UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
Commission File No. 0-27742
CYLINK CORPORATION
(Exact name of registrant as specified in its charter)
California 95-3891600
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3131 Jay Street
Santa Clara, California 95054
(Address of principal executive offices)
(408) 855-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No ___
As of August 13, 2002, there were 32,986,000 shares of the Registrant's
common stock outstanding.
CYLINK CORPORATION
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
a) Condensed Consolidated Balance Sheets at June 30, 2002
and December 31, 2001 1
b) Condensed Consolidated Statements of Operations for the
three and six months ended June 30, 2002 and July 1, 2001 2
c) Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2002 and July 1, 2001 3
d) Notes to Condensed Consolidated Financial Statements 4
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 9
Item 3 Quantitative and Qualitative Disclosures about Market Risk 21
PART II OTHER INFORMATION 22
Item 1. Legal Proceedings 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of the Security Holders 22
Item 5. Other information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signature 24
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and par value data; unaudited)
June 30, December 31,
2002 2001
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 10,535 $ 9,606
Accounts receivable, net of allowances of $768 and $1,057 4,419 10,102
Income tax receivable 475 50
Inventories 4,268 4,832
Other current assets 1,285 2,026
--------- ---------
Total current assets 20,982 26,616
Restricted cash 1,400 1,400
Property and equipment, net 5,122 6,075
Acquired technology, goodwill and other intangibles, net 15,666 16,648
Note receivable from employee 1,057 1,021
Other assets 626 932
--------- ---------
$ 44,853 $ 52,692
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Equipment line of credit $ 69 $ 139
Accounts payable 2,098 2,757
Accrued liabilities 5,515 5,439
Income taxes payable 410 412
Deferred revenue 2,704 2,130
--------- ---------
Total current liabilities 10,796 10,877
--------- ---------
Deferred revenue, less current portion 40 214
Restructuring and other accruals, less current portion 2,594 1,713
--------- ---------
Total long-term liabilities 2,634 1,927
Commitments and contingencies (Note 6)
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized;
none issued and outstanding -- --
Common stock, $0.01 par value; 55,000,000 shares authorized;
32,984,000 and 32,872,000 shares issued and outstanding 331 329
Additional paid-in capital 158,439 158,359
Accumulated other comprehensive loss (4) (18)
Accumulated deficit (127,343) (118,782)
--------- ---------
Total shareholders' equity 31,423 39,888
--------- ---------
$ 44,853 $ 52,692
========= =========
See accompanying notes to condensed consolidated financial statements.
1
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
Three Months Ended Six Months Ended
------------------------ ------------------------
June 30, July 1, June 30, July 1,
2002 2001 2002 2001
-------- -------- -------- --------
Revenue $ 7,372 $ 13,571 $ 14,471 $ 26,183
Cost of revenue 2,635 5,953 5,272 10,298
-------- -------- -------- --------
Gross profit 4,737 7,618 9,199 15,885
-------- -------- -------- --------
Operating expenses:
Research and development 2,968 5,190 5,886 11,135
Selling and marketing 2,774 5,013 5,830 10,762
General and administrative 1,434 2,729 3,470 5,743
Amortization of acquired intangibles 444 817 954 1,679
Loss from divestiture of Algorithmic Research, Ltd. -- 2,503 -- 2,503
Restructuring charges 1,862 -- 1,862 --
-------- -------- -------- --------
Total operating expenses 9,482 16,252 18,002 31,822
-------- -------- -------- --------
Loss from operations (4,745) (8,634) (8,803) (15,937)
Other income (expense):
Interest income, net 44 183 90 373
Other income (expense), net 126 (144) 40 (163)
Write-down of investment in unaffiliated company -- -- (222) --
-------- -------- -------- --------
Total other income (expense) 170 39 (92) 210
-------- -------- -------- --------
Loss before income taxes (4,575) (8,595) (8,895) (15,727)
Income tax expense (benefit) 90 (1,177) (334) (1,177)
-------- -------- -------- --------
Net loss $ (4,665) $ (7,418) $ (8,561) $(14,550)
======== ======== ======== ========
Loss per share - basic & diluted: $ (0.14) $ (0.23) $ (0.26) $ (0.45)
======== ======== ======== ========
Shares used in per share calculation - basic & diluted 32,892 32,384 32,879 32,331
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
2
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
Six months ended
----------------------------
June 30, July 1,
2002 2001
-------- --------
Cash flows from operating activities:
Net loss $ (8,561) $(14,550)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Loss on divestiture of Algorithmic Research, Ltd. -- 2,503
Loss on disposition of fixed assets 60 29
Depreciation 1,427 1,849
Amortization 953 1,784
Deferred income taxes -- 800
Amortization of imputed interest on note receivable (36) (25)
Deferred compensation related to stock options -- 412
Changes in operating assets and liabilities (net of effects of
acquisitions and divestitures):
Accounts receivable 5,683 4,022
Inventories 564 3,070
Income tax receivable (425) (900)
Other assets (175) (556)
Accounts payable (659) (1,905)
Accrued liabilities (183) (1,183)
Restructuring accrual 1,167 --
Deferred revenue 400 1,666
-------- --------
Net cash provided by (used in) operating activities 215 (2,984)
Cash flows from investing activities:
Acquisition of property and equipment (534) (526)
Collection of note receivable from former employee 1,000 --
Cash transferred with divestiture of Security Design International -- (28)
Write-down of investment in unaffiliated company 222 --
-------- --------
Net cash provided by (used in)
investing activities 688 (554)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 82 82
Other (70) (93)
-------- --------
Net cash provided by (used in) financing activities 12 (11)
-------- --------
Effect of exchange rate changes on
cash and cash equivalents 14 57
-------- --------
Net increase (decrease) in cash and cash equivalents 929 (3,492)
Cash and cash equivalents at beginning of period 9,606 15,250
-------- --------
Cash and cash equivalents at end of period $ 10,535 $ 11,758
======== ========
Supplemental disclosures
Cash refunds of income tax $ -- $ 2,541
Cash payments of income tax $ 90 $ --
See accompanying notes to condensed consolidated financial statements.
3
CYLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements included
herein contain all adjustments, consisting only of normal recurring adjustments,
which, in the opinion of management, are necessary to state fairly the
consolidated financial position, results of operations and cash flows of Cylink
Corporation ("Cylink" or "the Company") for the periods presented. These
financial statements should be read in conjunction with the Company's audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2001. Interim results of operations
are not necessarily indicative of the results to be expected for the full year.
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States of America for interim financial information and the instructions
to Form 10-Q and Article 10 of Regulation S-X. The condensed consolidated
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in
the normal course of business. As shown in the Company's consolidated financial
statements, the Company has experienced declining annual revenues and has
incurred losses from continuing operations of $8.6 million in the first half of
2002, $20.1 million in 2001 and $35.4 million in 2000. These factors, among
others indicate that the Company may be unable to continue as a going concern
for a reasonable period of time. The condensed consolidated financial statements
do not include any adjustments relating to the recoverability and classification
of recorded asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
To address these issues, the Company has effected significant cost cutting
measures beginning in the fourth quarter of 2000 and continuing into 2002,
including staff reductions and field office consolidations, divestiture of
unprofitable operations and has planned to sublease a portion of its corporate
headquarters facility. Management believes that the Company will be able to
continue operations through the successful implementation of its plan to
increase revenues, continued reduction of its cost structure and ultimate
attainment of profitable operations. In addition, the Company may seek debt or
equity financing if required; however, no assurances can be given that the
Company will attain profitable operations or that additional financing will be
available.
Certain 2001 financial statement amounts were reclassified to conform
with 2002 classifications. These reclassifications had no effect on net loss or
shareholders' equity as previously reported.
2. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations", which was effective for business combinations initiated after
June 30, 2001. In October 2001, the FASB issued SFAS 144, "Impairment or
Disposal of Long-Lived Assets", which is effective for fiscal years beginning
after December 15, 2001. In June 2001, the FASB issued SFAS 143, "Accounting for
Retirement Obligations," which is effective for the Company's fiscal year
beginning January 1, 2003. We have not yet assessed the impact that the adoption
of FAS 143 will have on our financial condition or results of operations. The
adoption of SFAS 141 and SFAS 144 did not have a material effect on our
financial condition or results of operations.
Accounting for Business Combinations, Goodwill and Intangible Assets:
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets".
SFAS 142 requires that goodwill is no longer amortized, but tested for
impairment at least annually, or more frequently if certain indications arise.
The Company adopted SFAS 142 effective January 1, 2002. Cylink completed its
initial goodwill impairment tests on March 31, 2002 and determined that no
impairment of goodwill had occurred as of that date. The Company further
determined that no circumstances or events occurred in the quarter ended June
30, 2002 that would require it to conduct an impairment test between annual
tests. Subsequent impairment losses, if any, will be reflected in operating
expense in the consolidated statement of operations. The Company is not able to
predict at this time whether the determination of fair value under SFAS 142 will
result in an impairment of goodwill at a future date. Given the $15.7 million
net carrying value of the Company's goodwill and intangibles at June 30, 2002,
an impairment determination could have a material
4
impact on Cylink's financial position and results of operations. Had the Company
been accounting for its goodwill under SFAS 142 for all periods presented, the
Company's net loss and net loss per share would have been as follows:
Three months ended: Six months ended:
-------------------- --------------------
June 30, July 1, June 30, July 1,
2002 2001 2002 2001
-------------------- --------------------
(in thousands (in thousands
except per share data) except per share data)
Reported net loss $ (4,665) $ (7,418) $ (8,561) $(14,550)
Add back goodwill
amortization, net of
income taxes -- 307 -- 659
-------- -------- -------- --------
Proforma adjusted net loss $ (4,665) $ (7,111) $ (8,561) $(13,891)
======== ======== ======== ========
Proforma adjusted net loss
per share $ (0.14) $ (0.22) $ (0.26) $ (0.43)
======== ======== ======== ========
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company
will adopt the provisions of SFAS 146 for the restructuring activities initiated
after December 31, 2002. SFAS 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred. Under Issue 94-3, a liability for an exit cost was recognized at the
date of the Company's commitment to an exit plan. SFAS 146 also established that
the liability should initially be measured and recorded at fair value.
Accordingly, SFAS 146 may affect the timing of recognizing future restructuring
costs as well as the amounts recognized.
3. Inventories
Inventories are stated at the lower of standard costs (which
approximates actual costs on a first-in, first-out basis) or market and consist
of:
June 30, December 31,
2002 2001
------ ------
(in thousands)
Inventories:
Raw materials $1,852 $2,482
Work in process and subassemblies 1,821 1,171
Finished goods 595 1,179
------ ------
$4,268 $4,832
====== ======
4. Loss Per Share
Basic loss per share is based on the weighted-average number of common
shares outstanding, excluding shares in escrow. Diluted loss per share is based
on the weighted-average number of shares outstanding and dilutive potential
common shares outstanding, excluding contingent shares held in escrow. The
Company's only potentially dilutive securities are stock options. As of June 30,
2002 and July 1, 2001, the Company had 6,754,000 and 7,135,000 stock options
outstanding with a weighted-average exercise price of $3.63 and $5.59,
respectively. These options expire on various dates through 2008. All
potentially dilutive securities have been excluded from the computation of
diluted loss per share, as their effect is anti-dilutive on the net loss for the
periods presented.
5
5. Comprehensive Loss
The components of comprehensive loss, consisting of the Company's
reported net loss and unrealized gains or losses in the translation of foreign
currencies, are as follows:
Three months ended: Six months ended:
-------------------- --------------------
June 30, July 1, June 30, July 1,
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands) (in thousands)
Net loss $ (4,665) $ (7,418) $ (8,561) $(14,550)
Other comprehensive income
(loss) (15) (28) 14 57
-------- -------- -------- --------
Total comprehensive loss $ (4,680) $ (7,446) $ (8,547) $(14,493)
======== ======== ======== ========
6. Commitments and Contingencies
Cylink is currently engaged in litigation. See Part II, Item 1. "Legal
Proceedings."
7. Restructuring Charge
In the fourth quarter of 2001, the Company recorded a $1.4 million
charge to accrue a reserve for losses relative to the estimated costs of excess
leased facilities and related furniture and equipment, net of estimated proceeds
from planned subleasing of excess office space in Santa Clara. In the second
quarter of 2002, the Company increased its estimate by an additional $1.2
million based on a continued weak sublease market. In addition, the Company
recorded as expense $0.7 million in restructuring charges during the second
quarter of 2002 related to severance payments to 36 former employees affected by
the workforce reduction. Approximately $0.2 million of the reserves have been
utilized through June 30, 2002. The reserves will be utilized for excess lease
costs associated with the Company's headquarters in future periods.
The following table summarizes the activity representing the
restructuring charge liability in the condensed consolidated balance sheet for
the periods presented:
Current Long-term Total
------- --------- -----
(in millions)
Balance at December 31, 2001 $ 0.5 $ 0.9 $ 1.4
Additions 0.3 0.9 1.2
Utilization (0.1) (0.1) (0.2)
Reclassification from Long-term
to Current 0.2 (0.2) --
------ ------ ------
Balance at June 30, 2002 $ 0.9 $ 1.5 $ 2.4
====== ====== ======
8. Goodwill & Other Intangible Assets
Changes in the carrying amount of goodwill for the six months ended
June 30, 2002 are as follows (in thousands):
Balance as of December 31, 2001 $ 6,222
Write-off of Cylink-Belguim (29)
-------
Balance as of June 30, 2002 $ 6,193
=======
In connection with the adoption of SFAS No. 142, the Company performed
a transitional impairment test on goodwill as of March 31, 2002 and determined
that no impairment of the Company's goodwill had occurred and that no further
impairment test was necessary during this quarter. See Note 2.
6
Information regarding the Company's other intangible assets is as follows
(in thousands):
June 30, 2002 December 31, 2001
---------------------------------------- ----------------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------- ------------ ------- ------- ------------ -------
Developed Technology $12,077 $(3,168) $ 8,909 $12,077 $(2,305) $ 9,772
Customer Base 894 (330) 564 894 (240) 654
------- ------- ------- ------- ------- -------
Total $12,971 $(3,498) $ 9,473 $12,971 $(2,545) $10,426
======= ======= ======= ======= ======= =======
Amortization expense of other intangible assets was $444,000, and
$953,000 for the three months and the six months ended June 30, 2002,
respectively.
The estimated amortization for each of the five fiscal years subsequent
to December 31, 2001 is as follows:
Year Ended Amortization
December 31, Expense
------------ -------
2002 $ 1,908
2003 1,908
2004 1,908
2005 1,842
2006 1,728
Thereafter 179
-------
Total $ 9,473
=======
9. Working Capital Loan
The Company's $7.5 million revolving working capital loan facility
matured on June 27, 2002, and was extended by the bank as described below. This
loan is secured by all of Cylink's tangible assets and contains a covenant to
maintain a minimum tangible net worth. The Company fell out of compliance with
its covenant in February 2002 and remained out of compliance as of June 30,
2002. The bank has waived the Company's compliance with these covenants, pending
renewal of this credit facility. The Company is working with the bank to renew
this credit facility for one year at $5.0 million and the bank has extended the
maturity date for $5.0 million of this loan facility through August 27, 2002
pending its renewal. There have been no borrowings under the loan since its
inception.
10. Contingent Liability
The Company is obligated under its Master Lease on its Santa Clara
headquarters facility to assume responsibility for and begin paying rent at a
pre-determined rental rate on approximately 24,600 sq. ft. currently leased by
the landlord to a third party tenant, when and if that space becomes available.
In June 2002, the landlord notified the Company that this tenant was in default
as to a portion of the rent due. Subsequently, the landlord notified the Company
that this tenant had entered into an assignment for the benefit of creditors
with the intent of winding up its operations. The third party tenant has
subleased the facility to a third party subtenant through August 2004 and it is
uncertain at this date what are the rights and obligations of this subtenant.
Should the space become available sooner than the termination of the sublease,
the Company would be obligated to assume occupancy under the Master Lease and
pay rent at the current rate of $55,400 per month subject to 3% annual
escalations through the September 2009 termination of its Master Lease. No
accrual has been recorded in the accompanying financial statements for this
contingent liability because the event that would trigger the obligation has not
occurred and therefore, the obligation is not reasonably estimable.
7
11. NASDAQ Listing Notice
On June 27, 2002, the Company received a notice from the staff of the
NASDAQ National Market that its Common Stock had failed to maintain the minimum
bid price of $1.00 over the prior 30 trading days as required for continued
listing on the NASDAQ National Market. The notice stated that, if during the 90
days following the date of the notice the bid price of Cylink Common Stock
failed to close at or above $1.00 for at least 10 consecutive trading days,
Cylink Common Stock could be delisted.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements
within the "safe harbor" provisions of the Private Securities Litigation Reform
Act of 1995. All statements included or incorporated by reference in this
Quarterly Report, other than statements that are purely historical, are
forward-looking statements. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions also identify
forward-looking statements. Forward-looking statements in this Report include,
without limitation, statements regarding: revisions to the Company's financial
plan and implementation by the Company of the plan and additional cost cutting
measures in the third quarter; failure of the Company to meet covenants in its
loan documents, renewal of the credit facility, and the Company's need to seek
additional funds to support working capital requirements; failure to raise
additional funds as needed; plans to continue cost reducing measures in 2002;
the sufficiency of the Company's existing cash balances and available borrowing
to fund operations through 2002; and the belief that the Company has meritorious
defenses and adequate insurance for the damages claimed in shareholder
litigation actions and the Company's intentions to defend itself vigorously.
These forward-looking statements and any expectations based on such
forward-looking statements are not guarantees of future performance and are
subject to risks and uncertainties that could cause actual results to differ
materially from the results contemplated by the forward-looking statements. Any
of Cylink's actual results could differ materially from those included in such
forward-looking statements. The above forward-looking statements are subject to
the risks and uncertainties further discussed under "Risk Factors That May
Affect Future Results" beginning on page 13.
All forward-looking statements included in this document are based on
information available to Cylink on the date hereof, and Cylink assumes no
obligation to update any such forward-looking statements. Shareholders are
cautioned not to place undue reliance on such statements, which speak only as of
the date of this Report. The reader should also consult the cautionary
statements and risk factors listed from time to time in Cylink's Reports on
Forms 10-Q, 8-K, 10-K and its Annual Reports to Shareholders for other trends,
risks or uncertainties which could cause the Company's results to differ from
those expressed in such forward looking statements.
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations should be read in conjunction with the
unaudited condensed consolidated financial statements and notes thereto included
in Part I Item 1 of this Report on Form 10-Q and the audited consolidated
financial statements and notes thereto and Management's Discussion and Analysis
of Financial Condition and Results of Operations included in the Company's
Report on Form 10-K for the year ended December 31, 2001.
Critical Accounting Policies and Estimates
Cylink's discussion and analysis of its financial condition and results
of operations are based upon the Company's condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these consolidated
financial statements requires Cylink to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent liabilities. On an ongoing basis, Cylink evaluates its
estimates, including those related to allowance for doubtful accounts,
inventories, investments, deferred tax assets, intangible assets, income taxes,
warranty obligations, restructuring, and contingencies and litigation. Cylink
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
A description of those accounting policies that Cylink believes are
critical is contained in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
9
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of
operations data as a percentage of revenue for the periods indicated:
Three months ended Six months ended
----------------------- ------------------------
June 30, July 1, June 30, July 1,
2002 2001 2002 2001
-------- ------- -------- -------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 35.7 43.9 36.4 39.3
----- ----- ----- -----
Gross profit 64.3 56.1 63.6 60.7
Operating expenses:
Research and development 40.3 38.2 40.6 42.6
Selling and marketing 37.6 37.0 40.3 41.1
General and administrative 19.5 20.1 24.0 21.9
Amortization of acquired intangibles 6.0 6.0 6.6 6.4
Loss from divestiture of Algorithmic Research Ltd. - 18.4 - 9.6
Restructuring charges 25.3 - 12.9 -
----- ----- ----- -----
Total operating expenses 128.7 119.7 124.4 121.6
----- ----- ----- -----
Loss from operations (64.4) (63.6) (60.8) (60.9)
Other income (expense), net 2.3 0.3 (0.7) 0.8
----- ----- ----- -----
Loss before income taxes (62.1) (63.3) (61.5) (60.1)
Income tax expense (benefit) 1.2 (8.6) (2.3) (4.5)
----- ----- ----- -----
Net loss (63.3)% (54.7)% (59.2)% (55.6)%
===== ===== ===== =====
Revenue. Revenue decreased 46% from $13.6 million for the three months
ended July 1, 2001 to $7.4 million for the three months ended June 30, 2002, and
decreased 45% from $26.2 million for the six months ended July 1, 2001 to $14.5
million for the six months ended June 30, 2002. The decrease is primarily due to
lower unit volumes resulting from the market slowdown generally and the
divestiture of our Israeli subsidiary, Algorithmic Research, Limited (ARL) .
International revenue comprised 32% and 36% of total revenue for the second
quarter of 2001 and 2002, respectively. The increase in international revenues
in the second quarter of 2002 as a percentage of total revenue from the prior
year second quarter was due to a smaller decline in international revenues over
domestic revenues in a weakened global environment.
Gross Profit. Gross profit decreased from $7.6 million for the three
months ended July 1, 2001 to $4.7 million for the three months ended June 30,
2002, and decreased from $15.9 million for the six months ended July 1, 2001 to
$9.2 million for the six months ended June 30, 2002. This decrease in dollars
primarily was a result of the overall decrease in revenue for the same period.
As a percentage of sales, gross profit was approximately 56% and 64% for the
quarters ended July 1, 2001 and June 30, 2002, respectively, and 61% and 64% for
the six months ended July 1, 2001 and June 30, 2002, respectively. The increase
in gross profit as a percentage of revenue was due to higher service revenue
margins due to benefits realized from cost reduction programs implemented by the
Company in 2002, reduced excess and obsolete inventory and warranty adjustments,
offset by lower product margins resulting from the spread of fixed manufacturing
and facility costs over a much lower revenue base.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel related expenses, depreciation of
development equipment, facilities and supplies. Research and development
expenses decreased 43% from $5.2 million for the three months ended July 1, 2001
to $3.0 million for
10
the three months ended June 30, 2002 and decreased 47% from $11.1 million for
the six months ended July 1, 2001 to $5.9 million for the six months ended June
30, 2002. Research and development expenses as a percentage of revenue were 38%
for the second quarter of 2001 and 40% for the second quarter 2002, and 43% for
the first six months of 2001 and 41% for the first six months of 2002. The
dollar decrease in research and development expenses was a result of reduced
project spending and headcount, due to cost savings initiatives implemented by
the Company, and the divestiture of ARL. The increase in expense as a percentage
of revenue for the second quarter of each period was due to a greater decline in
revenues than the reduction in product development expenditures. The decrease in
expense as a percentage of revenue for the first six months of each period is
due to revenue increases in the second quarter of each period when compared to
the dollar decrease in expenses for reasons mentioned above.
Selling and Marketing. Selling and marketing expenses consist primarily
of personnel expenses, including sales commissions and bonuses, and expenses for
public relations, seminars and trade shows. Selling and marketing expenses
decreased 45% from $5.0 million for the three months ended July 1, 2001 to $2.8
million for the three months ended June 30, 2002 and decreased 46% from $10.8
million for the six months ended July 1, 2001 to $5.8 million for the six months
ended June 30, 2002. Selling and marketing expenses as a percentage of revenue
were 37% for the second quarter of 2001 and 38% for the second quarter of 2002,
and 41% for the first six months of 2001 and 40% for the first six months of
2002. The dollar decrease in selling and marketing expenses was a result of
lower commission spending due to decreased revenues, lower headcount spending
driven by the reduction in workforce actions taken during 2002, and lower
marketing and bonus spending due to the implementation of cost savings
initiatives by the Company. The increase in expense as a percentage of revenue
for the second quarter of each period was due to a greater decline in revenues
than the reduction in selling and marketing expenditures. For the first six
months of each period, the percentages were essentially comparable.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, information systems costs, and audit,
legal and other professional service fees. General and administrative expenses
decreased 47% from $2.7 million for the three months ended July 1, 2001 to $1.4
million for the three months ended June 30, 2002 and decreased 40% from $5.7
million for the six months ended July 1, 2001 to $3.5 million for the six months
ended June 30, 2002. General and administrative expenses as a percentage of
revenue were 20% for the second quarter of 2001 and 19% for the second quarter
2002, and 22% for the first six months of 2001 and 24% for the first six months
of 2002. The dollar decrease in general and administrative expenses was due to
lower headcount spending driven by the reduction in workforce actions taken
during 2002, and lower bonus spending due to the implementation of cost savings
initiatives by the Company. The decrease in expense as a percentage of revenue
for the second quarter of each period was due to a greater decline in
expenditures than the reduction in revenues. The increase in expense as a
percentage of revenues for the first six months of each period was due to a
faster decline in revenues than expenses could be adjusted.
Restructuring Charges. Restructuring charges consist of severance
expenses due or paid to former employees and the estimated cost of excess leased
facilities and related furniture and equipment, net of estimated proceeds from
planned subleasing of excess office space. In the second quarter of 2002, the
Company eliminated 36 positions incurring a pre-tax severance charge of $0.7
million. In light of the workforce reduction, and the continued weak demand for
vacant office space in Santa Clara, CA, the Company increased its estimate of
the loss from excess leased facilities by $1.2 million.
Amortization of Acquired Intangibles. Amortization of intangible assets
declined from $0.8 million for the three months ended July 1, 2001 to $0.4
million for the three months ended June 30, 2002 and declined from $1.7 million
for the six months ended July 1, 2001 to $1.0 million for the three months ended
June 30, 2002. Pursuant to the adoption of SFAS 142, "Goodwill and Other
Intangibles," on January 1, 2002, Cylink ceased amortizing its goodwill.
Other Income (Expense), Net. Other income (expense), net consists
primarily of interest income and interest expense, foreign exchange gains or
losses, royalty income, and impairment losses from investments in non-operating
companies. Other income, net increased from $39 thousand for the quarter ended
July 1, 2001 to $170 thousand for the quarter ended June 30, 2002, principally
due to foreign exchange gains in the current period versus losses in the prior
period. Other income, net decreased from income of $210 thousand for the six
months ended July 1, 2001 to a loss of $92 thousand for the six months ended
June 30, 2002, principally due to the write-down of our investment in an
unaffiliated company in 2002.
11
Provision for Income Taxes. A charge for state taxes paid was
recognized in the quarter ended June 30, 2002. Cylink recognized a tax benefit
of $1.2 million for the quarter ended July 1, 2001 representing the partial
recognition of the Company's net operating loss for income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002, the Company had working capital of $10.2 million
(including cash and cash equivalents of $10.5 million) and $2.6 million of
long-term obligations. For the six months ended June 30, 2002, the Company
recorded a net loss of $8.6 million. Net cash provided by operating activities
for the first six months of 2002 was $0.2 million, consisting primarily of the
loss from operations, offset by $2.4 million of non-cash depreciation and
amortization and a net decrease in working capital. The decrease in working
capital included a decrease in accounts receivable of $5.7 million, an increase
in deferred revenue of $0.4 million, a decrease in inventories of $0.6 million,
an increase in restructuring accruals of $1.2 million, partially offset by a
decrease in accounts payable and accrued liabilities of $0.8 million, an
increase in income tax receivables of $0.4 million, and an increase in other
assets of $0.2 million. The decrease in accounts receivable was due to lower
shipments during the second quarter of 2002, and improved collection activities.
The decrease in inventories and accounts payable was due to continued strict
purchasing controls. The decrease in accrued liabilities was due principally to
decreased commission and bonus liabilities, along with decreased employment
liabilities resulting from reduced headcount.
Net cash used in operating activities for the first half of 2001 was
$3.0 million consisting primarily of the loss from operations of $14.6 million,
partially offset by a decrease in working capital which included a decrease in
accounts receivable of $4.0 million, a decrease in inventories of $3.1 million,
an increase in deferred revenue of $1.7 million, partially offset by a decrease
in accounts payable and accrued liabilities of $3.1 million, an increase in
income tax receivables of $0.4 million, and an increase in other assets of $0.6
million. The decrease in accounts receivable was due to lower than average
shipments during the quarter supported by improved collection activities. The
decrease in inventories and the decrease in accounts payable were the result of
stricter purchasing controls. The decrease in accrued liabilities was due
principally to decreased commission, bonus, and legal liabilities.
Cash provided by investing activities was $0.7 million for the six
months ended June 30, 2002 as compared to cash used by investing activities of
$0.6 million for the six months ended July 1, 2001. Cash provided by investing
activities for the first six months of 2002 resulted from the collection of a
$1.0 million note receivable, and the write-down of an investment in an
unaffiliated company, partially offset by the acquisition of $0.5 million of
property, plant and equipment. Cash used in investing activities for the first
six months of 2001 consisted primarily of the acquisition of $0.5 million of
property, plant and equipment.
Cash provided by (used in) financing activities for the six months
ended June 30, 2002 and July 1, 2001, respectively, was not material in both
periods.
On June 27, 2001, the Company entered into a loan and security
agreement with a bank under which it may borrow up to $7.5 million by way of
revolving advances. This loan matured on June 27, 2002. The loan is secured by
all of Cylink's tangible assets and contains a covenant to maintain a minimum
tangible net worth. The Company fell out of compliance with its covenant in
February 2002 and remains not in compliance with said covenant as of June 30,
2002. The bank has waived the Company's compliance with said covenant, pending
renewal of this credit facility. The Company is working with the bank to renew
this credit facility for one year at $5.0 million and the bank has extended the
maturity date for $5.0 million of this loan facility through August 27, 2002
pending its renewal. There have been no borrowings under the loan since its
inception.
In conjunction with the acquisition of Celotek Corporation in August
2000, Cylink assumed an equipment loan with an outstanding balance of $0.3
million. This loan matures December 1, 2002 and bears interest at the prime rate
plus 1%. As of June 30, 2002, the outstanding balance under the equipment line
was $0.1 million. The equipment line requires the Company to maintain certain
liquidity and profitability covenants, with which the Company was not in
compliance as of June 30, 2002.
12
As of the date of filing of this Quarterly Report on Form 10Q, the
Company's revenue to date for 2002 is significantly below the revenue
anticipated under its current financial plan. Under the Company's financial plan
for 2002, the Company had projected a positive operating cashflow for the 2002
fiscal year. Due to the decrease in the Company's revenues below the amounts
anticipated by the Company under its financial plan, the Company undertook a
workforce reduction in June 2002 and is prepared to undertake certain additional
cost cutting actions predicated on actual revenue performance during the third
quarter. However, there can be no assurance that the Company will be able to
implement or achieve a revised plan, that such a revised plan, if implemented,
would be sufficient for the Company to achieve profitability, or that the
Company's existing cash balances and available borrowing will be sufficient to
fund operations through 2002.
In the event the Company's financial plan is unsuccessful, the Company
may require additional funds in the near term to support working capital
requirements or for other purposes and may seek to raise such additional funds
through public or private equity or debt financing, sales of assets, or from
other sources. No assurance can be given that additional financing will be
available or that, if available, will be on terms favorable to the Company or
its shareholders. If Cylink is unsuccessful in implementing it's revised
financial plan, and cannot raise additional funds, the Company may not have the
resources to maintain its operations.
On June 27, 2002, the Company received a notice from the staff of the
NASDAQ National Market that its Common Stock had failed to maintain the minimum
bid price of $1.00 over the prior 30 trading days as required for continued
listing on the NASDAQ National Market. The notice stated that if during the 90
days following the date of the notice the bid price of Cylink Common Stock
failed to close at or above $1.00 for at least 10 consecutive trading days, then
Cylink Common Stock could be delisted.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
We have a history of losses, and may not be able to meet our needs for working
capital.
We incurred significant net losses in 2001 and in prior years. We had
an accumulated deficit of $127.3 million as of June 30, 2002. Our prior losses
may also adversely impact our ability to raise additional capital if required to
sustain our operations.
As of the date of filing of this Quarterly Report on Form 10-Q, our
revenue to date for 2002 is significantly below the revenue anticipated under
our current financial plan. Under our financial plan for 2002, we had projected
a positive operating cash flow for the 2002 fiscal year. Due to the decrease in
the Company's revenues below the amounts anticipated by the Company under its
financial plan, we undertook a workforce reduction in June 2002 and are prepared
to undertake certain additional cost cutting actions predicated on actual
revenue performance during the third quarter. However, there can be no assurance
that we will be able to implement or achieve our revised plan, that such a
revised plan, if implemented, would be sufficient for the Company to achieve
profitability, or that our principal sources of liquidity, which include cash
and cash equivalents of $10.5 million as of June 30, 2002, will satisfy our
current anticipated working capital and capital expenditure requirements through
at least the next twelve months. Our previous credit line expired in June 2002
and it undergoing the renewal process. In February 2002, we breached certain
financial covenants contained in the loan agreement for such credit line. The
bank has waived compliance with the covenants pending renewal of the loan. There
is no guarantee that we will satisfy the renewal covenants or other covenants in
the loan agreement in the future, and there is no guarantee that the bank will
renew the credit line after its extended expiration in August 2002. If we fail
to meet our financial covenants or if the bank does not renew the facility, the
line of credit will not be available to fund our operations if it is needed.
In 2001, we began to realize the benefits of the actions taken in the
fourth quarter of 2000, and throughout 2001 to reduce operating costs in our
core business. We plan to continue such cost reducing measures in 2002. However,
there can be no assurance that we will be able to continue reducing costs at a
pace that reflects further reduction in revenues, or that we will not need to
raise additional capital to fund operations within this period or that
additional financing can be obtained on acceptable terms, or at all. If
additional funds are raised by issuing equity securities, dilution to
shareholders may result. If adequate funds are not available, we, our business,
and the price of our Common Stock will be adversely affected.
Our quarterly operating results may vary in the future, which could cause our
stock price to drop.
13
We have historically experienced significant fluctuations in our
operating results on a quarterly basis and could experience such fluctuations in
the future. Our revenues and operating results could be affected by a number of
factors outside of our control, including the following:
o our inability to accurately forecast revenues and respond in a
timely manner to changes in revenue levels;
o the timing of the introduction by us or by our competitors of
new or enhanced products;
o market acceptance of our new products and those of our
competitors;
o the timing, cancellation or delay of customer orders,
including cancellation or delay in anticipation of new product
introductions or enhancements;
o changes in our pricing policies or those of our competitors;
o changes in operating costs and expenses, including those
resulting from changes in available production capacity of
independent foundries and other suppliers and the availability
of raw materials;
o changes in the revenue mix from products or services sold;
o changes in the percentage of products sold through our direct
sales force;
o loss of an important customer;
o failure to grow our customer base in accordance with market
expectations;
o customer discounts and credits;
o our limited ability to reduce expenses to offset any
unexpected shortfall in revenue growth or decrease in revenue;
o delays in manufacturing due to shortages in components or
unanticipated revisions in product design;
o expenses incurred in seeking to enforce or defend claims with
respect to intellectual property rights;
o changes in the economy that affect the purchasing decisions of
our customers;
o defaults by existing subtenants under our long term lease for
leasehold space may increase our net costs in a deteriorating
office rental market; and
o disruption in our operations caused by reductions in our
workforce.
Many of these factors are outside of our control. Unforeseen reductions
in revenue can materially and adversely affect our ability to raise capital or
sustain ongoing operations.
We are currently involved in litigation.
Several securities class action complaints have been filed against us
and certain of our current and former directors and officers in federal courts
in California. These complaints allege, among other things, that our previously
issued financial statements were materially false and misleading and that the
defendants knew or should have known that these financial statements caused our
common stock price to rise artificially and allege violations of Section 10(b)
of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated
thereunder, and Section 20 of the Exchange Act. The securities class action
lawsuits have been ordered consolidated into a single action pending in the
United States District Court for the Northern District of California, captioned
In Re Cylink Securities Litigation, No. C98-4292 (VRW). For more information on
this lawsuit, see Part II, Item 1. "Legal Proceedings." Although we believe we
have meritorious defenses and adequate insurance for the damages claimed in
these actions, it is not feasible to predict or determine the final outcome of
these proceedings, and if the outcome were to be unfavorable and exceed our
applicable insurance, our business, financial condition, cash flows and results
of operations could be materially adversely affected.
Our sales cycles are long and unpredictable, which makes period-to-period
revenues difficult to predict.
14
Sales of our products generally involve a significant commitment of
capital by customers, with the attendant delays frequently associated with large
capital expenditures. For these and other reasons, the sales cycle associated
with our products is typically lengthy and subject to a number of significant
risks over which we have little or no control. We are often required to ship
products shortly after we receive orders. Consequently, order backlog at the
beginning of any period has, at times in the past, represented only a small
portion of that period's expected revenue. Furthermore, increases in backlog
from quarter to quarter may be due to placement of orders calling for delivery
dates extended over a much longer period of time into future periods.
Consequently, our order backlog becomes more vulnerable to customer
cancellations. As a result of these fluctuations in our sales cycle and order
backlog, product revenue in any period has been and will continue to be
substantially dependent on orders booked and shipped in that period. We
typically plan our production and inventory levels based on internal forecasts
of customer demand, which are highly unpredictable and can fluctuate
substantially. In particular, market forces beyond our control, including
recession, and limits or changes in government spending may have a material
affect on customer demand for our products. If revenue falls significantly below
anticipated levels, as it has at times in the past, our financial condition and
results of operations would be materially and adversely affected. In addition,
our operating expenses are based on anticipated revenue levels and a high
percentage of our expenses are generally fixed in the short term. Based on these
factors, a small fluctuation in the timing of sales can cause operating results
to vary significantly from period to period. It is possible that in the future
our operating results will again be below the expectations of securities
analysts and investors. In such an event, or in the event that adverse
conditions prevail or are perceived to prevail generally or with respect to our
business, or the market sector in which we operate, the price of our Common
Stock would likely be adversely affected. These factors make it difficult to
predict our financial performance. As our quarterly results fluctuate, they may
fall below the expectations of public market analysts or investors. If this
occurs, the price of our Common Stock may drop.
The overall economic climate continues to be weak.
Our products typically represent substantial capital commitments by
customers, involving a potentially long sales cycle. As a result, customer
purchase decisions may be significantly affected by a variety of factors
including trends in capital spending for communication networks, market
competition, and the availability or announcement of alternative technologies.
Continued recent weakness in general economic conditions has resulted in many of
our customers delaying and/or reducing their capital spending related to
information systems. If the economy continues to be weak, demand for our
products could decrease, resulting in lower revenues and a decline in the
overall rate of our revenue growth.
We are dependent on recently introduced and new network security products.
Our future results of operations will be highly dependent on the
successful marketing and manufacture of the NetHawk product, as well as
successful marketing and manufacture of the Cylink Link Encryptors, PrivaCy
Manager, Cylink ATM, and Cylink Frame Encryptor products. Through the second
quarter of 2002, we have made only limited commercial shipments of our NetHawk
product, which began shipping in mid-year 2000. This product requires additional
development work, enhancement, and testing to achieve widespread commercial
success. If this or other new or recently introduced products have performance,
reliability, quality or other shortcomings, such products could fail to achieve
adequate market acceptance. The failure of our new or existing products to
achieve or enjoy market acceptance, whether for these or other reasons, could
cause us to experience reduced orders, higher manufacturing costs, delays in
collecting accounts receivable and additional warranty and service expenses,
which in each case could have a material adverse effect on our business,
financial condition and results of operations.
Due to insufficient market acceptance of stand alone public key
infrastructure ("PKI") products, such as our Net Authority and similar products
of our competitors, we revised our marketing approach in the second half of 2001
by discontinuing efforts to sell Net Authority as a stand alone product and
focused our efforts on potential customers seeking to embed our PKI as part of
their application or service. In addition, on February 8, 2002, we received
notice from the United States Postal Service ("USPS") that it was terminating
its license to Cylink's Net Authority product as of March 17, 2002, noting that
its decision was "not a reflection of the quality of work performance provided
by Cylink" but was due to "USPS' immediate need to reduce cost" and downsize its
non core businesses following the anthrax attack on its operations in October of
2001. After granting USPS a continuation of its license, at its request, through
May 30, 2002, this license and all further revenue earned under Cylink's
contract with the USPS finally expired in the second quarter of 2002. Revenue
for the second quarter of 2002, and the first six months of 2002 resulting from
USPS was $0.2 million, and $0.5 million, respectively. We discontinued all
further development of our PKI technology in July 2002.
15
We face significant competition from other providers of network security systems
Competition is intense among providers of network security systems, and
we expect such competition to increase in the future. Significant competitive
factors in these markets include:
o the development of new products and features;
o product quality and performance;
o customer perception regarding the adequacy of security
provided by existing software and routers;
o adoption of embedded security solutions in other vendors'
hardware and software products;
o the quality and experience of our sales, marketing and service
organizations;
o product price;
o name recognition; and
o perception of our stability and long-term viability.
Many of these competitive factors are beyond our control.
Our competitors in the information security markets, including
companies that offer products similar to, or are perceived as an alternative to,
our products, are Checkpoint Software Technologies, Ltd., Network Associates,
Inc., SafeNet, Inc., Secure Computing Corporation, RSA Security, Inc., Symantec
Corporation, and Thales e-Security, Inc. Our NetHawk VPN appliance competes with
numerous other products, including those offered or under development by Cisco
Systems, Inc., Newbridge Networks Corporation, Netscreen Technologies, Inc.,
Nokia Corp, and Sonic Wall, Inc. A number of significant vendors, including
Microsoft Corporation, and Cisco Systems, Inc. have embedded security solutions
in their software. To the extent that these embedded or optional security
capabilities provide all or a portion of the functionality provided by our
products, our products may no longer be required by customers to attain network
security.
Many of our competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer standing relationships with customers than we possess. Competitors
with greater financial resources are better able to engage in more aggressive
marketing campaigns and sustained price reductions in order to gain market
share. Any period of sustained price reductions would have a material adverse
effect on our financial condition and results of operations. We may not be able
to compete successfully in the future and competitive pressures may result in
price reductions, loss of market share or otherwise have a material adverse
effect on our financial condition and results of operations.
We face the risks from tort and warranty claims that may be made against us.
We face the risks from tort and warranty claims that may be made
against us. Customers rely on our network security products to prevent
unauthorized access to their networks and data transmissions. A malfunction or
the inadequate design of our products could result in tort or warranty claims. A
breach of a customer's network by an unauthorized party, which is attributable
to an alleged defect in our products, may cause substantial damages due to loss
or compromise of the customer's valuable information. Furthermore, there is
inadequate legal precedent for allocating responsibility for such losses caused
by the wrongful acts of third parties. Although we attempt to reduce the risk of
such losses through warranty disclaimers and liability limitation clauses in our
sales and license agreements and by maintaining product liability insurance,
there can be no assurance that such measures will be effective in limiting our
liability for any such damages. Any liability for damages resulting from
security breaches or other product defects could be substantial and could have a
material adverse effect on our business, financial condition and results of
operations.
In addition, a well-publicized actual or perceived security breach
could adversely affect the market's perception of security products in general,
or our products in particular, regardless of whether such breach is attributable
to our products. This could result in a decline in demand for our products,
which would have a material adverse effect on our business, financial condition
and results of operations.
16
On August 2, 2001, Cylink determined that a hardware design could cause
a premature failure of the backup battery on its Cylink Frame Encryptor (CFE)
product. Shortly thereafter, Cylink announced a program to give its customers
the option of updating their CFE units by returning them to the factory, or
receiving an extended warranty covering the battery through the end of December
2002. Cylink accrued approximately $1.0 million in warranty costs during the
second quarter of 2001 associated with this program. While we believe this
reserve was based on reasonable estimates based on information available to us
at the time, actual costs could exceed these reserves. Since announcing this
program, two of our major customers stated their intention to submit substantial
claims related to their costs of avoiding product failures. Although we believe
such claims may be barred or significantly reduced by the limitations and
exclusions in the governing contracts of sale, there can be no assurance that we
will be found free from liability and any obligation to reimburse customers may
have a material effect on our operations.
We may be unable to retain our executive officers and key personnel that are
critical to our business.
Our future success will depend in large part on the abilities of our
executive officers, key management and technical personnel and our ability to
retain qualified and competent individuals following our reductions in the
employee workforce. There is no guarantee that our present executive management
and technical staff will remain with the Company, particularly if our
performance is not up to expectations, and particularly if general economic
recovery leads to expanded alternative opportunities for such employees. The
loss of the services of one or more of our executive officers or key personnel,
or the inability to attract and retain additional executives and other qualified
personnel, could delay product development cycles or otherwise have a material
adverse effect on our business and operating results.
We may not be able to hire and retain sufficient technical, marketing and
management personnel that we need to succeed because these people are limited in
number and are in high demand.
We may not be able to hire and retain sufficient technical, marketing
and management personnel that we need to succeed because we have limited
resources to expand our work force. We recently experienced, and may continue to
experience, substantial fluctuations in the number of employees and the scope of
our operations in the network security business, resulting in increased
responsibilities for management. To manage our business effectively, we will
need to continue to improve our operational, financial and management
information systems and to retain, motivate and manage our employees. In the
recent past, competition has been intense for qualified technical, marketing and
management personnel. Furthermore, the recent reductions in our workforce, and
fluctuation in our stock price, may create greater uncertainty amongst our
existing employees, who may decide not to continue employment with the Company.
There can be no assurance that we will be able effectively to achieve or manage
any future growth, and our failure to do so could delay product development
cycles or otherwise have a material adverse effect on our financial condition
and results of operations.
Any inability to protect our intellectual property could reduce our competitive
advantage, divert management attention, and require additional intellectual
property to be developed or cause us to incur expenses to enforce our rights.
We rely on patents, trademarks, copyrights, licenses and trade secret
law to establish and preserve our intellectual property rights. We own a number
of U.S. patents covering certain features of our network security product
designs, and have additional U.S. patent applications pending. There can be no
assurance that any patent, trademark, copyright or license owned or held by us
will not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to us or that any of our pending
or future patent applications will be issued with the scope of the claims sought
by us, if at all. Further, there can be no assurance that others will not
develop technologies that are similar or superior to our technology, duplicate
our technology, misappropriate our trade secrets, or design around the patents
owned by us. Resorting to the courts to protect our intellectual property would
require significant financial and management resources. In addition, the laws of
certain countries in which our products are or may be developed, manufactured or
sold may not protect our products and intellectual property rights to the same
extent as the laws of the United States. Our inability to protect our
intellectual property adequately could have a material adverse effect on our
financial condition and results of operations.
The computer, communications, software and network security industries
are characterized by substantial litigation regarding patent and other
intellectual property rights. In the past, we have received communications from
third parties asserting that our patents, features or content of certain of our
products infringe upon the intellectual
17
property rights held by third parties, and we may receive such communications in
the future. There can be no assurance that third parties will not assert claims
against us that result in litigation. Any litigation, whether or not determined
in our favor, could result in significant expense to us and could divert
management and other resources. In the event of an adverse ruling in any
litigation involving intellectual property, we might be required to discontinue
the use of certain processes, cease the manufacture, use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to the infringing technology and we may suffer significant
monetary damages, which could include treble damages. There can be no assurance
that under such circumstances a license would be available to us on reasonable
terms or at all. In the event of a successful claim against us and our failure
to develop or license a substitute technology on commercially reasonable terms,
our financial condition and results of operations would be adversely affected.
There can be no assurance that existing claims or any other assertions (or
claims for indemnity from customers resulting from infringement claims) will not
materially and adversely affect our financial condition and results of
operations.
If we are unable to adapt our services to rapidly changing technology, or if the
market for our network security products fails to grow, our business and
operating results could suffer.
The market for our network security products is characterized by
rapidly changing technology, emerging industry standards, new product
introductions and changes in customer requirements and preferences. Our future
success will depend in part upon end users' demand for network security products
in general, and upon our ability to enhance our existing products and to develop
and introduce new products and technologies that meet customer requirements. We
face continuing challenges to educate customers as to the value of our security
products. We believe that many potential customers do not appreciate the need
for our security products unless and until they have faced a major security
breach. Many potential customers prefer not to disclose significant security
breaches of their networks or are reluctant to invest in the development of a
professional security architecture to protect their networks. This market
resistance is compounded by our limited resources to invest in marketing
campaigns for our products and services.
If we are unable successfully to educate potential customers as to the
value of, and thereby obtain broad market acceptance for, our products and
services, we will continue to rely primarily on selling new and existing
products to our base of existing customers, which will significantly limit any
opportunity for growth. In addition, any significant advance in technologies for
attacking cryptographic systems could render some or all of our existing and new
products obsolete or unmarketable. To the extent that a specific method other
than ours is adopted as the standard for implementing network security in any
segment of the network security market, sales of our existing and planned
products in that market segment may be adversely impacted, which could have a
material adverse effect on our business, financial condition and results of
operations. The National Institute of Standards and Technology has announced a
new Advanced Encryption Standard, or AES, which we expect to integrate into our
products. Our ability to timely implement the AES into our products may
materially affect our development costs and ability to timely market our
solutions. Network security-related products or technologies developed by others
may adversely affect our competitive position or render our products or
technologies noncompetitive or obsolete.
In addition, a portion of the sales of our network security products
will depend upon a robust industry and infrastructure for providing access to
public switched networks, such as the Internet. The infrastructure or
complementary products necessary to turn these networks into viable commercial
marketplaces may not be fully developed, and once developed, these networks may
not become viable commercial marketplaces.
If our research and development activities are unsuccessful, we will not be able
to market new products and services and our business operations and financial
results could be harmed.
The markets for our products are characterized by rapidly changing
technologies, extensive research and new product introductions. We believe that
our future success will depend in part upon our ability to continue to enhance
our existing products and to develop, manufacture and market new products. As a
result, we expect to continue to make a significant investment in engineering,
research and development. We may not be able to develop and introduce new
products or enhancements to our existing products in a timely manner that
satisfy customer needs, achieve market acceptance or address technological
changes in our target markets. If we fail to develop products and introduce them
successfully and in a timely manner, this could adversely affect our competitive
position, financial condition and results of operations.
We face risks associated with our international operations.
18
We plan to continue to maintain our foreign sales channels, which
require significant management attention and financial resources. International
sales are subject to a number of risks, including unexpected changes in
regulatory requirements, export control laws, tariffs and other trade barriers,
political and economic instability in foreign markets, difficulties in the
staffing, management and integration of foreign operations, longer payment
cycles, greater difficulty in collecting accounts receivable, currency
fluctuations and potentially adverse tax consequences. Since most of our foreign
sales are denominated in U.S. dollars, our products become less price
competitive in countries in which local currencies decline in value relative to
the U.S. dollar. The uncertainties of monetary exchange values have caused, and
may in the future cause, some foreign customers to delay new orders or delay
payment for existing orders. The long-term impact of such devaluation, including
any possible effect on the business outlook in other developing countries,
cannot be predicted.
Our ability to compete successfully in foreign countries is dependent
in part on our ability to obtain and retain reliable and experienced in-country
distributors and other strategic partners. We do not have long-term contracts
with most of our value added resellers and distributors and, therefore, have no
assurance of a continuing relationship within a given market.
Due to U.S. government regulations restricting the export of
cryptographic devices and software, including our network security products to
non-civilian agencies of foreign governments, we are often at a disadvantage in
competing for international sales compared to companies located outside the
United States that are not subject to such restrictions. Furthermore, in certain
foreign countries, our distributors are required to secure licenses or formal
permission before encryption products can be imported. Although the Department
of Commerce continues to relax the export control laws as they apply to sales of
our products to our commercial customers, we still face export controls on sales
to certain foreign governments and transfers of our technology to foreign
partners. To date, we have been able to secure the necessary export and import
licenses to compete effectively in the international market. However, we may not
be able to secure such licenses in a timely manner in the future, or at all.
We face risks from our dependence on third party subcontractors and suppliers.
Our ability to deliver our products in a timely manner is dependent
upon the availability of quality components and subsystems used in these
products. We depend in part upon subcontractors to manufacture, assemble and
deliver certain items in a timely and satisfactory manner. We obtain certain
components and subsystems from a single, or a limited number of, sources. A
significant delay in obtaining a source of supply for components selected by our
design engineers or interruption in the delivery of such items could have a
material adverse effect on our financial condition and results of operations.
On February 14, 2002, we notified our OEM supplier of our ISDN
encryption products, Biodata Information Technology AG ("Biodata") of our
decision to terminate our development and supply agreement following Biodata's
declaration of insolvency. Due to Biodata's financial failure, and that of the
previous supplier of our ISDN encryption products, Dica, in the first half of
2001, we have discontinued all further sales and support for this product line.
Although we attempted to disclaim all liability for Biodata and Dica's failure
in our supply contract with our principal customer for ISDN encryption products,
there can be no assurance that the suppliers' failure, and our discontinuance of
this ISDN product line, will not cause claims for breach of warranty and support
by our customer and end users.
We face risks of additional losses from excess leased facilities.
In the fourth quarter of 2001, we recorded a $1.4 million charge to
accrue a reserve for losses relative to the estimated costs of excess leased
facilities in Santa Clara and related furniture and equipment, net of estimated
proceeds from planned subleasing of excess office space. In the second quarter
of 2002, the Company increased its estimate by an additional $1.2 million based
on a continued weak sublease market. These losses reflect decreased space
utilization from our reduced workforce along with estimates of sublease income
and the time to market that excess space for sublease. The Company is obligated
to assume occupancy and pay rent on space covered by its Master Lease on its
Santa Clara facility, currently leased by its landlord to a third party tenant
through August 2004. Various events might require additional increases in our
reserves for potential losses due to excess leased facilities, including
additional workforce reductions, further deterioration in the market for
sublease space, or early termination of existing subleases. If any of these
events occur, we would incur additional losses form excess leased facilities,
which would have a material adverse affect on our financial position and results
of operations.
19
Cylink Common Stock could be delisted from the NASDAQ National Market, which
could adversely affect Cylink and its shareholders.
On June 27, 2002, the Company received a notice from the staff of the
NASDAQ National Market that its Common Stock had failed to maintain the minimum
bid price of $1.00 over the prior 30 trading days as required for continued
listing on the NASDAQ National Market. The notice stated that if during the 90
days following the date of the notice the bid price of Cylink Common Stock
failed to close at or above $1.00 for at least 10 consecutive trading days, then
Cylink Common Stock could be delisted.
If Cylink Common Stock were to be delisted from the NASDAQ National
Market, we could apply for listing on the NASDAQ SmallCap Market, the OTC
Bulletin Board or another quotation system or exchange for which we could
qualify. We cannot guarantee, however, that we could apply for listing on
another quotation system or exchange if we are delisted from the NASDAQ National
Market or that if we do apply for listing that we will be eligible initially for
such listing or that if we do become listed, that we will be able to maintain
eligibility. Listing on another quotation system or exchange may negatively
affect the price of our Common Stock because stocks trading on over-the-counter
markets are typically less liquid and trade with larger variations between the
bid and ask prices. In addition, the delisting of our Common Stock from the
NASDAQ National Market would adversely affect or limit or restrict our ability
to raise funds through stock issuances.
If the market price for our Common Stock remains below $1.00 per share
and we are no longer listed on the NASDAQ National Market, our Common Stock will
be deemed to be penny stock. If our Common Stock were considered penny stock, it
would be subject to rules that impose additional sales practices on
broker-dealers who sell our securities. For example, broker-dealers must make a
special suitability determination for the purchaser and have received the
purchaser's written consent to the transaction prior to sale. Also, a disclosure
schedule must be prepared prior to any transaction involving a penny stock and
disclosure is required about sales commissions payable to both the broker-dealer
and the registered representative and current quotations for the securities.
Monthly statements are also required to be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stock. Because of these additional obligations, some
brokers may be unwilling to effect transactions in penny stocks. This could have
an adverse effect on the liquidity of our Common Stock under those
circumstances.
Terrorist attacks may negatively impact all aspects of our operations, revenues,
costs and stock price.
Recent terrorist attacks in the United States, as well as future events
occurring in response or connection to them, including, without limitation,
future terrorist attacks against United States targets, rumors or threats of
war, actual conflicts involving the United States or its allies or military or
trade disruptions impacting our domestic or foreign suppliers of merchandise,
may impact our operations, including, among other things, causing delays or
losses in the delivery of goods and supplies to us and decreased sales of the
products we carry. More generally, any of these events may have affected, and
may continue to affect, the general economy and customers' demand for capital
equipment. Any of these occurrences could have a significant impact on our
operating results, revenues and costs, may result in the volatility of the
market price for our Common Stock, and have an adverse impact on the future
price of our Common Stock.
Recent accounting pronouncements may impact our financial position and results
of operations.
We have adopted recent changes in financial accounting standards. In
June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible Assets". The
valuation of the Company's goodwill and intangible assets under SFAS 142 depends
on certain factors outside of our control, including our stock price, and we may
be required to write down some or all of the $15.7 million net carrying value of
our investment in intangibles reported as of June 30, 2002. Any determination
under SFAS 142 of an impairment of our investment in intangibles could have a
material impact on Cylink's financial position and results of operations. In
June, July and August, 2001, the FASB also issued SFAS 141 "Business
Combinations", SFAS 143, "Accounting for Asset Retirement Obligations", and SFAS
144,"Impairment or Disposal of Long-Lived Assets", respectively, which are
effective for fiscal years beginning after December 15, 2001. The adoption of
these statements did not have a material effect on our financial condition or
results of operations. There can be no assurances, however, that the issuance by
FASB of additional statements of financial accounting standards would not
materially adversely affect our business, financial condition, and results of
operations if such are required to be adopted by us in the future.
20
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force Issue No. 94-3. The Company
will adopt the provisions of SFAS 146 for the restructuring activities initiated
after December 31, 2002. SFAS 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred. Under Issue 94-3, a liability for an exit cost was recognized at the
date of the Company's commitment to an exit plan. SFAS 146 also established that
the liability should initially be measured and recorded at fair value.
Accordingly, SFAS 146 may affect the timing of recognizing future restructuring
costs as well as the amounts recognized.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of June 30, 2002, we held a total of $10.5 million of cash and cash
equivalents. These securities consist primarily of money market funds and
high-grade, short-term corporate obligations. Certain of these securities are
subject to interest rate risk and will decline in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from levels as of June 30, 2002, the decline in fair value of the portfolio
would not be material.
We transact substantially all of our revenues and costs in U.S. dollars
and our results of operations would not be materially affected by fluctuations
in foreign exchange rates. Accordingly, to date, we have not used material
amounts of derivative financial instruments. As of June 30, 2002, we had no
fixed rate obligations except for an equipment loan with a balance of
approximately $69,000. As such, the fair value of our fixed rate obligations is
not subject to a material adverse impact from changes in interest rates.
21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Securities Class Action.
In 1998, we filed amended Forms 10-Q for the first and second quarters
of 1998 and an amended Form 10-K for 1997, reflecting restated financial results
for those quarters, and for the fourth quarter of 1997. Between November 6, 1998
and December 14, 1998, several securities class action complaints were filed
against us and certain of our current and former directors and officers in
federal courts in California. These complaints allege, among other things, that
our previously issued financial statements were materially false and misleading
and that the defendants knew or should have known that these financial
statements caused our common stock price to rise artificially. The actions
variously allege violations of Section 10(b) of the Securities Exchange Act of
1934 (the "Exchange Act"), as amended, and SEC Rule 10b-5 promulgated
thereunder, and Section 20 of the Exchange Act.
The securities class action lawsuits have been ordered consolidated
into a single action pending in the United States District Court for the
Northern District of California, captioned In Re Cylink Securities Litigation,
No. C98-4292 (VRW). The action is currently pending before the Court.
We believe we have meritorious defenses and adequate insurance for the
damages claimed in these actions and we intend to defend the Company vigorously.
However, it is not feasible to predict or determine the final outcome of these
proceedings, and if the outcome were to be unfavorable and exceed our applicable
insurance, our business, financial condition, cash flows and results of
operations could be materially adversely affected.
Other Litigation
In addition, in the normal course of business, we, from time to time,
receive inquiries or other communication with regard to possible infringement of
third party intellectual property rights by our patents, or the features or
content of certain of our products. We believe it is unlikely that the outcome
of these infringement inquiries will have a material adverse effect on our
financial position or results of operations, however if litigation results from
any of these inquires and the outcome is unfavorable to us, it could have a
material adverse effect on our cash flows, results of operations and financial
condition.
There has been substantial litigation regarding patent and other
intellectual property rights in the software and network security related
industries. Further commercialization of our products could provoke claims of
infringement from third parties. In the future, litigation may be necessary to
enforce our patents, to protect our trade secrets or know-how or to defend
against claimed infringement of the rights of others and to determine the scope
and validity of the proprietary rights of others. Any such litigation could
result in substantial cost and diversion of our efforts, which by itself could
have a material adverse effect on our financial condition and operating results.
Further, adverse determinations in such litigation could result in loss of
proprietary rights, subject us to significant liabilities to third parties,
require us to seek licenses from third parties or prevent us from manufacturing
or selling our products, any of which could have a material adverse effect on
our business, financial condition or results of operations.
Item 2. Changes in Securities and Use of Proceeds
Not applicable
Item 3. Defaults upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Registrant's Annual Meeting of Shareholders was held May 15, 2002.
The vote of the holders of record of 33,035,017 shares of Cylink's
common stock outstanding at the close of business on March 29, 2002 was
solicited by proxy pursuant to Regulation 14A under the Securities Act
of 1934.
22
(b) The following persons were elected Directors of Cylink at the Annual
Meeting:
Votes Votes
Name of Director For Against
- ---------------- ------- -------
Mr. Paul Gauvreau 21,825,592 111,004
Mr. Regis McKenna 21,612,948 323,648
(c) The shareholders ratified the appointment of Deloitte & Touche LLP as
Cylink's independent auditor for the fiscal year ending December 31,
2002.
Votes Votes Votes
For Against Withheld
--- ------- --------
21,860,396 56,585 19,615
(d) There were no other matters voted on at the meeting.
Item 5. Other Information.
Notice was received June 27, 2002 from the NASDAQ National Market indicating
possible delisting for failure to meet NASDAQ's minimum bid requirements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
None
23
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: August 13, 2002 CYLINK CORPORATION
By: /s/ R. Christopher Chillingworth
-------------------------------------
R. Christopher Chillingworth
Vice President of Finance
and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
24