to which Executive is a party or by which he is bound, (ii) except with respect to agreements which have been furnished to the Company and relate primarily to confidentiality, intellectual properties and/or ethical conduct entered into between Executive and IBM or between Executive and other entities in the course of his employment with IBM, Executive is not a party to or bound by any employment agreement, change in control agreement, non-compete agreement or confidentiality agreement with any other person or entity, (iii) upon the execution and delivery of this Agreement by the Company, this Agreement shall be the valid and binding obligation of Executive, enforceable in accordance with its terms, (iv) Executive is a United States citizen or a 41 resident alien thereof entitled to work therein, and (v) Executive will in performing his duties not utilize any confidential information of any other person or entity. 18. Entire Agreement; Modification. This Agreement constitutes the full and complete understanding of the parties hereto and will supersede all prior agreements and understandings, oral or written, with respect to the subject matter hereof. Each party to this Agreement acknowledges that no representations, inducements, promises or agreements, oral or otherwise, have been made by either party, or anyone acting on behalf of either party, which are not embodied herein and that no other agreement, statement or promise not contained in this Agreement shall be valid or binding. This Agreement may not be modified or amended except by an instrument in writing signed by the party against whom or which enforcement may be sought. 19. Gross Ups. All gross ups hereunder shall be determined by agreement of the Company's, and Executive's accountants. The Executive shall provide the Company's accountants with such information as they reasonably request in order to make the necessary determination as to 42 Executive's tax rates and the deductibility of various items. In calculating the gross up, the Company's gross up items when combined with Executive's other deductions shall receive the most favored treatment and the Company shall get the full benefits of any deductions available. If Executive voluntarily terminates employment without Good Reason or is terminated with Cause, any lost tax deduction on any gross up item shall be treated as if such termination did not occur. Gross ups shall be paid as soon as reasonably possible after payment of the respective item (and shall generally be withheld and paid to the applicable taxing authorities), subject to adjustment at year end (including, if applicable, repayment). 20. Survival. The provisions of this agreement which by their terms imply continuation beyond the end of the Employment Term shall survive notwithstanding any termination of the Employment Term. 21. Severability. Any term or provision of this Agreement which is invalid or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity or 43 unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms of provisions of this Agreement in any other jurisdiction. 22. Waiver of Breach. The waiver by any party of a breach of any provisions of this Agreement, which waiver must be in writing to be effective, shall not operate as or be construed as a waiver of any subsequent breach. 23. Notices. All notices hereunder shall be in writing and shall be deemed to have been duly given when delivered by hand, or one (1) day after sending by express mail or other "overnight mail service," or three (3) days after sending by certified or registered mail, postage prepaid, return receipt requested. Notice shall be sent as follows: if to Executive, to the address as listed in the Company's records, and if to the Company, to the Company at the address set forth on the first page of this Agreement, attention of the Chairman of the Board. Either party may change the notice address by notice given as aforesaid. 44 24. Assignability; Binding Effect. This Agreement shall be binding upon and inure to the benefit of Executive and Executive's legal representatives, heirs and distributees, and shall be binding upon and inure to the benefit of the Company, its successors and assigns. This Agreement may not be assigned by the Executive. This Agreement may not be assigned by the Company, except in connection with a merger or a sale by the Company of all or substantially all of its assets and then only provided the assignee specifically assumes in writing all of the Company's obligations hereunder. 25. Legal Fee Reimbursement. The Company agrees to pay Executive's reasonable legal fees associated with entering into this Agreement up to $10,000 upon presentation of an invoice and time sheets for such legal services. 26. Governing Law. All issues pertaining to the validity, construction, execution and performance of this Agreement shall be construed and governed in accordance with the laws of the State of California, without giving effect to the conflict or choice of law provisions thereof. 45 27. Headings. The headings in this Agreement are intended solely for convenience or reference and shall be given no effect in the construction or interpretation of this Agreement. 28. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the Company has caused this Agreement to be duly executed and Executive has hereunto set his hand as of the date first set forth above. CYLINK CORPORATION By: _________________________ Name: Title: ________________________________ Fernand Sarrat 46 EXHIBIT A CYLINK CORPORATION NONQUALIFIED STOCK OPTION AGREEMENT This Agreement is made as of November 6, 1996, between CYLINK CORPORATION, a California corporation (the "Company"), and Fernand Sarrat ("Optionee"). WITNESSETH: WHEREAS, the Company has adopted its 1994 Flexible Stock Incentive Plan (the "Plan"), which Plan is incorporated in this Agreement by reference and made a part of it; and WHEREAS, the Company regards Optionee as a valuable employee of or service provider to the Company, and has determined that it would be to the advantage and in the interests of the Company and its shareholders to grant the options provided for in this Agreement to Optionee as an inducement to remain in the employ or service of the Company and as an incentive for increased efforts during such employment or service; NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth, the parties to this Agreement hereby agree as follows: 1. Option Grant. The Company hereby grants to Optionee the right and option to purchase from the Company on the terms and conditions hereinafter set forth, all or any part of an aggregate of 1,000,000 shares of the Company's Common Stock, $0.01 par value (the "Stock"). This option is not intended to satisfy the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code") and qualify as an incentive stock option. All of the terms and conditions of this Option Grant are subject to Optionee's Employment Agreement dated November 6, 1996 (the "Employment Agreement"), and in the event of any conflict between Optionee's Employment Agreement and this Option Grant, the terms of the Employment Agreement shall prevail. 2. Option Price. The per share purchase price of the Stock subject to this option shall be $11.00, which price is not less than one hundred percent (100%) of the per share fair market value of such Stock as of the Grant Date (defined below) as determined by the Board of Directors of the Company or a Committee designated by it (the "Committee"). The term "Option Price" as used in this agreement refers to the per share purchase price of the Stock subject to this option. 1 3. Option Period. This option shall be exercisable only during the Option Period, and during such Option Period, the exercisability of the option shall be subject to the limitations of paragraph 4 and the vesting provisions of paragraph 5. The Option Period shall commence on November 6, 1996 (the "Grant Date") and except as provided in paragraph 4, shall terminate ten (10) years from the Grant Date (the "Termination Date"). 4. Limits on Option Period. The Option Period may end before the Termination Date, as follows: (a) If Optionee ceases to be a bona fide employee of or service provider to the Company or an Affiliate (as defined in the Plan) for any reason other than disability (within the meaning of subparagraph (c)) or death during the Option Period, unless otherwise determined by the Committee, (i) the Option Period shall terminate three (3) months after the date of such cessation of employment or service or on the Termination Date, whichever shall first occur, and (ii) the option shall be exercisable only to the extent exercisable under paragraph 5 on the date of Optionee's cessation of employment or service and shall thereafter cease to be exercisable. (b) If Optionee dies while in the employ of or service to the Company or an Affiliate, unless otherwise determined by the Committee, (i) the Option Period shall end one (1) year after the date of death or on the Termination Date, whichever shall first occur, and (ii) Optionee's executor or administrator or the person or persons to whom Optionee's rights under this option shall pass by will or by the applicable laws of descent and distribution may exercise this option only to the extent exercisable under paragraph 5 on the date of Optionee's death. (c) If Optionee's employment or service is terminated by reason of medically determinable disability, unless otherwise determined by the Committee, (i) the Option Period shall end one (1) year after the date of Optionee's cessation of employment or service or on the Termination Date, whichever shall first occur, and (ii) the option shall be exercisable only to the extent exercisable under paragraph 5 on the date of Optionee's cessation of employment or service. (d) If Optionee is on a leave of absence from the Company or an Affiliate because of Optionee's disability, or for the purpose of serving the government of the country in which the principal place of employment of Optionee is located, either in a military or civilian capacity, or for such other purpose or reason as the Committee may approve, Optionee shall not be deemed during the period of such absence, by virtue of such absence alone, to have terminated employment or service with the Company or an Affiliate except as the Committee may otherwise expressly provide. 5. Vesting of Right to Exercise Options. Subject to the terms of the Employment Agreement, and any limitations contained in this Agreement, the Optionee shall 2 have the right to exercise the options granted hereunder as to 1.666% of the number of shares of Stock covered by the option per month for each month following the Grant Date, such that the option shall be fully exercisable five (5) years after the Grant Date. Provided, however, that the Optionee shall not have the right to exercise any options unless and until the Optionee remains in the Company's employment for a period of one year from the date the Optionee commences his employment by the Company. (a) Any portion of the option that is not exercised shall accumulate and may be exercised at any time during the Option Period prior to the Termination Date. No partial exercise of this option may be for less than five percent (5%) of the total number of shares of Stock then available under this option. In no event shall the Company be required to issue fractional shares. 6. Method of Exercise. Optionee may exercise this option with respect to all or any part of the shares of Stock then subject to such exercise as follows: (a) By giving the Company written notice of such exercise, specifying the number of such shares of Stock as to which this option is exercised. Such notice shall be accompanied by an amount equal to the Option Price of such shares, in the form of any one or combination of the following: cash, a certified check, bank draft, postal or express money order payable to the order of the Company in lawful money of the United States. The Committee, at its sole discretion, may also permit Optionee to pay the Option Price with shares of Stock valued at fair market value, a promissory note of the Optionee or in any combination of the foregoing. The shares of Stock shall be valued in accordance with procedures established by the Committee. Any note used to exercise this option shall be a full recourse, interest-bearing obligation containing such terms as the Committee shall determine. If a promissory note is used, the Optionee agrees to execute such further documents as the Committee may deem necessary or appropriate in connection with issuing the note, perfecting a security interest in the Stock purchased with the note, and any related terms or conditions that the Committee may propose. Such further documents may include, not by way of limitation, a security agreement, an escrow agreement, a voting trust agreement and an assignment separate from certificate. In the event that the exercise price is satisfied by the Committee retaining from the shares of Stock otherwise to be issued to Optionee shares of Stock having a value equal to the exercise price, the Committee may issue Optionee an additional option, with terms identical to this option agreement, entitling Optionee to purchase additional Stock in an amount equal to the number of shares of Stock so retained. (b) Optionee shall be required, as a condition precedent to acquiring Stock through exercise of the option, to execute one or more agreements relating to obligations in connection with ownership of the Stock or restrictions on transfer of the Stock no less restrictive than the obligations and restrictions to which the other shareholders of the Company are subject at the time of such exercise. (c) If required by the Committee, Optionee shall give the Company satisfactory assurance in writing, signed by Optionee or Optionee's legal representative, as the 3 case may be, that such shares are being purchased for investment and not with a view to the distribution thereof; provided, however, that such assurance shall be deemed inapplicable to (1) any sale of such shares by such Optionee made in accordance with the terms of a registration statement covering such sale, which may hereafter be filed and become effective under the Securities Act of 1933, as amended (the "Securities Act"), and with respect to which no stop order suspending the effectiveness thereof has been issued, and (2) any other sale of such shares with respect to which in the opinion of counsel for the Company, such assurance is not required to be given in order to comply with the provisions of the Securities Act. As soon as practicable after receipt of the notice required in paragraph 6(a) and satisfaction of the conditions set forth in paragraphs 6(b) and 6(c), the Company shall, without transfer or issue tax and without other incidental expense to Optionee, deliver to Optionee at the office of the Company, at 910 Hermosa Court, Sunnyvale, California 94086, attention of the Secretary, or such other place as may be mutually acceptable to the Company and Optionee, a certificate or certificates of such shares of Stock; provided, however, that the time of such delivery may be postponed by the Company for such period as may be required for it with reasonable diligence to comply with applicable registration requirements under the Securities Act, the Securities Exchange Act of 1934, as amended, any applicable listing requirements of any national securities exchange or the Nasdaq Stock Market, and requirements under any other law or regulation applicable to the issuance or transfer of such shares. 7. Corporate Transactions. (a) If there should be any change in a class of Stock subject to this option, through merger, consolidation, reorganization, recapitalization, reincorporation, stock split, stock dividend (in excess of two percent (2%)) or other change in the corporate structure of the Company, the Company may make appropriate adjustments in order to preserve, but not to increase, the benefits to Optionee, including adjustments in the number of shares of such Stock subject to this option and in the per share purchase price thereof. Any adjustment made pursuant to this paragraph 7 as a consequence of a change in the corporate structure of the Company shall not entitle Optionee to acquire a number of shares of such Stock of the Company or shares of stock of any successor company greater than the number of shares Optionee would receive if, prior to such change, Optionee had actually held a number of shares of such Stock equal to the number of shares subject to this option. (b) For purposes of this paragraph 7, a "Corporate Transaction" shall include any of the following shareholder-approved transactions to which the Company is a party: (i) a merger or consolidation in which the Company is not the surviving entity, except for a transaction the principal purpose of which is to change the state of the Company's incorporation; (ii) the sale, transfer or other disposition of all or substantially all of the assets of the Company in liquidation or dissolution of the Company; or 4 (iii) any reverse merger in which the Company is the surviving entity but in which securities possessing more than fifty percent (50%) of the total combined voting power of the Company's outstanding securities are transferred to a holder or holders different from those who held such securities immediately prior to such merger. (c) In the event of any Corporate Transaction, this option shall terminate as of the closing of the Corporate Transaction to the extent unexercised; provided, however, that notwithstanding the terms of this option, the surviving or acquiring corporation or its parent company may assume the outstanding option, or issue in place hereof options providing substantially equal value and having substantially equivalent provisions as this option. 8. Limitations on Transfer. This option shall, during Optionee's lifetime, be exercisable only by Optionee, and neither this option nor any right hereunder shall be transferable by Optionee by operation of law or otherwise other than by will or the laws of descent and distribution. In the event of any attempt by Optionee to alienate, assign, pledge, hypothecate, or otherwise dispose of this option or of any right hereunder, except as provided for in this Agreement, or in the event of the levy of any attachment, execution, or similar process upon the rights or interest hereby conferred, the Company at its election may terminate this option by notice to Optionee and this option shall thereupon become null and void. 9. No Shareholder Rights. Neither Optionee nor any person entitled to exercise Optionee's rights in the event of his death shall have any of the rights of a shareholder with respect to the shares of Stock subject to this option except to the extent the certificates for such shares shall have been issued upon the exercise of this option. 10. NO EFFECT ON TERMS OF EMPLOYMENT. SUBJECT TO THE TERMS OF ANY WRITTEN EMPLOYMENT CONTRACT TO THE CONTRARY, THE COMPANY (OR ITS AFFILIATE WHICH EMPLOYS OPTIONEE) SHALL HAVE THE RIGHT TO TERMINATE OR CHANGE THE TERMS OF EMPLOYMENT OF OPTIONEE AT ANY TIME AND FOR ANY REASON WHATSOEVER, WITH OR WITHOUT CAUSE. 11. Notice. Any notice required to be given under the terms of this Agreement shall be addressed to the Company in care of its Secretary at the Office of the Company set forth in Section 6 hereof, and any notice to be given to Optionee shall be addressed to Optionee at the address given by Optionee beneath Optionee's signature to this Agreement, or such other address as either party to this Agreement may hereafter designate in writing to the other. Any such notice shall be deemed to have been duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid, registered or certified and deposited (postage or registration or certification fee prepaid) in a post office or branch post office regularly maintained by the United States. 12. Lock-Up Agreement. Optionee, if requested by the Company and an underwriter of Common Stock or other securities of the Company, agrees not to sell or otherwise 5 transfer or dispose of any Common Stock of the Company held by the Optionee (except Common Stock included in such registration) during the 180 day period following the effective date of a registration statement of the Company filed under the Securities Act, or such shorter period of time as the underwriter shall require. The Company may impose stop-transfer instructions with respect to such Common Stock subject to the foregoing restriction until the end of said period. 13. Committee Decisions Conclusive. All decisions of the Committee upon any question arising under the Plan or under this Agreement shall be conclusive. 14. Successors. This Agreement shall be binding upon and inure to the benefit of any successor or successors of the Company. Where the context permits, "Optionee" as used in this Agreement shall include Optionee's spouse, executor, administrator or other legal representative or the person or persons to whom Optionee's rights pass by will or the applicable laws of descent and distribution. 15. Withholding. Optionee agrees to withholding of shares from exercise for satisfaction of any applicable federal, state or local income tax or employment tax withholding requirements. The Committee may issue Optionee an additional option, with terms identical to this option agreement, entitling Optionee to purchase additional Stock in an amount equal to the number of shares so retained. 16. California Law. The interpretation, performance and enforcement of this Agreement shall be governed by the laws of the State of California. IN WITNESS WHEREOF, the Company and Optionee have executed this Agreement as of the day and year first above written. CYLINK CORPORATION GRANTEE By: ------------------------------------- ------------------------------------- Robert B. Fougner Title: Corporate Secretary ---------------------------------- 6 Address: ------------------------- ---------------------------------- ---------------------------------- 7 EXHIBIT B INDEMNIFICATION AGREEMENT THIS AGREEMENT is entered into, effective as of 11/6, 1996 by and between CYLINK CORPORATION, California corporation (the "Company"), and Fernand Sarrat ("Indemnitee"). WHEREAS, it is essential to the Company to retain and attract as directors and officers the most capable person available; WHEREAS, Indemnitee is a director and/or officer of the Company; WHEREAS, both the Company and Indemnitee recognize the increased risk of litigation and other claims currently being asserted against directors and officers of corporations; and WHEREAS, in recognition of Indemnitee's need for substantial protection against personal liability in order to enhance Indemnitee's continued and effective service to the Company, and in order to induce Indemnitee to provide services to the Company as a director and/or officer, the Company wishes to provide in this Agreement for the indemnification of and the advancing of expenses to Indemnitee to the fullest extent (whether partial or complete) permitted by California law and as set forth in this Agreement, and, to the extent insurance is maintained, for the coverage of Indemnitee under the Company's directors' and officers' liability insurance policies. NOW, THEREFORE, in consideration of the above premises and of Indemnitee's continuing to serve the Company directly or, at its request, with another enterprise, and intending to be legally bound hereby, the parties agree as follows: 1. Certain Definitions: (a) Board: the Board of Directors of the Company. (b) Change in Control: shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Act")), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company or a corporation owned directly or indirectly by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company, is or becomes the "Beneficial Owner" (as defined in Rule 13d-3 under the Act), directly or indirectly, of securities of the Company representing 30% or more of the total voting power represented by the Company's then outstanding Voting Securities, or (ii) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board and any new director whose election by the Board or nomination for election by the Company's shareholders was approved by a vote of at least two-thirds (2/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority of the Board, or, or (iii) the shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation that would result in the Voting Securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into Voting Securities of the surviving entity) at least 80% of the total voting power represented by the Voting Securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (iv) the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company (in one transaction or a series of transaction) of all or substantially all of the Company's assets. (c) Expenses: any expense, liability, or loss, including attorneys' fees, judgments, fines, ERISA excise taxes and penalties, amounts paid or to be paid in settlement, any interest, assessments, or other charges imposed thereon, and any federal, state, local, or foreign taxes imposed as a result of the accrual or deemed receipt of any payments under this Agreement, paid or incurred in connection with investigating, defending, being a witness in, or participating in (including on appeal), or preparing for any of the foregoing in, any Proceeding relating to any Indemnifiable Event. (d) Indemnifiable Event: any event or occurrence that takes place either prior to or after the execution of this Agreement, related to the fact that Indemnitee is or was a director or an officer of the Company, or while a director or officer is or was serving at the request of the Company as a director, officer, employee, trustee, agent, or fiduciary of another foreign or domestic corporation, partnership, joint venture, employee benefit plan, trust, or other enterprise, or was a director, officer, employee, or agent of a foreign or domestic corporation that was a predecessor corporation of the Company or of another enterprise at the request of such predecessor corporation, or related to anything done or not done by Indemnitee in any such capacity, whether or not the basis of the Proceeding is alleged action in an official capacity as a director, officer, employee, or agent or in any other capacity while serving as a director, officer, employee, or agent of the Company, as described above. (e) Independent Counsel: the person or body appointed in connection with Section 3. (f) Potential Change in Control: shall be deemed to have occurred if (i) the Company enters into an agreement or arrangement, the consummation of which would result in the occurrence of a Change in Control; (ii) any person (including the Company) publicly announces an intention to take or to consider taking actions that, if consummated, would constitute a Change in Control; (iii) any person (other than a trustee or other fiduciary holding securities under an employee benefit plan of the Company acting in such capacity or a corporation owned, directly or indirectly, by the shareholders of the Company in substantially the same proportions as their ownership of stock of the Company), who is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 10% or more of the combined voting power of the Company's then outstanding Voting Securities, increases his beneficial ownership of such securities by 5% or more over the percentage so owned by such person on the date hereof, or (iv) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred. (g) Proceeding: (i) any threatened, pending, or completed action, suit, or proceeding, or whether civil, criminal, administrative, investigative, or other; (ii) any inquiry, hearing, or investigation, whether conducted by the Company or any other party, that Indemnitee in good faith believes might lead to the institution of any such action, suit, or proceeding. (h) Reviewing Party: the person or body appointed in accordance with Section 3. (i) Voting Securities: any securities of the Company that vote generally in the election of directors. 2. Agreement to Indemnify: (a) General Agreement. In the event Indemnitee was, is, or becomes a party to or witness or other participant in, or is threatened to be made a party to or witness or other participant in, a Proceeding by reason of (or arising in part out of) an Indemnifiable Event, the Company shall indemnify Indemnitee from and against any and all Expenses to the fullest extent permitted by law, as the same exists or may hereafter be amended or interpreted (but in the case of any such amendment or interpretation, only to the extent that such amendment or interpretation permits the Company to provide broader indemnification rights than were permitted prior thereto). The parties hereto intend that this Agreement shall provide for indemnification in excess of that expressly permitted by statute, including, without limitation, any indemnification provided by the Company's Articles of Incorporation, its bylaws, vote of its shareholders or disinterested directors, or applicable law. (b) Initiation of Proceeding. Notwithstanding anything in this Agreement to the contrary, Indemnitee shall not be entitled to indemnification pursuant to this Agreement in connection with any Proceeding initiated by Indemnitee against the Company or any director or officer of the Company unless (i) the Company has joined in or the Board has consented to the initiation of such Proceeding; (ii) the Proceeding is one to enforce indemnification rights under Section 5; or (iii) the Proceeding is instituted after a Change in Control and Independent Counsel has approved its initiation. (c) Expense Advances. If so requested by Indemnitee, the Company shall advance (within ten business days of such request) any and all Expenses to Indemnitee (an "Expense Advance"); provided that, if and to the extent that the Reviewing Party determines that Indemnitee would not be permitted to be so indemnified under applicable law, the Company shall be entitled to be reimbursed by Indemnitee (who hereby agrees to reimburse the Company) for all such amounts theretofore paid. If Indemnitee has commenced legal proceedings in a court of competent jurisdiction to secure a determination that Indemnitee should be indemnified under applicable law, as provided in Section 4, any determination made by the Reviewing Party that Indemnitee would not be permitted to be indemnified under applicable law shall not be binding and Indemnitee shall not be required to reimburse the Company for any Expense Advance until a final judicial determination is made with respect thereto (as to which all rights of appeal therefrom have been exhausted or have lapsed). Indemnitee's obligation to reimburse the Company for Expense Advances shall be unsecured and no interest shall be charged thereon. (d) Mandatory Indemnification. Notwithstanding any other provision of this Agreement (other than Section 2(f) below), to the extent that Indemnitee has been successful on the merits in defense of any Proceeding relating in whole or in part to an Indemnifiable Event or in defense of any issue or matter therein, Indemnitee shall be indemnified against all Expenses incurred in connection therewith. (e) Partial Indemnification. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of Expenses, but not, however, for the total amount thereof, the Company shall nevertheless indemnify Indemnitee for the portion thereof to which Indemnitee is entitled. (f) Prohibited Indemnification. No indemnification pursuant to this Agreement shall be paid by the Company on account of any Proceeding in which judgment is rendered against Indemnitee for an accounting of profits made from the purchase or sale by Indemnitee of securities of the Company pursuant to the provisions of Section 16(b) of the Act or similar provisions of any federal, state, or local laws. 3. Reviewing Party. Prior to any Change in Control, the Reviewing Party shall be any appropriate person or body consisting of a member or members of the Board or any other person or body appointed by the Board who is not a party to the particular Proceeding with respect to which Indemnitee is seeking indemnification: after a Change in Control, the Reviewing Party shall be the Independent Counsel referred to below. With respect to all matters arising after a Change in Control (other than a Change in Control approved by a majority of the directors on the Board who were directors immediately prior to such Change in Control) concerning the rights of Indemnitee to indemnity payments and Expense Advances under this Agreement or any other agreement or under applicable law or the Company's Articles of Incorporation or Bylaws now or hereafter in effect relating to indemnification for Indemnifiable Events, the Company shall seek legal advice only from independent Counsel selected by Indemnitee and approved by the Company (which approval shall not be unreasonably withheld), and who has not otherwise performed services for the Company or the Indemnitee (other than in connection with indemnification matters) within the last five years. The Independent Counsel shall not include any person who, under the applicable standards of professional conduct then prevailing, would have a conflict of interest in representing either the Company or Indemnitee in an action to determine Indemnitee's rights under this Agreement. Such counsel, among other things, shall render its written opinion to the Company and Indemnitee as to whether and to what extent the Indemnitee should be permitted to be indemnified under applicable law. The Company agrees to pay the reasonable fees of the Independent Counsel and to indemnify fully such counsel against any and all expenses (including attorneys' fees), claims, liabilities, loss, and damages arising out of or relating to this Agreement or the engagement of Independent Counsel pursuant hereto. 4. Indemnification Process and Appeal. (a) Indemnification Payment. Indemnitee shall be entitled to indemnification of Expenses, and shall receive payment thereof, from the Company in accordance with this Agreement as soon as practicable after Indemnitee has made written demand on the Company for indemnification, unless the Reviewing Party has given a written opinion to the Company that Indemnitee is not entitled to indemnification under applicable law. (b) Suit to Enforce Right. Regardless of any action by the Reviewing Party, if Indemnitee has not received full indemnification within thirty days after making a demand in accordance with Section 4(a). Indemnitee shall have the right to enforce its indemnification rights under this Agreement by commencing litigation in any court in the State of California having subject matter jurisdiction thereof and in which venue is proper seeking an initial determination by the court or challenging any determination by the Reviewing Party or any aspect thereof. The Company hereby consents to service of process and to appear in any such proceeding. Any determination by the Reviewing Party not challenged by the Indemnitee shall be binding on the Company and Indemnitee. The remedy provided for in this Section 4 shall be in addition to any other remedies available to Indemnitee in law or equity. (c) Defense to Indemnification, Burden of Proof and Presumptions. It shall be a defense to any action brought by Indemnitee against the Company to enforce this Agreement (other than an action brought to enforce a claim for Expenses incurred in defending a Proceeding in advance of its final disposition where the required undertaking has been tendered to the Company) that it is not permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed. In connection with any such action or any determination by the Reviewing Party or otherwise as to whether Indemnitee is entitled to be indemnified hereunder, the burden of proving such a defense or determination shall be on the Company. Neither the failure of the Reviewing Party or the Company (including its Board, independent legal counsel, or its shareholders) to have made a determination prior to the commencement of such action by Indemnitee that indemnification of the claimant is proper under the circumstances because Indemnitee has met the standard of conduct set forth in applicable law, nor an actual determination by the Reviewing Party or Company (including its Board, independent legal counsel, or its shareholders) that the Indemnitee had not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the Indemnitee has not met the applicable standard of conduct. For purposes of this Agreement, the termination of any claim, action, suit, or proceeding, by judgment, order, settlement (whether with or without court approval), conviction, or upon a plea of nolo contendere, or its equivalent, shall not create a presumption that Indemnitee did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. 5. Indemnification for Expenses Incurred in Enforcing Rights. The Company shall indemnify Indemnitee against any and all Expenses and, if requested by Indemnitee, shall (within ten business days of such request), advance such Expenses to Indemnitee, that are incurred by Indemnitee in connection with any claim asserted against or action brought by Indemnitee for (i) Indemnification of Expenses or Expense Advances by the Company under this Agreement or any other agreement or under applicable law or the Company's Articles of Incorporation or Bylaws now or hereafter in effect relating to indemnification for Indemnifiable Events, and/or (ii) recovery under directors' and officers' liability insurance policies maintained by the Company. regardless of whether Indemnitee ultimately is determined to be entitled to such indemnification. Expense Advances, or insurance recovery, as the case may be. 6. Notification and Defense of Proceeding. (a) Notice. Promptly after receipt by Indemnitee of notice of the commencement of any Proceeding. Indemnitee shall, if a claim in respect thereof is to be made against the Company under this Agreement, notify the Company of the commencement thereof, but the omission so to notify the Company will not relieve the Company from any liability that it may have to Indemnitee, except as provided in Section 6(c). (b) Defense. With respect to any Proceeding as to which Indemnitee notifies the Company of the commencement thereof, the Company shall be entitled to participate in the Proceeding at its own expense and except as otherwise provided below, to the extent the Company so wishes, it may assume the defense thereof with counsel reasonably satisfactory to Indemnitee. After notice from the company to Indemnitee of its election to assume the defense of any Proceeding, the Company shall not be liable to Indemnitee under this Agreement or otherwise for any Expenses subsequently incurred by Indemnitee in connection with the defense of such Proceeding other than reasonable costs of investigation or as otherwise provided below. Indemnitee shall have the right to employ his or her own legal counsel in such Proceeding, but all Expenses related thereto incurred after notice from the Company of its assumption of the defense shall be at Indemnitee's expense unless: (i) the employment of legal counsel by Indemnitee has been authorized by the Company, (ii) Indemnitee has reasonably determined that there may be a conflict of interest between Indemnitee and the Company in the defense of the Proceeding, (iii) after Change in Control, the employment of counsel by Indemnitee has been approved by the Independent Counsel, or (iv) the Company shall not in fact have employed counsel to assume the defense of such Proceeding, in each of which case all Expenses of the Proceeding shall be borne by the Company. The Company shall not be entitled to assume the defense of any Proceeding brought by or on behalf of the Company or as to which Indmenitee shall have made the determination provided for in (ii) above. (c) Settlement of Claims. The Company shall not be liable to indemnify Indemnitee under this Agreement or otherwise for any amounts paid in settlement of any Proceeding effected without the Company's written consent, provided, however, that if a Change in Control has occurred, the Company shall be liable for indemnification of Indemnitee for amounts paid in settlement if the Independent Counsel has approved the settlement. The Company shall not settle any Proceeding in any manner that would impose any penalty or limitation on Indemnitee without Indemnitee's written consent. Neither the Company nor the Indemnitee will unreasonably withhold their consent to any proposed settlement. The Company shall not be liable to indemnify the Indemnitee under this Agreement with regard to any judicial award if the Company was not given a reasonable and timely opportunity, at its expense, to participate in the defense of such action; he Company's liability hereunder shall not be excused if participation in the Proceeding by the Company was barred by this Agreement. 7. Establishment of Trust. In the event of a Change in Control or a Potential Change in Control, the Company shall, upon written request by Indemnitee, create a Trust for the benefit of the Indemnitee and from time to time upon written request of Indemnitee shall fund the Trust in an amount sufficient to satisfy any and all Expenses reasonably anticipated at the time of each such request to be incurred in connection with investigating, preparing for, participating in, and/or defending any Proceeding relating to an Indenmifiable Event. The amount or amounts to be deposited in the Trust pursuant to the foregoing funding obligation shall be determined by the Reviewing Party. The terms of the Trust shall provide that upon a Change in Control, (i) the Trust shall not be revoked or the principal thereof invaded, without the written consent of the Indemnitee, (ii) the Trustee shall advance, within ten business days of a request by the Indemnitee, any and all Expenses to the Indemnitee (and the Indemnitee hereby agrees to reimburse the Trust under the same circumstances for which the Indemnities would be required to reimburse the Company under Section 2(c) of this Agreement, (iii) the Trust shall continue to be funded by the Company in accordance with the funding obligation set forth above, (iv) the Trustee shall promptly pay to the Indemnitee all amounts for which the Indemnitee shall be entitled to indemnification pursuant to this Agreement or otherwise, and (v) all unexpended funds in the Trust shall revert to the Company upon a final determination by the Reviewing Party or a court of competent jurisdiction, as the case may be, that the Indemnitee has been fully indemnified under the terms of this Agreement. The Trustee shall be chosen by the Indemnitee. Nothing in this Section 7 shall relieve the Company of any of its obligations under this Agreement. All income earned on the assets held in the Trust shall be reported as income by the Company for federal, state, local, and foreign tax purposes. The Company shall pay all costs of establishing and maintaining the Trust and shall indemnify the Trustee against any and all expenses (including attorney's fees), claims, liabilities, loss, and damages arising out of or relating to this Agreement or the establishment and maintenance of the Trust. 8. Non-Exclusivity. The rights of Indemnitee hereunder shall be in addition to any other right Indemnitee may have under the Company's Articles of Incorporation, Bylaws, applicable law, or otherwise. To the extent that a change in applicable law (whether by statute or judicial decision) permits greater indemnification by agreement than would be afforded currently under the Company's Articles of Incorporation. Bylaws, applicable law, or this Agreement, it is the intent of the parties that Indemnitee enjoy by this Agreement the greater benefits so afforded by such change. 9. Liability Insurance. To the extent the Company maintains an insurance policy or policies providing directors' and officers' liability insurance, Indemnitee shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage available for any Company director or officer. 10. Period of Limitations. No legal action shall be brought and no cause of action shall be asserted by or on behalf of the Company or any affiliate of the Company against Indemnitee, Indemnitee's spouse, heirs, executors, or personal or legal representatives after the expiration of two years from the date of accrual of such cause of action, or such longer period as may be required by state law under the circumstances. Any claim or cause of action of the Company or its affiliate shall be extinguished and deemed released unless asserted by the timely filing of a legal action within such period; provided, however, that if any shorter period of limitations is otherwise applicable to any such cause of action the shorter period shall govern. 11. Amendment of this Agreement. No supplement, modification, or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall operate as a waiver of any other provisions hereof (whether or not similar), nor shall such waiver constitute a continuing waiver. Except as specifically provided herein, no failure to exercise or any delay in exercising any right or remedy hereunder shall constitute a waiver thereof. 12. Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the Company effectively to being suit to enforce such rights. 13. No Duplication of Payments. The Company shall not be liable under this Agreement to make any payment in connection with any claim made against Indemnitee to the extent Indemnitee has otherwise received payment (under any insurance policy, Bylaw, or otherwise) of the amounts otherwise indemnifiable hereunder. 14. Binding Effect. This Agreement shall be binding upon and inure to the benefit of and be enforceable by the parties hereto and their respective successors (including any direct or indirect successor by purchase, merger, consolidation, or otherwise to all or substantially all of the business and/or assets of the Company), assigns, spouses, heirs, and personal and legal representatives. The Company shall require and cause any successor (whether direct or indirect by purchase, merger, consolidation, or otherwise) to all, substantially all, or a substantial part, of the business and/or assets of the Company, by written agreement in form and substance satisfactory to Indemnitee, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. The indemnification provided under this Agreement shall continue as to Indemnitee for any action taken or not taken while serving in an indemnified capacity pertaining to an Indemnifiable Event even though he or she may have ceased to serve in such capacity at the time of any Proceeding. 15. Severability. If any provision (or portion thereof) of this Agreement shall be held by a court of competent jurisdiction to be invalid, void, or otherwise unenforceable, the remaining provisions shall remain enforceable to the fullest extent permitted by law. Furthermore, to the fullest extent possible, the provisions of this Agreement (including, without limitation, each portion of this Agreement containing any provision held to be invalid, void, or otherwise unenforceable, that is not itself invalid, void, or unenforceable) shall be constructed so as to give effect to the intent manifested by the provision held valid, void or uneforceable. 16. Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California applicable to contracts made and to be performed in such State without giving effect to the principles of conflicts of laws. 17. Notices. All notices, demands, and other communications required or permitted hereunder shall be made in writing and shall be deemed to have been duly given if delivered by hand, against receipt, or mailed, postage prepaid, certified or registered mail, return receipt requested, and addressed to the Company at: CYLINK CORPORATION 910 Hermosa Court Sunnyvale, CA 94086 Attn: President and to Indemnitee at: Same as above -------------------- -------------------- Attn: Fernand Sarrat Notice of change of address be effective only when given in accordance with this Section. All notices complying with this Section shall be deemed to have been received on the date of delivery or on the third business day after mailing. 18. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of the day specified above. CYLINK CORPORATION INDEMNITEE: By: /s/ ROBERT FOUGNER /s/ FERNAND SARRAT --------------------------- --------------------------- [Signature] [Signature] Title: Corporate Secretary FERNAND SARRAT ------------------------ --------------------------- [Print Name] EXHIBIT C CYLINK CORPORATION PROPRIETARY INFORMATION AND INVENTIONS AND EMPLOYMENT AGREEMENT I recognize that Cylink Corporation (the "Company") a California corporation, is engaged in a continuous program of research, development and production respecting its business, present and future. As used in this Agreement, the term "Company" means Cylink Corporation, its successor companies, subsidiaries and all affiliated companies or operations in which it may have an interest whether by stock ownership, joint venture arrangements or otherwise. I understand that: A. As part of my employment by the Company, I am expected to make new contributions and inventions of value to the Company; B. My employment creates a relationship of confidence and trust between me and the Company with respect to any information: (1) Applicable to the business of the Company; or (2) Applicable to the business of any client or customer of the Company, which may be made known to me by the Company or by any client or customer of the Company, or learned by me in such context during the period of my employment. C. The Company possesses and will continue to possess information that has been created, discovered, developed, or otherwise become known to the Company (including, without limitation, information created, discovered, developed, or made known by me during the period of or arising out of my employment by the Company) and/or in which property rights have been assigned or otherwise conveyed to the Company, which information has commercial value in the business in which the Company is engaged. All of the aforementioned information is hereinafter called "Proprietary Information". By way of illustration, but not limitation, Proprietary Information includes trade secrets, -1- processes, structures, formulas, data and know-how, improvements, inventions, techniques, marketing plans, strategies, forecasts, and customer lists. D. As used herein, the period of my employment includes any time in which I may be retained by the Company as a consultant. In consideration of my employment or continued employment, as the case may be, and the compensation received by me from the Company from time to time, I hereby agree as follows: 1. All Proprietary Information shall be the sole property of the Company and its assigns, and the Company and its assigns shall be the sole owner of all patents and other rights in connection therewith. I hereby assign to the Company any right I may have or acquire in such Proprietary Information. At all times, both during my employment by the Company and after its termination, I will keep in confidence and trust all Proprietary Information, and I will not use or disclose any Proprietary Information or anything directly relating to it without the written consent of the Company, except as may be necessary in the ordinary course of performing my duties as an employee of the Company. Notwithstanding the foregoing, it is understood that, at all such times, I am free to use (a) information in the public domain not as a result of a breach of this Agreement and (b) my own skill, knowledge, know-how and experience to whatever extent and in whatever way I wish. 2. I agree that during the period of my employment by the Company I will not, without the Company's express written consent, engage in any employment or business other than for the Company. 3. In the event of the termination of my employment by me or by the Company for any reason, I will deliver to the Company all documents and data (whether written or electronically stored) of any nature pertaining to my work with the Company and I will not take with me or deliver to anyone else any documents or data of any description or any reproduction of any description containing or pertaining to any Proprietary Information. 4. I will promptly disclose to the Company, or any persons designated by it, all improvements, inventions, designs, ideas, copyrightable works, discoveries, trade marks, copyrights, trade secrets, formulas, processes, -2- techniques, know-how, and data, whether or not patentable, made or conceived or reduced to practice or learned by me, either alone or jointly with others, during the period of my employment which are related to or useful in the business of the Company, or result from tasks assigned me by the Company or result from use of premises owned, leased, or contracted for by the Company (all said improvements, inventions, designs, ideas, copyrightable works, discoveries, trade marks, copyrights, trade secrets, formulas, processes, techniques, know-how, and data shall be collectively hereinafter call "Inventions"). 5. I agree that all Inventions shall be the sole property of the Company and its assigns, and the Company and its assigns shall be the sole owner of all patents and other rights in connection therewith. I hereby assign to the Company any rights I may have or acquire in such Inventions. I further agree as to all such Inventions to assist the Company in every proper way (but at the Company's expense) to obtain and from time to time enforce patents on said inventions in any and all countries, and to that end I will execute all documents for use in applying for and obtaining such patents thereon and enforcing same, as the Company may desire, together with any assignments thereof to the Company or persons designated by it. My obligation to assist the Company in obtaining and enforcing patents for such Inventions in any and all countries shall continue beyond the termination of my employment, but the Company shall compensate me at a reasonable rate after such termination for time actually spent by me at the Company's request on such assistance. Any provision in this Agreement requiring me to assign my rights in any invention does not apply to an invention which qualifies fully under the provisions of Section 2870 of the California Labor Code. That section provides as follows: Any provision in an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall not apply to an invention that the employee developed entirely on his or her own time without using the employer's equipment, supplies, facilities, or trade secret information except for those inventions that either; -3- (1) Relate at the time of conception or reduction to practice of the invention to the employer's business, or actual or demonstrably anticipated research or development of the employer. (2) Result from any work performed by the employee for the employer. I acknowledge that receipt and execution of this Agreement by me constitutes written notification, as required by Section 2872 of the California Labor Code, regarding above Section 2870 and its protective effect on certain inventions by me. 6. As a matter of record I have identified on Exhibit A attached hereto all inventions or improvements relevant to the subject matter of my employment by the Company which have been made or conceived or first reduced to practice by me alone or jointly with others prior to my engagement by the Company, which I desire to remove from the operation of this Agreement; and I covenant that such list is complete. If there is no such list on Exhibit A, I represent that I have made no such inventions and improvements at the time of signing this Agreement. 7. I represent that my performance of all the terms of this Agreement and as an employee of the Company does not, to the best of my present knowledge and belief, and will not breach any agreement or duty to keep in confidence proprietary information acquired by me in confidence or in trust prior to my employment by the Company. I have not entered into, and I agree I will not enter into, any agreement either written or oral in conflict herewith. 8. I understand as part of the consideration for the offer of employment extended to me by the Company and of my employment or continued employment by the Company, that I have not brought and will to bring with me to the Company or use in the performance of my responsibilities at the Company any materials or documents of a former employer which are not generally available to the public, unless I have obtained written authorization from the former employer for their possession and use. Accordingly, this is to advise the company that the only materials or documents of a former employer which are not generally available to the public that I will bring to -4- the Company or use in my employment are identified on Exhibit A attached hereto, and as to each such item, I represent that I have obtained prior to the effective data of my employment with the Company written authorization for their possession and use in my employment with the Company. I also understand that, in my employment with the Company, I am not to breach any obligation of confidentiality or duty that I have to former employers, and I agree that I shall fulfill all such obligations during my employment with the Company. 9. I agree that the Company is not by reason of this Agreement obligated to continue me in its employment. 10. I agree that any breach of this Agreement by me would cause irreparable damage to the Company and that, in the event of such breach, the Company shall have, in addition to any and all remedies of law, the right to an injunction, specific performance or other equitable relief to prevent the violation of my obligations hereunder. 11. If any provision hereof shall be declared unenforceable for any reason, such unenforceability shall not affect the enforceability of the remaining provisons of this Agreement. Further, such provision shall be reformed and construed to the extent permitted by law so that it would be valid, legal and enforceable to the maximum extent possible. 12. This Agreement shall be effective as of the first day of my employment by the Company, namely:________________________________________________________. 13. This Agreement shall be binding upon me, my heirs, executors, assigns, and administrators, shall inure to the benefit of the Company, is successors, and assigns and shall survive my employment by the Company. Dated Date of Hire By /s/ Fernand Sarrat - ----- ---------------- ------------------------------- ACCEPTED AND AGREED TO: CYLINK CORPORATION By Robert Fougner --------------------------- Corporate Secretary -5- CYLINK CORPORATION Dear Sirs: 1. The following is a complete list of all inventions or improvements relevant to the subject matter of my employment by Cylink Corporation (the "Company") which have been made or conceived or first reduced to practice by me alone or jointly with others prior to my engagement by the Company: X No inventions or improvements ---------- See Below ---------- --------------------------------------------------------------------------- --------------------------------------------------------------------------- --------------------------------------------------------------------------- Additional sheets attached ---------- 2. I propose to bring to my employment the following materials and documents of a former employer which are not generally available to the public, which materials and documents may be used in my employment: X No materials ---------- See Below ---------- --------------------------------------------------------------------------- --------------------------------------------------------------------------- --------------------------------------------------------------------------- Additional sheets attached ---------- The signature below confirms that my continued possession and use of these materials is authorized. Very truly yours, /s/ Fernand Sarrat ------------------------------ -6- EX-11.1 5 STATEMENT REGARDING CALCULATION OF NET INCOME EXHIBIT 11.1 CYLINK CORPORATION STATEMENT REGARDING CALCULATION OF NET INCOME (LOSS) PER SHARE (1) (in thousands, except per share amounts)
Years ended December 31, --------------------------------- 1996 1995 1994 ---- ---- ---- Net income (loss) $ 1,197 $ (1,079) $ (700) ======== ========= ========= Weighted average shares outstanding: Common stock 24,412 17,862 17,619 Common stock issuable upon exercise of options 1,167 254 274 Common stock issuable upon exercise of options granted subsequent to November 30, 1994 through February 15, 1996 (2) 182 1,456 1,456 ---------- --------- --------- Weighted average common shares and equivalents 25,761 19,572 19,351 -------- -------- -------- Net income (loss) per share $ 0.05 $ (0.06) $ (0.04) ======== ======== ======== - ------------ (1) This Exhibit should be read in conjunction with Note 1 of Notes to Consolidated Financial Statements. (2) Stock options granted subsequent to November 30, 1994 through February 15, 1996 have been included in the calculation of common equivalent shares (using the treasury stock method and the initial public offering price) as if they were outstanding for all periods through the effective date of the Company's initial public offering.
EX-23.1 6 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-09797) of Cylink Corporation of our report dated January 24, 1997 appearing on page 23 the Company's Annual Report on Form 10-K for the year ended December 31, 1996. PRICE WATERHOUSE LLP San Jose, California March 26, 1997 EX-27 7 FINANCIAL DATA SCHEDULE
5 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 12/31/96 CONSOLIDATED BALANCE SHEET AND THE STATEMENT OF OPERATIONS FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 78,849 0 13,346 664 8,828 103,142 8,256 4,496 107,088 9,624 0 257 0 0 96,954 107,088 51,958 51,958 21,767 21,767 31,949 0 110 1,448 251 0 0 0 0 1,197 0.05 0.05
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