SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 28, 1999
Commission File No. 0-27742
CYLINK CORPORATION
(Exact name of registrant as specified in its charter)
California 95-3891600
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
910 Hermosa Court
Sunnyvale, California 94086
(Address of principal executive offices)
(408) 735-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
------- -------
As of May 12, 1999, there were 29,126,000 shares of the Registrant's common
stock outstanding.
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data; unaudited)
March 28, December 31,
1999 1998
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 42,884 $ 46,575
Accounts receivable, net of allowances of $1,363 and $1,251 10,500 7,958
Note Receivable 3,545 3,545
Inventories 7,935 10,289
Deferred income taxes 4,495 4,495
Other current assets 6,597 6,675
--------- ---------
Total current assets 75,956 79,537
Property and equipment, net 5,287 5,731
Acquired technology, goodwill and other intangibles, net 4,657 5,341
Notes receivable from employees or former employees 2,609 2,558
Other assets 1,085 1,151
--------- ---------
$ 89,594 $ 94,318
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of lease obligations and long-term debt $ 100 $ 120
Accounts payable 2,763 3,656
Accrued liabilities 8,273 8,230
Accrued liabilities related to discontinued operations 3,626 3,878
Income taxes payable 1,085 1,091
Deferred revenue 2,426 1,975
--------- ---------
Total current liabilities 18,273 18,950
--------- ---------
Capital lease obligations and long-term debt 128 147
--------- ---------
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized;
none issued and outstanding -- --
Common stock, $0.01 par value; 40,000,000 shares authorized;
29,119,000 and 29,115,000 shares issued and outstanding 291 291
Additional paid-in capital 123,957 123,929
Deferred compensation related to stock options (146) (167)
Accumulated other comprehensive loss (73) (61)
Accumulated deficit (52,836) (48,771)
--------- ---------
Total shareholders' equity 71,193 75,221
--------- ---------
$ 89,594 $ 94,318
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
2
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data; unaudited)
Three Months Ended
------------------------------
March 28, March 29,
1999 1998
-------- --=-----
(restated-see Note 2)
Revenue $ 11,885 $ 8,062
Cost of revenue 4,112 2,631
-------- --------
Gross profit 7,773 5,431
-------- --------
Operating expenses:
Research and development, net 3,553 3,045
Selling and marketing 5,419 5,573
General and administrative 2,613 1,478
Amortization of purchased intangibles 680 679
-------- --------
Total operating expenses 12,265 10,775
-------- --------
Loss from operations (4,492) (5,344)
Other income (expense):
Interest income, net 308 167
Royalty and other income (expense), net 119 (15)
-------- --------
Loss from continuing operations before income taxes (4,065) (5,192)
Benefit from income taxes -- (1,817)
-------- --------
Loss from continuing operations (4,065) (3,375)
Income (loss) from discontinued operations,
net of income tax benefit of $139 -- (259)
Gain on disposal of discontinued operations,
net of income tax expense of $12,358 -- 22,776
-------- --------
Net income (loss) $ (4,065) $ 19,142
======== ========
Earnings (loss) per share - basic:
Continuing operations $ (0.14) $ (0.12)
Discontinued operations -- 0.78
-------- --------
Net income (loss) $ (0.14) $ 0.66
======== ========
Earnings (loss) per share - diluted:
Continuing operations $ (0.14) $ (0.12)
Discontinued operations -- 0.78
-------- --------
Net income (loss) $ (0.14) $ 0.66
======== ========
Shares used in per share calculation - basic 29,117 28,820
======== ========
Shares used in per share calculation - diluted 29,117 28,820
======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
3
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands; unaudited)
Three Months Ended
--------------------------
March 28, March 29,
1999 1998
-------- --------
Cash flows from operating activities: (restated-see Note 2)
Net income (loss) $ (4,065) $ (3,375)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation 635 309
Amortization 683 679
Deferred income taxes -- (227)
Amortization of imputed interest on employee notes receivable (66) --
Deferred compensation related to stock options 21 21
Deferred compensation related to employee notes receivable 66 --
Changes in assets and liabilities:
Accounts receivable (2,408) 1,158
Inventories 2,354 (711)
Other assets (40) (197)
Accounts payable (893) 698
Accrued liabilities 43 311
Income taxes payable (6) (2,450)
Deferred revenue 451 959
-------- --------
Net cash used in continuing operations (3,225) (2,825)
Net cash provided by (used in) discontinued operations (252) (4,243)
-------- --------
Net cash used in operating activities (3,477) (7,068)
-------- --------
Cash flows from investing activities:
Acquisition of property and equipment (191) (707)
Loans to employees in exchange for notes receivable -- (845)
Proceeds from sale of discontinued operations -- 46,000
Acquisition of preferred stock of unaffiliated company -- (3,000)
-------- --------
Net cash provided by (used in) investing activities (191) 41,448
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 28 760
Repayment of capital lease obligations and long-term debt (39) (55)
-------- --------
Net cash provided by (used in) financing activities (11) 705
-------- --------
Effect of exchange rate changes on cash and cash equivalents (12) 16
-------- --------
Net increase (decrease) in cash and cash equivalents (3,691) 35,101
Cash and cash equivalents at beginning of period 46,575 22,977
-------- --------
Cash and cash equivalents at end of period $ 42,884 $ 58,078
======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
4
CYLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements
included herein contain all adjustments, consisting only of normal
recurring adjustments which, in the opinion of management, are necessary
to fairly state the consolidated financial position, results of operations
and cash flows of Cylink Corporation ("Cylink" or the "Company") for the
periods presented. These financial statements should be read in
conjunction with the Company's audited financial statements included in
the Company's Annual Report on Form 10-K for the year ended December 31,
1998. Interim results of operations are not necessarily indicative of the
results to be expected for the full year.
2. Restatement of Financial Results
On November 5, 1998, the Company publicly announced that it and
its independent accountants had initiated a review of revenue recognition
practices which would result in a restatement of previously issued first
and second quarter 1998 results and that all three quarters of 1998 were
expected to show substantial operating losses. During the review, certain
facts became known indicating errors had been made in the application of
revenue recognition policies which also impacted the fourth quarter of
1997, and as a result, 1997 full-year results have been restated along
with first and second quarter 1998 results. These restated results were
announced in a press release dated December 16, 1998.
As a result of the restatement, the statements of operations and
financial position for the three months ended March 29, 1998 have been
restated as follows:
Three Months Ended
------------------
March 29, 1998
--------------
As Originally
-------------
Reported As Restated
-------- -----------
(in thousands)
Revenue $ 15,829 $ 8,062
Operating expenses 10,705 10,775
Income (loss) from
continuing operations 1,082 (3,375)
Net income (loss) $ 23,706 $ 19,142
======== ========
Earnings (loss) per share - diluted
Continuing operations $ 0.04 $ (0.12)
Discontinued operations 0.74 0.78
-------- --------
Net Income $ 0.78 $ 0.66
======== ========
As of March 29, 1998
--------------------
Accumulated Deficit $(27,258) $(34,790)
======== ========
5
3. Discontinued Operations
On March 28, 1998, the Company sold its Wireless Communications
Group ("Wireless") to P-Com, Inc. for $60.5 million ($46.0 million in cash
and an unsecured promissory note in the amount of $14.5 million due 100
days after closing, subject to closing adjustments). The sale resulted in
an after tax gain of approximately $22.8 million. As a result, the
operations of Wireless have been classified as discontinued operations in
the accompanying Condensed Consolidated Financial Statements and related
Notes. Accrued expenses in the amount of approximately $6.8 million,
primarily for professional services, anticipated excess facilities
expenses, and certain other transaction-related accruals were charged to
discontinued operations and reduced the gain on disposal. Pursuant to the
restatement referred to in Note 2, certain revenues of Wireless previously
recognized in the fourth quarter of 1997 and the first quarter of 1998 were
adjusted. On July 14, 1998, P-Com made a partial payment on its promissory
note, which along with other credits, totaled $8.9 million. P-Com is
disputing the remaining balance of the note which the Company presently
records at $3.5 million. Wireless revenues were $4.4 million in the first
quarter of 1998 through the date of disposal.
4. Inventories
March 28, December 31,
1999 1998
-------------------------------
(in thousands)
Raw materials $ 2,705 $ 2,813
Work in process and subassemblies 1,510 1,877
Finished goods 3,720 5,599
------- --------
$ 7,935 $10,289
======= ========
6
5. Earnings (Loss) Per Share
Basic earnings (loss) per share is based on the weighted-average
number of common shares outstanding. Diluted earnings (loss) per share is
based on the weighted-average number of shares outstanding and dilutive
potential common shares outstanding. The Company's only potentially
dilutive securities are stock options. All potentially dilutive securities
have been excluded from the computation of diluted earnings (loss) per
share as their effect is anti-dilutive on the loss from continuing
operations for the periods presented.
As of March 28, 1999 and March 29, 1998, the Company had 5,898,000
and 4,972,000 stock options outstanding with a weighted average exercise
price of $5.21 and $8.70, respectively. These options expire on various
dates beginning in 1999 through 2008.
6. Comprehensive Income (Loss)
The components of comprehensive income (loss) are as follows:
Three Months Ended
-------------------------
March 28, March 29,
1999 1998
-------- --------
(restated-See Note 2)
(in thousands)
Net income (loss) $(4,065) $19,142
Other comprehensive income (loss) (12) 16
------- -------
Total comprehensive income (loss) $(4,077) $19,158
======= =======
7. Subsequent Event
On May 10, 1999, the Company reached agreement to lease
approximately 96,000 square feet of office and manufacturing space located
in Santa Clara, California for use as it principal office and manufacturing
facility. The lease term is for 120 months commencing approximately
September 1, 1999, and includes an option to extend the lease for an
additional 5 years on commercially reasonable terms. The Landlord is
obligated to contribute up to $2.4 million for the construction of tenant's
interior improvements; however, tenant's interior improvements are expected
to exceed this allowance by approximately $1.5 million. The lease agreement
provides for the payment of rent on a net industrial lease basis commencing
at $174,000 per month for the first year and escalating to $228,000 per
month in the tenth year of the lease. The Company's lease on its present
86,000 square foot headquarters facility expires in 1999, and it is the
Company's intention to sublease its present manufacturing facility which
occupies 34,500 square feet.
7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Report on Form 10-Q includes statements that reflect Cylink's
belief concerning future events and financial performance. Statements which
are not purely historical in nature are called "forward looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934. We sometimes identify forward
looking statements with such words as "expects", "anticipates", "intends",
"believes" or similar words concerning future events.
You should not rely too heavily on these forward looking
statements. They are subject to certain risks and uncertainties that may
cause actual results to differ materially from past results or Cylink's
predictions. For a description of these risks see the reasons described in
Item 2 "Risk Factors That May Affect Future Results," and other sections of
this Report on Form 10-Q. You should also consult the risk factors listed
from time to time in Cylink's Reports on Form 10-K, 10-Q/A, and 8-K.
All forward-looking statements included in this document are based
on information available to Cylink as of the date of this Report on Form
10-Q, and Cylink assumes no obligation to update any such forward-looking
statements, or to update the reasons why actual results could differ from
those projected in the forward-looking statements.
RESTATEMENT OF FINANCIAL RESULTS
On November 5, 1998, the Company publicly announced that it and
its independent accountants had initiated a review of revenue recognition
practices which would result in a restatement of previously issued first
and second quarter 1998 results and that all three quarters of 1998 were
expected to show substantial operating losses. First quarter 1998 results
reported in this Form 10-Q reflect the results of the restatement.
DISCONTINUED OPERATIONS
Pursuant to an asset purchase agreement dated March 27, 1998, the
Company sold its Wireless business to P-Com, Inc. See Note 3 of Notes to
Condensed Consolidated Financial Statements. The sale resulted in an after
tax gain of approximately $22.8 million. Except where noted, the following
comments are associated with the continuing network security business.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of
operations data as a percentage of revenue for the periods indicated:
8
Three months ended
------------------
Mar 28, 1999 March 29, 1998
------------ --------------
(restated)
Revenue 100.0% 100.0%
Cost of revenue 34.6 32.6
-------- --------
Gross profit 65.4 67.4
-------- --------
Operating expenses:
Research and development, net 29.9 37.8
Selling and marketing 45.6 69.1
General and administrative 22.0 18.3
Amortization of purchased intangibles 5.7 8.4
-------- --------
Total operating expenses 103.2 133.6
-------- --------
Loss from operations (37.8) (66.3)
Other income, net 3.6 1.9
-------- --------
before income taxes (34.2) (64.4)
Benefit from income taxes -- (22.5)
-------- --------
Loss from continuing operations (34.2)% (41.9)%
======== ========
Revenue. The Company's revenue is derived primarily from sales of
its family of commercial network security products, and to a lesser extent,
from the license of software products. Fees for maintenance and support
services are charged separately. Revenue arising from sales of hardware
products is recognized upon shipment to customers. Concurrently, a
provision is made for estimated cost to repair or replace products under
warranty arrangements. Revenue from sales to distributors is recognized
upon shipment; no right of return, stock rotation or price protection is
given. Revenue from sales to value added resellers is recognized upon
shipment and concurrently a provision for estimated returns is recorded
based on historical and anticipated experience.
The Company also derives revenue from the license of its software
products as well as fees for software maintenance and support. License
revenues are recognized upon shipment of the product if no significant
vendor obligations remain and collection of the resulting receivable is
probable. In instances where a significant vendor obligation exists,
revenue recognition is delayed until the obligation has been satisfied.
Allowances for estimated future returns, which to date have been
immaterial, are provided upon shipment and revised periodically by
management based on historical and anticipated experience. Maintenance and
support fees consist of ongoing support and product updates and are
recognized ratably over the term of the contract, which is typically twelve
months. The Company has recognized software revenue in accordance with
Statement of Position 97-2 entitled "Software Revenue Recognition."
Software revenue, including related maintenance and support fees, was not
material in any period presented.
Revenue increased 47% from $8.1 million for the three months ended
March 29, 1998 to $11.9 million for the three months ended March 28, 1999.
The increase is attributable to increases in unit shipments of existing
products, the introduction of products with higher average selling prices,
and increased revenues associated with maintenance and support services.
International revenue was 50% and 40% of total revenue for the first
quarter of 1998 and 1999, respectively.
9
Gross Profit. Gross profit increased 43% from $5.4 million for the
three months ended March 29, 1998 to $7.8 million for the three months
ended March 28, 1999. The increase in dollars was primarily a result of the
increase in revenue. As a percentage of sales, gross profit was 67% and 65%
for the first quarter of 1998 and 1999, respectively. The decrease in gross
margin resulted primarily from unplanned excess manufacturing capacity and
the introduction of lower margin OEM products.
Research and Development. Research and development expenses
consist primarily of salaries and other personnel related expenses,
depreciation of development equipment, facilities and supplies. Gross
research and development expenses increased 33% from $3.0 million for the
three months ended March 29, 1998 to $4.0 million for the three months
ended March 28, 1999. Gross research and development expenses as a
percentage of revenue were 38% for the first quarter of 1998 and 34% for
the first quarter of 1999. The dollar increase resulted from increased
spending on externally funded contracts and development costs of new
products, particularly in Israel. The decrease in expense as a percentage
of revenue is due to the increased revenue base.
From time to time the Company receives engineering funding for
development of projects to apply or enhance the Company's technology to a
particular customer's need. The amounts recognized under these research and
development contracts are offset against research and development expenses.
No engineering funding was recognized during the first quarter of 1998.
Amounts recognized under non-recurring engineering contracts totaled $0.4
million for the first quarter of 1999.
Selling and Marketing. Selling and marketing expenses consist
primarily of personnel expenses, including sales commissions, and expenses
for advertising, public relations, seminars and trade shows. Selling and
marketing expenses decreased 3% from $5.6 million for the three months
ended March 29, 1998 to $5.4 million for the three months ended March 28,
1999. Selling and marketing expenses as a percentage of revenue were 69%
and 46% for the first quarter of 1998 and 1999, respectively. Sales and
marketing expenses decreased for the first quarter of 1999 primarily due to
reduced travel, headcount and payroll related costs undertaken as a
streamlining measure, offset by increased advertising, trade shows and
other marketing costs. Selling and marketing expenses, expressed as a
percentage of revenue, also decreased as a result of the increased revenue
base.
General and Administrative. General and administrative expenses
consist primarily of personnel and related costs, recruitment expenses,
information systems costs, and audit, legal and other professional service
fees. General and administrative expenses increased 77% from $1.5 million
for the three months ended March 29, 1998 to $2.6 million for the three
months ended March 28, 1999. General and administrative expenses as a
percentage of revenue were 18% and 22% for the first quarter of 1998 and
1999, respectively. The dollar and percentage of revenue increases in the
first quarter of 1999 were primarily due to increases in legal fees for
litigation defense, and accounting and consulting expenses resulting from
the restatement, as well as recruiting and relocation expenses related to
senior management transition.
Amortization of Goodwill and Other Intangibles. Amortization
relating to goodwill and other intangibles was $0.7 million in each period
presented and relates to the acquisition of Algorithmic Research, Ltd and
Algart Holdings, Ltd. (collectively "ARL") in September 1997.
Benefit from Income Taxes. No provision for or benefit from income
taxes was recognized in the quarter ended March 28, 1999 as the Company
incurred a net operating loss for income tax purposes and had no carryback
potential.
Other Income (Expense), Net. Other income (expense), net, consists
primarily of interest income and interest expense. Interest income, net,
increased from $0.2 million for the first three months of 1998 to $0.3
million for the first three months of 1999, principally due to the increase
in cash and cash equivalents resulting from proceeds of the Wireless Group
divestiture.
LIQUIDITY AND CAPITAL RESOURCES
At March 28, 1999, the Company had cash and cash equivalents of
$42.9 million, working capital of $57.7 million and minimal long-term
obligations. For the three months ended March 28, 1999, the Company
recorded a net loss of $4.1 million. Net cash used in continuing operating
activities for the first quarter of 1999 of $3.6 million consisted
primarily of the loss from continuing operations and an increase in
accounts receivable of $2.6 million, offset in part by a decrease in
10
inventories of $2.4 million. Both the increase in accounts receivable and
the decrease in inventories were the result of increased sales. For the
three months ended March 29, 1998, the Company recorded net income of $19.1
million due to the gain on sale of Wireless. Net cash used in continuing
operating activities for the first quarter of 1998 of $2.8 million
consisted primarily of the loss from continuing operations of $3.4 million
and a decrease in income taxes payable of $2.4 million, offset in part by a
decrease in accounts receivable of $1.2 million and increases in accounts
payable and accrued liabilities of $1.0 million and deferred revenue of
$1.0 million.
Cash used in investing activities for the three months ended March
28, 1999 was $0.1 million, primarily to fund the acquisition of property,
plant and equipment. Cash provided by investing activities for the three
months ended March 29, 1998 was $41.4 million, of which $46.0 million was
attributable to the sale of Wireless. The funds attributable to the
Wireless sale were partially offset by expenditures for property and
equipment of $0.7 million, long-term loans to employees of $0.8 million,
and a $3.0 million investment in the preferred stock of an unaffiliated
company.
The Company is currently engaged in litigation. See Part II, Item
1 "Legal Proceedings." Management believes that the ultimate resolution of
these matters will not have a material adverse effect on the Company's
financial position or results of operations.
The Company believes that existing cash balances and cash
generated from operations, if any, will be sufficient to fund necessary
purchases of capital equipment and to provide working capital through at
least the next twelve months. However, the Company may require additional
funds to support its working capital requirements or for other purposes and
may seek to raise such additional funds through public or private equity
financing or from other sources. No assurance can be given that additional
financing will be available or that, if available, will be on terms
favorable to the Company or its shareholders.
Year 2000 Compliance
"Year 2000 Compliance" refers generally to the problems that some
software, including firmware embedded in Cylink's products, may have in
determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures
or the creation of erroneous results. Cylink has defined "Year 2000
Compliant" as the ability to: (i) correctly handle date information needed
for the December 31, 1999 to January 1, 2000 date change; (ii) function
according to the product documentation provided for this date change,
without changes in operation resulting from the advent of a new century,
assuming correct configuration; (iii) where appropriate, respond to
two-digit date input in a way that resolves the ambiguity as to century in
a disclosed, defined, and predetermined manner, such as in certificate
based products, or in accordance with Cylink's Year 2000 Compliant test
plan; and (iv) recognize year 2000 as a leap year.
Cylink has developed a Year 2000 readiness plan for the current
versions of its products. Cylink has largely completed all phases of its
plan, except for contingency planning, with respect to the current versions
of all of its products. As a result, the current versions of each of its
products currently offered for sale are "Year 2000 Compliant." In some
cases, Cylink's products require an upgrade provided by Cylink which is
either sold as a complete substitute or as a kit sold with the product in
order to be Year 2000 Compliant.
Cylink has initiated a review of its mission critical internal
information systems (including the third-party software for its management
information systems, networks and desktop applications, and its hardware
telecommunications technology). Cylink expects to complete that review by
mid 1999. When deficiencies are identified in critical components, Cylink
is purchasing new or upgraded versions which have been certified by their
vendors as compliant.
Cylink has funded its Year 2000 plan from operating cash. While
Cylink does not expect such costs to be material, Cylink will incur
additional amounts related to the Year 2000 plan for administrative
personnel to manage Cylink's readiness plans, technical support for its
product engineering and customer satisfaction.
Cylink has not developed a comprehensive contingency plan to
address situations that may result if Cylink is unable to achieve Year 2000
readiness of its critical operations. The cost of developing and
implementing such a plan may itself be material.
11
Despite testing by Cylink and current and potential customers, and
any assurances from developers of products incorporated into Cylink's
products or in use in Cylink's business operations, Cylink's products may
contain undetected errors or defects associated with Year 2000 date
functions. Further, Cylink may be using products in its business operations
which are not Year 2000 compliant. An unanticipated Year 2000 interruption
could have material adverse financial consequences to the Company or
seriously impair business operations for an indefinite period of time.
For a more comprehensive discussion of Cylink's Year 2000 plans
and exposures, see the "Year 2000" topic under Part I, Item 2, "Risk
Factors That May Affect Future Results."
12
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Recent Losses; Potential Fluctuations in Operating Results, Future
Operating Results Uncertain.
Cylink incurred losses from continuing operations in 1998 and for
each of the prior four years. Cylink expects to incur net losses through
1999. Cylink may not increase or maintain its revenue or be profitable on a
quarterly or an annual basis 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 operating results are affected by a
number of factors, many of which are outside of Cylink's control,
including: the timing of the introduction of new or enhanced products by
Cylink or its competitors; market acceptance of new products of Cylink, its
customers and its competitors; the timing, cancellation or delay of
customer orders, including cancellation or delay in anticipation of new
product introduction or enhancement or resulting from uncertainty relating
to intellectual property claims; competitive factors, including pricing
pressures; changes in operating expenses, including those resulting from
changes in available production capacity of independent foundries and other
suppliers and the availability of raw materials; expenses associated with
obtaining, enforcing and defending claims with respect to intellectual
property rights; the mix of products sold; changes in the percentage of
products sold through Cylink's direct sales force; personnel changes;
general economic conditions; and fluctuations in foreign currency exchange
rates. Cylink expects to introduce a number of new products during 1999.
The failure of such new products to achieve market acceptance at the time
anticipated by Cylink, or at all, would materially and adversely affect
Cylink's financial condition and results of operations.
In connection with the acquisition of ARL in September 1997, the
Company allocated $63.9 million of the purchase price to in-process
research and development ("IPR&D"), and in accordance with generally
accepted accounting principles recorded an immediate charge off of that
amount on the date of acquisition. The amount allocated to IPR&D was
determined in a manner consistent with widely recognized appraisal
practices and reviewed by our independent accountants in the context of
their examination of the financial statements taken as a whole.
In a letter dated September 15, 1998, to the American Institute of
Certified Public Accountants, the Chief Accountant of the Securities and
Exchange Commission ("SEC") indicated the SEC Staff's concerns related to
certain appraisal practices generally employed in determining the fair
value of IPR&D. As a result, it is possible that the SEC staff may require
that any enterprise that recorded an IPR&D charge revise its estimate of
the value of the IPR&D. To the extent the Company is required by the SEC
Staff to retroactively revise its estimate of the value of IPR&D, such
revision could result in the capitalization of additional goodwill, the
amortization of which would reduce future operating results.
Pending Litigation
See Part II, Item 1. "Legal Proceedings."
Dependence on Key Personnel
On November 4, Mr. William C. Crowell, formerly Vice President of
Product Strategy, was promoted to President and Chief Executive Officer,
and on November 16, Mr. Roger A. Barnes became Cylink's Chief Financial
Officer. Cylink's future success will depend on the abilities of Mr.
Crowell and the contributions by its other executive officers, key
management and technical personnel. The loss of the services of one or more
of Cylink's executive officers or key personnel, or the inability to
continue to attract and retain qualified personnel, could delay product
development cycles or otherwise have a material adverse effect on Cylink's
business and operating results. Retention and attraction of such qualified
13
personnel may become even more difficult for Cylink following Cylink's
recent restatement of its financial statements and recently determined
losses.
Lengthy Sales Cycle
Sales of Cylink's products generally involve a significant
commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures. For these and other reasons,
the sales cycle associated with 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 orders and, consequently, order backlog at the beginning of any
period has in the past represented only a small portion of that period's
expected revenue. As a result, product revenue in any period is
substantially dependent on orders booked and shipped in that period. Cylink
typically plans its production and inventory levels based on internal
forecasts of customer demand, which are highly unpredictable and can
fluctuate substantially. In addition, Cylink's current or future customers
may curtail or suspend investments in securing their existing networks as
the Year 2000 approaches, or divert technology expenditures reserved for
enterprise security products in order to address Year 2000 compliance
problems (see further discussion under Year 2000 below). If revenue falls
significantly below anticipated levels, as it has at times in the past,
Cylink's financial condition and results of operations would be materially
and adversely affected. In addition, Cylink's operating expenses are based
on anticipated revenue levels and a high percentage of Cylink's expenses
are generally fixed in the short term. Based on these factors, a small
fluctuation in the timing of sales can cause operating results to vary
significantly from period to period. For example, on September 14, 1998,
Cylink announced that its earnings for the third quarter of 1998 would be
below consensus estimates. It is possible that in the future Cylink's
operating results will again be below the expectations of securities
analysts and investors. In such an event, or in the event that adverse
conditions prevail or are perceived to prevail generally or with respect to
Cylink's business, the price of Cylink's Common Stock would likely be
materially adversely affected.
Dependence on Recently Introduced and New Information Security Products
Cylink's future results of operations will be highly dependent on
the successful completion of the design, development, introduction,
marketing and manufacture of the Cylink Link Encryptors, PrivaCy Manager,
PrivateWire and Cylink Frame Encryptor products, which were recently
introduced. To date, Cylink has made only limited and, in some cases, no
commercial shipments of certain versions of such products. Furthermore,
Cylink relies on a third party original equipment manufacturer to supply
Cylink's ATM Encryptor product, and Cylink is dependent on this supplier to
complete successful integration of Cylink's PrivaCy Manager with the ATM
Encryptor. These products may require additional development work,
enhancement, testing or further refinement before they can be introduced
and made commercially available by Cylink or achieve market acceptance. If
such new and recently introduced products have performance, reliability,
quality or other shortcomings, then such products could fail to achieve
market acceptance. The failure by 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.
Competition
Competition is intense among providers of network security
systems, and Cylink expects such competition to increase in the future.
Significant competitive factors in these markets include the development of
new products and features, product quality and performance, the quality and
experience of sales, marketing and service organizations, product price,
name recognition and perception of Company stability and long-term
viability. Many of these factors are beyond Cylink's control. In addition,
some factors, such as the perception of Cylink's stability and viability
over the long term may have been adversely affected by the recent
restatement of Cylink's 1997 and first and second quarter 1998 financial
statements, which could materially adversely impact Cylink's ability to
compete.
Cylink's competitors in the information security markets,
including companies that offer products similar to or as an alternative to
the Company's products, include Axent Technologies, Inc., Checkpoint
Software Technologies, Ltd., Network Associates, Inc., Secure Computing
Corporation, Security Dynamics Technologies, Inc., Racal-Guardata, Inc.,
and Information Resource Engineering, Inc. Cylink's OEM supplier
14
of its ATM Encryptor product also competes with Cylink, both directly and
through other channels, for sales of this product. In addition, Northern
Telecom Limited, AT&T, Motorola Corporation, and Sun Microsystems, Inc.
offer certain information security products as part of their overall
networking solutions. A number of significant vendors, including Microsoft
Corporation, Netscape Communications Corporation and Cisco Systems, Inc.,
have embedded security solutions in their software. To the extent that
these embedded or optional security capabilities provide all or a portion
of the functionality provided by Cylink's products, Cylink's products may
no longer be required by customers to attain network security.
Certicom Corporation and RSA Data Security, Inc., a subsidiary of
Security Dynamics ("RSA DSI"), license various methods of implementing
public key cryptography, including some that are different from (and
incompatible with) the method of implementing public key cryptography
currently used by Cylink in most of its products. Although Cylink has a
license to use all of the public key methods promoted by Certicom and RSA
DSI, to the extent significant segments of the network security market
adopt technical standards different from those currently used by Cylink, to
the exclusion of Cylink's methods, sales of Cylink's existing and planned
products in that market segment may be adversely impacted, which could have
a material adverse effect on Cylink's financial condition and results of
operations.
Many of Cylink's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name
recognition and longer standing relationships with customers than Cylink.
Competitors with greater financial resources are better able to engage in
sustained price reductions in order to gain market share. Any period of
sustained price reductions would have a material adverse effect on Cylink's
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 Cylink's financial condition and results of operations.
Product Liability Risks
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 Cylink's products could result in tort or
warranty claims. Although Cylink attempts to reduce the risk of such losses
through warranty disclaimers and liability limitation clauses in its sales
and license agreements and by maintaining product liability insurance,
there can be no assurance that such measures will be effective in limiting
Cylink's liability for any such damages. Any liability for damages
resulting from security breaches could be substantial and could have a
material adverse effect on 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. This could result in a decline
in demand for Cylink's products, which would have a material adverse effect
on Cylink's business, financial condition and results of operations.
Year 2000
The "Year 2000 Issue" refers generally to the problems that some
software, including firmware embedded in Cylink's products, may have in
determining the correct century for the year. For example, software with
date-sensitive functions that is not Year 2000 compliant may not be able to
distinguish whether "00" means 1900 or 2000, which may result in failures
or the creation of erroneous results.
Cylink has developed a Year 2000 readiness plan for the current
versions of its products. The plan includes development of corporate
awareness, assessment, implementation (including remediation, upgrading and
replacement of certain product versions), validation testing, and
contingency planning. The Company continues to respond to customer concerns
about prior versions of its products on a case-by-case basis.
Cylink has largely completed all phases of its plan, except for
contingency planning, with respect to the current versions of all of its
products. As a result, the current versions of each of its products
currently offered for sale are "Year 2000 Compliant" as defined below,
when configured and used in accordance with the related documentation, and
provided that the underlying operating system of the host machine and any
other software used with or in the host machine or Cylink's products are
also Year 2000 Compliant. In some cases, Cylink's products require an
15
upgrade provided by Cylink which is either sold as a complete substitute or
as a kit sold with the product in order to be Year 2000 Compliant.
Cylink has defined "Year 2000 Compliant" as the ability to: (i)
correctly handle date information needed for the December 31, 1999 to
January 1, 2000 date change; (ii) function according to the product
documentation provided for this date change, without changes in operation
resulting from the advent of a new century, assuming correct configuration;
(iii) where appropriate, respond to two-digit date input in a way that
resolves the ambiguity as to century in a disclosed, defined, and
predetermined manner, such as in certificate based products, or in
accordance with Cylink's Year 2000 Compliant test plan; and (iv) recognize
year 2000 as a leap year. Cylink has not tested its products on all
platforms or all versions of operating systems that it currently supports
and has advised its customers to verify that their platforms and operating
systems support the transition to the year 2000.
Cylink has not specifically tested software obtained from third
parties (licensed software, shareware, and freeware) that is incorporated
into its products, but Cylink's test plan was designed to reveal Year 2000
deficiencies with third party software incorporated in Cylink's products.
Despite testing by Cylink and current and potential customers, and
any assurances from developers of products incorporated into Cylink's
products, Cylink's products may contain undetected errors or defects
associated with Year 2000 date functions. Also, certain prior versions of
the Company's products are not fully Year 2000 Compliant, and Cylink is
working to address these issues by offering for sale upgrades to compliant
versions. Known or unknown errors or defects in Cylink's products could
result in delay or loss of revenue, diversion of development resources,
damage to Cylink's reputation, or increased service and warranty costs, any
of which could materially adversely affect Cylink's business, operating
results, or financial condition.
Cylink does not currently have any information concerning the Year
2000 compliance status of its customers. If Cylink's current or future
customers suspend investments in securing their existing networks while
they achieve Year 2000 compliance, or if they divert technology
expenditures (especially technology expenditures that are reserved for
enterprise security products) to address Year 2000 compliance problems,
Cylink's business, results of operations, or financial condition could be
materially adversely affected.
Some commentators have predicted significant litigation regarding
Year 2000 compliance issues. Because this type of litigation lacks
precedent, it is uncertain whether or to what extent Cylink may be affected
by it.
Cylink has initiated a review of its mission critical internal
information systems (including the third-party software for its management
information systems, networks and desktop applications, and its hardware
telecommunications technology). Cylink expects to complete that review by
mid 1999. To the extent that Cylink is not able to test the technology
provided by third-party vendors, Cylink is purchasing upgrades for versions
which have been certified by their vendors as compliant. Although Cylink is
not currently aware of any material operational issues or costs associated
with preparing its internal information systems for the Year 2000, Cylink
may experience material unanticipated problems and costs caused by
undetected errors or defects in the technology used in its information
systems.
Cylink has funded its Year 2000 plan from operating cash. While
Cylink does not expect such costs to be material, Cylink will incur
additional amounts related to the Year 2000 plan for administrative
personnel to manage Cylink's readiness plans, technical support for its
product engineering and customer satisfaction. Cylink may experience
material problems and costs with Year 2000 compliance that could adversely
affect Cylink's business, results of operations, and financial condition.
Cylink has not developed a comprehensive contingency plan to
address situations that may result if Cylink is unable to achieve Year 2000
readiness of its critical operations. The cost of developing and
implementing such a plan may itself be material. Finally, Cylink is also
subject to external forces that might generally affect industry and
commerce, such as utility or transportation company Year 2000 compliance
failures and related service interruptions.
Were Cylink to experience an unanticipated Year 2000 interruption,
business operations could be seriously impaired for an indefinite period of
time until remedial efforts could be achieved.
16
Management of Growth And Reduction In Employees
Cylink has recently and may continue to experience substantial
fluctuations in the number of employees and the scope of its operations in
the network security business, resulting in increased responsibilities for
management. To manage its business effectively, Cylink will need to
continue to improve its operational, financial and management information
systems and to hire, train, motivate and manage its employees. Competition
is intense for qualified technical, marketing and management personnel,
particularly highly skilled engineers. In particular, the current
availability of qualified engineers is quite limited, and competition among
companies, academic institutions, government entities and other
organizations for skilled and experienced engineering personnel is very
intense. Cylink has experienced delays in filling positions for engineering
personnel and the Company expects to experience continued difficulty in
filling its needs for qualified engineers and other personnel, especially
given the recent announcement regarding the restatement of its financial
results and associated issues. There can be no assurance that Cylink will
be able to effectively achieve or manage any future growth, and its failure
to do so could delay product development cycles or otherwise have a
material adverse effect on the Company's financial condition and results of
operations.
With the sale of its Wireless Communications Group (the "Wireless
Group") in March, 1998, Cylink has experienced a significant reduction in
employees, including Cylink's former Chief Technical Officer, Dr. Jim
Omura. The sale of its Wireless Group, the uncertainty created by Cylink's
recent restatements of its financial results, the initiation of highly
publicized class actions securities litigation against Cylink, and the
occasional reductions in specific engineering programs in the network
security business, has created some instability within the existing
employee population resulting in departures of certain key employees
critical to sustaining growth in Cylink's network security business.
Furthermore, sudden reductions in the number of Cylink's employees places
greater demands on the remaining employees which may distract them from
fulfilling their responsibilities necessary to accomplishing Cylink's
financial goals.
In September 1997, Cylink acquired Algorithmic Research, Ltd.
("ARL") and assumed responsibility for management of its worldwide
operations which currently consists of approximately seventy-three
employees. Cylink is heavily dependent on ARL's success in continuing to
develop marketable technology and products, such as the PrivateWire family,
including PrivateSafe and PrivateCard, toolkits and other components, as
well as Cylink's next generation virtual private network ("VPN") product.
Key factors which will determine ARL's success include whether Cylink can
integrate ARL's management, employee culture and organizational practices
into Cylink, whether Cylink can adequately fund ARL's development
objectives, whether Cylink can provide accurate information for ARL to
focus its technology on significant market opportunities, and whether
Cylink can predict the most attractive features and functions for ARL's
products. Cylink's success in realizing the anticipated return from its
investment in ARL also will be determined by Cylink's ability to position
and introduce ARL's products into Cylink's markets and channels, and
Cylink's ability to provide adequate sales and customer support for ARL's
products. To date, Cylink's efforts to market ARL's products through
Cylink's direct sales channel have not met Cylink's expectations due to
differences between the sales expertise required for selling the ARL
products and that required for Cylink's other products. Consequently,
Cylink has recently reorganized the management of ARL to strengthen ARL's
responsibility for marketing and sales of its products. In addition, ARL's
improvements and development of new products have been delayed by
inadequate coordination between engineering departments located in
Sunnyvale, CA and Petach Tikva, Israel. This inadequate coordination to
date is due to differing engineering practices concerning development
planning and restrictions imposed by U.S. export control laws governing the
transfer of cryptographic expertise. Cylink and ARL's successful working
relationship may be hindered significantly by differences between the two
organizations created by time, distance, language and culture. ARL operates
from its principal offices in Israel, a country which is vulnerable to
disruption due to the sudden outbreak of hostilities with its neighbors and
various indigenous factions. Many of ARL's employees have extensive
commitments to the country's military organizations which may require a
loss of their services on the Company's behalf in times of political
instability.
Intellectual Property and Other Proprietary Rights
Cylink relies on patents, trademarks, copyrights, licenses and
trade secret law to establish and preserve its intellectual property
rights. The Company owns a number of U.S. patents covering certain aspects
of its network security product designs, and has additional U.S. patent
applications pending. There can be no assurance that any patent, trademark,
copyright or license owned or held by Cylink will not be invalidated,
17
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
Cylink, 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 or design around the patents owned by Cylink.
Cylink may be subject to or may initiate interference proceedings in the
U.S. Patent Office, which can require significant financial and management
resources. In addition, the laws of certain countries in which Cylink's
products are or may be developed, manufactured or sold may not protect
Cylink's products and intellectual property rights to the same extent as
the laws of the United States. The inability of Cylink to protect its
intellectual property adequately could have a material adverse effect on
its financial condition and results of operations.
The computer, communications, software and network security
industries are characterized by substantial litigation regarding patent and
other intellectual property rights. From time to time, Cylink has received
communications from third parties asserting that Cylink's patents, features
or content of certain of Cylink's products infringe upon the intellectual
property rights held by third parties, and Cylink may receive such
communications in the future. There can be no assurance that third parties
will not assert claims against Cylink that result in litigation. Any
litigation, whether or not determined in favor of Cylink, could result in
significant expense to Cylink and could divert management and other
resources. In the event of an adverse ruling in any litigation involving
intellectual property, 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 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 and Cylink's failure to develop or license a substitute
technology on commercially reasonable terms, Cylink's financial condition
and results of operations would be adversely affected. There can be no
assurance that existing claims or any other assertions (or claims for
indemnity from customers resulting from infringement claims) will not
materially and adversely affect Cylink's financial condition and results of
operations.
Evolving Network Security Market; Market Acceptance Risks
The market for Cylink's network security products is only
beginning to emerge. This market is characterized by rapidly changing
technology, emerging industry standards, new product introductions and
changes in customer requirements and preferences. 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 customers as to
the value of its security products. Cylink believes that many potential
customers do not appreciate the need for high-end security products unless
and until they have faced a major security breach. If Cylink is unable to
successfully educate potential customers as to the value of, and thereby
obtain broad market acceptance for, its products, it will continue to rely
primarily on selling new and existing products to its base of existing
customers, which will significantly limit any opportunity for growth. In
addition, any significant advance in technologies for attacking
cryptographic systems could render some or all of Cylink's existing and new
products obsolete or unmarketable. To the extent that a specific method
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 Cylink's business,
financial condition and results of operations. See "Competition." Network
security-related products or technologies developed by others may adversely
affect Cylink's competitive position or render its products or technologies
noncompetitive or obsolete.
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 make these networks
into viable commercial marketplaces may not be fully developed, and once
developed, these networks may not become viable commercial marketplaces.
Rapid Technological Change
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 its
18
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. Cylink may not be able to develop and introduce new products
or enhancements to its existing products in a timely manner which satisfy
customer needs, achieve market acceptance or address technological changes
in its target markets. The failure of Cylink to develop products and
introduce them successfully and in a timely manner could adversely affect
Cylink's competitive position, financial condition and results of
operations.
Risks Associated with International Sales; Reliance Upon Local Partners;
Restrictions on Export
Cylink plans to continue to expand its foreign sales channels and
to enter additional international markets, both of which will require
significant management attention and financial resources. International
sales are subject to a number of risks, including unexpected changes in
regulatory requirements, export control laws, tariffs and other trade
barriers, political and economic instability in foreign markets,
difficulties in the staffing, management and integration of foreign
operations, longer payment cycles, greater difficulty in collecting
accounts receivable, currency fluctuations and potentially adverse tax
consequences. Since most of Cylink's foreign sales are denominated in U.S.
dollars, Cylink's products become less price competitive in countries in
which local currencies decline in value relative to the U.S. dollar. The
uncertainty of monetary exchange values has caused, and may in the future
cause, some foreign customers to delay new orders or delay payment for
existing orders. The long-term impact of such devaluation, including any
possible effect on the business outlook in other developing countries,
cannot be predicted.
Cylink's ability to compete successfully in foreign countries is
dependent in part on Cylink's ability to obtain and retain reliable and
experienced in-country distributors and other strategic partners. Cylink
does not have long-term relationships with any of its value added resellers
and distributors and, therefore, has no assurance of a continuing
relationship within a given market.
Due to U.S. and Israeli government regulations restricting the
export of cryptographic devices and software, including certain of Cylink's
network security products, Cylink is often at a disadvantage in competing
for international sales compared to companies located outside the United
States and Israel that are not subject to such restrictions. The regulatory
environment in the United States for export of encryption products is
particularly unsettled, with various pending legislative initiatives and
conflicting judicial decisions, all causing substantial uncertainty in
Cylink's international market. This confusion is often exacerbated by U.S.
vendors' incomplete or inaccurate press releases concerning export licenses
for their products, and foreign competitors marketing campaigns which
stress the restrictions on purchasing encryption products from U.S.
vendors. There is no assurance that this disruption will end anytime within
the near future.
Dependence on Component Availability, Subcontractor Performance and Key
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 items in a timely and
satisfactory manner. Cylink obtains certain components and subsystems from
single, or a limited number of, sources. A significant interruption in the
delivery of such items could have a material adverse effect on Cylink's
financial condition and results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company's market risk exposures are set forth in its Annual
Report on Form 10-K for the year ended December 31, 1998 and have not
changed significantly.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On March 7, 1997, ten former employees of the Company filed suit
in action No. CV764647 in the Superior Court of California, County of Santa
Clara, against the Company, each of its Directors and its General Counsel,
asserting claims for wrongful termination, fraud, libel, slander, age
discrimination, invasion of privacy, and violation of the federal RICO
statute. On July 11, 1997, an eleventh employee filed suit in action no.
CV767448 in the Superior Court of California, County of Santa Clara,
alleging similar claims against the Company and its Chief Executive
Officer. The Company removed CV764647 to the Federal District Court for the
Northern District of California and, after the Company obtained an order
dismissing certain of the plaintiff's claims, including the claims of libel
and RICO violations, the Court remanded the action back to the Santa Clara
19
Superior Court. Following mediation efforts in October, 1998, the plaintiff
in CV767448 accepted a settlement and dismissed his complaint with
prejudice. The remaining plaintiffs subsequently dismissed, with prejudice,
all of the outside Directors except the Chairman. On December 4, 1998,
December 18, 1998, March 26, 1999, and April 5, 1999, the Court granted
various motions by Cylink for summary judgement and for dismissal of the
majority of the claims in CV764647, including all claims against the
Chairman. Discovery with respect to the remaining claims is continuing,
with trial expected by late 1999. Although the Company has placed its
insurers on notice of these claims, all of its insurers have reserved their
rights and defenses under their policies, and the extent of the insurers'
liability under their respective policies is undetermined. The Company
believes the terminations were lawful, in the best interest of the Company,
and intends to defend the matter vigorously. The defense of this matter may
divert a material amount of management's attention and require the
expenditure of significant legal fees and costs. An unfavorable outcome
which exceeds the Company's insurance coverage, if any, could also result
in a material adverse effect on the Company's financial condition.
After asserting certain deductions arising under the contract
dated March 28, 1998, for the purchase of Cylink's Wireless Group, P-Com
made a partial payment on July 14, 1998, in the amount of $8.9 million on
its promissory note dated April 1, 1998. Cylink is presently discussing
with P-Com the basis of its deductions and, failing an amicable resolution
of P-Com's contentions, the matter may proceed to litigation.
On September 3, 1998, P-Com put Cylink on notice that certain
shipments in the fourth quarter of 1997 and the first quarter of 1998 by
the Company's former Wireless Group and having an invoice value of
approximately $3.5 million had been seized by an agency of the United
States Department of the Treasury and that P-Com intends to hold Cylink
responsible for the consequences of this event. P-Com is currently
petitioning for release of the goods. Based on Cylink's investigation to
date, Cylink believes either that the grounds for the seizure are unfounded
or that P-Com is responsible for this action. Cylink has no reason at this
time to believe that it is the subject of any official investigation and
Cylink has been informed that P-Com is presently petitioning for the
release of the seized goods. A failure by P-com to obtain release of the
shipment due to a violation of law by Cylink might adversely affect the
amount collected from P-Com on its outstanding obligations under the
promissory note, including payment of any relevant fines or penalties.
On September 14, 1998, Cylink announced that its earnings for the
third quarter would be below consensus estimates. On November 5, 1998,
Cylink announced that, with the assistance of its independent accountants,
it was reviewing its revenue recognition practices, and Cylink announced
that its first and second quarter earnings would have to be restated and
that it would have operating losses for each of the three quarters for the
period ended September 27, 1998. During the review, certain facts became
known indicating errors had been made in the application of revenue
recognition policies which also impacted the fourth quarter of 1997, and as
a result, 1997 full-year results have been restated along with first and
second quarter 1998 results. Cylink has filed amended Forms 10-Q for the
first and second quarters of 1998 and an amended Form 10-K for 1997.
Between November 6 and November 25, 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
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 Cylink's
common stock price to rise artificially. The actions variously allege
violations of Section 10(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), as amended, and SEC Rule 10b-5 promulgated thereunder, and
Section 20 of the Exchange Act.
Cylink believes it has meritorious defenses to these actions and
intends to defend itself vigorously. However, it is not feasible to predict
or determine the final outcome of these proceedings, and if the outcome
were to be unfavorable, Cylink's business, financial condition, cash flows
and results of operations could be materially adversely affected.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Index:
Exhibit
Number Description of Exhibit
------ ----------------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K;
Cylink filed a report on Form 8-K, with respect to Items five and
seven, on January 29, 1999.
Items 3, 4, and 5 are not applicable and have been omitted.
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: May 12, 1999 CYLINK CORPORATION
By: /s/ ROGER A. BARNES
------------------------------
Roger A. Barnes
Vice President of Finance
and Administration and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
21