UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q/A
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURTIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
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 November 25, 2002, there were approximately 33,065,000 shares of
the Registrant's common stock outstanding.
EXPLANATORY NOTE
This quarterly report on Form 10-Q/A for the quarterly period ended September
29, 2002 is being filed to restate Cylink's financial statements to reflect a
legal settlement payable and related insurance claim receivable gross in the
condensed consolidated balance sheet as of September 29, 2002. See Note 13 to
condensed consolidated financial statements in Item 1. The restatement had no
impact on net loss or net loss per share. Certain exhibits included in Cylink's
Form 10-Q for the period ended September 29, 2002 have been incorporated by
reference from such filing into this Quarterly Report on Form 10-Q/A.
CYLINK CORPORATION
FORM 10-Q/A FOR THE QUARTER ENDED SEPTEMBER 29, 2002
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
a) Condensed Consolidated Balance Sheets at September 29, 2002
(As Restated) and December 31, 2001 1
b) Condensed Consolidated Statements of Operations for the three and
nine months ended September 29, 2002 and September 30, 2001 2
c) Condensed Consolidated Statements of Cash Flows for the nine months
ended September 29, 2002 (As Restated) and September 30, 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 22
Item 4 Controls and Procedures 22
PART II OTHER INFORMATION 23
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults upon Senior Securities 23
Item 4. Submission of Matters to a Vote of the Security Holders 23
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 26
Exhibits Index 29
2.1
4.1
10.1
10.2
10.3
10.4
99.1
99.2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and par value data; unaudited)
Sep 29, Dec 31,
2002 2001
--------- ---------
Assets (As restated,
Current assets: See Note 13)
Cash and cash equivalents $ 8,175 $ 9,606
Accounts receivable, net of allowances of $516 and $984 5,425 10,102
Income tax receivable 475 50
Insurance claim receivable 6,200 --
Inventories 3,565 4,832
Other current assets 1,171 2,026
--------- ---------
Total current assets 25,011 26,616
Restricted cash 1,400 1,400
Property and equipment, net 4,553 6,075
Acquired technology and other intangibles, net 8,996 10,426
Goodwill, net -- 6,222
Note receivable from employee 1,074 1,021
Other assets 552 932
--------- ---------
$ 41,586 $ 52,692
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Equipment line of credit $ 35 $ 139
Accounts payable 1,583 2,757
Accrued liabilities 6,808 5,439
Legal settlement payable 6,200 --
Income taxes payable 410 412
Deferred revenue 1,824 2,130
--------- ---------
Total current liabilities 16,860 10,877
--------- ---------
Deferred revenue, less current portion 9 214
Deferred rent and other accruals, less current portion 1,140 1,713
--------- ---------
Total long-term liabilities 1,149 1,927
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; 330 329
33,002,000 and 32,872,000 shares issued and outstanding
Additional paid-in capital 158,450 158,359
Accumulated other comprehensive loss 5 (18)
Accumulated deficit (135,208) (118,782)
--------- ---------
Total shareholders' equity 23,577 39,888
--------- ---------
$ 41,586 $ 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 Nine Months Ended
------------------------ ------------------------
Sep 29, Sep 30, Sep 29, Sep 30,
2002 2001 2002 2001
-------- -------- -------- --------
Revenue $ 7,101 $ 10,345 $ 21,572 $ 36,528
Cost of revenue 2,280 4,905 7,552 15,203
-------- -------- -------- --------
Gross profit 4,821 5,440 14,020 21,325
-------- -------- -------- --------
Operating expenses:
Research and development 2,419 3,716 8,305 14,851
Selling and marketing 2,208 3,133 8,038 13,895
General and administrative 1,650 2,838 5,120 8,581
Amortization of acquired intangibles 477 768 1,431 2,447
Loss from divestiture of Algorithmic Research, Ltd. -- 294 -- 2,797
Impairment of goodwill 6,222 -- 6,222 --
Restructuring charges 181 -- 2,043 --
-------- -------- -------- --------
Total operating expenses 13,157 10,749 31,159 42,571
-------- -------- -------- --------
Loss from operations (8,336) (5,309) (17,139) (21,246)
Other income (expense):
Interest income, net 5 223 95 596
Other income, net 466 580 506 417
Write-down of investment in unaffiliated company -- (253) (222) (253)
-------- -------- -------- --------
Total other income 471 550 379 760
-------- -------- -------- --------
Loss before income taxes (7,865) (4,759) (16,760) (20,486)
Income tax benefit -- -- (334) (1,177)
-------- -------- -------- --------
Net loss $ (7,865) $ (4,759) $(16,426) $(19,309)
======== ======== ======== ========
Loss per share - basic & diluted: $ (0.24) $ (0.15) $ (0.50) $ (0.60)
======== ======== ======== ========
Shares used in per share calculation - basic & diluted 32,970 32,623 32,912 32,437
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
2
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
Nine months ended
----------------------------
Sep 29, Sep 30,
2002 2001
-------- --------
(As restated,
Cash flows from operating activities: see Note 13)
Net loss $(16,426) $(19,309)
Adjustments to reconcile net loss to net
cash used in operating activities:
Impairment of goodwill 6,222 --
Loss on divestiture of Algorithmic Research, Ltd. -- 2,797
Loss on disposition of fixed assets 112 31
Write-down of investment in unaffiliated company 222 253
Depreciation 2,014 2,597
Amortization of acquired intangibles 1,431 2,447
Deferred income taxes -- 800
Amortization of imputed interest on note receivable (53) (211)
Deferred compensation related to stock options -- 528
Changes in assets and liabilities:
Accounts receivable 4,677 6,415
Insurance claim receivable (6,200) --
Inventories 1,267 4,722
Income tax receivable (425) (109)
Other assets 13 309
Accounts payable (1,174) (2,427)
Accrued liabilities 795 (2,192)
Legal settlement payable 6,200 --
Income taxes payable (2) (7)
Deferred revenue (511) 509
-------- --------
Net cash used in operating activities (1,838) (2,847)
Cash flows from investing activities:
Acquisition of property and equipment (604) (605)
Collections of notes receivable from former employee 1,000 560
Cash transferred with divestiture of Security Design International -- (28)
Cash transferred with divestiture of Algorithmic Research, Ltd. -- (1,900)
-------- --------
Net cash provided by (used in) investing activities 396 (1,973)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 92 82
Other (104) (109)
-------- --------
Net cash used in financing activities (12) (27)
-------- --------
Effect of exchange rate changes on
cash and cash equivalents 23 (10)
-------- --------
Net decrease in cash and cash equivalents (1,431) (4,857)
Cash and cash equivalents at beginning of period 9,606 15,250
-------- --------
Cash and cash equivalents at end of period $ 8,175 $ 10,393
======== ========
Supplemental disclosures
Cash refunds of income tax -- $ 3,342
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") for the periods presented. These financial statements
should be read in conjunction with Cylink's audited consolidated financial
statements included in Cylink'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 Cylink's Condensed consolidated
financial statements, Cylink experienced declining annual revenues and incurred
losses from continuing operations of $16.4 million in the first nine months of
2002, and $20.1 million in 2001. These factors, among others, raise substantial
doubt that Cylink will be able 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 Cylink be unable to continue as a going concern. To address
these issues, Cylink 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
entered into a modification of its lease on its corporate headquarters facility;
however, no assurances can be given that these measures will allow Cylink to
attain profitable operations. Additionally, on October 30, 2002, Cylink entered
into a definitive agreement with SafeNet, Inc. to be acquired through a merger
of Cylink with a wholly-owned subsidiary of SafeNet, Inc. Please see Note 11
"Definitive Merger Agreement." In the event the merger with SafeNet is not
consummated for any reason, Cylink may find it necessary to seek debt or equity
financing; however, no assurances can be given that additional financing will be
available to Cylink on acceptable terms, or at all.
Critical Accounting Policies and Estimates
Cylink's discussion and analysis of its financial condition and results
of operations are based upon Cylink'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 Cylink's Annual Report on Form 10-K for the year ended
December 31, 2001.
Certain 2001 financial statement amounts were reclassified to conform
with 2002 classifications. These reclassifications had no effect on net loss or
shareholders' equity 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
September 29, 2001. In October 2001, the FASB issued SFAS 144, "Impairment or
Disposal of Long-Lived
4
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 Cylink's fiscal year beginning January 1, 2003. Cylink
has not yet assessed the impact that the adoption of FAS 143 will have on its
financial condition or results of operations. The adoption of SFAS 141 and SFAS
144 did not have a material effect on Cylink's financial condition or results of
operations.
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. Cylink will
adopt the provisions of SFAS 146 for the restructuring activities, if any,
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 Cylink'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:
September 29, December 31,
2002 2001
------ ------
(in thousands)
Inventories:
Raw materials $1,471 $2,482
Work in process and subassemblies 1,256 1,171
Finished goods 838 1,179
------ ------
$3,565 $4,832
====== ======
4. Loss Per Share
Basic loss per share is based on the weighted-average number of common
shares outstanding. Diluted loss per share is based on the weighted-average
number of shares outstanding and dilutive potential common shares outstanding.
Cylink's only potentially dilutive securities are stock options. As of September
29, 2002 and September 30, 2001, Cylink had 7,052,000 and 8,452,000 stock
options outstanding with a weighted-average exercise price of $3.11 and $4.05,
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. Comprehensive Loss
The components of comprehensive loss, consisting of Cylink's reported
net loss and unrealized gains or losses in the translation of foreign
currencies, are as follows:
Three months ended: Nine months ended:
---------------------------- ----------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands) (in thousands)
Net loss $ (7,865) $ (4,759) $(16,426) $(19,309)
Other comprehensive income (loss) 9 (67) 23 (10)
-------- -------- -------- --------
Total comprehensive loss $ (7,856) $ (4,826) $(16,403) $(19,319)
======== ======== ======== ========
6. Litigation
Cylink is currently engaged in litigation. See Part II, Item 1. "Legal
Proceedings."
5
7. Restructuring Charge
In the fourth quarter of 2001, Cylink recorded a $1.4 million charge to
accrue a reserve for the estimated costs of excess office space in Santa Clara
and related furniture and equipment, net of estimated proceeds from planned
subleasing. In the first nine months of 2002, Cylink increased its estimate by
an additional $1.3 million based on a continued weak sublease market.
Approximately $0.4 million of the reserves have been utilized through September
29, 2002. The reserves will be utilized for excess lease costs associated with
Cylink'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 thousands)
Balance at December 31, 2001 $ 478 $ 881 $ 1,359
Additions 448 871 1,319
Utilization -- (364) (364)
Reclassifications 1,388 (1,388) --
------- ------- -------
Balance at September 29, 2002 $ 2,314 $ 0 $ 2,314
======= ======= =======
Subsequent to the end of the quarter, Cylink entered into an agreement
to terminate a portion of the lease arrangement with the landlord (see Note 12).
As a result of that lease termination, Cylink reclassified the long-term portion
of it's restructuring liability to current.
Included in restructuring charges for the nine months ended September
29, 2002, Cylink recorded as expense $0.7 million related to severance payments
to 36 former employees affected by the workforce reduction.
8. Goodwill and Other Intangible Assets
Cylink adopted SFAS 142, "Goodwill and Other Intangible Assets"
effective Jan 1, 2002. SFAS 142 requires that goodwill is no longer amortized,
but tested for impairment at least annually, or more frequently if certain
indications arise. As a result of the adoption of SFAS 142, $333,000 relating to
acquired workforce was reclassified from identified intangibles to goodwill.
Cylink completed its initial goodwill impairment tests on January 1, 2002 and
determined that no impairment of goodwill had occurred as of that date.
For the quarter ended September 29, 2002, a significant decrease in
market value of Cylink's publicly traded shares reduced the fair value of the
company well below its carrying amount. As a result, Cylink conducted an
additional impairment test and determined that all of its goodwill is impaired.
The resulting impairment loss of $6.2 million is reflected in the accompanying
condensed consolidated statement of operations.
Changes in the carrying amount of goodwill for the nine months ended
September 29, 2002 are as follows (in thousands):
Balance as of December 31, 2001 $ 6,222
Write-off of Cylink-Belguim (29)
Write-off of Cylink-ATM-TC (6,193)
-------
Balance as of September 30, 2002 $ --
=======
A reconciliation of the previously reported net income and earnings per
share to the amounts adjusted for the exclusion of goodwill amortization
follows:
6
Three months ended: Nine months ended:
--------------------------------- ----------------------------------
September 29, September 30, September 29, September 30,
2002 2001 2002 2001
------------ ------------- ------------- -------------
(in thousands, except per share data) (in thousands, except per share data)
Reported net loss $ (7,865) $ (4,759) $ (16,426) $ (19,309)
Add back goodwill amortization,
net of income taxes -- 360 -- 1,019
------------ ------------- ------------- -------------
Adjusted net loss $ (7,865) $ (4,399) $ (16,426) $ (18,290)
============ ============= ============= =============
Adjusted basic and diluted
net loss per share $ (0.24) $ (0.13) $ (0.50) $ (0.56)
============ ============= ============= =============
Information regarding Cylink's other intangible assets is as follows
(in thousands):
September 29, 2002 December 31, 2001
----------------------------------------- -----------------------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- ------------ ------- -------- ------------ -------
Developed Technology $12,077 $(3,600) $ 8,477 $12,077 $(2,305) $ 9,772
Customer Base 894 (375) 519 894 (240) 654
------- ------- ------- ------- ------- -------
Total $12,971 $(3,975) $ 8,996 $12,971 $(2,545) $10,426
======= ======= ======= ======= ======= =======
Amortization expense of other intangible assets was $477,000, and
$1,430,000 for the three months and the nine months ended September 29, 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 1,132
--------
Total $ 10,426
========
9. Working Capital Loan
Cylink's $7.5 million revolving working capital loan facility matured
on June 27, 2002, and was renewed during the third quarter of 2002 at $5.0
million through July 27, 2003. This loan is secured by all of Cylink's tangible
assets and contains a covenant to maintain a minimum tangible net worth. Due to
restructuring costs associated with modification of Cylink's Santa Clara lease
and professional fees incurred with respect to Cylink's pending merger with
SafeNet's subsidiary, Cylink fell out of compliance with this covenant in
November 2002. There have been no borrowings under the loan since its inception.
7
10. Move to NASDAQ Small Cap Market
On June 27, 2002, Cylink 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. On October 3, 2002, Cylink Corporation moved
trading of its common stock from The Nasdaq National Market to The Nasdaq Small
Cap Market. Cylink continues to be traded under the symbol, "CYLK".
11. Definitive Merger Agreement
On October 30, 2002, Cylink announced that it had entered into a
definitive agreement to be acquired by SafeNet, Inc. ("SafeNet"), a publicly
traded Delaware corporation. SafeNet trades on The Nasdaq National market under
the symbol "SFNT". Cylink will be acquired by SafeNet through a merger of Cylink
with a wholly-owned subsidiary of SafeNet. If the merger is consummated each
share of Cylink common stock outstanding as of the date of the closing of the
merger will be converted into the right to receive 0.05 of a share of SafeNet
common stock on a fixed exchange ratio basis. The transaction will be accounted
for using the purchase method of accounting, whereby Cylink's net assets and
operating results will be included in the consolidated financial statements of
SafeNet from the date of the closing of the merger, and is intended to qualify
as a tax-free reorganization under applicable U.S. tax laws and regulations. As
of October 30, 2002, this represented an issuance by SafeNet of approximately
1.839 million of its shares, or approximately 16% of the outstanding stock of
SafeNet, and, in accordance with purchase accounting, based on the closing
prices of Cylink and SafeNet common stock on October 30, 2002, the transaction
has an implied value of approximately $35.4 million. The merger agreement has
been approved by the Boards of Directors of both Cylink and SafeNet and the
merger is expected to formally close in the first quarter of 2003; however,
there can be no assurances that the merger will be completed in that quarter, or
at all. If the merger is consummated, Cylink will continue to operate as a
wholly-owned subsidiary of SafeNet. The consummation of the merger is subject to
the satisfaction of customary closing conditions, including the declaration by
the Securities and Exchange Commission of the effectiveness of the registration
statement to be filed by SafeNet in connection with the merger and the approval
of both Cylink's and SafeNet's shareholders.
12. Subsequent Events
Lease Modification
On October 30, 2002, Cylink entered into a lease modification agreement
with its landlord for its Santa Clara headquarters and manufacturing facility to
terminate its lease obligations on approximately 46,724 square feet effective
November 1, 2002, and another 49,104 square feet effective March 1, 2003 in
exchange for the payment of $3.2 million, $1.0 million to come from an existing
security deposit held by the landlord, and a warrant to purchase 500,000 shares
of Cylink common stock at a price of $0.3838 per share (the average closing
price of Cylink's common stock for the 15 business days prior to the effective
date of the lease modification agreement). This modification will result in a
restructuring charge of approximately $ 2.2 million in the fourth quarter of
2002, including the $189,000 value of the warrant. Cylink will continue to lease
approximately 46,724 square feet as its headquarters and manufacturing facility
from the existing landlord at the previous rates set forth in its lease
agreement.
Class Action Settlement
On October 16, 2002, after lengthy settlement discussions, Cylink
entered into an agreement to settle a class action suit, stemming from a 1998
restatement of revenues, for $6.2 million to be paid entirely from insurance
proceeds. The settlement agreement is subject to approval by the United States
District Court for the Northern District of California. The $6.2 million
settlement is reflected in the accompanying condensed consolidated balance sheet
as of September 29, 2002 as an insurance claim receivable and a legal settlement
payable.
13. Restatement
Subsequent to the issuance of its financial statements for the three
and nine month period ended September 29, 2002, the Company determined that a
legal payment liability and related insurance claim receivable which were
reported net should be reported gross in the condensed consolidated balance
sheet (see Note 12). As such, the accompanying condensed consolidated financial
statements have been restated to reflect a $6.2 million legal payment payable
and a $6.2 million insurance claim receivable within current liabilities and
current assets as of September 29, 2002. The restatement had no impact on net
loss or net loss per share.
8
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
As discussed in Note 13 to the condensed consolidated financial
statements included in Item 1, the accompanying financial statements have been
restated. The following Management's Discussion and Analysis reflects this
restatement.
Forward Looking Statements
This Quarterly Report on Form 10-Q/A 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: implementation
by Cylink of its financial plan; Cylink's plans to continue cost reducing
measures in 2002; Cylink's intentions to raise additional funds through public
or private equity or debt financing, sales of assets, or from other sources if
necessary; expectations that Cylink will consummate its merger with a
wholly-owned subsidiary of SafeNet during the first quarter of 2003 and other
expectations regarding the status of completion of the merger; and Cylink's
beliefs regarding when the court will approve the settlement agreement in the
shareholder litigation actions.
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 Cylink'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 Quarterly Report on Form 10-Q/A and the audited
consolidated financial statements and notes thereto and Management's Discussion
and Analysis of Financial Condition and Results of Operations included in
Cylink's Annual 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 Cylink'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 Cylink'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 Nine months ended
---------------------- ---------------------
Sep 29, Sep 30, Sep 29, Sep 30,
2002 2001 2002 2001
----- ----- ----- -----
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue 32.1 47.4 35.0 41.6
----- ----- ----- -----
Gross profit 67.9 52.6 65.0 58.4
Operating expenses:
Research and development 34.1 35.9 38.5 40.7
Selling and marketing 31.1 30.3 37.3 38.0
General and administrative 23.6 27.4 23.9 23.5
Amortization of acquired intangibles 6.7 7.4 6.6 6.7
Loss from divestiture of Algorithmic Research Ltd. - 2.8 - 7.7
Impairment of Goodwill 87.2 28.7 -
Restructuring charges 2.6 - 9.5 -
----- ----- ----- -----
Total operating expenses 185.3 103.8 144.5 116.6
----- ----- ----- -----
Loss from operations (117.4) (51.2) (79.5) (58.2)
Other income, net 6.6 5.3 1.8 2.1
----- ----- ----- -----
Loss before income taxes (110.8) (45.9) (77.7) (56.1)
Income tax benefit - - (1.6) (3.2)
----- ----- ----- -----
Net loss (110.8)% (45.9)% (76.1)% (52.9)%
===== ===== ===== =====
Revenue. Revenue decreased 31% from $10.3 million for the three months
ended September 30, 2001 to $7.1 million for the three months ended September
29, 2002, and decreased 41% from $36.5 million for the nine months ended
September 30, 2001 to $21.6 million for the nine months ended September 29,
2002. The decreases in revenue are primarily due to the recent general weakening
of the global economy as well as due to lower than anticipated information
technology spending by Cylink's existing and prospective customers, and loss of
business to competitors. International revenue comprised 32% and 29% of total
revenue for the third quarter of 2001 and 2002, respectively.
Gross Profit. Gross profit decreased from $5.4 million for the three
months ended September 30, 2001 to $4.8 million for the three months ended
September 29, 2002, and decreased from $21.3 million for the nine months ended
September 30, 2001 to $14.0 million for the nine months ended September 29,
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 53% and 68% for the quarters ended September 30, 2001 and
September 29, 2002, respectively, and 58% and 65% for the nine months ended
September 30, 2001 and September 29, 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 Cylink 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.
10
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 35% from $3.7 million for the three months ended September
30, 2001 to $2.4 million for the three months ended September 29, 2002 and
decreased 44% from $14.9 million for the nine months ended September 30, 2001 to
$8.3 million for the nine months ended September 29, 2002. Research and
development expenses as a percentage of revenue were 36% for the third quarter
of 2001 and 34% for the third quarter 2002, and 41% for the first nine months of
2001 and 39% for the first nine 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 Cylink. The decrease in expense
as a percentage of revenue for the third quarter of each period was due to a
greater decline in product development expenditures than the reduction in
revenues.
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 30% from $3.1 million for the three months ended September 30, 2001 to
$2.2 million for the three months ended September 29, 2002 and decreased 42%
from $13.9 million for the nine months ended September 30, 2001 to $8.0 million
for the nine months ended September 29, 2002. Selling and marketing expenses as
a percentage of revenue were 30% for the third quarter of 2001 and 31% for the
third quarter of 2002, and 38% for the first nine months of 2001 and 37% for the
first nine 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 Cylink. The decrease in expense as a percentage of
revenue for the third quarter of each period was due to a greater decline in
selling and marketing expenditures than the reduction revenues.
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 41% from $2.8 million for the three months ended September 30, 2001 to
$1.7 million for the three months ended September 29, 2002 and decreased 40%
from $8.6 million for the nine months ended September 30, 2001 to $5.1 million
for the nine months ended September 29, 2002. General and administrative
expenses as a percentage of revenue were 27% for the third quarter of 2001 and
24% for the third quarter 2002, and 24% for the first nine months of 2001 and
24% for the first nine 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 Cylink, offset by an
increase in professional fees associated with the acquisition by SafeNet.
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 third quarter of 2002, Cylink
increased its estimate of the loss from excess leased facilities by $0.2
million.
Amortization of Acquired Intangibles. Amortization of intangible assets
declined from $0.8 million for the three months ended September 30, 2001 to $0.5
million for the three months ended September 29, 2002 and declined from $2.4
million for the nine months ended September 30, 2001 to $1.4 million for the
three months ended September 29, 2002. The decline in the expense in 2002 as
compared to 2001 was due to the adoption of SFAS 142, "Goodwill and Other
Intangibles," on January 1, 2002, pursuant to which 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 decreased from $0.6 million for the quarter ended
September 30, 2001 to $0.5 million for the quarter ended September 29, 2002,
principally due to a decline in foreign exchange gains and net interest income
offset by the absence of a write-down of an investment in an unaffiliated
company taken in the third quarter of 2001. Other income, net decreased from
income of $0.8 million for the nine months ended September 30, 2001 to $0.4
million for the nine months ended September 29, 2002, principally due to a
decline in foreign exchange gains and net interest income.
Provision for Income Taxes. No provision for or benefit from income
taxes was recognized in the either the quarter ended September 30, 2001 or the
quarter ended September 29, 2002, as Cylink incurred a net operating loss for
income tax purposes.
11
Material Contracts. On October 30, 2002 Cylink entered into a lease
modification agreement with its landlord for its Santa Clara headquarters and
manufacturing facility to terminate its lease obligations on approximately
46,724 square feet effective November 1, 2002, and another 49,104 square feet
effective March 1, 2003 in exchange for the payment of $3.2 million, $1.0
million to come from an existing security deposit held by the landlord, and a
warrant to purchase 500,000 shares of Cylink common stock at a price of $0.3838
per share (the average closing price of Cylink's common stock for the 15
business days prior to the effective date of the lease modification agreement).
This modification will result in an additional restructuring charge of
approximately $ 2.2 million in the fourth quarter of 2002, including the
$189,000 value of the warrant. Cylink will continue to lease approximately
46,724 square feet as its headquarters and manufacturing facility from the
existing landlord at the previous rates set forth in its lease agreement.
Pending Acquisition. On October 30, 2002, Cylink announced that it had
entered into a definitive agreement to be acquired by SafeNet, Inc., a publicly
traded Delaware corporation. SafeNet trades on The Nasdaq National market under
the symbol "SFNT". Cylink will be acquired by SafeNet through a merger of Cylink
with a wholly-owned subsidiary of SafeNet. If the merger is consummated each
share of Cylink common stock outstanding as of the date of the closing of the
merger will be converted into the right to receive 0.05 of a share of SafeNet
common stock on a fixed exchange ratio basis. The transaction will be accounted
for using the purchase method of accounting, whereby Cylink's net assets and
operating results will be included in the consolidated financial statements of
SafeNet from the date of the closing of the merger, and is intended to qualify
as a tax-free reorganization under applicable U.S. tax laws and regulations. As
of October 30, 2002 this represented an issuance by SafeNet of approximately
1.839 million of its shares, or approximately 16% of the outstanding stock of
SafeNet. The merger agreement has been approved by the Boards of Directors of
both Cylink and SafeNet and the merger is expected to formally close in the
first quarter of 2003; however, there can be no assurances that the merger will
be completed in that quarter, or at all. If the merger is consummated, Cylink
will continue to operate as a wholly-owned subsidiary of SafeNet. The
consummation of the merger is subject to the satisfaction of customary closing
conditions, including the declaration by the Securities and Exchange Commission
of the effectiveness of the registration statement to be filed by SafeNet in
connection with the merger and the approval of both Cylink's and SafeNet's
shareholders. Please see Item 5-Other Information on page 24 of this Quarterly
Report on Form 10-Q.
LIQUIDITY AND CAPITAL RESOURCES
At September 29, 2002, Cylink had working capital of $8.2 million
(including cash and cash equivalents of $8.2 million) and $1.1 million of
long-term obligations. For the nine months ended September 29, 2002, Cylink
recorded a net loss of $16.4 million. Net cash used by operating activities for
the first nine months of 2002 was $1.8 million, consisting primarily of the loss
from operations, offset by $3.4 million of non-cash depreciation and
amortization, $6.2 million non-cash write-off of goodwill, $0.2 million
write-down of an investment in an unaffiliated company, and a net decrease in
working capital. The decrease in working capital included a decrease in accounts
receivable of $4.7 million, a decrease in inventories of $1.3 million, an
increase in accrued liabilities of $0.8 million, and an increase in a legal
settlement payable of $6.2 million, partially offset by a decrease in accounts
payable of $1.2 million, an increase in an insurance claim receivable of $6.2
million, an increase in income tax receivables of $0.4 million, and a decrease
in deferred revenues of $0.5 million. The decrease in accounts receivable was
due to lower shipments during 2002 and improved collection activities. The
decrease in inventories was due to continued strict purchasing controls. The
increase in accrued liabilities was due principally to the reclassification of
long-term lease restructuring accruals to short-term accruals as a result of the
Santa Clara lease modification, offset by decreased commission, bonus and
warranty liabilities, along with decreased employment liabilities resulting from
reduced headcount. The decrease in accounts payable is due to the settlement of
certain royalty obligations and reduced inventory purchasing.
Net cash used in operating activities for the first nine months of 2001
was $2.8 million consisting primarily of the loss from operations of $19.3
million, partially offset by a decrease in working capital which included a
decrease in accounts receivable of $6.4 million, a decrease in inventories of
$4.7 million, an increase in deferred revenue of $0.5 million, a decrease in
other assets of $0.3 million partially offset by a decrease in accounts payable
and accrued liabilities of $4.6 million, an increase in income tax receivables
of $0.1 million,. The decrease in accounts receivable was due to lower than
average shipments during the year 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 $0.4 million for the nine
months ended September 29, 2002 as compared to cash used by investing activities
of $2.0 million for the nine months ended September 30, 2001. Cash provided by
investing activities for the first nine months of 2002 resulted from the
collection of a $1.0 million note
12
receivable, partially offset by the acquisition of $0.6 million of property,
plant and equipment. Cash used in investing activities for the first nine months
of 2001 consisted primarily of the acquisition of $0.6 million of property,
plant and equipment, cash transferred in connection with the divestiture of
Cylink's Algorithmic Research, Ltd subsidiary, offset by the collection of a
$0.6 million note receivable.
Cash used in financing activities for the nine months ended September
29, 2002 and September 30, 2001, respectively, was not material in both periods.
Cylink's $7.5 million revolving working capital loan facility matured
on June 27, 2002, and was renewed during the third quarter of 2002 at $5.0
million through July 27, 2003. This loan is secured by all of Cylink's tangible
assets and contains a covenant to maintain a minimum tangible net worth. Cylink
fell out of compliance with this covenant on October 30, 2002. 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 September 29, 2002, the outstanding balance under the equipment
loan was $35,000. The equipment loan requires Cylink to maintain certain
liquidity and profitability covenants, with which it was not in compliance as of
September 29, 2002.
In connection with the lease modification on its Santa Clara
headquarters and manufacturing facility, Cylink paid a $3.2 million lease
termination fee to the landlord in the fourth quarter of 2002, of which
approximately $1.0 million came from the security deposit already held by the
landlord. Thus, Cylink's cash and cash equivalents were further reduced by $2.2
million in the fourth quarter of 2002.
As of the date of filing of this Quarterly Report on Form 10Q, Cylink's
revenue to date for 2002 is significantly below the revenue anticipated under
its current financial plan for fiscal 2002. Under Cylink's financial plan for
2002, Cylink had projected a positive operating cashflow for the 2002 fiscal
year, but as of September 29, 2002, Cylink's operations are not generating a
positive cash flow. Due to this continued decrease in Cylink's revenues below
the amounts anticipated by its management under its 2002 financial plan, Cylink
undertook certain actions to reduce operating costs in its core businesses in
both 2001 and 2002, including a workforce reduction in June 2002. In addition,
on October 30, 2002, Cylink entered into a modification of its lease on its
corporate headquarters facility. In 2002 Cylink began to realize the benefits of
the actions taken in the fourth quarter of 2000, throughout 2001 and the first
nine months of 2002 to reduce operating costs. Cylink plans to continue such
cost reducing measures in the fourth quarter of 2002 to the extent necessary or
advisable. However, there can be no assurance that cost cutting measures already
implemented, either alone or in combination with such other cost cutting
measures as the management of Cylink determines are necessary or advisable would
be sufficient for Cylink to achieve profitability, or that Cylink's existing
cash balances and available borrowing will be sufficient to fund operations
through 2002. And, although Cylink has entered into a definitive agreement to be
acquired by SafeNet, there can be no assurance that the acquisition of Cylink by
SafeNet will be successfully concluded.
In the event Cylink continues to experience a decline in revenues and
cannot successfully implement additional effective cost cutting measures or its
financial plan is otherwise unsuccessful, or if the acquisition by SafeNet is
not consummated for any reason, Cylink may require additional funds in the near
term to support its working capital requirements or for other purposes and may
seek to raise such additional funds through public or private equity or debt
financing, 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 Cylink or its shareholders. If Cylink is unsuccessful in
implementing it's revised financial plan, and cannot raise additional funds,
Cylink may not have the resources to maintain its operations.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Cylink has a history of losses, and may not be able to meet its needs for
working capital.
Cylink incurred significant net losses in the nine month period ended
September 29, 2002, in the fiscal year 2001 and in prior fiscal years. Cylink
had an accumulated deficit of $135.2 million as of September 29, 2002. Cylink's
prior losses may also adversely impact Cylink's ability to raise additional
capital if required to sustain its operations.
13
As of the date of filing of this Quarterly Report on Form 10-Q,
Cylink's revenue to date for 2002 is significantly below the revenue anticipated
under its current financial plan for such year. Under Cylink's financial plan
for 2002, Cylink had projected a positive operating cash flow for the 2002
fiscal year, but as of September 29, 2002, Cylink's operations are not
generating a positive cash flow. Due to the decrease in Cylink's revenues in
2001 and the continued decrease in Cylink's revenues in 2002 below the amounts
anticipated by its management under its internal financial plan for 2002, Cylink
undertook certain actions to reduce operating costs in its core businesses in
2001 and 2002, including a workforce reduction in June 2002. In addition, on
October 30, 2002, Cylink entered into a modification of its lease on its
corporate headquarters facility in Santa Clara, CA. In 2002, Cylink began to
realize the benefits of the actions taken in the fourth quarter of 2000, through
2001 and the first nine months of 2002 to reduce operating costs. Cylink plans
to continue such cost reducing measures in the fourth quarter 2002 to the extent
necessary or advisable. However, there can be no assurance that Cylink's cost
cutting measures as it's management determines are necessary or advisable, if
implemented, would be sufficient for Cylink to achieve profitability or that
Cylink will be able to continue reducing costs at a pace that reflects any
further reduction in its revenues below anticipated levels or that Cylink will
not need to raise additional capital to fund its operations or that additional
financing could be obtained by Cylink on acceptable terms, or at all.
There also can be no assurances that Cylink's principal sources of
liquidity, which include cash and cash equivalents of $8.2 million as of
September 29, 2002, will satisfy its current anticipated working capital and
capital expenditure requirements through at least the next twelve months. As a
result of the lease termination fees resulting from the modification of Cylink's
Santa Clara lease on October 30, 2002, Cylink's cash and cash equivalents were
further reduced by $2.2 million in the fourth quarter of 2002. Cylink's $7.5
million revolving working capital loan facility matured on June 27, 2002. During
the third quarter of 2002, the bank renewed Cylink's line of credit for $5.0
million through July 27, 2003. The loan is secured by all of Cylink's tangible
assets and the loan agreement for such credit line contains a covenant to
maintain a minimum tangible net worth. In February 2002, Cylink breached certain
financial covenants contained in this loan agreement. The minimum tangible net
worth covenant was reset at the time of the loan renewal; however, due to
restructuring costs associated with modification of Cylink's Santa Clara lease
and professional fees incurred with respect to Cylink's pending merger with
SafeNet's subsidiary, Cylink fell out of compliance with this covenant on
October 30, 2002. There is no guarantee that Cylink will satisfy those covenants
or other covenants in the loan agreement in the future. If Cylink fails to meet
such financial covenants, the line of credit may not be available to fund
Cylink's operations if needed.
Further, if additional funds are raised by issuing equity securities,
dilution to Cylink's shareholders may result. If adequate funds needed to
sustain Cylink's operations are not available, Cylink, its business, and the
price of its Common Stock will be adversely affected.
Cylink's quarterly operating results vary from period to period and may vary in
the future.
Cylink has historically experienced significant fluctuations in its
operating results on a quarterly basis and could experience such fluctuations in
the future. Cylink's revenues and operating results are affected by a number of
factors outside of Cylink's control, including the following:
o Cylink's inability to accurately forecast revenues and respond
in a timely manner to changes in revenue levels;
o the timing of the introduction by Cylink or by its competitors
of new or enhanced products;
o market acceptance of Cylink's new products and those of its
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 Cylink's pricing policies or those of its
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 Cylink's
direct sales force;
o loss of an important customer;
o failure to grow Cylink's customer base in accordance with
market expectations;
14
o customer discounts and credits;
o Cylink's 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
Cylink's customers; and
o disruption in Cylink's operations caused by reductions in its
workforce.
Many of these factors are outside of Cylink's control. It is possible
that in the future Cylink'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 specifically
with respect to Cylink's business or the market sector in which Cylink operates,
the price of its common stock may be adversely affected.
If the merger with SafeNet, Inc. is not completed Cylink's stock price and
future business and operations could be harmed.
If the merger with SafeNet is not completed, Cylink will be subject to
the following material risks, among others:
o The price of Cylink's common stock may change to the
extent that the current market price of Cylink's
common stock reflects an assumption that the merger
will be completed;
o Cylink's costs related to the merger, such as legal,
accounting and some of the fees of its financial
advisors, must be paid even if the merger is not
completed; and
o Under some circumstances Cylink may be required to
pay SafeNet a cash termination fee.
Further, if the merger is terminated or otherwise is not consummated
and Cylink's board of directors determines to seek another merger or business
combination, it is not certain that Cylink will be able to find a merger partner
or that the new merger partner would be willing to pay an equivalent or more
attractive price than that which would be paid by SafeNet in the merger. While
the reorganization agreement is in effect, subject to specified exceptions,
Cylink is prohibited from entering into or soliciting, initiating or
intentionally encouraging any inquiries or proposals that may lead to a proposal
or offer for a merger, consolidation, business combination, sale of substantial
assets, tender offer, sale of shares of capital stock or other similar
transactions with any person other than SafeNet. These restrictions could limit
Cylink's ability to enter into an alternative transaction at a favorable price.
Cylink is currently involved in litigation.
Several securities class action complaints were filed against Cylink
and certain of its current and former directors and officers in federal courts
in California. These complaints allege, among other things, that Cylink's
previously issued financial statements were materially false and misleading and
that the defendants knew or should have known that these financial statements
caused its common stock price to rise artificially. The complaints also 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."
On October 16, 2002, Cylink entered into an agreement with all plaintiffs to
settle the class action for $6.2 million. The settlement amount will be paid
entirely from insurance proceeds under insurance policies held by Cylink. The
settlement agreement is subject to approval by the United States District Court
for the Northern District of California, and Cylink expects that the settlement
agreement will be approved in March 2003.
15
Cylink's sales cycles are long and unpredictable, which makes period-to-period
revenues difficult to predict.
Sales of Cylink's products generally involve a significant commitment
of capital by its customers, with the attendant delays frequently associated
with large capital expenditures. For these and other reasons, the sales cycle
associated with Cylink's products is typically lengthy and subject to a number
of significant risks over which Cylink has little or no control. Cylink is often
required to ship products shortly after it receives the orders from its
customers. 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, Cylink's order backlog becomes
more vulnerable to customer cancellations. As a result of these fluctuations in
its sales cycle and because of order backlog, Cylink's product revenue in any
period has been and will continue to be substantially dependent on orders booked
and shipped in that period.
Cylink typically plans its production and inventory levels based on
internal forecasts of customer demand, which are highly unpredictable and can
fluctuate substantially. In particular, market forces beyond its control,
including a general economic recession and limits or changes in government
spending may have a material affect on customer demand for its products. In
addition, Cylink's operating expenses are based on anticipated revenue levels
and a high percentage of its 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 Cylink's operating results will be below the expectations of
securities analysts and investors, as they have in the past. If Cylink
disappoints the expectations of securities analysts and investors, or in the
event that adverse market conditions prevail or are perceived to prevail
generally or with respect to the market sector in which Cylink operates, the
price of its common stock would likely be adversely affected. All of these
factors make it difficult to predict Cylink's financial performance from period
to period. As Cylink's quarterly results fluctuate, they may fall below the
expectations of the public market analysts or investors. If this occurs, the
price of Cylink's Common Stock may drop and Cylink's financial condition and
results of operations may be materially and adversely affected.
The overall economic climate continues to be weak.
Cylink's products typically represent substantial capital commitments
by its customers, and potentially involve a long sales cycle. As a result, its
customers' purchase decisions may be significantly affected by a variety of
factors outside of Cylink's control, including downward trends in capital
spending for communication networks, increased market competition, and the
availability or announcement of alternative technologies by its competitors.
Continued recent weakness in general economic conditions has resulted in many of
Cylink's customers delaying and/or reducing their capital spending related to
information systems. If the economy continues to be weak or further weakens,
demand for Cylink's products could decrease, resulting in lower revenues and a
decline in the overall rate of its revenue growth.
Cylink is dependent on recently introduced and new network security products.
Cylink's future results of operations will be highly dependent on the
successful marketing and manufacture of Cylink's 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 third
quarter of 2002, Cylink has made only limited commercial shipments of its
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 Cylink's new or
existing products to achieve or enjoy market acceptance, whether for these or
other reasons, could cause Cylink 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 Cylink's business, financial condition and results of operations.
Due to insufficient market acceptance of stand alone public key
infrastructure (PKI) products generally, such as Cylink's Net Authority product
and similar products of its competitors, Cylink revised its marketing approach
in the second half of 2001 by discontinuing efforts to sell Net Authority as a
stand alone product. Instead, Cylink focused its efforts on potential customers
seeking to embed its PKI product as part of their application or service. In
addition, on February 8, 2002, Cylink 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
16
cost" and downsize its non core businesses following the anthrax attack on its
operations in October of 2001. At its request, Cylink granted USPS a
continuation of its license through May 30, 2002. On May 31, 2002, this
Cylink/USPS license terminated and all revenue earned under the contract expired
in the second quarter of 2002. Revenue for the second quarter of 2002, and for
the first nine months of 2002 resulting from the USPS license was $0.2 million,
and $0.5 million, respectively. Cylink completely discontinued all further
development of its PKI technology and products in July 2002.
Cylink faces significant competition from other providers of network security
systems
Competition is intense among providers of network security systems, and
Cylink expects that such competition will increase in the future. Significant
competitive factors in these markets include:
o the rapid development of new products and features by market
participants;
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 Cylink's sales, marketing and
service organizations;
o Cylink's products' prices and the prices of similar products
of its competitors;
o name recognition of Cylink versus its competitors; and
o customers' perception of Cylink's stability and long-term
viability.
Many of these competitive factors are beyond Cylink's control.
Cylink's competitors in the information security markets, including
companies that offer products similar to, or are perceived as an alternative to,
Cylink's products, are Checkpoint Software Technologies, Ltd., Network
Associates, Inc., SafeNet, Inc., Secure Computing Corporation, RSA Security,
Inc., Symantec Corporation, and Thales e-Security, Inc. Cylink's 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 Cylink's products, Cylink's products may no longer be
required by its customers to attain network security.
Many of Cylink's competitors have substantially greater financial,
technical, marketing, distribution and other resources, and greater name
recognition and longer standing relationships with customers than possessed by
Cylink. 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. However, any period of sustained price reductions in
Cylink products would have a material adverse effect on its financial condition
and results of operations. Cylink 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 its financial condition and
results of operations.
Cylink faces the risks from tort and warranty claims that may be made against
it.
Cylink faces risks from tort and warranty claims that third parties may
make against it. Customers rely on Cylink's network security products to prevent
unauthorized access to their networks and data transmissions. A malfunction or
the inadequate design of a Cylink product could result in tort or warranty
claims from its customers. Additionally, a breach of a Cylink customer's network
by an unauthorized party, which is determined to be attributable to an alleged
defect in its 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 Cylink attempts to reduce the risk of such
losses and claims through warranty disclaimers and liability limitation clauses
in its standard forms of sales and license agreements and by maintaining product
liability insurance, there can be no assurance that such measures will be
effective in limiting Cylink's liability for any such damages. Any liability for
damages resulting from security
17
breaches or other alleged product defects could be substantial and could have a
material adverse effect on Cylink's 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 Cylink's products in particular, regardless of whether such breach is
attributable to Cylink's products. Such negative perceptions could result in a
decline in demand for Cylink's products, which, in turn, would have a material
adverse effect on Cylink's business, financial condition and results of
operations.
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
third quarter of 2001 associated with this program. While Cylink management
believes that this reserve is adequate based on reasonable estimates derived
from information available at the time the reserve was accrued and actual costs
incurred to date, Cylink's total actual costs resulting from this program could
exceed these reserves. After Cylink announced this program, two of its major
customers stated their intention to submit substantial claims to Cylink related
to their costs of avoiding product failures; however, neither of these customers
(nor any other Cylink customer of this product line) has made a claim against
Cylink for damages related to the failure of the backup battery. Although Cylink
believes any such claims may be barred or significantly reduced by the
limitations and exclusions set forth in the governing contracts of sale, there
can be no assurance that Cylink would be found free from liability or any
obligation to reimburse these customers should such customers bring such a claim
against Cylink. If such claims were brought against Cylink and Cylink were found
to be liable for these customers' damages, Cylink's operations and financial
condition may be materially and adversely affected.
In addition, Cylink may face warranty and support claims from users of
its ISDN product line. See "Cylink faces risks from its dependence on third
party subcontractors and suppliers" on page 21 below.
Cylink may be unable to retain executive officers and key personnel that are
critical to its business.
Cylink's future success depends in large part on the abilities of its
executive officers, key management and technical personnel and its ability to
retain qualified and competent individuals following its recent reductions in
the employee workforce and the announcement on October 30, 2002 of Cylink's
agreement to be acquired by SafeNet, Inc. There is no guarantee that Cylink's
present executive management and technical staff will remain with Cylink,
particularly if Cylink's performance is not up to the executive's expectations,
if there is prolonged uncertainty concerning the effect of the SafeNet
transaction on individual positions, and if a general economic recovery leads to
expanded alternative opportunities for such employees. The loss of the services
of one or more of Cylink's 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
Cylink's business and operating results.
Cylink may not be able to hire and retain sufficient technical, marketing and
management personnel that it needs to succeed.
Cylink may not be able to hire and retain sufficient technical,
marketing and management personnel that it needs to succeed because Cylink has
limited resources to expand its work force. Cylink recently experienced, and may
continue to experience, substantial fluctuations in the number of employees and
the scope of its operations in the network security business. These fluctuations
resulted in increased responsibilities for the Cylink management team. To manage
Cylink's businesses effectively, Cylink must continue to improve its
operational, financial and management information systems and must retain,
motivate and manage its employees. In the recent past, competition among
companies has been intense for qualified technical, marketing and management
personnel. Furthermore, the recent reductions in Cylink's workforce, the
recently announced transaction with SafeNet, and the fluctuation in Cylink's
stock price, may create greater uncertainty amongst Cylink's existing employees.
There can be no assurance that Cylink will be able to effectively achieve or
manage future growth in its work force, and its failure to do so could delay
product development cycles or otherwise have a material adverse effect on its
financial condition and results of operations.
Cylink's intellectual property is critical to the success of its business.
Cylink relies on patents, trademarks, copyrights, licenses and trade
secret law to establish and preserve its intellectual property rights. Cylink
owns a number of U.S. patents covering certain features of Cylink's network
security product designs, and has additional U.S. patent applications pending.
However, there can be no assurance
18
that any patent, trademark, copyright or license owned or held by Cylink will
not be invalidated, circumvented or challenged, that the rights granted
thereunder will provide competitive advantages to Cylink or that any of Cylink's
pending or future patent applications will be issued with the scope of the
claims sought by it, if at all. Further, there can be no assurance that others
will not develop technologies that are similar or superior to Cylink's
technology, duplicate Cylink's technology, misappropriate its trade secrets, or
design around the patents owned by it. Resorting to the courts to protect
Cylink's intellectual property would require significant financial and
management resources. In addition, the laws of certain countries in which
Cylink's products are or may be developed, manufactured or sold may not protect
those products and intellectual property rights to the same extent as the laws
of the United States. Cylink's inability to protect its intellectual property
rights adequately could have a material adverse effect on its financial
condition and results of operations.
The computer, communications, software and network security industries
are characterized by substantial litigation regarding patent and other
intellectual property rights. In the past, Cylink has received communications
from third parties asserting that its patents, features or content of certain of
its products infringe upon the intellectual property rights of third parties,
and Cylink may receive such communications in the future. There can be no
assurance that these third parties will not assert claims against Cylink that
result in litigation. Any litigation, whether or not determined in Cylink's
favor, could result in significant expense to Cylink and could divert its
management's attention and other resources from the day-to-day operations of the
company. In the event of an adverse ruling in any such litigation involving a
dispute over Cylink's intellectual property rights, Cylink 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 Cylink 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
Cylink on reasonable terms or at all. In the event of a successful claim against
Cylink, combined with its failure to develop or license a substitute technology
on commercially reasonable terms, Cylink's financial condition and results of
operations would be adversely affected.
If Cylink is unable to adapt its services to rapidly changing technology, or if
the market for its network security products fails to grow, its business and
operating results could suffer.
The market for Cylink's network security products is characterized by
rapidly changing technology, emerging industry standards, new product
introductions and changes in customer requirements and preferences. Cylink's
future success will depend in part upon end users' demand for network security
products in general, and upon Cylink's ability to enhance its existing products
and to develop and introduce new products and technologies that meet customer
requirements. Cylink faces continuing challenges to educate potential customers
as to the value of its security products. 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 because of the expense. Cylink also believes that many potential
customers do not appreciate the need for its security products unless and until
they have faced a major security breach. This general market resistance to the
purchase of security products is compounded by Cylink's limited resources to
invest in marketing campaigns to promote its products and services. In addition,
a portion of the sales of Cylink's 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
fully develop, or once fully developed, may not become viable commercial
marketplaces.
If Cylink is unable successfully to educate potential customers as to
the value of its products and services, it is unlikely that its products will
gain broad market acceptance. Without broad market acceptance for its products
and services, Cylink will continue to rely primarily on selling new and existing
products to its base of existing customers, which will significantly limit any
opportunity for real growth. In addition, any significant advance in
technologies for attacking cryptographic systems could render some or all of
Cylink's existing and new products obsolete or unmarketable. Additionally, if a
specific product or technology other than Cylink's is adopted as the standard
for implementing network security in any segment of the network security market,
sales of Cylink's existing and planned products in that market segment may be
adversely impacted, which could have a material adverse effect on its business,
financial condition and results of operations.
The National Institute of Standards and Technology has announced a new
Advanced Encryption Standard, or AES, which Cylink expects to integrate into its
products. Cylink's ability to timely implement the AES into its products may
materially affect its development costs and ability to timely market its
solutions.
19
If Cylink's research and development activities are unsuccessful, it will not be
able to market new products and services.
The markets for Cylink's products are characterized by rapidly changing
technologies, extensive research and new product introductions. Cylink believes
that its future success will depend in part upon Cylink's ability to continue to
enhance its existing products and to develop, manufacture and market new
products. As a result, Cylink expects to continue to make a significant
investment in engineering, research and development. However, there can be no
assurances that such investments will lead to the development of new or viable
products or enhancements to Cylink's existing products. In addition, Cylink may
not be able to develop and introduce new products or enhancements in a timely
manner that satisfies its customer needs, achieves broad market acceptance or
addresses technological changes in its target markets. If Cylink fails to
develop new products and enhancements or to introduce them successfully and in a
timely manner, its competitive position, financial condition and results of
operations will be adversely affected.
Cylink faces risks associated with its international operations.
Cylink plans to continue to maintain its foreign sales channels, which
require significant management attention and financial resources. International
sales are subject to a number of risks, including:
o unexpected changes in regulatory requirements;
o export control laws, tariffs and other trade barriers;
o political and economic instability in foreign markets;
o difficulties in the staffing, management and integration of
foreign operations;
o longer payment cycles and greater difficulty in collecting
accounts receivable;
o currency fluctuations; and
o potentially adverse tax consequences.
Because most of Cylink's foreign sales are denominated in U.S. dollars,
its 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 in the short
term, although the long-term impact of such devaluation, cannot be predicted.
Cylink's ability to compete successfully in foreign countries is
dependent in part on its ability to obtain and retain reliable and experienced
in-country distributors and other strategic partners. Cylink does not have
long-term contracts with most of its value added resellers and distributors and,
therefore, has no assurance of a continuing relationship with such reseller and
distributors within a given market.
Due to U.S. government regulations restricting the export of
cryptographic devices and software, including Cylink's network security products
to non-civilian agencies of foreign governments, Cylink often is disadvantaged
in competing for international sales against companies located outside the
United States which are not subject to such restrictions. Furthermore, in
certain foreign countries, Cylink's distributors are required to secure licenses
or formal permission before encryption products can be imported. Although the
U.S. Department of Commerce continues to relax certain export control laws as
they apply to sales of Cylink's products to its international commercial
customers, Cylink still faces export controls on sales of its products to
certain foreign governments and on transfers of its technology to its foreign
partners. To date, Cylink has been able to secure the necessary export and
import licenses to compete effectively in the international market. However,
there can be no assurances that Cylink will be able to secure such licenses in a
timely manner in the future, or at all.
Cylink faces risks from its dependence on third party subcontractors and
suppliers.
Cylink's ability to deliver its products in a timely manner is
dependent upon the availability of quality components and subsystems used in
these products. Cylink depends in part upon subcontractors to manufacture,
assemble and deliver certain components and subsystems used in its products in a
timely and satisfactory manner. Cylink obtains certain components and subsystems
from a single, or a limited number of, suppliers. A significant
20
delay in obtaining a supply of components selected by Cylink's design engineers
or an interruption in the delivery of such items could have a material adverse
effect on Cylink's financial condition and results of operations.
On February 14, 2002, Cylink notified its OEM supplier of its ISDN
encryption products, Biodata Information Technology AG ("Biodata") of its
decision to terminate Cylink's development and supply agreement with Biodata,
following Biodata's declaration of insolvency. Due to Biodata's financial
failure, as well as the financial failure of Cylink's previous supplier of its
ISDN encryption products, Dica, in the first nine months of 2001, Cylink
discontinued all further sales and support for this product line. Cylink has
disclaimed all liability for Biodata's and Dica's failures in terms of its
supply contract with Cylink's principal customer for its ISDN encryption
products; however, there can be no assurance that Biodata's and Dica's financial
failures, and Cylink's subsequent discontinuance of this ISDN product line, will
not give rise to claims for breach of warranty and support by Cylink's customer
and end users of this product line. If these customers should bring such claims
against Cylink, and if Cylink were found to be liable for these customers'
damages, Cylink's operations and financial condition may be materially and
adversely effected
Cylink common stock could be delisted from The Nasdaq Small Cap Market, which
could adversely affect Cylink and its shareholders.
On June 27, 2002, Cylink 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 the
Cylink common stock could be delisted.
On September 24, 2002, Cylink submitted its application to Nasdaq to
move trading of its common stock from The Nasdaq National Market to The Nasdaq
Small Cap Market. Cylink's application was accepted and on October 9, 2002
Cylink common stock began trading on The Nasdaq Small Cap Market under the
symbol "CYLK". Under the listing rules of The Nasdaq Small Cap Market, Cylink
received an extension of an additional 90 days to comply with the $1.00 minimum
bid requirement until December 24, 2002. However, should Cylink's common stock
continue to close below $1.00, Cylink common stock could be delisted from The
Nasdaq Small Capital Market. If Cylink's common stock were to be delisted from
The Nasdaq Small Cap Market, Cylink could apply for listing on the OTC Bulletin
Board or another quotation system or exchange for which it could qualify. Cylink
cannot guarantee, however, that it could apply for listing on another quotation
system or exchange if it is delisted from The Nasdaq Small Cap Market or that if
it does apply for listing that it will be eligible initially for such listing or
that if it does become listed, that it will be able to maintain eligibility.
Also, listing on another quotation system or exchange may negatively affect the
price of Cylink's common stock because stocks trading on over-the-counter
markets are typically less liquid and trade with larger variations between bid
and ask prices. In addition, the delisting of Cylink's common stock from the
Nasdaq Small Cap Market would adversely affect or limit or restrict its ability
to raise funds through stock issuances.
If the market price for Cylink's common stock remains below $1.00 per
share, its common stock will be deemed to be penny stock and be subject to rules
that impose additional sales practices on broker-dealers who sell Cylink's
securities. For example, broker-dealers must make a special suitability
determination for the purchaser of a penny stock and have received the
purchaser's written consent to the transaction prior to the 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. Such
circumstances could have an adverse effect on the liquidity of Cylink's common
stock.
Terrorist attacks may negatively impact all aspects of Cylink's operations,
revenues, costs and stock price.
Recent terrorist attacks in the United States, as well as future events
occurring in response or connection to such attacks, including 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 Cylink's domestic or foreign suppliers of merchandise, may
negatively impact Cylink's operations by causing delays or losses in the
delivery of goods and supplies to Cylink and decreased sales of the products it
carries. More generally, any of these events may
21
continue to negatively affect the general economy and Cylink's customers' demand
for capital equipment, thereby negatively impacting Cylink's operating results,
revenues and costs.
Recent accounting pronouncements may impact Cylink's financial position and
results of operations.
In June, July and August, 2001, the FASB 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 Cylink's 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 Cylink's business, financial condition, and results
of operations if such are required to be adopted by us in the future.
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. Cylink will
adopt the provisions of SFAS 146 for the restructuring activities, if any,
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 Cylink'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 Cylink future
restructuring costs as well as the amounts ultimately recognized by Cylink in
this regard.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As of September 29, 2002, Cylink held a total of $8.2 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 September 29, 2002, the decline in fair value
of the portfolio would not be material.
Cylink transacts substantially all of its revenues and costs in U.S.
dollars and its results of operations would not be materially affected by
fluctuations in foreign exchange rates. Accordingly, to date, Cylink has not
used material amounts of derivative financial instruments. As of September 29,
2002, Cylink had no fixed rate obligations except for an equipment loan with a
balance of approximately $35,000. As such, the fair value of Cylink's fixed rate
obligations is not subject to a material adverse impact from changes in interest
rates.
Item 4. Controls and Procedures.
Within 90 days prior to the filing of this Quarterly Report, Cylink's
President and Chief Executive Officer along with Cylink's Vice President of
Finance and Chief Financial Officer evaluated Cylink's disclosure controls and
procedures. Based upon this evaluation, Cylink's President and Chief Executive
Officer along with Cylink's Vice President of Finance and Chief Financial
Officer concluded that Cylink's disclosure controls and procedures are effective
in ensuring that material information related to Cylink that is required to be
disclosed in its periodic filings with the Securities and Exchange Commission is
included in the reports that it files with the Commission. There were no
significant changes in Cylink's internal controls or, to the knowledge of the
management of Cylink, in other factors that could significantly affect these
controls subsequent to the evaluation date, including any corrective actions
with regard to significant deficiencies and material weaknesses.
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Securities Class Action.
In 1998, Cylink filed amended Forms 10-Q for the first and third
quarters of 1998 and an amended Form 10-K for the 1997 fiscal year, 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 Cylink and certain of its current and
former directors and officers in federal courts in California. These complaints
alleged, among other things, that Cylink's previously issued financial
statements were materially false and misleading and that the defendants knew or
should have known that these financial statements caused Cylink's common stock
price to rise artificially. The actions variously alleged 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 were 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).
On October 16, 2002, Cylink entered into an agreement with all
plaintiffs in the securities class action lawsuit to settle all claims in the
class action for $6.2 million. The settlement amount will be paid entirely from
insurance proceeds under insurance policies held by Cylink. The settlement
agreement is subject to approval by the United States District Court for the
Northern District of California. Cylink expects that the settlement agreement
will be approved in March 2003. The Stipulation and Agreement of Settlement
effecting the above is attached as an exhibit to Cylink's Quarterly Report on
Form 10-Q for the period ended September 29, 2002 filed with the Securities and
Exchange Commission on November 13, 2002 (File No. 0-27742).
Other Litigation
In addition, in the normal course of business, Cylink, from time to
time, receives inquiries or other communication with regard to possible
infringement of third party intellectual property rights by Cylink's patents or
the features or content of certain of its products. Cylink believes that it is
unlikely that the outcome of any of these infringement inquiries will have a
material adverse effect on its financial position or results of operations,
however if litigation results from any of these inquires and the outcome is
unfavorable to Cylink, it could have a material adverse effect on Cylink's 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 in which Cylink operates. Further commercialization of Cylink's
products could provoke claims of infringement from third parties. In the future,
litigation may be necessary to enforce Cylink's patents, to protect its trade
secrets or know-how or to defend against claimed infringement of the
intellectual property rights of others and to determine the scope and validity
of the proprietary rights of others. Any litigation regarding the intellectual
property rights of Cylink or others could result in substantial cost and
diversion of Cylink's management's efforts from the operation of its businesses,
which by itself could have a material adverse effect on its financial condition
and operating results. Further, adverse determinations in such litigation could
result in loss of Cylink's proprietary rights, subject Cylink to significant
liabilities to third parties, require it to seek licenses from third parties or
prevent Cylink from manufacturing or selling its products, any of which could
have a material adverse effect on its 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
23
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information.
On October 9, 2002, Cylink Corporation moved trading of its common
stock from The Nasdaq National Market to The Nasdaq Small Cap Market. Cylink
continues to be traded under the symbol "CYLK".
On October 16, 2002, Cylink entered into an agreement with all
plaintiffs to settle several securities class action complaints that were filed
against Cylink and certain of its current and former directors and officers in
federal courts in California for $6.2 million. The securities class action
lawsuits were 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 settlement amount will be
paid entirely from insurance proceeds under insurance policies held by Cylink.
The settlement agreement is subject to approval by the United States District
Court for the Northern District of California. Cylink expects that the
settlement agreement will be approved in March 2003. For more information on
this lawsuit, see Part II, Item 1. "Legal Proceedings." The Stipulation and
Agreement of Settlement filed on November 5, 2002 in the referenced action is
attached as an exhibit to Cylink's Quarterly Report on Form 10-Q for the period
ended September 29, 2002 filed with the Securities and Exchange Commission on
November 13, 2002 (File No. 0-27742).
On October 30, 2002, Cylink announced that it had entered into a
definitive agreement to be acquired by SafeNet, Inc., a publicly traded Delaware
corporation. SafeNet trades on The Nasdaq National market under the symbol
"SFNT". Cylink will be acquired by SafeNet through a merger of Cylink with a
wholly-owned subsidiary of SafeNet. If the merger is consummated each share of
Cylink common stock outstanding as of the date of the closing of the merger will
be converted into the right to receive 0.05 of a share of SafeNet common stock
on a fixed exchange ratio basis. The transaction will be accounted for using the
purchase method of accounting, whereby Cylink's net assets and operating results
will be included in the consolidated financial statements of SafeNet from the
date of the closing of the merger, and is intended to qualify as a tax-free
reorganization under applicable U.S. tax laws and regulations. As of October 30,
2002 this represented an issuance by SafeNet of approximately 1.839 million of
its shares, or approximately 16% of the outstanding stock of SafeNet. The merger
agreement has been approved by the Boards of Directors of both Cylink and
SafeNet and the merger is expected to formally close in the first quarter of
2003; however, there can be no assurances that the merger will be completed in
that quarter, or at all. If the merger is consummated, Cylink will continue to
operate as a wholly-owned subsidiary of SafeNet. The consummation of the merger
is subject to the satisfaction of customary closing conditions, including the
declaration by the Securities and Exchange Commission of the effectiveness of
the registration statement to be filed by SafeNet in connection with the merger
and the approval of both Cylink's and SafeNet's shareholders. The merger
agreement is attached as an exhibit to Cylink's Quarterly Report on Form 10-Q
for the period ended September 29, 2002 filed with the Securities and Exchange
Commission on November 13, 2002 (File No. 0-27742). You are urged to read the
merger agreement in its entirety for a complete description of the merger and
related transactions.
Directors, executive officers and certain affiliates of Cylink and
Cylink's Directors have executed a voting agreement agreeing to approve the
merger and the merger agreement and an irrevocable proxy in favor of SafeNet,
Inc. in connection with such voting agreement. These Directors, executive
officers and affiliates hold approximately 23% of all outstanding shares of
Cylink common stock. A form of the voting agreement is attached as an exhibit to
Cylink's Quarterly Report on Form 10-Q for the period ended September 29, 2002
filed with the Securities and Exchange Commission on November 13, 2002 (File No.
0-27742). You are urged to read the voting agreement in its entirety for a
complete description of such agreement and the proxy.
Also on October 30, 2002 Cylink entered into a lease modification
agreement with its landlord for its Santa Clara headquarters and manufacturing
facility to terminate its lease obligations on approximately 46,724 square feet
effective November 1, 2002, and another 49,104 square feet effective March 1,
2003 in exchange for the payment of $3.2 million, $1.0 million to come from an
existing security deposit held by the landlord, and a warrant to purchase
500,000 shares of Cylink common stock at a price of $0.3838 per share (the
average closing price of Cylink's common stock for the 15 business days prior to
the effective date of the lease modification agreement). Cylink will continue to
lease approximately 46,724 square feet as its headquarters and manufacturing
facility from the existing landlord at the previous rates set forth in its lease
agreement. The Second Amendment to Lease and Partial Termination Agreement,
Assignment of Sublease; Consent of Landlord and Warrant effecting the above are
attached as exhibits to Cylink's Quarterly Report on Form 10-Q for the period
ended September 29, 2002 filed with the Securities and Exchange Commission on
November 13, 2002 (File No. 0-27742).
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
2.1 Agreement and Plan of Reorganization By and Among
SafeNet, Inc., Sapphire Acquisition Corp. and Cylink
Corporation dated as of October 30, 2002. (1)
4.1 Form of Voting Agreement, executed in connection with
the Agreement and Plan of Reorganization By and Among
SafeNet, Inc., Sapphire Acquisition Corp., and
Cylink. (1)
10.1 Stipulation and Agreement of Settlement filed on
November 5, 2002, in the United States District Court
for the Northern District of California, No. C98-4292
(VRW) (1)
24
10.2 Second Amendment to Lease and Partial Termination
Agreement between Orchard Jay Investors, LLC and
Cylink Corporation dated as of October 30, 2002. (1)
10.3 Assignment to Sublease; Consent of Landlord between
Orchard Jay Investors, LLC and Cylink Corporation
dated as of October 30, 2002. (1)
10.4 Warrant to Purchase Common Stock of Cylink
Corporation between Orchard Jay Investors, LLC and
Cylink Corporation dated as of October 30, 2002. (1)
99.1 Certification of William P. Crowell, President and
Chief Executive Officer of Cylink Corporation dated
November 26, 2002 in accordance with 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certification of R. Christopher Chillingworth Vice
President of Finance and Chief Financial Officer of
Cylink Corporation dated November 26, 2002 in
accordance with 18 U.S.C. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(1) Incorporated by reference from Cylink's Quarterly
Report on Form 10-Q for the period ended September
29, 2002 filed with the Securities and Exchange
Commission on November 13, 2002 (File No. 0-27742).
(b) Reports on Form 8-K:
On September 30, 2002 Cylink filed a report on Form 8-K announcing that
Cylink had submitted its application to Nasdaq on September 24, 2002 to
move the trading of its common stock from The Nasdaq National Market to
The Nasdaq Small Cap Market.
On October 9, 2002 Cylink filed a report on Form 8-K announcing that
Cylink had moved the trading of its common stock from The Nasdaq
National Market to The Nasdaq Small Cap Market.
25
SIGNATURES
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: November 26, 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)
26
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, William P. Crowell, President and Chief Executive Officer of Cylink
Corporation certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Cylink
Corporation;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 26, 2002 By: /s/ William P. Crowell
----------------------
Chief Executive Officer
Cylink Corporation
27
CERTIFICATION
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, R. Christopher Chillingworth, Vice President of Finance and Chief
Financial Officer of Cylink Corporation certify that:
1. I have reviewed this quarterly report on Form 10-Q/A of Cylink
Corporation;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in
the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 26, 2002 By: /s/ R. Christopher Chillingworth
--------------------------------
Chief Financial Officer
Cylink Corporation
28
EXHIBIT INDEX
2.1 Agreement and Plan of Reorganization By and Among
SafeNet, Inc., Sapphire Acquisition Corp. and Cylink
Corporation dated as of October 30, 2002. (1)
4.1 Form of Voting Agreement, executed in connection with
the Agreement and Plan of Reorganization By and Among
SafeNet, Inc., Sapphire Acquisition Corp., and
Cylink. (1)
10.1 Stipulation and Agreement of Settlement filed on
November 5, 2002, in the United States District Court
for the Northern District of California, No. C98-4292
(VRW) (1)
10.2 Second Amendment to Lease and Partial Termination
Agreement between Orchard Jay Investors, LLC and
Cylink Corporation dated as of October 30, 2002. (1)
10.3 Assignment to Sublease; Consent of Landlord between
Orchard Jay Investors, LLC and Cylink Corporation
dated as of October 30, 2002. (1)
10.4 Warrant to Purchase Common Stock of Cylink
Corporation between Orchard Jay Investors, LLC and
Cylink Corporation dated as of October 30, 2002. (1)
99.1 Certification of William P. Crowell, President and
Chief Executive Officer of Cylink Corporation dated
November 26, 2002 in accordance with 18 U.S.C. 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of R. Christopher Chillingworth Vice
President of Finance and Chief Financial Officer of
Cylink Corporation dated November 26, 2002 in
accordance with 18 U.S.C. 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference from Cylink's Quarterly
Report on Form 10-Q for the period ended September
29, 2002 filed with the Securities and Exchange
Commission on November 13, 2002 (File No. 0-27742).
29