SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                    FORM 10-K

              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 1996          Commission File No. 0-27742


                               CYLINK CORPORATION
             (Exact name of registrant as specified in its charter)



          California                                          95-3891600
(State or other jurisdiction of                           (I.R.S. Employer
incorporation or organization)                           Identification No.)

                                910 Hermosa Court
                           Sunnyvale, California 94086
                    (Address of principal executive offices)

                                 (408) 735-5800
              (Registrant's telephone number, including area code)


        Securities registered pursuant to Section 12(b) of the Act: None

    Securities registered pursuant to Section 12(g) of the Act: Common Stock


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.

       Yes           X              No
                   -----                -----

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best  of  the  Registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [ X ]


The  aggregate  market  value of  voting  stock  held by  non-affiliates  of the
Registrant,  based upon the closing  sale price of the Common Stock on March 14,
1997, as reported by the Nasdaq National Market, was approximately $103,661,000.
Shares of Common  Stock held by each officer and director and by each person who
owns 5% or more of the outstanding  Common Stock, based on Schedule 13G filings,
have been excluded from the computation in that such persons may be deemed to be
affiliates.   This  determination  of  affiliate  status  is  not  a  conclusive
determination for other purposes.

As of March 14, 1997, there were 25,755,468  shares of the  Registrant's  Common
Stock outstanding.


                       DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant's Proxy Statement for its Annual Meeting of Shareholders
(the  "Proxy  Statement")  to be held  on May  22,  1997,  are  incorporated  by
reference in Part III of this Form 10-K to the extent stated herein.


<PAGE>
                                     PART I


         The  statements  contained  in this  Report  on Form  10-K that are not
purely historical are  forward-looking  statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including  statements  regarding Cylink Corporation's  ("Cylink" or the
"Company") expectations,  hopes, intentions, beliefs or strategies regarding the
future.  Forward looking statements include: the Company's statements in Part I,
Item 1 "Business"  regarding (i) its belief that solving network security issues
will  increase  applications   accessible  through  public  networks,  (ii)  its
strategies  for  continuing  to  be  a  leading   provider  of   enterprise-wide
information  security products and to establish  network security  standards for
the secure exchange of  information,  (iii) its belief that it has a competitive
advantage,  and that its AirLink  products  respond to a need,  in the  wireless
communications  market for spread spectrum radio products,  and its strategy for
its AirLink products providing last mile and data network solutions at ranges of
up to 30 miles, (iv) its plans to develop domestic and  international  strategic
marketing and product development  relationships,  (v) its expected research and
development expenditures for the enhancement of the Company's existing products,
including its Secure Enterprise Architecture Stack and AirLink products, and for
the  development  and  introduction  of new  products,  and (vi)  the  Company's
intention to expand  foreign sales channels and enter  additional  international
markets;  the  Company's  statements  in  Item 7  "Management's  Discussion  and
Analysis of Financial  Condition  and Results of  Operations"  regarding (i) the
Company's expectation that it will more likely than not realize its net deferred
tax  assets  based on future  income  in the next  twelve  months,  and (ii) the
sufficiency  of the Company's  existing  liquidity and capital  resources;  and,
management's  belief that resolution of certain litigation  described in Note 10
of the Notes to Consolidated Financial Statements contained in Item 8 "Financial
Statements and  Supplementary  Data" will not have a material  adverse effect on
the Company's  financial position.  All  forward-looking  statements included in
this document are based on  information  available to the Company as of the date
of this Report on Form 10-K, and the Company assumes no obligation to update any
such  forward-looking  statements,  or to update the reasons why actual  results
could  differ from those  projected  in the  forward-looking  statements.  It is
important to note that the Company's actual results could differ materially from
those in such  forward-looking  statements  for the  reasons  detailed in Item 1
"Business - The Cylink Strategy, - Information Security Products, - Research and
Development,  and - Risk  Factors  That May Affect  Future  Results,"  and other
sections of this Report on Form 10-K.  You should also  consult the risk factors
listed from time to time in the  Company's  Reports on Form 10-Q,  8-K, 10-K and
Annual Reports to the Shareholders.


ITEM 1.  BUSINESS

         The Company supplies network information  security products that enable
the secure  transmission  and  authentication  of data over local area  networks
("LANs"),  wide area networks ("WANs") and public packet switched networks, such
as the  Internet.  The Company's  broad line of  information  security  products
provides  an  integrated   solution  that   prevents   unauthorized   access  or
manipulation  of  information,  enables  secure  electronic  commerce  over  the
Internet and allows mobile users to securely access corporate  networks.  Cylink
further   offers  a  line  of  spread   spectrum  radio  products  for  wireless
transmission  of voice and data  communications  which operate in the unlicensed
spread  spectrum  bands adopted by the U.S.  Federal  Communications  Commission
("FCC") in 1985 and subsequently  adopted in many other countries throughout the
world. The Company's spread spectrum radio products focus primarily on the fixed
location, outdoor, wireless communications infrastructure market.

         The  Company  was  formed  in 1984 as a  partnership  and  subsequently
incorporated  in California in 1989. In February and March of 1996,  the Company
completed its initial public  offering and its Common Stock began trading on the
Nasdaq National Market under the symbol CYLK. Through the offering,  the Company
sold 5,750,000  shares of its Common Stock which generated  approximately  $79.3
million of cash, net of underwriting  discounts,  commissions and other offering
costs.  The Company  operates in one industry  segment -- secure  communications
products.  The  Company's  operations  outside  of  the  United  States  consist
primarily  of a sales and service  office in the United  Kingdom,  with  smaller
sales  offices  in  several  other  countries.  See  Note  11 of  the  Notes  to
Consolidated Financial Statements for geographic area information.

Industry Background

         The demand  for  information  security  and  authentication  of data in
computer  networks  has  increased  significantly  as a result of the shift from
mainframe to  distributed  computing  and the  increasing  use of shared  public
packet switched




                                       2
<PAGE>

networks, such as the Internet. The increased number of users that can now share
computing  resources and communicate  with each other over LANs, WANs and public
networks  raises  significant  new  access  and  security  issues  that are more
difficult to address than in mainframe-based host systems.

         Over the last decade, the shift from mainframe to distributed computing
has   increased   the  level  of  electronic   information   transmission.   The
client/server    environment   enables   information   sharing   and   efficient
communications that are increasingly seen as competitive advantages in business.
In addition,  the prevalence and  ease-of-use  of modem-based  connections  have
broadened the definition of a LAN,  enabling users in remote locations to access
the central  databases and  applications on the LAN.  However,  as organizations
increasingly rely on electronic  transmission of data, their information becomes
increasingly vulnerable. Individuals have been able to exploit system weaknesses
to gain unauthorized  access to networks,  network  transmissions and individual
network computers,  and have used such access to alter or steal data or, in some
cases,  to launch  destructive  attacks on data or  computers  within a network.
Several  well-publicized  attacks have brought  attention to certain  attackers'
techniques (given colorful names such as "packet spoofing," "password sniffing,"
"Trojan horse," and "session hijacking").

         Until 1993, the primary means by which  sensitive data was  transmitted
between distant points within a WAN was through  private leased lines.  Cost and
other  factors have led  organizations  to move away from these  private  leased
lines to public  networks,  such as the  Internet.  Compared  to private  leased
lines,  public  networks offer improved  support at a  significantly  lower user
charge due to economies  of scale  achieved  through the larger  number of users
sharing the network.  While providing these benefits, the use of public networks
increases the need to ensure the security of information  transmitted over these
networks. In public networks,  transmitted information is exposed to others, who
can, in the absence of effective security  measures,  gain access to, manipulate
and divert the transmitted data.

         Public networks enable  connections among home personal computer ("PC")
users,  remote users and  corporate  networks.  Much of the recent growth of the
Internet has been attributed to an increase in commercial  access  providers and
organizations  seeking to market products or services to users. The Internet and
other  public  networks  are enabling  increasing  numbers of computer  users to
engage in electronic commerce,  such as banking,  trading securities,  verifying
credit  and  purchasing  products  and  services.  These  increasing  levels  of
electronic  commerce  place a premium on ensuring the  integrity and security of
information transmission.

         Complete  information  security  solutions  for LANs,  WANs and  public
networks must perform each of the following five critical functions:

o    Access  control -- Access to a  computer  network  must be limited  only to
     specific authorized users.

o    Privacy  -- An  authorized  user must be  prevented  from  viewing  another
     party's private data.

o    Authentication -- The receiver of the transmitted  information must be able
     to verify the identity of the sender.

o    Integrity  -- The  receiver  and the sender must know that the  transmitted
     data has not been changed or compromised by any unauthorized manipulation.

o    Non-repudiation -- Both the sender and receiver must be able to verify that
     a data  transmission  has been  executed and cannot be later  repudiated by
     either party.

         To date, a substantial  portion of the demand for information  security
over public  networks has been addressed by only partial  solutions.  "Firewall"
products offer access control primarily by filtering incoming  information based
on packet addresses. Greater access control is possible with secret passwords of
various types, including the use of time-varying and challenge-response password
tokens.  These tokens and access control systems generally provide some level of
user authentication,  but no privacy,  integrity or non-repudiation.  Many other
encryption  products  provide  privacy,  but do not perform  the other  security
functions,  nor are they easily controlled or managed from one central location.
The Company believes that the use of public networks for electronic commerce and
other  applications has been slowed to date by concern over network security and
that solving security issues will increase the types of applications that can be
accessed through public networks.

The Cylink Solution

         Through its recently  introduced  products and those under development,
Cylink offers information  security products designed to provide a comprehensive
system-wide  information  security  solution  that  addresses  the five critical
functions   of  access   control,   privacy,   authentication,   integrity   and
non-repudiation in a scaleable, centrally-managed


                                       3
<PAGE>

system. The Company's  products  incorporate the latest  commercially  available
security   technologies,   including  Public  Key   cryptography-based   digital
signatures,  certificates and key exchange techniques,  which enable the Company
to offer a broad,  flexible and scaleable  information  security  solution.  The
Company's  information  security products incorporate Cylink's Secure Enterprise
Architecture  Stack,  an  integrated  group of software  security  modules  that
provide the foundation for an enterprise-wide information security solution.

The Cylink Strategy

         The Company  intends to maintain its position as a leading  provider of
enterprise-wide  information  security solutions and to establish  standards for
the  secure  exchange  of  information  among  users  of LANs,  WANs and  public
networks, such as the Internet. The Company seeks to achieve these goals through
the following strategies:

o    Offer Comprehensive  Enterprise-Wide  Information  Security Solutions.  The
     Company's strategy is to offer a broad,  centrally  manageable and flexible
     line of  information  security  products  that  provides a virtual  private
     network  from end  node to end  node.  The  Company's  recently  introduced
     products and those under  development are designed to authenticate the user
     (not just the IP  address)  and  prevent  unauthorized  access to a network
     system and information within that system.

o    Maintain and Leverage Technology Expertise in Public Key Cryptography.  The
     Company plans to maintain its  technology  expertise in the  application of
     Public Key  cryptography  through a  combination  of internal  research and
     development  efforts,  government  research and  development  contracts and
     customer funded research,  and partnering with strategic vendors,  focusing
     on  technologies  that are  critical  to the  proliferation  of  electronic
     commerce  over  public  switched  networks.  The  Company's   technological
     achievement  has  resulted  in the use of  Cylink's  products  by the  U.S.
     Federal  Reserve  System and  Society  for  Worldwide  Interbank  Financial
     Telecommunications  ("S.W.I.F.T."), and the development of one of the first
     government  approved key recovery  architectures.  In 1996, the Company had
     net research and development expenses of approximately $11.3 million.

o    Broaden Use of Public Key Technology through  Licensing.  The Company seeks
     to proliferate its specific  methods of implementing  Public Key technology
     by licensing  certain of its core  technical  components and its Public Key
     cryptographic  libraries to  strategic  partners.  To encourage  the use of
     Public Key  cryptography,  the Company has licensed  the  Stanford  Patents
     (defined  below)  to over  30  companies,  including  Cisco  Systems,  Inc.
     ("Cisco"),  3Com Corporation,  Hughes Aircraft Company,  Intel Corporation,
     Microsoft  Corporation,  Motorola,  Inc.,  Open  Market,  Inc.,  PictureTel
     Corporation,  Scientific-Atlanta,  Inc., Sun Microsystems,  Inc. and Tandem
     Computers,  Inc. The Company's technology licensing partnership with Cygnus
     Solutions,  Inc.  enables software  developers to incorporate  basic Cylink
     information security protocols and techniques into their software products.
     The Company's goal is to provide a migration  path that enables  vendors to
     upgrade their systems with certain base technology  which is  complementary
     with the Company's products.

o    Expand  into  Emerging  Public  Network  Markets.  The  Company  intends to
     leverage its expertise in providing  solutions for virtual private networks
     by introducing new information  security products for public network users.
     Demand for information  security has historically  been limited to business
     in  security-conscious  industries  such  as  banking,  telecommunications,
     aerospace and defense.  However, with the increased use of the Internet and
     public  networks,  as well as  remote  access  to LANs  and  WANs,  network
     security  is  of   increasing   concern  to  most   businesses   and  other
     organizations that use network-based information resources.

o    Build and Foster Strategic  Relationships.  The Company intends to continue
     to develop strategic marketing and product  development  relationships with
     key original  equipment  manufacturers  ("OEMs") in order to further market
     acceptance of the Company's products. For example, the Company has licensed
     to Cisco certain of its software  security  module  protocols under its OEM
     agreement to provide enhanced  information  security  solutions for Cisco's
     customers.

         Note, however,  that the market for the Company's  information security
products is only beginning to emerge.  This market is  characterized  by rapidly
changing technology,  emerging industry standards, new product introductions and
changes in customer  requirements  and  preferences.  The Company's  future will
depend in part upon end  users'  demand for  information  security  products  in
general,  and upon the Company's ability to enhance its existing products and to
develop  and  introduce  new  products  and  technologies   that  meet  customer
requirements.  Any significant advance in techniques for attacking cryptographic
systems  could  render some or all of the  Company's  existing  and new products
obsolete or unmarketable.  To the extent that the Company is unable to adopt and
incorporate emerging standards for implementing information security in a market
segment,  sales of the  Company's  existing and planned  products in that market
segment would be significantly less than the levels currently anticipated by the
Company. There can be no assurance that



                                       4
<PAGE>

information  security-related  products or technologies developed by others will
not adversely affect the Company's  competitive  position or render its products
or technologies  noncompetitive  or obsolete.  See "Business - Risk Factors That
May Affect  Future  Results --  Competition,  -- Evolving  Information  Security
Market, and -- Rapid Technological Change."

Technology

         The  Company's  information  security  products are based on Public Key
cryptography  techniques,  which  were  first  developed  in  1976  at  Stanford
University by Drs.  Diffie and Hellman.  The Company has the exclusive  right to
sublicense  certain  patents that were  granted to Stanford  with respect to the
original  Public Key methods (the  "Stanford  Patents").  The  Stanford  Patents
issued in the  United  States  will  expire in the third  quarter  of 1997.  See
"Business - Risk Factors That May Affect Future Results -- Intellectual Property
and Other  Proprietary  Rights." The Public Key cryptography  methods adopted by
the Company require that each user be assigned both a private  number,  which is
confidential,  and a mathematically related public number, which can be revealed
without  compromising  the user's private  number.  Diffie-Hellman  key exchange
provides  for two users in a data network to exchange  their public  numbers and
then compute a shared secret  number that is unique to them.  This shared secret
number  can  then  be  used  as the  secret  encryption  key  in a  conventional
encryption  system to  maintain  the  privacy of the  communication  between two
users.

         The Company has adopted advanced Public Key digital signature  methods.
An individual's  digital  signature is a set of unique binary numbers,  which is
derived from a combination of the message and the signer's  private number.  Any
user in the network can verify this digital signature by using only the sender's
public number.  Digital  signature methods are part of the foundation for secure
electronic  transactions  that  can  scale  to  potentially  millions  of  users
conducting commerce on the Internet.

         The  Company's  products  enable  network   administrators  to  act  as
certificate  authorities that permit each authorized user in the network to have
his or  her  public  number  validated  for  the  purpose  of  establishing  its
authenticity  to  other  users.  The  certification   authority   provides  each
authorized user with an electronic  message  containing that user's name, public
number,  unique  privileges within the network and expiration date. This message
is  digitally  signed  by  the  network   administrator  to  create  the  user's
certificate,  which in effect  serves to notarize the user's  public  number and
enable that user to conduct secure  communications  with other  certified  users
within the network.  Certificates can also be issued by a public authority, such
as that contemplated by the U.S. Postal Service's pilot program, to authenticate
users of public networks such as the Internet.

         The Company has developed an  integrated  set of  independent  software
modules on which the Company's  information  security  products are based.  This
software  incorporates Public Key cryptography  techniques in its key management
system,  digital  signatures and  certificates  to provide  complete,  scaleable
enterprise-wide  security  solutions.  This  flexible  architecture  includes  a
certification authority and a network management system that enables the network
administrator to create virtual private workgroups.

         The Company designs application  specific integrated circuits ("ASICs")
and custom integrated circuits to implement its encryption algorithms and Public
Key  techniques  in  order  to  provide  increased  performance,   security  and
functionality in its products at reduced cost.  Cylink's  significant  technical
achievements  in the area of proprietary  ASIC design include  encryption  chips
with speeds up to 155 megabits per second  ("Mbps") and Public Key  co-processor
chips that have the capability of handling 1,024 bit numbers.

         Cylink has developed  hardware and software  implementations of network
interfaces,  standards and protocols.  Cylink information  security products are
designed to secure existing  networks without reducing  performance or requiring
modifications  of  existing  network  hardware  or  software.  The  Company  has
developed a broad range of network  interfaces  for its products,  which enables
the  Company's  security  products  to  connect  to most  networks  in use today
throughout  the world.  The current list of network  interfaces  used in Company
products  include:  T1 (1.5 Mbps),  T2 (6.2 Mbps), T3 (45 Mbps), E1 (2 Mbps), E3
(34 Mbps),  X.25,  V.35,  X.21,  Frame Relay  (FRF.1,  FRF.3 and FRF.4),  NTT T1
(Japan), 10 Base 2, 10 Base 5, 10 Base T, HSSI, RS-232 and RS-422.

Information Security Products

         Cylink originally entered the information  security market in 1986 with
hardware-based  link  encryptors to secure  transmissions  between users in WANs
that were communicating over private, leased communication lines. These original
products formed the foundation for Cylink's  SecureWAN  product line, which is a
family of encryption  products that


                                       5
<PAGE>

provide security solutions for WANs operated by government  agencies,  financial
institutions,  Fortune  1000  companies  and  telecommunications  companies.  In
response to the movement of WAN users to public  networks,  Cylink has developed
packet encryptors that enable secure transmission of packets of data between two
points  in  X.25  and  Frame  Relay  based  public  networks.   Because  of  the
proliferation  of LANs,  the Company  developed  its  SecureLAN  product line to
manage,  control and monitor information within a LAN. Cylink also developed its
SecureAccess  product line to allow  remote and mobile  users  secure  access to
their corporate computing resources.

         The  Company's   products  are  designed  to  be  modular,   scaleable,
configurable  and easy to use.  Customers can easily configure and upgrade their
Cylink security  systems through the purchase of Cylink products that meet their
specific,  evolving  information  security needs. Most of the Company's recently
introduced products are based upon the Company's Secure Enterprise  Architecture
Stack and are designed to be managed as an  integrated,  interoperable  security
system by the Company's SecureManager products.

         The following table sets forth Cylink's principal  information security
products currently offered or under development:

                                                                       Year
 Product                        Description                         Introduced
 -------                        -----------                         ----------

SecureWAN Family
CIDEC-HS                   High Speed T1 Link Encryption               1986
CIDEC-MS                   Medium Speed Link Encryption                1987
CIDEC-LS                   Low Speed Link Encryption                   1987
CIDEC-VHS                  Very High Speed T3 Encryption               1990
CIDEC-MLS                  Integrated Link Cards                       1993
SecureX25L                 Low Speed X.25 Packet Encryption            1993
SecureX25H                 High Speed X.25 Packet Encryption           1994
SecureFrame                Frame Relay Packet Encryption               1996

SecureLAN Family
SecureDomain               Router Domain Packet Encryption/Access      1996
SecureNode Software        PC Packet Encryption/Access                   *
SecureNode Card            Accelerator Card for SecureNode Software      *

SecureAccess Family
SecurePhone                Telephone Encryption                        1989
SecureFX                   Group 3 Fax Encryption                      1990
SecureGate                 Server Software for SecureAccess Family     1996
SecureTraveler             Windows Software Encryption/Access          1997
SecurePocket Traveler      Stand Alone Encryption/Access               1997
Trust Point Data           Mail and File Encryption                      *

SecureManager
CSMS                       SecureX25 Network Management                1994
SecureManager              Manages all SecureLAN Products              1996

----------
*    Indicates  products under  development  and scheduled for  introduction  in
     1997.

         SecureWAN Product Family.  The Company's  SecureWAN product family is a
complete line of link  encryptors  that utilize  Diffie-Hellman  key  management
techniques  to  support  conventional  encryption  algorithms,  such as the data
encryption standard ("DES") and Cylink proprietary algorithms.  Depending on the
product  model,  the  SecureWAN  encryptors  operate at varying  data rates over
private and public networks and support most widely used data link protocols.

         The Company's original CIDEC line of data and voice encryption products
offers full encryption and access control and is available in a number of models
that range from high speed T1 and T3 data transfer rates (1.54 Mbps and 45 Mbps,
respectively)  to low speed transfer rates (1200 bits per second to 256 kilobits
per second ("kbps")).  The Company believes that its CIDEC-VHS/VHX  products are
the fastest data link encryptors commercially available in the world today.


                                       6
<PAGE>

         Cylink's  high  speed   SecureX25H  and  low  speed   SecureX25L  offer
encryption for public switched packet networks based on X.25 packet transmission
technology and support data rates up to 64 kbps and up to 512 virtual circuits.

         Cylink's  SecureFrame  product is  designed  to operate as a  dedicated
Frame  Relay  encryptor  capable of  operations  on any public or private  Frame
Relay-based  network. The SecureFrame is designed to support data rates of up to
2.048 Mbps and up to 1,024 user addresses.

         SecureLAN  Product Family.  The Company's  SecureLAN  product family is
designed to provide packet-based  security solutions for both private and public
networks.  The Company's  SecureLAN products are designed to allow a customer to
create and control access to groups within the network, known as virtual private
workgroups.  For example,  a customer could  segregate  within a network certain
departments,  such as human resources and finance,  denying employees from other
departments  access to files  within the  virtual  private  workgroup.  Further,
within a  virtual  private  workgroup,  the  Company's  SecureLAN  products  are
designed  to allow  certain  users,  such as the  director  of human  resources,
greater access to files than other users.

         The SecureDomain  product is a hardware device that resides between the
router and  subnet in a LAN.  The  SecureDomain  product  supports  simultaneous
secured  TCP/IP  and  IPX  communications   among  networks  and  subnets.   The
SecureDomain  product is designed to allow  organizations to use the Internet as
part of their own secure virtual private network.  Under the Company's  existing
licensing relationship with Cisco, Cisco is authorized to embed the SecureDomain
software product in its router products as part of Cisco's IOS operating system.

         Cylink's  SecureNode  products  are  under  development  and are  being
designed to extend the  functionality  of  SecureDomain to the desktop level and
enable  encryption at substantially  faster speeds than are currently  available
from software-only solutions.

         SecureAccess  Product  Family.  Addressing  the need for secure  remote
access to private networks,  the Company's SecureAccess product line is designed
to enable secure dial-up access to a corporation's  LAN or WAN. The SecureAccess
products can be combined to create an access control  solution that provides the
network administrator with the five critical functions of network security for a
virtual private network over public switched  telephone  networks  ("PSTNs") and
the  Internet.  The  SecureAccess  product  line  is  scaleable  to  accommodate
thousands of users and, among other applications, can enable electronic commerce
over the Internet.

         The SecureGate Server,  which physically resides between the customer's
communications  server and modems, can monitor and protect corporate information
resources by  controlling  incoming and outgoing  calls to and from the network.
SecureGate  provides  centralized  management  and  tracking of remote users and
their individual security profiles,  with audit trails of all system activities.
SecureGate also acts as the certificate authority for the SecureAccess system.

         SecureTraveler  for Windows is a PC-based  software security client for
SecureGate and responds to customers'  needs to share critical  information over
PSTNs and the Internet. SecureTraveler is designed to operate transparently with
Windows  communications  applications  to secure  end-to-end  sessions  in their
entirety.

         SecurePocket Traveler is a pocket-sized,  hardware security device that
is inserted between a laptop PC, desktop PC or other computer device and a modem
and provides security  functions similar to those provided by SecureTraveler for
Windows.

         SecureManager.  The  SecureManager  is  designed  to allow the  network
administrator  to centrally  manage the security  features of a secured network,
subnet,  host and node within a LAN, to create or dissolve secure workgroups and
to  monitor  the  performance  of other  Cylink  products  within  the  network.
SecureManager  enables the network administrator to configure,  manage,  install
and modify all  information  security  within a LAN or WAN from one point in the
network.

         The Company's  future results of operations will be highly dependent on
the   successful   marketing  and  customer   acceptance  of  the   SecureFrame,
SecureManager,    SecureGate,   SecureTraveler,    SecurePocket   Traveler   and
SecureDomain products, which were recently introduced.  To date, the Company has
made only  modest  commercial  shipments  of  certain  of such  products  and no
commercial  shipments of the  remainder of such  products.  No assurance  can be
given  that  these  products  will  not  require  additional  development  work,
enhancement,  testing or further  refinement  before they can be



                                       7
<PAGE>

introduced  and made  commercially  available  by the  Company or that they will
achieve market  acceptance.  If such new and recently  introduced  products have
performance,  reliability,  quality or other  shortcomings,  then such  products
could fail to achieve market  acceptance and the Company may experience  reduced
orders, higher manufacturing costs, delays in collecting accounts receivable and
additional  warranty  and  service  expenses,  which in each case  could  have a
material  adverse  effect on the  Company's  financial  condition and results of
operations.  See  "Business - Risk  Factors  That May Affect  Future  Results --
Dependence on Recently Introduced and New Information Security Products,  and --
Product Liability Risks."

Sales, Marketing and Customer Support

         Cylink markets its information  security products primarily through its
direct sales force and, to a lesser extent,  through  distributors and OEMs. The
Company's  direct  sales  force  operates  from the  Company's  headquarters  in
Sunnyvale,  California  and from four sales  offices,  and  directs  its efforts
primarily at government agencies, financial institutions, Fortune 1000 companies
and telecommunication  carriers.  Cylink's sales force,  engineers and technical
personnel  work closely with  customers in order to design  system  security and
network configurations that are tailored to the customers' needs.

         International sales of information security products are made primarily
through the Company's six foreign sales offices and numerous  distributors.  The
Company  does  not  have  long-term  contractual  relationships  with any of its
distributors  and,  therefore,  has no assurance  of a  continuing  relationship
within a given market.

         To date, the customers of the Company's  information  security products
have  primarily  consisted of Fortune 1000  companies,  financial  institutions,
government  agencies  and  telecommunication  carriers  who  use  the  Company's
SecureWAN  products to encrypt and secure their private  leased line WANs.  From
inception  through  December  31,  1996,  the Company  sold over $125 million of
information  security  products in the U.S. and abroad.  Demand for computer and
network   security   has   historically    been   limited   to   businesses   in
security-conscious industries such as banking, telecommunications, aerospace and
defense.  However,  with the increased use of WANs,  public  networks and remote
access to LANs and WANs,  network  security  is of  increasing  concern  to most
businesses  and  other   organizations   that  use  computer-  or  network-based
information resources.

<TABLE>
         A  representative  list of the end users of the  Company's  information
security products is set forth below:

<CAPTION>

Fortune 1000                  Financial                 Government                  Telecommunications
Companies                   Institutions                 Agencies                        Carriers
---------                   ------------                 --------                        --------
<S>                        <C>                       <C>                                <C>
Caterpillar                Bank of America           Department of Defense              AT&T
Computer Sciences Corp.    Bank of China             Department of Justice              Bell Atlantic
IBM                        Bankers Trust             Department of Treasury             MCI Communications
Lockeed Martin             Citibank                  Federal Reserve Bank               Pacific Bell
Motorola                   Credit Suisse             Internal Revenue Service           U.S. Sprint
                           Lloyds Bank               U.S. Postal Service
                           S.W.I.F.T.
                           Swiss Bank
</TABLE>

         The Company  believes that customer  support is essential to developing
and  maintaining  good  relationships  with  its  customers.   Cylink's  support
personnel  are  responsible  for  providing  installation,  technical  training,
technical  support,  on-site support and repair services.  The Company sells end
users a number of different levels of support,  maintenance and service options,
including extended warranties,  emergency replacement services, product upgrades
and  on-site   support.   The  company  offers  service  and  support  from  its
headquarters  and from  service  and support  centers in New Jersey,  the United
Kingdom, Singapore, China and Russia. Telephone support is available twenty-four
hours per day, seven days per week, through a toll-free hotline.

Wireless Communications Product Line

         Cylink offers a line of spread  spectrum  radio  products that are used
for wireless  transmission of voice and data communications which operate in the
unlicensed  spread  spectrum  bands adopted by the FCC in 1985 and  subsequently
adopted in many other countries throughout the world. In 1990, the Company began
to focus on the growing market for



                                       8
<PAGE>

wireless  communications,  particularly that section of the wireless market that
cannot be addressed by conventional  wireless cellular  solutions.  During 1994,
1995 and 1996, sales of AirLink products  accounted for  approximately  32%, 38%
and 50%,  respectively,  of the Company's revenue. A large portion of the demand
for wireless  communications  products comes from developing countries where the
absence  of  a  reliable  wired  telecommunications  infrastructure  provides  a
significant opportunity for a wireless spread spectrum based solution to respond
to the growing need for modern data communications capabilities.

         The Company's AirLink product line was first introduced in 1991 and has
two  primary  applications.  The  first  application  is  to  provide  telephone
connectivity  to remote  locations  where the  limited  number of users does not
justify the cost of a cellular station or wired  communications link. AirLink is
capable of providing  point-to-point  communications over distances up to thirty
miles.  The  second  application  is to provide a data  transmission  network in
locations,   such  as  developing  countries,   where  wired  telecommunications
infrastructure is either  unreliable or nonexistent.  Cellular phone systems are
designed for voice communications,  and are believed by Cylink's customers to be
too expensive for, and do not support sufficiently fast data transfer rates for,
data communications.

         In addressing these two markets, the Company has positioned its AirLink
product  line  between  the  full  featured,  point-to-point,  very  high  speed
microwave radio links and the high volume,  low power spread  spectrum  wireless
devices. The Company believes that its AirLink product line responds to a market
need that exists between these two ends of the marketplace for a cost effective,
ruggedized, outdoor wireless product offering that is capable of transmitting at
medium  data rates  between  19.2 kbps and 2 Mbps.  The  Company  offers over 20
different models of its AirLink products to specifically address a wide range of
individual customer needs within this market segment.

         The Company's  strategy for its AirLink product line is to provide last
mile and data  network  solutions at ranges of up to 30 miles and to continue to
seek  feature  improvements  and cost  reductions  to enhance and  maintain  its
position within this market segment.  The Company intends to maintain its strong
technical  position in the  wireless  communications  market  through  continued
improvement  of its radio  frequency  designs,  ASIC  modem  chips and  software
modules.

<TABLE>
         The following table lists the Company's current wireless  communication
product lines:

<CAPTION>
                                                                                                    Year
   Product                            Description                      Frequency Band            Introduced
   -------                            -----------                      --------------            ----------
<S>                          <C>                                         <C>                       <C>
AirLink Modem Family
AirLink L-Band               Data Rate: 19.2 kbps to 256 kbps            902-928 MHz               1992
                             Extended Temperature Operation
AirLink S-Band               Data Rate: 19.2 kbps to 512 kbps            2.400-2.483 GHz           1993
                             Meets ETSI (European) Standard
AirLink VF                   Single Channel Voice Link                   902-928 MHz               1992
AirLink Bridge               Wireless Ethernet Bridge Link               2.400-2.483 GHz           1995
AirLink Data Metro           Wireless Remote Access Router               2.400-2.483 GHz             *
AirLink Pro 64               64 kbps WAN Solution with                   2.400-2.483 GHz             *
                             Network Management

AirLink T1/E1 Family
AirLink T1                   Data Rate: 1.544 Mbps (US T1)               5.725-5.850 GHz           1995
AirLink E1                   Data Rate: 2.048 Mbps (European E1)         5.725-5.850 GHz           1995
AirLink T1/E1 Pro            Wireless T1/E1 with Advanced                5.725-5.850GHz              *
                             Network Management

<FN>
----------
*  Indicates products under development and scheduled for introduction in 1997.
</FN>
</TABLE>

         The  AirLink   L-Band  and  S-Band   offer   varying   data  rates  for
point-to-point  communications  solutions for fixed location, last mile wireless
networking.  The AirLink VF product is used primarily for  point-to-point  voice
communications in last mile applications.  The AirLink Bridge is a full function
ethernet LAN bridge that enables a customer to establish a wireless link between
separate LANs within a fifteen mile radius. The AirLink T1 and E1 products offer
data  transfer  rates at T1 rates for the United States and E1 rates for Europe,
and represent the Company's fastest and most advanced products for wireless data
transmission.


                                       9
<PAGE>

         The Company believes that it has certain core technical competencies in
spread spectrum signal  processing that have enabled its AirLink product line to
be high performance, cost-effective solutions for its targeted applications. The
Company has developed  certain  radio  frequency  ("RF") and  microwave  circuit
designs that provide  high  sensitivity  to weak  signals  while  retaining  the
ability to reject  out-of-band  interference.  The AirLink product line has been
approved for use by over 30 foreign  governments.  All Cylink wireless  products
are based on  proprietary,  custom  integrated  circuits  that  permit low power
operation,  are cost-effective and easy to manufacture.  The Company has further
developed a number of wireless  architecture  features and  algorithms and holds
five U.S.  patents for such  features  as spread  spectrum  correlation  design,
multi-user  detection  schemes and spread spectrum  modulation and  demodulation
designs. The Company believes that this combination of proprietary  technologies
and experience in spread  spectrum  radio have given it a competitive  advantage
with  respect  to the  breadth  of data rates  covered,  network  manageability,
transmission range and ease of use.

         The Company directs its wireless sales and marketing  efforts primarily
at   countries   that  do  not   have  a   reliable   wired   telecommunications
infrastructure.  These sales are made  primarily  through value added  resellers
("VARs") and distributors and, to a lesser extent, directly by Cylink in certain
targeted  applications.  Cylink intends to pursue strategic  alliances with both
international  and domestic  system  integrators  and other  partners that would
integrate  AirLink  products  into their last mile  solutions for voice and data
networks. Cylink believes that this strategy will be particularly significant in
developing  countries  where  alliances  with local  partners can provide better
access to and knowledge of these local markets.  International customers for the
AirLink  products  include  Dole  Fruit & Nut Co.  (Central  America),  Pakistan
Telecommunications  Corp., Unicom (China), IUSAC (Mexico), Banco Popular (Puerto
Rico),  the post office for the Czech Republic and Chase Manhattan Bank.  United
States end users of AirLink products include AT&T Corp.  ("AT&T"),  Southwestern
Bell, Cellular One, the U.S. State Department,  Lockeed Martin Corporation,  the
U.S. Department of Energy, AirTouch Cellular, GTE MobilNet, Peek Traffic/Transyt
and McCain Traffic Supply.

Research and Development

         The  Company's   research  and  development   efforts  are  focused  on
developing  new  products,   core  technologies  and  enhancements  to  existing
products.  For its information  security  products,  the Company's  research and
development strategy has in recent periods focused on the development of modular
software and hardware products that can be readily integrated and adapted to the
changing standards and requirements of the  communications  and  internetworking
industries.  A focus of the Company's  research and development  efforts in 1996
has  been the  development  of the  SecureLAN,  SecureAccess  and  SecureManager
product  families.   The  Company  expects  that  it  will  continue  to  devote
substantial research and development  resources to the enhancement of its Secure
Enterprise Architecture Stack software modules for the foreseeable future.

         The Company's research and development  efforts for its AirLink product
line are focused on strengthening  its position in the fixed location,  outdoor,
wireless  communications  infrastructure  market.  The Company's  principal 1996
development effort for its AirLink products was the development and introduction
of a new AirLink  T1/E1  wireless  system,  which the Company  expects will be a
primary focus of its continuing product  enhancement and cost reduction efforts.
The Company also  expects to continue  development  of its custom ASIC  wireless
components, which provide the core for the AirLink product line.

         In 1994,  1995 and 1996, the Company's  gross research and  development
expenses were $8.8 million, $11.3 million and $17.4 million, respectively.  From
time to time, the Company receives  engineering funding for development projects
to apply or enhance the Company's  technology to a particular  customer's  need.
The amount recognized under these research and development  contracts are offset
against research and development expense. Amounts recognized under non-recurring
engineering  contracts  totaled $0.7  million,  $1.1 million and $6.1 million in
1994, 1995 and 1996, respectively.

         The Company  believes that its ability to attract and retain  qualified
development  personnel is essential to the success of its development  programs.
The  market  for  such  personnel  is  highly   competitive  and  the  Company's
development   activities   could  be  adversely   affected  if  the  Company  is
unsuccessful  in  attracting  and retaining  skilled  technical  personnel.  See
"Business - Risk Factors That May Affect  Future  Results --  Dependence  on Key
Personnel,  and  --Management  of  Growth."  In  addition,  the  markets for the
Company's products are characterized by rapidly changing technologies, extensive
research and new product  introductions.  The Company  believes  that its future
success will depend in part upon its ability to continue to enhance its existing
products and to develop and  introduce new  products.  As a result,  the Company
expects to continue to make a significant  investment in  engineering,  research
and  development.  There can be no  assurance  that the Company  will be able to
develop and introduce new products or enhancements to its existing



                                       10
<PAGE>

products  in a timely  manner  which  satisfy  customer  needs,  achieve  market
acceptance or address  technological  changes in its target markets. The failure
of the Company to develop  products and introduce  them in a timely manner could
adversely affect the Company's  competitive  position,  financial  condition and
results of  operations.  See  "Business - Risk  Factors  That May Affect  Future
Results -- Competition, -- Dependence on Recently Introduced and New Information
Security   Products,   --  Evolving   Information   Security  Market,  --  Rapid
Technological  Change,  and  --  Wireless   Communications  Industry  Regulatory
Environment."

Regulatory Matters

         The Company's  information  security products are subject to the export
restrictions  recently  transferred to administration by the U.S.  Department of
Commerce,  which  license the export of encryption  products  subject to certain
technical restrictions.  In addition, these U.S. export laws prohibit the export
of encryption  products to a number of hostile  countries.  Although to date the
Company has been able to secure all U.S. export licenses routinely, there can be
no assurance  that the Company will  continue to be able to secure such licenses
in a timely manner in the future, or at all. In certain foreign  countries,  the
Company's  distributors  are  required to secure  licenses or formal  permission
before encryption products can be imported.  To date, except for certain limited
cases, the Company's  distributors have not been denied permission to import the
Company's products.  See "Business - Risk Factors That May Affect Future Results
-- Risks  Associated  with  International  Sales;  Reliance Upon Local Partners;
Restrictions on Export."

         The Company's  wireless  products are subject to regulations of the FCC
and regulations of the  telecommunications  regulatory authority in each country
where the  Company  sells its  products.  These  regulations  are in the form of
general  approval to sell  products  within a given  country for  operation in a
given frequency  band, one time equipment  certification,  and, at times,  local
approval for  installation.  In the United States,  all Cylink wireless products
are subject to FCC Part 15 rules on unlicensed spread spectrum operation. In the
international markets, government regulations vary. In those countries that have
accepted certain worldwide standards,  such as the FCC rulings or those from the
European  Telecommunications  Standards  Institute,  Cylink has not  experienced
significant  regulatory  issues in bringing its products to market.  Approval in
these  markets  involves  retaining  local testing  agencies to verify  specific
product  compliance.  However,  many developing  countries,  including the large
markets  in India and  China,  have not  fully  developed  or have no  frequency
allocation,  equipment certification or telecommunications regulatory standards.
In these markets,  Cylink is actively  working,  both directly and with industry
standard bodies, to conform regulations to worldwide standards.  See "Business -
Risk Factors That May Affect Future Results -- Wireless  Communications Industry
Regulatory Environment."

Backlog

         Orders for the Company's products are usually placed by customers on an
as-needed  basis and the Company has typically been able to ship products within
thirty days after the customer  submits a firm  purchase  order.  The  Company's
backlog consists of all orders received,  regardless of the anticipated shipping
date.  Because of the possibility of customer  changes in delivery  schedules or
cancellation of orders,  the Company's backlog as of any particular date may not
be  indicative  of sales in any future  period.  The Company does not  generally
maintain  long-term  contracts  with its  customers  that  require  customers to
purchase the Company's  products.  The Company's backlog as of December 31, 1995
and 1996 was  approximately  $5.1 million and $6.9  million,  respectively.  See
"Business - Risk Factors That May Affect Future Results -- Lengthy Sales Cycle."

Manufacturing

         The Company's  manufacturing  operations consist primarily of component
procurement,  final assembly and test, and quality control of subassemblies  and
systems.  The  Company  generally  uses  domestic  independent   contractors  to
manufacture  and assemble  printed  circuit boards.  The  manufacturing  process
enables the Company to configure  the hardware and software in  combinations  to
meet a wide variety of customer requirements.  The Company installs its software
into the  electronically  programmable  read  only  memory  of its  products  to
maintain  quality control and security,  and performs  "burn-in"  procedures and
functional tests, as well as comprehensive inspections to assure the quality and
reliability of its products.

         The Company's product designs are proprietary but generally incorporate
industry-standard  hardware components.  However, certain semiconductor devices,
electronic components and subassemblies are presently purchased from sole source
suppliers.  Certain other  components  are presently  available or acquired from
only a limited number of suppliers.


                                       11
<PAGE>

         The Company's  ability to timely deliver its products is dependent upon
the  availability  of quality  components and subsystems used in these products.
The Company depends in part upon  subcontractors  to  manufacture,  assemble and
deliver  certain  items in a  timely  and  satisfactory  manner.  A  significant
interruption in the delivery of such items could have a material  adverse effect
on the Company's  results of  operations.  See "Business - Risk Factors That May
Affect Future  Results -- Dependence  on Component  Availability,  Subcontractor
Performance and Key Suppliers."

Employees

         As of December 31,  1996,  the Company had 347  employees,  of whom 119
were primarily engaged in research and development,  98 in sales,  marketing and
related   customer  support   services,   26  in   administration   and  104  in
manufacturing.  Of these employees, 326 were located in the United States, 15 in
Europe  and 6 in Asia.  None of the  Company's  employees  is  represented  by a
collective  bargaining  agreement  with respect to his or her  employment by the
Company,  nor has the Company  experienced  any  organized  work  stoppage.  The
Company considers its relations with its existing employees to be good.

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

Recent Losses;  Potential  Fluctuations in Operating  Results,  Future Operating
Results Uncertain.

          Due  primarily  to  increased  research  and  development,  sales  and
marketing, and litigation expenses, the Company incurred losses in 1994 and 1995
and the first six months of 1996.  There can be no  assurances  that the Company
will  increase or maintain  its revenue or be  profitable  on a quarterly  or an
annual basis in the future.

         The Company has historically  experienced  significant  fluctuations in
its operating  results on an annual and a quarterly  basis and could  experience
such fluctuations in the future. The Company's operating results are affected by
a number  of  factors,  many of which  are  outside  of the  Company's  control,
including:  the timing of the  introduction  of new or enhanced  products by the
Company or its  competitors;  market  acceptance of new products of the Company,
its customers and its competitors; the timing, cancellation or delay of customer
orders,   including  cancellation  or  delay  in  anticipation  of  new  product
introduction   or  enhancement  or  resulting  from   uncertainty   relating  to
intellectual property claims;  competitive factors, including pricing pressures;
changes  in  operating  expenses,  including  those  resulting  from  changes in
available  production capacity of independent  foundries and other suppliers and
the availability of raw materials; expenses associated with obtaining, enforcing
and defending claims with respect to intellectual  property  rights;  the mix of
products sold;  changes in the percentage of products sold through the Company's
direct  sales  force;  personnel  changes;  general  economic  conditions;   and
fluctuations  in  foreign  currency  exchange  rates.  The  Company  expects  to
introduce a number of new products in 1997.  The failure of such new products to
achieve market  acceptance at the time  anticipated  by the Company,  or at all,
would  materially  and adversely  affect the Company's  financial  condition and
results of operations.

Pending Litigation

See Item 3. "Legal Proceedings."

Dependence on Key Personnel

         On November 13, 1996, the Company  announced the appointment of Fernand
B. Sarrat as President and Chief  Executive  Officer  ("CEO").  Mr. Sarrat,  45,
succeeds Lewis C. Morris,  64, who resigned in July, 1996. Dr. Jim Omura,  Chief
Technology Officer, had been serving as acting CEO. At this time, the Company is
unable to assess the  potential  impact  resulting  from the  retirement  of Mr.
Morris,  a co-founder  of the Company,  and the  transition to Mr. Sarrat as new
CEO.

         The  Company's  future  success  will  depend to a large  extent on the
abilities of and successful  transition to Mr. Sarrat as the new CEO, as well as
the  contributions  by its  executive  officers,  key  management  and technical
personnel.  The failure to  successfully  integrate Mr. Sarrat into the Company,
loss of the services of one or more of the Company's  executive  officers or key
personnel,  or the inability to continue to attract qualified  personnel,  could
delay product  development cycles or otherwise have a material adverse effect on
the Company's business and operating results.


                                       12
<PAGE>

Lengthy Sales Cycle

         Sales  of  the  Company's  products  generally  involve  a  significant
commitment  of  capital  by  customers,  with the  attendant  delays  frequently
associated  with large capital  expenditures.  For these and other reasons,  the
sales cycle  associated  with the  Company's  products is typically  lengthy and
subject to a number of significant risks over which the Company has little or no
control.  The  Company  is often  required  to ship  products  shortly  after it
receives orders and, consequently,  order backlog at the beginning of any period
has in the past  represented  only a small  portion  of that  period's  expected
revenue. As a result,  product revenue in any period is substantially  dependent
on orders  booked and shipped in that period.  The Company  typically  plans its
production and inventory levels based on internal  forecasts of customer demand,
which is highly unpredictable and can fluctuate substantially.  If revenue falls
significantly  below anticipated  levels, the Company's  financial condition and
results of operations would be materially and adversely  affected.  In addition,
the Company's  operating expenses are based on anticipated  revenue levels and a
high percentage of the Company's expenses are generally fixed in the short term.
Based on these  factors,  a small  fluctuation  in the timing of sales can cause
operating results to vary significantly  from period to period. In addition,  it
is possible that in the future the Company's operating results will be below the
expectations of securities  analysts and investors.  In such an event, or in the
event that adverse  conditions  prevail or are perceived to prevail generally or
with respect to the Company's business,  the price of the Company's Common Stock
would likely be materially adversely affected.

Dependence on Recently Introduced and New Information Security Products

         The Company's  future results of operations will be highly dependent on
the successful completion of the design,  development,  introduction,  marketing
and manufacture of the SecureManager and SecureNode products,  some of which are
under development,  and the SecureGate,  SecureTraveler,  SecurePocket Traveler,
SecureFrame and SecureDomain products, which were recently introduced.  To date,
the  Company  has made only  limited  commercial  shipments  of  certain of such
products and no  commercial  shipments of the  remainder  of such  products.  No
assurance  can be given that any of such  products  will not require  additional
development work, enhancement,  testing or further refinement before they can be
introduced  and made  commercially  available  by the  Company or that they will
achieve market  acceptance.  If such new and recently  introduced  products have
performance,  reliability,  quality or other  shortcomings,  then such  products
could fail to achieve market  acceptance and the Company may experience  reduced
orders, higher manufacturing costs, delays in collecting accounts receivable and
additional  warranty  and  service  expenses,  which in each case  could  have a
material  adverse  effect on the  Company's  financial  condition and results of
operations.

Competition

         Competition is intense among providers of information  security systems
and wireless communications  equipment and systems, and the Company expects such
competition to increase in the future.  Significant competitive factors in these
markets  include the  development of new products and features,  product quality
and  performance,  the quality and  experience  of sales,  marketing and service
organizations,  product  price and name  recognition.  Many of these factors are
beyond the Company's control.

         The Company's  competitors in the information  security markets include
Security  Dynamics,   Semaphore,  Cray  Research,   Racal-Guardata,   Inc.,  and
Information Resource Engineering,  Inc. Northern Telecom Limited, AT&T, Motorola
Corporation,  Digital  Equipment  Corporation and Sun  Microsystems,  Inc. offer
certain  information  security  products  as part of  their  overall  networking
solutions.  In addition,  a number of significant  vendors,  including Microsoft
Corporation,   Netscape  Communications  Corporation  and  Cisco  have  embedded
security  solutions  in their  software.  To the extent  that these  embedded or
optional  security  capabilities  provide all or a portion of the  functionality
provided by the  Company's  products,  the  Company's  products may no longer be
required by customers to attain information security.

         RSA Data Security, Inc., a subsidiary of Security Dynamics, ("RSA DSI")
licenses various methods of implementing Public Key cryptography, including some
that are  different  than (and  incompatible  with) the  method of  implementing
Public Key  cryptography  currently used by the Company in most of its products.
Although  Cylink has a license to use all of the Public Key methods  promoted by
RSA DSI, to the extent relevant  industries impose technical standards different
than  those  currently  used by the  Company in any  segment of the  information
security  market,  sales of the Company's  existing and planned products in that
market segment may be adversely  impacted,  which could have a material  adverse
effect on the Company's financial condition and results of operations.


                                       13
<PAGE>

         The Company  competes  with a large number of companies in the wireless
communications  markets,  including  U.S.  local  exchange  carriers and foreign
telephone  companies.  The most significant  competition for sub-T1 rate AirLink
products in the wireless  market is from  telephone  companies that offer leased
line data services.  The Company also competes with other  suppliers of wireless
products such as Digital  Wireless,  Utilicom,  Western Multiplex and California
Microwave, Inc.

         Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer standing  relationships with customers than the Company.  Competitors
with greater  financial  resources are better able to engage in sustained  price
reductions  in order  to gain  market  share.  Any  period  of  sustained  price
reductions  would  have a material  adverse  effect on the  Company's  financial
condition and results of operations.  There can be no assurance that the Company
will be able to compete successfully in the future or that competitive pressures
will not materially and adversely affect the Company's  financial  condition and
results of operations.

Product Liability Risks

         Customers  rely  on the  Company's  information  security  products  to
prevent  unauthorized  access  to  their  networks  and  data  transmissions.  A
malfunction or the inadequate  design of the Company's  products could result in
tort or warranty  claims.  Although  the Company  attempts to reduce the risk of
such losses through warranty disclaimers and liability limitation clauses in its
sales agreements and by maintaining product liability insurance, there can be no
assurance  that such  measures  will be  effective  in  limiting  the  Company's
liability  for any such  damages.  Any  liability  for  damages  resulting  from
security  breaches could be substantial and could have a material adverse effect
on  the  Company's   business  and  results  of  operations.   In  addition,   a
well-publicized  actual or perceived  security breach could adversely affect the
market's  perception of security products in general,  or the Company's products
in  particular,  regardless  of  whether  such  breach  is  attributable  to the
Company's  products.  This could result in a decline in demand for the Company's
products,  which would have a material adverse effect on the Company's financial
condition and results of operations.

Management of Growth

         The Company has recently  experienced  and may  continue to  experience
substantial  growth  in the  number  of  its  employees  and  the  scope  of its
operations,  resulting in increased  responsibilities for management.  To manage
growth   effectively,   the  Company  will  need  to  continue  to  improve  its
operational,  financial and management  information  systems and to hire, train,
motivate and manage a growing  number of employees.  Competition  is intense for
qualified  technical,  marketing and management  personnel,  particularly highly
skilled  engineers.  In  particular,   the  current  availability  of  qualified
engineers  is  quite  limited,   and  competition   among  companies,   academic
institutions,  government  entities  and other  organizations  for  skilled  and
experienced  engineering  personnel  is very  intense.  The Company is currently
attempting to hire a number of engineering  personnel and has experienced delays
in  filling  such  positions.   The  Company  expects  to  experience  continued
difficulty  in filling its needs for qualified  engineers  and other  personnel.
There can be no assurance that the Company will be able to  effectively  achieve
or manage any  future  growth,  and its  failure  to do so could  delay  product
development  cycles or otherwise have a material adverse effect on the Company's
financial condition and results of operations.

Intellectual Property and Other Proprietary Rights

         The Company  relies on patents,  trademarks,  copyrights,  licenses and
trade secret law to establish and preserve its intellectual property rights. The
Company owns twelve U.S. patents covering certain aspects of its product designs
and has one additional U.S. patent application pending. The Company also has the
exclusive right to sublicense the Stanford  Patents,  which expire in the United
States in the third quarter of 1997.  There can be no assurance that any patent,
trademark,  copyright  or  license  owned  or held by the  Company  will  not be
invalidated, circumvented or challenged, that the rights granted thereunder will
provide  competitive  advantages  to the  Company  or that any of the  Company's
pending  or future  patent  applications  will be  issued  with the scope of the
claims sought by the Company, if at all. Further, there can be no assurance that
others  will not  develop  technologies  that are  similar  or  superior  to the
Company's  technology,  duplicate the Company's  technology or design around the
patents  owned by the  Company.  The Company  may be subject to or may  initiate
interference   proceedings  in  the  U.S.  Patent  Office,   which  can  require
significant financial and management resources. In addition, the laws of certain
countries in which the Company's products are or may be developed,  manufactured
or sold may not protect the Company's products and intellectual  property rights
to the same


                                       14
<PAGE>

extent as the laws of the United States. The inability of the Company to protect
its intellectual property adequately could have a material adverse effect on its
financial condition and results of operations.

         The network information security and wireless communications industries
in which the  Company  sells  its  products  are  characterized  by  substantial
litigation regarding patent and other intellectual property rights. From time to
time, the Company has received  communications from third parties asserting that
the Company's patents,  features or content of certain of the Company's products
infringe upon the  intellectual  property rights held by third parties,  and the
Company may receive such  communications in the future. The Company is not aware
that any of the features or content of its products  wrongfully  infringe on any
valid  intellectual  property  rights of others.  There can be no assurance that
third  parties  will not  assert  claims  against  the  Company  that  result in
litigation.  Any litigation,  whether or not determined in favor of the Company,
could result in significant  expense to the Company and could divert  management
and  other  resources.  In the  event of an  adverse  ruling  in any  litigation
involving  intellectual  property,  the Company might be required to discontinue
the use of certain processes, cease the manufacture,  use and sale of infringing
products,  expend significant resources to develop non-infringing  technology or
obtain licenses to the infringing technology and may suffer significant monetary
damages,  which could include  treble  damages.  There can be no assurance  that
under  such  circumstances  a  license  would be  available  to the  Company  on
reasonable  terms or at all.  In the event of a  successful  claim  against  the
Company and the Company's failure to develop or license a substitute  technology
on commercially  reasonable terms, the Company's financial condition and results
of  operations  would be  adversely  affected.  There can be no  assurance  that
existing claims or any other  assertions (or claims for indemnity from customers
resulting from infringement claims) will not materially and adversely affect the
Company's financial condition and results of operations.

Evolving Information Security Market

         The market for the  Company's  information  security  products  is only
beginning  to  emerge.   This  market  is   characterized  by  rapidly  changing
technology,  emerging industry standards,  new product introductions and changes
in customer  requirements  and  preferences.  The Company's  future success will
depend in part upon end  users'  demand for  information  security  products  in
general,  and upon the Company's ability to enhance its existing products and to
develop  and  introduce  new  products  and  technologies   that  meet  customer
requirements.   Any   significant   advance  in   technologies   for   attacking
cryptographic systems could render some or all of the Company's existing and new
products  obsolete or  unmarketable.  To the extent that a specific method other
than the  Company's  is adopted as the  standard  for  implementing  information
security  in any  segment  of the  information  security  market,  sales  of the
Company's  existing and planned products in that market segment may be adversely
impacted,  which could have a material adverse effect on the Company's financial
condition and results of operations.  There can be no assurance that information
security-related products or technologies developed by others will not adversely
affect the Company's competitive position or render its products or technologies
noncompetitive or obsolete.

         In  addition,  a  portion  of the  sales of the  Company's  information
security  products  will depend upon a robust  industry and  infrastructure  for
providing access to public switched networks, such as the Internet. There can be
no assurance that the infrastructure or complementary products necessary to make
these networks into viable  commercial  marketplaces  will be developed,  or, if
developed, that these networks will become viable commercial marketplaces.

Rapid Technological Change

         The markets for the  Company's  products are  characterized  by rapidly
changing  technologies,  extensive research and new product  introductions.  The
Company believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop, manufacture and market
new products. As a result, the Company expects to continue to make a significant
investment in engineering,  research and development.  There can be no assurance
that  the  Company  will  be able to  develop  and  introduce  new  products  or
enhancements to its existing  products in a timely manner which satisfy customer
needs, achieve market acceptance or address  technological changes in its target
markets.  The  failure of the Company to develop  products  and  introduce  them
successfully  and in a  timely  manner  could  adversely  affect  the  Company's
competitive position, financial condition and results of operations.

Wireless Communications Industry Regulatory Environment

         Wireless communications are subject to regulations by United States and
foreign laws and  international  treaties.  In the United States,  the Company's
wireless  communications products are subject to various regulations of the FCC.
Current FCC regulations permit  license-free  operation of certain FCC certified
wireless  products.  The  future of  remote


                                       15
<PAGE>

wireless  communications is highly volatile,  due in part to ongoing uncertainty
regarding telecommunications deregulation and the status of initiatives relating
to  the  auction  of  licenses  for  personal   communications  service  ("PCS")
frequencies.   Regulatory  changes,  including  changes  in  the  allocation  of
available  frequencies,  could significantly  affect the Company's operations by
diverting the Company's development efforts, making current products obsolete or
increasing the opportunity for additional competition. There can be no assurance
that new regulations will not be promulgated which could have a material adverse
effect on the Company's financial condition and results of operations.

         The  Company  also is subject  to  regulatory  requirements  in foreign
markets.  Equipment  can be marketed in a country  only if permitted by suitable
frequency  allocations and regulations,  and only if such equipment has received
type  approval by the country in  question.  The process of  complying  with new
regulations  and of obtaining type approval is often complex and lengthy and can
result in significant  expense and delays in the introduction of products in new
countries.

         Changes in, or the failure by the  Company to comply  with,  applicable
domestic and  international  regulations could have a material adverse effect on
the Company's business and operating results. There can be no assurance that the
Company will be able to comply with regulations in any particular country.

Risks  Associated  with  International  Sales;  Reliance  Upon  Local  Partners;
Restrictions on Export

         International product sales represented  approximately 35%, 47% and 59%
of revenue in 1994,  1995 and 1996,  respectively.  In particular,  sales of the
Company's  wireless   communications  products  are  currently  concentrated  in
developing countries.  The Company plans to continue to expand its foreign sales
channels  and to enter  additional  international  markets,  both of which  will
require significant management attention and financial resources.  International
sales  are  subject  to a number  of  risks,  including  unexpected  changes  in
regulatory  requirements,  tariffs  and  other  trade  barriers,  political  and
economic   instability  in  foreign  markets,   difficulties  in  the  staffing,
management and integration of foreign operations, longer payment cycles, greater
difficulty  in  collecting  accounts  receivable,   currency   fluctuations  and
potentially adverse tax consequences.  Since most of the Company's foreign sales
are  denominated  in U.S.  dollars,  the  Company's  products  become less price
competitive in countries in which local currencies  decline in value relative to
the U.S. dollar. The uncertainty of monetary exchange values has caused, and may
in the future cause, some foreign customers to delay new orders or delay payment
for existing  orders.  The long-term impact of such  devaluation,  including any
possible effect on the business outlook in other developing countries, cannot be
predicted.

         The Company's  ability to compete  successfully in foreign countries is
dependent  in part on the  Company's  ability to obtain and retain  reliable and
experienced  in-country  distributors and other strategic partners.  The Company
does not have  long-term  relationships  with any of its  value-added  resellers
("VARs")  and  distributors  and,  therefore,  has no  assurance of a continuing
relationship within a given market.

         United  States  government  regulations  restrict the export of certain
cryptographic  devices,  including certain of the Company's information security
products.  As a result,  the Company may be at a  disadvantage  in competing for
international sales compared to companies located outside the United States that
are not subject to such restrictions.

Dependence  on  Component  Availability,   Subcontractor   Performance  and  Key
Suppliers

         The Company's  ability to timely deliver its products is dependent upon
the  availability  of quality  components and subsystems used in these products.
The Company depends in part upon  subcontractors  to  manufacture,  assemble and
deliver certain items in a timely and satisfactory  manner.  The Company obtains
certain  components and subsystems from single, or a limited number of, sources.
A significant  interruption  in the delivery of such items could have a material
adverse effect on the Company's financial condition and results of operations.


ITEM 2.  PROPERTIES

         The Company's  headquarters  occupies  86,000 square feet in Sunnyvale,
California,  the lease for which expires in June 1999. During the second quarter
of 1996, the Company signed a five-year lease agreement for approximately 35,000
square feet of office and manufacturing space, also in Sunnyvale.  Substantially
all  manufacturing  activities  have been moved to this site. The Company leases
facilities for sales offices in New Jersey, Virginia, United Kingdom, Singapore,
China, India and Pakistan.  The Company believes that its current facilities are
well  maintained and are adequate for the



                                       16
<PAGE>

foreseeable  future and that suitable  additional or  alternative  space will be
available in the future on commercially reasonable terms as needed.


ITEM 3.  LEGAL PROCEEDINGS

         On  September  6, 1995,  the  Company  obtained  an  arbitration  award
dissolving a former partnership,  known as Public Key Partners ("PKP"),  between
the  Company's  wholly-owned  subsidiary,  Caro-Kann  Corporation,  and RSA DSI.
Although various claims between the Company and RSA DSI were settled on December
31, 1996, a third party  continues to pursue  various claims against PKP and RSA
DSI for wrongful  business  practices in action  C-94-20512 SW before the United
States  District Court for the Northern  District of California.  An unfavorable
outcome might affect the residual  value the Company may receive from the former
partnership.

         On March 7, 1997,  ten former  employees  of the Company  filed suit in
action No. CV764647 in the Superior Court of California,  County of Santa Clara,
against the Company,  each of its Directors and its General  Counsel,  asserting
claims for wrongful  termination,  fraud,  libel,  slander,  age discrimination,
invasion of privacy,  and  violation of the federal RICO  statute.  Although the
Company  has placed its  insurers on notice of these  claims,  none of them have
admitted coverage. The Company believes the terminations were lawful and intends
to defend  the  matter  vigorously.  The  defense  of this  matter  may divert a
material  amount of  management's  attention  and  require  the  expenditure  of
significant  legal fees and costs.  An  unfavorable  outcome  which  exceeds the
Company's  insurance  coverage,  if any,  may also result in a material  adverse
effect on the Company's financial condition.


ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         No  matters  were  submitted  to a vote of  security  holders,  through
solicitation  of proxies or otherwise,  during the fourth  quarter of the fiscal
year covered by this report.


EXECUTIVE OFFICERS OF THE REGISTRANT

The following  table sets forth  certain  information  concerning  the executive
officers of the Company as of December 31, 1996:

Name                  Age     Position
----                  ---     --------

Fernand Sarrat         45     Director, Chief Executive Officer and President

Jimmy K. Omura         56     Director and Chief Technical Officer

John H. Daws           53     Vice President and Chief Financial Officer

Robert B. Fougner      44     Secretary and General Counsel

Steven Goldberg        43     Vice President and General Manager of the Wireless
                              Communications Division

Sarah L. Engel         53     Vice President, Human Resources and
                              Organizational Development

John Kalb              49     Vice President, Business Development

Les Nightingill        46     Vice President, Special Projects

Peter J. Slocum        41     Vice President, Engineering


                                       17
<PAGE>

         Mr. Sarrat joined the Company as Chief Executive  Officer and President
in  November  1996.  Prior to  joining  the  Company,  Mr.  Sarrat  was with IBM
Corporation  for over 20 years,  most recently as General  Manager of Networking
Computing Marketing & Services, and held such other positions as General Manager
of the Networked Application Services Division, the Assistant General Manager of
Marketing and Business Development,  and General Manager of Marketing & Services
in the Midwest.

         Dr. Omura co-founded the Company in 1984 and served as both Chairman of
the Board and Vice President, Research and Development, from 1984 until December
1995. Dr. Omura is currently the Company's Chief  Technical  Officer and, during
the  period  from June  until  November,  1996,  Dr.  Omura  also  served as the
Company's acting Chief Executive Officer.

         Mr.  Daws  joined the  Company as Vice  President  and Chief  Financial
Officer in September 1995. From April 1992 to August 1995, he was Vice President
and Chief  Financial  Officer of  Crosspoint  Solutions,  Inc.,  a software  and
semiconductor  company,  and  from  June  1988  to  December  1991  he was  Vice
President, Finance of Rolm Computer Corporation, a software and computer company
and a subsidiary of Loral Corporation.

         Mr.  Fougner has been  Secretary and General  Counsel since joining the
Company in December 1989. Prior to joining the Company,  he was a partner in the
New York law firm of Hill, Betts & Nash.

         Dr.  Goldberg  joined the Company as Vice President and General Manager
of the Wireless  Communications  Division in March 1995.  From September 1991 to
March 1995, he served as Manager of the Communications  Systems Group of Trimble
Navigation  Limited,  a manufacturer  of global  positioning  systems,  and from
September  1988 to  September  1991,  he served as a Senior  Engineer at Applied
Signal Technology, Inc., a manufacturer of signal processing equipment.

         Ms.  Engel  joined the Company in  February  1997.  Before  joining the
Company she was an independent  consultant  specializing in strategic  planning,
human resources and  organizational  development with such clients as Ford Motor
Company,  The Coca-Cola Company,  Exxon Corporation and Harcourt General,  Inc.,
among others.

         Mr.  Kalb  joined the  Company in January  1997.  Prior to joining  the
Company,  he was with IBM Corporation  for over 25 years,  most recently as Vice
President of Electronic Commerce, Internet Division,  responsible for marketing,
software  development  and operations  relating to IBM's  offerings for enabling
commerce over the Internet.

         Mr.  Nightingill  joined  the  Company  in  November  1995 and,  in the
capacity  of  Director,   and  later  Vice  President  of  Engineering,   headed
development of the Company's link, voice, and fax encryption products as well as
the  Company's  CSU and  access  multiplexer  communication  products.  Prior to
joining the Company,  he held  engineering  positions at TRW Vidar,  GTE Lenkurt
Fiber Optics Communications Division, and California Microwave's TXR subsidiary.

         Mr.  Slocum  joined the  Company in  February  1997.  From July 1993 to
February   1997  he  served  as  Vice   President  of   Engineering   for  Octel
Communications  Corporation, a provider of voice messaging systems and services.
Mr.  Slocum  served as Director of  Engineering  for Silicon  Graphics,  Inc., a
computing  systems  company,  from  July  1992 to July  1993 and  MIPS  Computer
Systems, Inc. (merged with Silicon Graphics, Inc. in July 1992) from August 1990
to July 1992.


                                       18
<PAGE>

                                     PART II


ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND
         RELATED STOCKHOLDER MATTERS

         The  Company's  Common  Stock has been  traded in the  over-the-counter
market  under the symbol CYLK since the  Company's  initial  public  offering on
February  15,  1996.  The  following  table sets forth the high and low  closing
prices as reported on the Nasdaq National Market during the last fiscal year:

                     First            Second         Third            Fourth
Fiscal 1996         Quarter          Quarter        Quarter          Quarter
-----------         -------          -------        -------          -------

High                26 1/4           23 1/2         17 1/2            15 1/16
Low                 17               17              9 13/16          10 15/16

As of March 14, 1997, the Company had  approximately 144 shareholders of record.
The  Company has never  declared or paid  dividends  on its capital  stock.  The
Company  currently  intends to reinvest its earnings in the  development  of its
business and does not intend to pay dividends in the foreseeable future.


ITEM 6.  SELECTED FINANCIAL DATA
<TABLE>

         The following selected financial  information has been derived from the
Company's audited consolidated  financial statements.  The information set forth
below is not  necessarily  indicative  of  results of future  operations  and is
qualified  by  reference  to  and  should  be  read  in  conjunction   with  the
consolidated  financial  statements  and related notes thereto and  Management's
Discussion  and  Analysis  of  Financial  Condition  and  Results of  Operations
included elsewhere herein.

<CAPTION>
                                                                                       Year ended December 31,
                                                          --------------------------------------------------------------------------
                                                            1996            1995             1994             1993             1992
                                                            ----            ----             ----             ----             ----
                                                                             (in thousands, except per share data)
<S>                                                       <C>             <C>              <C>              <C>             <C>
Revenue                                                   $ 51,958        $ 34,902         $ 26,646         $ 26,294        $ 17,209
Research and development expense, net                       11,342          10,185            8,117            5,508           5,114
Net income (loss)                                            1,197          (1,079)            (700)           1,901             932
Net income (loss) per share                               $   0.05        $  (0.06)        $  (0.04)        $   0.10        $   0.05
Shares used to compute
  net income (loss) per share                               25,761          19,572           19,351           19,901          19,255


                                                                                          As of December 31,
                                                          --------------------------------------------------------------------------
                                                             1996            1995            1994             1993            1992
                                                             ----            ----            ----             ----            ----
                                                                                        (in thousands)

Cash, cash equivalents and
   short-term investments                                 $ 78,849        $  6,098         $  6,626         $  7,193        $  5,819
Working capital                                             93,518          12,604           12,042           14,057          11,357
Total assets                                               107,088          22,725           20,663           19,777          15,795
Long-term obligations                                          241             291             --               --              --
Shareholders' equity                                      $ 97,211        $ 14,605         $ 14,149         $ 15,481        $ 13,561

</TABLE>



                                       19
<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS


RESULTS OF OPERATIONS

         The  following  table  sets forth  certain  consolidated  statement  of
operations data as a percentage of revenue for the periods indicated:

                                                   Year ended December 31,
                                             --------------------------------
                                             1996          1995         1994
                                             ----          ----         ----

Revenue                                      100.0%       100.0%       100.0%
Cost of revenue                               41.9         39.6         39.3
                                            ------       ------       ------

Gross profit                                  58.1         60.4         60.7
                                            ------       ------       ------

Operating expenses:
   Research and development, net              21.8         29.2         30.5
   Selling and marketing                      26.6         27.4         24.5
   General and administrative                 11.9         14.4         15.3
   Employee severance costs                    1.2          --           --
                                            ------       ------       ------

      Total operating expenses                61.5         71.0         70.3
                                            ------       ------       ------

Income (loss) from operations                 (3.4)       (10.6)        (9.6)
Other income, net                              6.2          5.3          5.2
                                           -------      -------      -------

Income (loss) before income taxes              2.8         (5.3)        (4.4)
Provision (benefit) for income taxes           0.5         (2.2)        (1.7)
                                           -------      -------      -------

Net income (loss)                              2.3%        (3.1)%       (2.7)%
                                           =======      =======      =======


The  following  table sets forth  certain  information  regarding  the Company's
information security products and wireless communications products:

                                                      Year ended December 31,
                                                   -----------------------------
                                                   1996         1995       1994
                                                   ----         ----       ----
                                                     (dollars in thousands)
Information security product revenue              $25,793    $21,534    $18,008
Information security product gross margin              62%        67%        66%

Wireless communications product revenue           $26,165     13,368      8,638
Wireless communications product gross margin           54%        49%        50%


         Revenue. The Company's revenue increased 49% from $34.9 million in 1995
to $52.0 million in 1996.  Sales of information  security  products and wireless
communications  products  increased by 20% and 96%,  respectively,  from 1995 to
1996. The increased revenue from information security products was primarily due
to increased unit sales of the Company's  Secure WAN, LAN and Access  encryption
product line, which are used in public and private linked  networks.  Unit sales
of the Company's older CIDEC  encryption  product line were  essentially flat in
comparison  with  1995.  The  increased  revenue  from  wireless  communications
products  was  primarily  a  result  of  significantly  increased  shipments  in
international markets.

         The Company's revenue increased 31% from $26.6 million in 1994 to $34.9
million  in  1995.   Sales  of  information   security   products  and  wireless
communications  products  increased by 20% and 55%,  respectively,  from 1994 to
1995.  These  increases were primarily due to higher unit sales of the Company's
existing products.


                                       20
<PAGE>

         International product revenue was 35%, 47% and 59% of revenue for 1994,
1995 and 1996,  respectively.  International  product revenue as a percentage of
total   revenue   increased   for  both   information   security   and  wireless
communications products in 1995 and 1996, but the overall increase was primarily
due to increased unit sales of wireless communications products.

         Gross Profit.  Gross profit increased 43% from $21.1 million in 1995 to
$30.2 million in 1996, but decreased  slightly as a percentage of sales from 60%
to 58%. As a  percentage  of revenue,  gross profit was  negatively  affected by
increased  sales of wireless  communications  products,  which  generally have a
lower gross margin than information security products.  Further, gross margin on
information  security  products  declined as some of the new products have lower
gross margins than the Company's older CIDEC  encryption  products and these new
products represented an increased percentage of revenue.  This decrease in gross
margin was  partially  offset by an overall  increase in wireless  communication
product gross margins due to increased  average  selling prices and reduced unit
costs.

         Gross profit  increased 31% from $16.2 million in 1994 to $21.1 million
in 1995  primarily  due to increased  unit volume.  As a percentage  of revenue,
gross profit  decreased  marginally  from 1994 to 1995 due to increased sales of
wireless communications products.

         Research and  Development.  Research and development  expenses  consist
primarily  of salaries and other  personnel-related  expenses,  depreciation  of
development equipment,  facilities and supplies.  Gross research and development
expenses  increased  28% from $8.8 million in 1994 to $11.3  million in 1995 and
54% to  $17.4  million  in  1996.  From  time  to  time,  the  Company  receives
engineering  funding for development  projects to apply or enhance the Company's
technology to a particular  customer's need. The amounts  recognized under these
research and development  contracts are offset against  research and development
expense.  Amounts recognized under non-recurring  engineering  contracts totaled
$0.7  million,   $1.1  million  and  $6.1  million  in  1994,   1995  and  1996,
respectively.

         Selling and Marketing. Selling and marketing expenses consist primarily
of personnel  costs,  including  sales  commissions,  and costs of  advertising,
public  relations,  seminars and trade  shows.  Selling and  marketing  expenses
increased 47% from $6.5 million in 1994 to $9.6 million in 1995 and 44% to $13.8
million in 1996. The increases were  primarily due to expenses  associated  with
expansion  of the  Company's  direct  sales  force,  personnel  increases in the
marketing  group,  and  increased  costs  associated  with  advertising,  public
relations and trade shows.

         General and Administrative. General and administrative expenses consist
primarily of personnel  and related  costs,  recruitment  expenses,  information
system costs, and audit, legal and other professional  service fees. General and
administrative  expenses increased 23% from $4.1 million in 1994 to $5.0 million
in 1995 and 23% to $6.2 million in 1996. General and administrative expense as a
percentage  of  revenue  was  15%,  14%  and  12%  for  1994,   1995  and  1996,
respectively.  The  dollar  increases  in 1995  and 1996  are  primarily  due to
increased  staffing and  professional  fees  necessary to manage and support the
Company's  recent  growth  and  provide  infrastructure  required  for a  public
company.  The  decreases  as a  percentage  of  revenue  in 1995 and  1996  were
primarily due to general and  administrative  expenses  allocated  over a larger
revenue base.

         Employee  Severance  Costs.  During  the fourth  quarter  of 1996,  the
Company recorded a $634,000  one-time charge related to the  reorganization  and
replacement of several senior management positions.

         Other Income  (Expense),  Net.  Other income  (expense),  net primarily
consists of  royalties,  interest  income and  interest  expense.  Other  income
increased  33% from $1.4 million in 1994 to $1.9 million in 1995 and 73% to $3.2
million in 1996.  The  increase  in 1995 was  primarily  due to an  increase  in
royalty  income  partially  offset by a decrease in interest  and other  income.
Royalty income in 1994 and 1995 included  royalty payments from two licensees of
the Company's  wireless ASIC products for cordless  telephones.  The increase in
other  income for 1996 was  principally  due to an increase  in interest  income
resulting  from funds  derived from the  Company's  initial  public  offering in
February and March 1996.  The Company  sustained a decrease in royalty income in
1996  from  the  aforementioned  licensees.   Additionally,   the  Company  sold
marketable securities at a loss of $432,000 in 1996.

         Provision  (Benefit)  for Income  Taxes.  The  provision  (benefit) for
income taxes as a percentage  of income (loss) before taxes was a benefit of 39%
in 1994, a benefit of 41% in 1995 and a provision  of 17% in 1996.  Net deferred
tax  assets of $1.4  million  at  December  31,  1996,  were  based  both on the
Company's  carryback  capacity and management's  determination  that the Company
will more likely than not realize such assets based on expected future income in
the next


                                       21
<PAGE>

twelve  months.  However,  there can be no  assurance  that the Company  will be
profitable  in future  periods.  See Item I  "Business - Risk  Factors  That May
Affect Future  Results -- Recent  Losses;  Potential  Fluctuations  in Operating
Results,  Future Operating Results  Uncertain." The Company's effective tax rate
for 1997 is expected to increase to approximately the federal statutory rate.

         Net income (loss).  The Company had losses of $700,000 in 1994 and $1.1
million in 1995,  and net income of $1.2 million in 1996.  In 1994,  the Company
began a  strategic  research  and  development  program  designed  to create new
products and enhance  existing  products.  While revenue  increased in 1995, the
Company  incurred  a net loss due to  continued  high  levels  of  research  and
development expenses related to the Company's strategic research and development
project.  In 1996,  increased  gross  profit  resulting  from newer  information
security products and international  sales of wireless  communications  products
was largely  offset by higher  spending for research and  development,  net, and
selling and marketing resulting in a loss from operations.

LIQUIDITY AND CAPITAL RESOURCES

         In February and March 1996,  the Company  completed its initial  public
offering and its Common Stock began trading on the Nasdaq  National Market under
the symbol CYLK.  Through the offering the Company sold 5,750,000  shares of its
Common  Stock  which  generated  approximately  $79.3  million  in cash,  net of
underwriting discounts, commissions and other offering costs. As of December 31,
1996, the Company had $78.8 million in cash and cash equivalents.

         Cash provided by operating  activities in 1994 consisted primarily of a
decrease  in  accounts  receivable  and  increases  in accrued  liabilities  and
deferred  revenue,  offset in part by a net loss and an increase in inventories.
Cash used in operating  activities  for 1995 was  principally  a result of a net
loss and  increased  inventory  and  accounts  receivable  to support  increased
revenue,  which were offset only in part by  increases  in accounts  payable and
accrued liabilities. Cash used in operating activities in 1996 was principally a
result of increased  inventory  and  accounts  receivable  to support  increased
revenue,  which was  offset in part by net  income  and  increases  in  accounts
payable and accrued liabilities.

         The Company made capital  expenditures of  approximately  $1.2 million,
$614,000 and $2.8 million in 1994, 1995 and 1996, respectively. Additionally, in
1995 and 1996 the Company acquired  $493,000 and $256,000 of equipment  financed
by capital  leases.  These  acquisitions  have  generally  consisted of computer
workstations,   networking  equipment,   office  furniture  and  equipment,  and
leasehold additions and improvements.  In 1994, the Company purchased marketable
securities of $2.8 million. These securities were sold in 1994 and 1996.

         The Company  believes that  existing  cash balances and cash  generated
from  operations  will be  sufficient  to fund  necessary  purchases  of capital
equipment and to provide working capital through 1997. However,  the Company may
require  additional  funds to support its working  capital  requirements  or for
other  purposes and may seek to raise such  additional  funds through  public or
private equity  financing or from other sources.  No assurance can be given that
additional financing will be available or that, if available,  will be available
on  terms  favorable  to the  Company  or its  shareholders.  See  Item 3 "Legal
Proceedings"  and  Item 1  "Business  - Risk  Factors  That  May  Affect  Future
Results."


                                       22
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements and Financial Statement Schedules


                                                                            Page
                                                                            ----
Financial Statements:

    Report of Price Waterhouse LLP, Independent Accountants                 23

    Consolidated Balance Sheets at December 31, 1996 and 1995                24

    Consolidated Statements of Operations for the years ended
       December 31, 1996, 1995 and 1994                                      25

    Consolidated Statements of Shareholders' Equity for the years ended
       December 31, 1996, 1995 and 1994                                      26

   Consolidated Statements of Cash Flows for the years ended
       December 31, 1996, 1995 and 1994                                      27

   Notes to Consolidated Financial Statements                                28

Financial Statement Schedule:

   Schedule II - Valuation and Qualifying Accounts                           42

All  other  schedules  are  omitted  because  they  are  not  required,  are not
applicable,  or  the  information  is  included  in the  consolidated  financial
statements or notes thereto.




                        Report of Independent Accountants

        To the Board of Directors and Shareholders of
          Cylink Corporation

        In our opinion,  the  consolidated  financial  statements  listed in the
        above index  present  fairly,  in all material  respects,  the financial
        position of Cylink Corporation and its subsidiaries at December 31, 1996
        and 1995,  and the results of their  operations and their cash flows for
        each of the three  years in the  period  ended  December  31,  1996,  in
        conformity  with  generally  accepted   accounting   principles.   These
        financial statements are the responsibility of the Company's management;
        our   responsibility  is  to  express  an  opinion  on  these  financial
        statements  based  on our  audits.  We  conducted  our  audits  of these
        statements in accordance  with  generally  accepted  auditing  standards
        which  require  that we plan and perform the audit to obtain  reasonable
        assurance  about whether the financial  statements  are free of material
        misstatement.  An audit includes  examining,  on a test basis,  evidence
        supporting  the amounts and  disclosures  in the  financial  statements,
        assessing the accounting  principles used and significant estimates made
        by  management,   and  evaluating   the  overall   financial   statement
        presentation.  We believe that our audits provide a reasonable basis for
        the opinion expressed above.



        PRICE WATERHOUSE LLP
        San Jose, California
        January 24, 1997


                                       23
<PAGE>

<TABLE>

Cylink Corporation
Consolidated Balance Sheets
(dollars in thousands, except per share data)

<CAPTION>
                                                                                                             December 31,
                                                                                                       1996                  1995
                                           Assets
<S>                                                                                                  <C>                  <C>
Current assets:
   Cash and cash equivalents                                                                         $  78,849            $   3,240
   Short-term investments                                                                                 --                  2,858
   Accounts receivable, net of allowances of $644 and $483                                              12,682                6,013
   Inventories                                                                                           8,828                6,096
   Deferred income taxes                                                                                 1,432                1,091
   Other current assets                                                                                  1,351                  948
                                                                                                     ---------            ---------
            Total current assets                                                                       103,142               20,246

Property and equipment, net                                                                              3,760                2,295
Other assets                                                                                               186                  184
                                                                                                     ---------            ---------
                                                                                                     $ 107,088            $  22,725
                                                                                                     =========            =========
                            Liabilities and Shareholders' Equity
Current liabilities:
   Bank borrowings under line of credit                                                              $    --              $   1,000
   Current portion of lease obligations                                                                    167                  144
   Accounts payable                                                                                      3,954                1,378
   Accrued liabilities                                                                                   5,090                3,741
   Income taxes payable                                                                                     60                   90
   Deferred revenue                                                                                        353                1,289
                                                                                                     ---------            ---------
         Total current liabilities                                                                       9,624                7,642
                                                                                                     ---------            ---------
Lease obligations, long-term                                                                               241                  291
                                                                                                     ---------            ---------
Deferred income taxes                                                                                       12                  187
                                                                                                     ---------            ---------

Commitments and contingencies (Notes 10 and 12)

Shareholders' equity:
   Preferred stock, $0.01 par value; 5,000,000 shares authorized;
      none issued and outstanding                                                                         --                   --
   Common stock, $0.01 par value; 40,000,000 shares authorized;
      25,597,000 and 19,087,000 shares issued and outstanding                                              257                  191
   Additional paid-in capital                                                                           89,772                9,281
   Notes receivable from shareholders                                                                     (301)                (515)
   Deferred compensation related to stock options                                                         (334)                (417)
   Unrealized loss on investments                                                                         --                   (416)
   Cumulative translation adjustment                                                                         4                 (135)
   Retained earnings                                                                                     7,813                6,616
                                                                                                     ---------            ---------
            Total shareholders' equity                                                                  97,211               14,605
                                                                                                     ---------            ---------
                                                                                                     $ 107,088            $  22,725
                                                                                                     =========            =========


<FN>
                             The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>


                                                                 24
<PAGE>

<TABLE>

Cylink Corporation
Consolidated Statements of Operations
(dollars in thousands, except per share data)

<CAPTION>
                                                                                          Year ended December 31,
                                                                               1996                 1995                   1994

<S>                                                                      <C>                    <C>                    <C>
Revenue                                                                  $     51,958           $     34,902           $     26,646
Cost of revenue                                                                21,767                 13,800                 10,474
                                                                         ------------           ------------           ------------
Gross profit                                                                   30,191                 21,102                 16,172
                                                                         ------------           ------------           ------------

Operating expenses:
   Research and development, net                                               11,342                 10,185                  8,117
   Selling and marketing                                                       13,788                  9,570                  6,516
   General and administrative                                                   6,185                  5,037                  4,088
   Employee severance costs                                                       634                   --                     --
                                                                         ------------           ------------           ------------
            Total operating expenses                                           31,949                 24,792                 18,721
                                                                         ------------           ------------           ------------

Income (loss) from operations                                                  (1,758)                (3,690)                (2,549)

Other income (expense):
   Interest income, net                                                         3,303                     50                    198
   Royalty and other income (expense), net                                        (97)                 1,806                  1,199
                                                                         ------------           ------------           ------------

Income (loss) before income taxes                                               1,448                 (1,834)                (1,152)
Provision (benefit) for income taxes                                              251                   (755)                  (452)
                                                                         ------------           ------------           ------------
Net income (loss)                                                        $      1,197           $     (1,079)          $       (700)
                                                                         ============           ============           ============

Net income (loss) per share                                              $       0.05           $      (0.06)          $      (0.04)
                                                                         ============           ============           ============

Shares used to compute net income (loss)
   per share                                                               25,761,000             19,572,000             19,351,000
                                                                         ============           ============           ============


<FN>
                             The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>


                                                                 25
<PAGE>

<TABLE>

Cylink Corporation
Consolidated Statements of Shareholders' Equity
(dollars in thousands)


<CAPTION>
                                                                                            Deferred
                                                                              Notes      Compensation
                                                                Additional  Receivable     Related to    Unrealized
                                         Common Stock            Paid-in      from           Stock         Loss on
                                      Shares       Amount        Capital   Shareholders     Options      Investments
<S>                                <C>           <C>           <C>          <C>            <C>            <C>
Balance at December 31, 1993       17,623,000    $   176       $   7,062    $  --          $  --          $   --
Issuance of common stock
   under stock option plans            14,000       --                10       --             --              --
Tax benefit from exercise of
   nonqualified stock options            --         --                 6       --             --              --
Repurchase of common stock            (13,000)      --               (15)      --             --              --
Unrealized loss on investments           --         --              --         --             --              (679)
Translation adjustment                   --         --              --         --             --              --
Net loss                                 --         --              --         --             --              --
                                   ----------    -------       ---------    -------        -------        --------

Balance at December 31, 1994       17,624,000        176           7,063       --             --              (679)
Issuance of common stock
   under stock option plans         1,463,000         15           1,801       (515)          --              --
Deferred compensation related
   to stock options                      --         --               417       --             (417)           --
Unrealized gain on investments           --         --              --         --             --               263
Translation adjustment                   --         --              --         --             --              --
Net loss                                 --         --              --         --             --              --
                                   ----------    -------       ---------    -------        -------        --------

Balance at December 31, 1995       19,087,000        191           9,281       (515)          (417)           (416)
Issuance of common stock
   under stock option plans           760,000          8           1,088       --             --              --
Issuance of common stock in
   initial public offering, net     5,750,000         58          78,806       --             --              --
Tax benefit from exercise of
   nonqualified stock options            --         --               597       --             --              --
Payment on notes receivable
   from shareholders                     --         --              --          214           --              --
Amortization of deferred
   compensation                          --         --              --         --               83            --
Reversal of unrealized loss on
   investments upon disposition          --         --              --         --             --               416
Translation adjustment                   --         --              --         --             --              --
Net income                               --         --              --         --             --              --
                                   ----------    -------       ---------    -------        -------        --------

Balance at December 31, 1996       25,597,000    $   257       $  89,772    $  (301)       $  (334)       $   --
                                   ==========    =======       =========    =======        =======        ========
</TABLE>

                                    Cumulative
                                   Translation      Retained
                                    Adjustment       Earnings         Total


Balance at December 31, 1993          $   (52)         8,395         15,481
Issuance of common stock
   under stock option plans              --             --               10
Tax benefit from exercise of
   nonqualified stock options            --             --                6
Repurchase of common stock               --             --              (15)
Unrealized loss on investments           --             --             (679)
Translation adjustment                     46           --               46
Net loss                                 --             (700)          (700)
                                      -------          -----         ------

Balance at December 31, 1994             (106)         7,695         14,149
Issuance of common stock
   under stock option plans              --             --            1,301
Deferred compensation related
   to stock options                      --             --             --
Unrealized gain on investments           --             --              263
Translation adjustment                    (29)          --              (29)
Net loss                                 --           (1,079)        (1,079)
                                      -------          -----         ------

Balance at December 31, 1995             (135)         6,616         14,605
Issuance of common stock
   under stock option plans              --             --            1,096
Issuance of common stock in
   initial public offering, net          --             --           78,864
Tax benefit from exercise of
   nonqualified stock options            --             --              597
Payment on notes receivable
   from shareholders                     --             --              214
Amortization of deferred
   compensation                          --             --               83
Reversal of unrealized loss on
   investments upon disposition          --             --              416
Translation adjustment                    139           --              139
Net income                               --            1,197          1,197
                                      -------          -----         ------

Balance at December 31, 1996          $     4          7,813         97,211
                                      =======          =====         ======


   The accompanying notes are an integral part of these financial statements.



                                       26
<PAGE>

<TABLE>
Cylink Corporation
Consolidated Statements of Cash Flows
(dollars in thousands)

<CAPTION>
                                                                                                Year ended December 31,
                                                                                       1996              1995                 1994
<S>                                                                                  <C>                <C>                <C>
Cash flows from operating activities:
   Net income (loss)                                                                 $  1,197           $ (1,079)          $   (700)
   Adjustments to reconcile net income (loss) to net
      cash provided by (used in) operating activities:
         Realized loss on sale of investments                                             432               --                 --
         Depreciation and amortization                                                  1,350                919                728
         Deferred compensation related to stock options                                    83               --                 --
         Deferred income taxes                                                           (516)              (383)              (202)
         Changes in assets and liabilities:
            Accounts receivable                                                        (6,669)            (1,269)               879
            Inventories                                                                (2,732)            (1,451)              (763)
            Other assets                                                                 (405)               573               (830)
            Accounts payable                                                            2,576                252                502
            Accrued liabilities                                                         1,349                414              1,130
            Income taxes payable                                                          (30)              (314)              (217)
            Deferred revenue                                                             (936)               (77)               815
                                                                                     --------           --------           --------
               Net cash provided by (used in)
                  operating activities                                                 (4,301)            (2,415)             1,342
                                                                                     --------           --------           --------

Cash flows from investing activities:
   Acquisition of property and equipment                                               (2,815)              (614)            (1,234)
   Purchase of short-term investments                                                    --                 --               (2,775)
   Proceeds from sale of short-term investments                                         2,842               --                  974
                                                                                     --------           --------           --------
               Net cash provided by (used in)
                   investing activities                                                    27               (614)            (3,035)
                                                                                     --------           --------           --------

Cash flows from financing activities:
   (Repayment) borrowings under bank line of credit                                    (1,000)             1,000               --
   Proceeds from issuance of common stock, net                                         79,960              1,301                 10
   Repurchase of common stock                                                            --                 --                  (15)
   Payment on notes receivable from shareholders                                          214               --                 --
   Repayment of capital lease obligations                                                 (27)               (58)              --
   Tax benefit from exercise of stock options                                             597               --                 --
                                                                                     --------           --------           --------
               Net cash provided by (used in)
                  financing activities                                                 79,744              2,243                 (5)
                                                                                     --------           --------           --------
Effect of exchange rate changes on
   cash and cash equivalents                                                              139                 (5)                 9
                                                                                     --------           --------           --------
Net increase (decrease) in cash and cash equivalents                                   75,609               (791)            (1,689)
Cash and cash equivalents at beginning of year                                          3,240              4,031              5,720
                                                                                     --------           --------           --------
Cash and cash equivalents at end of year                                             $ 78,849           $  3,240           $  4,031
                                                                                     ========           ========           ========

Supplemental disclosures:
   Cash paid for income taxes                                                        $     18           $     58           $    707
   Cash paid for interest                                                                 110                 32               --
   Equipment acquired under capital lease obligations                                     256                493               --
   Common stock issued for notes receivable                                              --                  515               --

<FN>
                             The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>


                                                                 27
<PAGE>

Cylink Corporation
Notes to Consolidated Financial Statements


1.   The Company and a Summary of its Significant Accounting Policies

     The Company

         Cylink  Corporation  (the "Company") was  incorporated in California in
     October  1989  to  engage  in the  development,  manufacture,  license  and
     marketing of  electronic  encryption  devices and in 1990 began  developing
     wireless communication products.

         The Company's operations outside of the United States consist primarily
     of a sales office in the United Kingdom.

     Basis of presentation

         The  consolidated  financial  statements  include  the  accounts of the
     Company and its  subsidiaries.  All significant  intercompany  accounts and
     transactions have been eliminated.

         The Company's  interim  quarters end on the Friday nearest the calendar
     quarter end. The Company's year end is December 31.

     Foreign currency

         The functional currencies of the Company's foreign subsidiaries are the
     local  currencies.  The balance sheet accounts are  translated  into United
     States  dollars at the exchange rate  prevailing at the balance sheet date.
     Revenues,  costs and expenses are translated  into United States dollars at
     average rates for the period.  Gains and losses  resulting from translation
     are presented as a component of shareholders'  equity. Net gains and losses
     resulting  from  foreign   exchange   transactions   are  included  in  the
     consolidated statement of operations and were not significant during any of
     the periods presented.

     Cash equivalents and short-term investments

         Cash equivalents consist of highly liquid investment instruments with a
     maturity at the time of purchase of three months or less.

         The    Company's    short-term    investments    are    classified   as
     available-for-sale and therefore are reported at fair value with unrealized
     gains and losses as a separate component of shareholders' equity.

     Inventories

         Inventories   are  stated  at  the  lower  of   standard   cost  (which
     approximates actual cost on a first-in, first-out basis) or market.

     Other assets

         Patent  acquisition costs are amortized using the straight-line  method
     over 10 years.  Patents,  net of  amortization,  of $18,000 and $27,000 are
     included in other assets as of December 31, 1996 and 1995, respectively.

     Property and equipment

         Property and equipment are recorded at cost.  Depreciation  is computed
     using the  straight-line  method  over the  estimated  useful  lives of the
     assets,  generally five years.  Amortization  of leasehold  improvements is
     computed using the  straight-line  method over the shorter of the estimated
     useful lives of the assets or the remaining lease term.


                                       28
<PAGE>

     Revenue recognition

         Revenue is  recognized  upon  shipment to  customers.  Concurrently,  a
     provision is made for estimated  cost to repair or replace  products  under
     warranty  arrangements.  Revenue from sales to  distributors  is recognized
     upon shipment;  no right of return,  stock rotation or price  protection is
     given.  Revenue  from sales to value added  resellers  is  recognized  upon
     shipment and concurrently a provision for estimated returns is recorded.

         Royalty  income of  $1,308,000,  $1,772,000  and $866,000 for the years
     ended December 31, 1996, 1995 and 1994, respectively,  is included in other
     income and is  generally  recognized  upon the  reported  sale of  products
     subject to royalties.

     Research and development

         Research and  development  costs are charged to operations as incurred.
     The  Company on  occasion  receives  nonrecurring  engineering  funding for
     development  projects to apply or enhance  the  Company's  technology  to a
     particular  customer's needs.  Non-refundable  receipts are recognized over
     the term of the  respective  contract  using the  percentage  of completion
     method.  Receipts,  which are refundable pending the achievement of certain
     results,  are deferred and  recognized  upon  acceptance  by the  customer.
     Amounts  billed  on  contracts  and  collected  prior to being  earned  are
     recorded as deferred revenue. At the time of recognition,  amounts received
     under research and  development  contracts are offset against  research and
     development expenses.

         Software development costs are included in research and development and
     are expensed as incurred.  Statement of Financial  Accounting Standards No.
     86 (SFAS 86) requires the  capitalization  of certain software  development
     costs once  technological  feasibility  is  established,  which the Company
     defines as  completion of a working  model.  The  capitalized  cost is then
     amortized on a straight-line  basis over the estimated  product life, or on
     the  ratio  of  current  revenues  to  total  projected  product  revenues,
     whichever is greater.  To date, the period between achieving  technological
     feasibility  and the general  availability  of such software has been short
     and software  development  costs  qualifying for  capitalization  have been
     insignificant.  Accordingly,  the Company has not  capitalized any software
     development costs.

     Stock-based compensation

         The Company  accounts for stock based  compensation using the intrinsic
     value method  prescribed in Accounting  Principles  Board Opinion (APB) No.
     25,   "Accounting   for   Stock   Issued   to   Employees,"   and   related
     Interpretations.  The Company provides  additional pro forma disclosures as
     required  under  Statement of Financial  Accounting  Standard No. 123 (SFAS
     123), "Accounting for Stock-Based Compensation." See Note 7.

     Income taxes

         Deferred tax assets and liabilities are recognized for the expected tax
     consequences of temporary  differences  between the tax bases of assets and
     liabilities and their financial statement reported amounts.

     Net income (loss) per share

         Net income  (loss) per share is  computed  using the  weighted  average
     number of outstanding  shares of common stock and common stock equivalents.
     Common stock equivalents consist of stock options (using the treasury stock
     method).  Common stock  equivalents  are excluded from the  computation  if
     their effect is antidilutive,  except that, pursuant to the requirements of
     the Securities and Exchange Commission, common stock equivalents (using the
     treasury  stock  method  and the  initial  public  offering  price)  issued
     subsequent  to  November  30,  1994  through  February  15,  1996 have been
     included in the  computation  as if they were  outstanding  for all periods
     through the effective date of the Company's initial public offering.

     Off-balance sheet risk and concentrations of credit risk

         Financial   instruments  that   potentially   subject  the  Company  to
     significant concentration of credit risk consist primarily of cash and cash
     equivalents,  short-term investments,  accounts receivable, and to a lesser
     extent  currency  fluctuation of balances  denominated in currencies  other
     than the United States dollar.  The Company limits the amount of investment
     exposure to any one financial  institution  and financial  instrument.  The
     Company  performs  on-going credit  evaluations and maintains  reserves for
     potential credit losses; historically such losses have been


                                       29
<PAGE>

     immaterial.  The Company minimizes the amount of cash it maintains in local
     currencies by maintaining excess cash in United States dollars.

         No customer accounted for more than 10% of total accounts receivable at
     December 31, 1996 and 1995 and no customer  accounted  for greater than 10%
     of revenue in any period presented.

     Use of estimates

         The  preparation of financial  statements in conformity  with generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosure  of  contingent  assets  and  liabilities  at  the  date  of the
     financial statements,  and reported amounts of revenues and expenses during
     the reporting period. Actual results could differ from those estimates.

     Reclassifications

         Certain amounts in the 1995 financial statements have been reclassified
     to conform to the 1996 presentation.

     Dependence on suppliers

         The Company's  ability to timely deliver its products is dependent upon
     the  availability  of  quality  components  and  subsystems  used in  these
     products.  The Company depends in part upon  subcontractors to manufacture,
     assemble and deliver certain items in a timely and satisfactory manner. The
     Company obtains certain components and subsystems from single, or a limited
     number of sources. A significant interruption in the delivery of such items
     could have a material adverse effect on the Company's  financial  condition
     and results of operations.

2.   Initial Public Offering

         In February 1996, the Company completed its initial public offering and
     issued  5,000,000  shares of its  common  stock to the public at a price of
     $15.00 per share. In March 1996, the underwriters exercised their option to
     cover over-allotments and an additional 750,000 shares of common stock were
     issued at $15.00 per share. The Company received  approximately $79 million
     of cash,  net of  underwriting  discounts,  commissions  and other offering
     costs.

     In connection  with the Company's  initial  public  offering,  the Board of
     Directors authorized the issuance of up to 5,000,000 shares of undesignated
     preferred  stock and the Board has the authority to issue the  undesignated
     preferred  stock in one or more series and to fix the rights,  preferences,
     privileges and restrictions  thereof. No preferred stock had been issued as
     of December 31, 1996.


                                       30
<PAGE>

3.   Details of Balance Sheet Components

                                                                December 31,
                                                           1996           1995
                                                              (in thousands)

Inventories:
   Raw materials                                         $ 4,126        $ 3,042
   Work in process and subassemblies                       3,196          1,773
   Finished goods                                          1,506          1,281
                                                         -------        -------
                                                         $ 8,828        $ 6,096
                                                         =======        =======

Property and equipment:
   Machinery and equipment                               $ 7,068        $ 4,995
   Furniture and fixtures                                    624            179
   Leasehold improvements                                    564            267
                                                         -------        -------
                                                           8,256          5,441
   Less:  accumulated depreciation
      and amortization                                    (4,496)        (3,146)
                                                         -------        -------
                                                         $ 3,760        $ 2,295
                                                         =======        =======

Accrued liabilities:
   Accrued compensation and benefits                     $ 2,116        $ 1,037
   Accrued royalties                                         665            428
   Accrued employee severance costs                          634           --
   Accrued distributor commissions                           543            252
   Accrued professional fees                                 235          1,365
   Other accrued liabilities                                 897            659
                                                         -------        -------
                                                         $ 5,090        $ 3,741
                                                         =======        =======


4.   Short-term Investments

         The cost and fair value of the Company's  short-term  investments as of
     December 31, 1995 were as follows (in thousands):


                                                                   Unrealized
                                          Cost       Fair Value       Loss

Short-term investments                   $3,274        $2,858        $  416
                                         ======        ======        ======


         Short-term  investments generally consisted of preferred stock and were
     sold  during  1996  resulting  in a loss of  $432,000.  The  Company had no
     short-term investments as of December 31, 1996.

5.   Bank Line of Credit

         In July 1995, the Company  signed a credit  agreement with a bank which
     provided a line of credit for working capital  advances of up to $5,000,000
     or a specified percentage of eligible accounts receivable,  plus $2,000,000
     or a specified  percentage of  short-term  investments,  respectively.  Any
     advances under the line of credit were  collaterized  by certain assets and
     intellectual property of the Company. Interest on borrowings under the line
     of credit was set at the 30 day LIBOR plus 2.0%.  Among  other  provisions,
     the  Company  was  required to maintain  certain  financial


                                       31
<PAGE>

     covenants.  In addition,  payment of cash dividends was prohibited  without
     the bank's  consent.  At December  31,  1995,  the  Company had  $1,000,000
     outstanding under the line of credit which was repaid during 1996. The line
     of  credit  agreement  expired  in July  1996  and was not  renewed  by the
     Company.

6.   Income Taxes

         The provision (benefit) for income taxes consists of the following:

                                             Year ended December 31,
                                     1996            1995             1994
                                                (in thousands)

Current:
   Federal                           $ 709           $(403)          $(258)
   State                                58             (92)            (58)
   Foreign                            --               123              66
                                     -----           -----           -----
                                       767            (372)           (250)
                                     -----           -----           -----

Deferred:
   Federal                            (478)           (348)           (143)
   State                               (38)            (35)            (59)
                                     -----           -----           -----
                                      (516)           (383)           (202)
                                     -----           -----           -----
                                     $ 251           $(755)          $(452)
                                     =====           =====           =====


         Deferred tax assets (liabilities) comprise the following:

                                                                December 31,
                                                            1996           1995
                                                              (in thousands)

Assets:
Net operating loss and credit carryforwards               $   984       $ 1,235
Unrealized capital loss                                       166           161
Bad debt reserve                                              230           162
Inventory reserves and basis differences                    1,382         1,063
Accrued expenses                                              448           200
Deferred rent                                                  30            22
Warranty reserve                                               60            33
Other                                                         102            77
                                                          -------       -------
         Total deferred tax assets                          3,402         2,953
                                                          -------       -------

Liabilities:
Depreciation                                                   (5)         (123)
Other liabilities                                              (7)          (64)
                                                          -------       -------
         Total deferred tax liabilities                       (12)         (187)
                                                          -------       -------
Valuation allowance                                        (1,970)       (1,862)
                                                          -------       -------
Net deferred tax assets                                   $ 1,420       $   904
                                                          =======       =======


                                       32
<PAGE>

         Net deferred tax assets of  $1,420,000  at December 31, 1996 were based
     on the Company's  carryback capacity and expected future income in the next
     twelve months.  Based on the available  objective  evidence,  including the
     operating losses  experienced in recent years,  management  cannot conclude
     that it is more likely than not a portion of the  deferred  tax assets will
     be realized and,  therefore,  the Company has recorded a partial  valuation
     against the deferred tax assets.

         The provision  (benefit)  reconciles to the amount computed by applying
     the United States federal statutory rate to income before taxes as follows:

                                                     Year ended December 31,
                                                  1996        1995      1994

U.S. federal statutory income tax rate            34.0%     (34.0)%    (34.0)%
State taxes, net of federal tax benefit            0.9       (4.6)      (6.7)
Research and development tax credits             (24.2)       --        (3.0)
Change in valuation allowance                      7.4        --         --
Foreign losses not benefitted                      5.2        --         --
Other                                             (6.0)      (2.6)       4.5
                                                  ----      -----      -----
   Effective tax rate                             17.3%     (41.2)%    (39.2)%
                                                  ====      =====      =====


         The Company has not provided  United States federal income taxes on the
     undistributed  earnings of foreign subsidiaries because it is the Company's
     intention to permanently reinvest such earnings. At December 31, 1996, 1995
     and  1994,  total   undistributed   earnings  of  these  subsidiaries  were
     approximately $1,846,000, $1,579,000 and $1,341,000, respectively.

         The Company had  research  and  development  credit  carry  forwards of
     approximately  $980,000  and  $1,200,000  at  December  31,  1996 and 1995,
     respectively, which expire from 2009 to 2010.


7.   Stock Option Plans

     The Company has  adopted the 1987 Stock  Option Plan and the 1994  Flexible
     Stock Incentive Plan (collectively  known as the "Plans") which provide for
     the grant of incentive  stock  options and  nonqualified  stock  options to
     executives,  employees  and  consultants  to purchase up to  2,010,000  and
     3,950,000  common  shares,  respectively.  Stock  options may be granted at
     prices  not less than 100% and 85% for  incentive  and  nonqualified  stock
     options, respectively, of the fair market value of the stock on the date of
     grant.  Through December 31, 1996, all nonqualified stock options have been
     granted at 100% of the fair market value of the stock on the date of grant.
     Options  granted  under the Plans are  exercisable  at such times and under
     such conditions as determined by the Board of Directors, and generally vest
     over five years. Options expire ten years from the date of grant.

     Shares issued upon exercise of options are subject to certain  restrictions
     on their  transferability.  The  Company has the right to  repurchase  such
     shares,  at a price equal to the fair market value, when the optionee is no
     longer associated with the Company.  Shares repurchased increase the number
     of shares available for grant under the Plans.


                                       33
<PAGE>

The following  table  summarizes the Company's stock option activity and related
weighted average exercise price within each category for each of the three years
in the period ended December 31, 1996:

                                                                      Weighted
                                         Shares                        Average
                                        Available       Options       Exercise
                                        for grant     Outstanding      Price

Balance at December 31, 1993             102,200       1,531,400      $ 0.93
   Approved                            2,750,000            --
   Granted at market price            (1,949,445)      1,949,445        1.84
   Exercised                                --           (13,800)       0.73
   Canceled                               67,100         (67,100)       1.61
   Repurchased                            13,200            --
                                      ----------       ---------

Balance at December 31, 1994             983,055       3,399,945        1.44
   Approved                            1,200,000            --
   Granted at market price              (779,450)        779,450        2.60
   Granted below market price           (436,000)        436,000        2.02
   Exercised                                --        (1,462,785)       1.25
   Canceled                              315,452        (315,452)       1.91
                                      ----------       ---------

Balance at December 31, 1995           1,283,057       2,837,158        1.89
   Approved                            2,000,000            --
   Granted at market price            (2,042,810)      2,042,810       12.53
                                      ----------       ---------
   Exercised                                --          (760,492)       1.44
   Canceled                              741,723        (741,723)       4.89
                                      ----------       ---------

Balance at December 31, 1996           1,981,970       3,377,753      $ 7.72
                                       =========       =========

<TABLE>

         Significant option groups outstanding at December 31, 1996, and related
weighted average exercise price and contractual life information are as follows:

<CAPTION>
                                       Options Outstanding                           Options Exercisable
                     --------------------------------------------------------   ------------------------------

                                           Weighted
                                            Average           Weighted                             Weighted
      Range of            Number           Remaining           Average             Number           Average
  Exercise Prices      Outstanding     Contractual Life    Exercise Price       Outstanding     Exercise Price
<S>                     <C>                    <C>             <C>                <C>             <C>
$ 0.25 to $ 4.80        1,398,753              7.0             $ 1.78             823,342         $ 1.65
$ 6.40 to $11.00        1,172,667              9.7              10.32              26,782           6.40
$11.25 to $14.56          550,633              9.9              12.08               4,601          12.73
$17.25 to $23.50          255,700              9.3              18.92              14,584          19.28
                       ----------                                                --------
$ 0.25 to $23.50        3,377,753              8.6             $ 7.72             869,309         $ 2.15
                       ==========                                                ========
</TABLE>

         The weighted  average  estimated  grant date fair value,  as defined by
SFAS 123, for options granted during 1995 at market price and below market price
on the dates of grant were $1.04 and $1.47,  respectively.  The weighted average
estimated  grant date fair value, as defined by SFAS 123, for options granted at
market  price  during  1996 was  $6.03.  The  estimated  grant  date fair  value
disclosed  by the  Company is  calculated  using the  Black-Scholes  model.  The
Black-Scholes  model,  as well as  other  currently  accepted  option  valuation
models,  was  developed  to estimate the fair value of freely  tradeable,  fully
transferable  options without vesting  restrictions,  which significantly differ
from the  Company's  stock  option  awards.  These  models also  require  highly
subjective  assumptions,  including  future stock price  volatility and expected
time until exercise, which greatly affect the calculated grant date fair value.


                                       34
<PAGE>

         The  following  weighted  average   assumptions  are  included  in  the
estimated  grant date fair value  calculations  for the  Company's  stock option
awards:

                                                   1996                1995

Expected life (years)                               3.04                3.04
Risk-free interest rate                             5.93%               6.22%
Volatility                                         69.46%              54.89%
Dividend yield                                      0.00%               0.00%


         Had the Company  recorded  compensation  costs  based on the  estimated
     grant date fair value, as defined by SFAS 123, for awards granted under its
     stock option  plans,  the Company's net income (loss) and net income (loss)
     per share would have been  reduced to the pro forma  amounts  below for the
     years ended December 31, 1996 and 1995 (in thousands,  except for per share
     amounts):

                                                             1996        1995

Net income (loss)                     As reported          $ 1,197     $(1,079)
                                      Pro forma               (325)     (1,354)

Net income (loss) per share           As reported          $  0.05     $ (0.06)
                                      Pro forma              (0.01)      (0.07)


         The pro forma  effect on net income  (loss)  and net income  (loss) per
     share for 1996 and 1995 is not  representative  of the pro forma  effect on
     net income in future years because it does not take into  consideration pro
     forma compensation expense related to grants made prior to 1995.

         As of December 31, 1995,  the Company had granted  certain  options for
     the  purchase of common stock at less than the deemed fair market value and
     approximately  $417,000 of compensation expense is being amortized over the
     five-year vesting period of the options.

8.   Notes Receivable From Shareholders

         During  November  1995,  the Company  made loans  totaling  $515,000 to
     certain  employees  pursuant to the Company's 1994 Flexible Stock Incentive
     Plan.  The loans bear interest at 8.0% per annum and are secured by 427,000
     shares of the Company's  common stock.  The loans were due in November 1996
     or, if earlier,  upon the  borrower's  termination  of employment  with the
     Company.  During 1996, the Company extended the due dates on certain of the
     loans.  As of  December  31,  1996,  the  remaining  balance on these loans
     totaled $301,000 and is due in February 1997.

9.   Research and Development Contracts

         During the years ended  December 31, 1996,  1995 and 1994,  the Company
     performed   research  and  development  under  several   government  funded
     arrangements aggregating $3,777,000,  $526,000 and $297,000,  respectively.
     These contracts provide funding  (irrespective of the results) for research
     and development of certain cryptographic technologies which will be jointly
     owned by the Company and these government agencies.  Amounts received under
     these contracts are offset against research and development expenses.

         The Company  performed  research and  development  under  several other
     research and  development  contracts  which provide for the development and
     transfer of technology  in exchange for  development  funding.  The Company
     recorded as a reduction of research and  development  expenses  $2,363,000,
     $604,000 and $367,000 under such  arrangements  in the years ended December
     31, 1996, 1995 and 1994,  respectively.  The funds received under contracts
     in  progress,   included  in  deferred   revenue  pending   achievement  of
     milestones,  totaled  $1,050,000 as of December 31, 1995. No funds had been
     received under such  contracts in advance of the  achievement of milestones
     as of December 31, 1996.


                                       35
<PAGE>

         In 1991,  the Company  entered into an agreement  with a third party to
     partially fund research and  development  related to certain  cryptographic
     technology.  The  Company is required  to pay  royalties  of 5% on sales of
     products  developed  under this  research  project.  In  connection  with a
     contract  amendment in 1993, the Company  prepaid  royalties of $300,000 in
     exchange for limitations on total royalties,  not to exceed  $712,000.  The
     prepaid royalties were fully amortized as of December 31, 1995.


10.  Joint Venture and Contingencies

         On  September  6, 1995,  the  Company  obtained  an  arbitration  award
     dissolving  a former  partnership,  known as Public Key  Partners  ("PKP"),
     between the Company's wholly-owned subsidiary,  Caro-Kann Corporation,  and
     RSA DSI.  Although  various  claims  between  the  Company and RSA DSI were
     settled on December  31, 1996,  a third party  continues to pursue  various
     claims  against PKP and RSA DSI for wrongful  business  practices in action
     C-94-20512  SW before the United  States  District  Court for the  Northern
     District of California. Management believes that the ultimate resolution of
     this  matter  will not have a  material  adverse  effect  on the  Company's
     financial position or results of operations.

     Subsequent event (unaudited)

         On March 7, 1997,  ten former  employees  of the Company  filed suit in
     action No.  CV764647 in the Superior Court of  California,  County of Santa
     Clara, against the Company,  each of its Directors and its General Counsel,
     asserting  claims for wrongful  termination,  fraud,  libel,  slander,  age
     discrimination,  invasion of privacy,  and  violation  of the federal  RICO
     statute.  Although  the Company has placed its  insurers on notice of these
     claims,  none of them have  admitted  coverage.  The Company  believes  the
     terminations were lawful and intends to defend the matter  vigorously.  The
     defense  of this  matter  may  divert a  material  amount  of  management's
     attention and require the expenditure of significant  legal fees and costs.
     An unfavorable outcome which exceeds the Company's  insurance coverage,  if
     any,  may  also  result  in a  material  adverse  effect  on the  Company's
     financial  condition.   However,  management  believes  that  the  ultimate
     resolution  of this matter will not have a material  adverse  effect on the
     Company's financial position or results of operations.



                                       36
<PAGE>

     11. Geographic Information

         The Company operates in one industry  segment.  Revenue,  income (loss)
     from operations and identifiable assets, classified by the major geographic
     areas in which the Company operates, were as follows:

                                                     Year ended December 31,
                                                  1996        1995        1994
                                                         (in thousands)

Revenue:
   Sales to unaffiliated customers:
      United States:
         Customers in United States            $ 21,553    $ 18,677    $ 17,425
         Customers in Central and
            South America                         9,387       5,084       3,778
         Customers in Europe                      7,067       2,076       1,027
         Other                                    9,736       5,455       2,134
      Europe                                      4,215       3,610       2,282
                                               --------    --------    --------
                                               $ 51,958    $ 34,902    $ 26,646
                                               ========    ========    ========

Intercompany sales among geographic
   entities eliminated in consolidation        $  2,445    $  1,950    $  1,098
                                               ========    ========    ========

Income (loss) from operations:
   United States                               $ (1,784)   $ (4,053)   $ (2,615)
   Europe                                            26         363          66
                                               --------    --------    --------
                                               $ (1,758)   $ (3,690)   $ (2,549)
                                               ========    ========    ========


                                                                December 31,
                                                             1996         1995
                                                                (in thousands)

Identifiable assets:
   United States                                           $ 26,026     $ 15,501
   Europe                                                     2,213        1,126
                                                           --------     --------
                                                             28,239       16,627

General corporate assets consisting of cash,
   cash equivalents and short-term investments               78,849        6,098
                                                           --------     --------
                                                           $107,088     $ 22,725
                                                           ========     ========


         Intercompany sales among the Company's geographic areas are recorded on
the basis of intercompany prices established by the Company.

         At December 31, 1996 and 1995,  total  foreign  liabilities  (excluding
intercompany balances) were $660,000 and $765,000, respectively.


                                       37
<PAGE>


12.  Lease Commitments

         The Company  leases its  headquarters  and  manufacturing  facility and
     sales offices under various  noncancelable  operating leases.  These leases
     expire at various  dates  through  June 2001 and  certain of the leases are
     renewable  for an additional  five years.  In addition to the minimum lease
     payments,  the Company is responsible  for  insurance,  repairs and certain
     other  operating  costs  under the terms of the leases.  The  Company  also
     leases  certain   equipment  under  long-term  lease  agreements  that  are
     classified as capital leases. These capital leases, which consist primarily
     of computer  equipment,  terminate at various  dates  through  2000.  Total
     equipment  acquired  under  these  capitalized  leases,  which  secure such
     borrowings,  was  $621,000  at cost and  $445,000  at net book  value as of
     December 31, 1996.

         Future  minimum lease payments  under all  noncancelable  operating and
     capital leases are as follows (in thousands):

                                                           Operating     Capital
Year ending December 31,                                     Leases      Leases

   1997                                                     $ 1,177      $ 219
   1998                                                       1,175        191
   1999                                                         721         86
   2000                                                         393          8
   2001                                                         197       --
                                                            -------      -----
   Total minimum payments                                   $ 3,663        504
                                                            =======
   Less:  amount representing interest                                     (96)
                                                                         -----
   Present value of capital lease obligations                              408
   Less:  current portion                                                 (167)
                                                                         -----
   Lease obligations, long-term                                          $ 241
                                                                         =====


         Rent expense under operating  leases totaled  $1,207,000,  $909,000 and
$708,000 during the years ended December 31, 1996, 1995 and 1994, respectively.






                                       38
<PAGE>


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         Not applicable.


                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The  information  required  by this Item  with  respect  to  directors,
appearing  under the  caption  "Election  of  Directors"  including  subcaptions
thereof,  in the  Company's  Proxy  Statement  for the 1997  annual  meeting  of
shareholders  to be held on or about May 22,  1997 (the "Proxy  Statement")  and
which will be filed in definitive  form  pursuant to  Regulation  14a before the
meeting  date  and  within  120 days  after  the end of  fiscal  year  1996,  is
incorporated  herein  by  reference.  The  information  required  by  this  Item
concerning the Company's  executive officers is set forth in Part I hereof under
the caption "Executive Officers of the Registrant."


ITEM 11.  EXECUTIVE COMPENSATION

         The  information  required  by this Item  appearing  under the  caption
"Executive  Compensation and Other Information" in the Company's Proxy Statement
is incorporated herein by reference.


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The  information  required  by this Item  appearing  under the  caption
"Security  Ownership  of  Certain  Beneficial  Owners  and  Management"  in  the
Company's Proxy Statement is incorporated herein by reference.


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The  information  required  by this Item  appearing  under the  caption
"Certain  Transactions" in the Company's Proxy Statement is incorporated  herein
by reference.


                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K

(a)   1.    Financial   Statements  --  See  index  to  Consolidated   Financial
            Statements and Financial  Statement Schedule at page 23 of this Form
            10-K.
      2.    Financial Statement Schedule -- See Index to Consolidated  Financial
            Statements and Financial  Statement Schedule at page 23 of this Form
            10-K.
      3.    Exhibits Index:

         Exhibit
         Number      Description of Exhibit
         ------      ----------------------

            3.1      Amended  and  Restated  Articles  of  Incorporation  of the
                     Registrant (1) and  Certificate of Amendment  thereto dated
                     March 5, 1996.

            3.2      Bylaws, as amended. (1)

            3.3      Certificates of Amendment of Bylaws dated March 26, 1997

            4.1      Reference is made to Exhibits 3.1 and 3.2.

            4.2      Specimen certificate for Common Stock. (1)


                                       39
<PAGE>

            10.1     Stockholder  Agreement,  dated as of  September  29,  1989,
                     between the Company and the shareholders set forth therein,
                     and amendments thereto. (1)

            10.2     Form of  Indemnification  Agreement between the Company and
                     each of its executive officers and directors. (1)

            10.3     Employment  Agreement  between  the  Company  and  Lewis C.
                     Morris,  dated April 1, 1989, and amendments  thereto.  (1)
                     (2)

            10.4     Employment  Agreement  between  the  Company  and  Jimmy K.
                     Omura,  dated as of April 1, 1989, and amendments  thereto.
                     (1) (2)

            10.5     Employment  Agreement  between  the  Company and Fernand B.
                     Sarrat, dated as of November 6, 1996. (2)

            10.6     Lease Agreement between the Company and ARGOSystems,  Inc.,
                     a wholly-owned  subsidiary of The Boeing Company, dated May
                     1, 1994. (1)

            10.7     License  Agreement  between  the  Company  and The Board of
                     Trustees of the Leland Stanford Junior University, dated as
                     of  August  25,  1989,  the  First   Amendment  to  License
                     Agreement,  dated  as of  April  6,  1990,  and the  Second
                     Amendment to License  Agreement,  dated as of July 7, 1995.
                     (1)

            10.8     Company's 1987 Non-Qualified  Stock Option Plan,  including
                     forms of agreements thereunder. (1) (2)

            10.9     Company's 1994 Flexible  Stock  Incentive  Plan,  including
                     forms of agreements thereunder, and amendments thereto. (1)
                     (2)

            10.10    Loan and Security Agreement between the Company and Silicon
                     Valley Bank dated as of July 20, 1995. (1)

            11.1     Statement  regarding  calculation  of net income (loss) per
                     share.

            21.1     Subsidiaries of the Company. (1)

            23.1     Consent of Price Waterhouse LLP.

            24.1     Power of Attorney. Reference is made to Page IV-2.

            27.1     Financial Data Schedule.


             ----------
            (1)      Incorporated  by reference from the Company's  Registration
                     Statement  on Form S-1  Registration  No. 33- 80719,  which
                     became effective February 15, 1996.

            (2)      Management  contract or  compensatory  plan or  arrangement
                     required  to be filed as an exhibit to this  report on Form
                     10-K pursuant to Item 14(a).

(b)    The Company did not file or amend any reports on Form 8-K during the last
       quarter of the fiscal year ending December 31, 1996.



                                       40
<PAGE>

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                      CYLINK CORPORATION

Date:  March 21, 1997                 By:      /s/  FERNAND B. SARRAT
                                                  -------------------
                                               Fernand B. Sarrat
                                               President and Chief Executive
                                                 Officer

         KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature
appears below  constitutes and appoints John H. Daws and Robert B. Fougner,  and
each of them, acting  individually,  as his or her  attorney-in-fact,  each with
full power of substitution  and  resubstitution,  for him and in his name, place
and stead,  in any and all  capacities,  to sign any and all  amendments to this
Report on Form 10-K, and to file the same, with all exhibits thereto,  and other
documents in connection therewith,  with the Securities and Exchange Commission,
granting unto said  attorneys-in-fact  and agents,  and each of them, full power
and  authority  to do and  perform  each and every act and thing  requisite  and
necessary to be done in connection therewith and about the premises, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said  attorneys-in-fact and agents, or any of them, or their
or his substitute or substitutes,  may lawfully do or cause to be done by virtue
hereof.
<TABLE>

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.

<CAPTION>

Signature                                            Title                                                Date
---------                                            -----                                                ----

<S>                                         <C>                                                  <C>
/s/  FERNAND B. SARRAT                      President and Chief Executive Officer                March 21, 1997
     -----------------                      (Principal Executive Officer)
     Fernand B. Sarrat

/s/  JOHN H. DAWS                           Vice President of Finance and Administration         March 21, 1997
     ------------                           and Chief Financial Officer
     John H. Daws                           (Principal Financial and Accounting Officer)


/s/  JIMMY K. OMURA                         Chief Technical Officer and Director                 March 21, 1997
     --------------
     Jimmy K. Omura

/s/  LEO A. GUTHART                         Chairman of the Board                                March 21, 1997
    ---------------
     Leo A. Guthart

/s/  ELWYN BERLEKAMP                        Director                                             March 21, 1997
     ----------------
     Elwyn Berlekamp

/s/  KING W.W. HARRIS                       Director                                             March 21, 1997
     ----------------
     King W.W. Harris

/s/  WILLIAM W. HARRIS                      Director                                             March 21, 1997
     -----------------
     William W. Harris

/s/  HOWARD L. MORGAN                       Director                                             March 21, 1997
     ----------------
     Howard L. Morgan

/s/  JAMES H. SIMMONS                       Director                                             March 21, 1997
     ----------------
     James H. Simmons

</TABLE>


                                       41
<PAGE>

                                                                     SCHEDULE II

                               CYLINK CORPORATION

                        VALUATION AND QUALIFYING ACCOUNTS
                  Years ended December 31, 1994, 1995 and 1996
                                 (in thousands)


                                                Additions
                                  Balance at    Charged to   Deductions  Balance
                                  Beginning    Statement of    from      at end
                                  of Period    Operations    Reserves  of Period
                                  ---------    ----------    --------  ---------
Allowance for doubtful accounts
Year ended December 31, 1994        $ 175         $ 104        $ --       $ 279

Year ended December 31, 1995        $ 279         $ 210        $  (6)     $ 483

Year ended December 31, 1996        $ 483         $ 269        $ 108      $ 644






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