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, 1998          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 Identification No.)
incorporation or organization) 


                                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. [ ]


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 29,
1999, as reported by the Nasdaq National Market, was approximately $127,390,000.
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 29, 1999, there were 29,118,467  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  14,  1999,  are  incorporated  by
reference in Part III of this Form 10-K to the extent stated herein.


<PAGE>

                                     PART I


This  Report on Form 10-K  includes  statements  that  reflect  Cylink's  belief
concerning  future events and financial  performance.  Statements  which are not
purely historical in nature are called "forward looking  statements"  within the
meaning of Section  27A of the  Securities  Act of 1933 and  Section  21E of the
Securities   Exchange  Act  of  1934.  We  sometimes  identify  forward  looking
statements with such words as "expects", "anticipates", "intends", "believes" or
similar words concerning future events.

You should not rely too heavily on these forward  looking  statements.  They are
subject to certain  risks and  uncertainties  that may cause  actual  results to
differ materially from past results or Cylink's  predictions.  For a description
of these risks see the reasons  described in Item 1  "Business" - "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 Cylink's
Reports on Form 10-Q, 10-Q/A, and 8-K.

All   forward-looking   statements  included  in  this  document  are  based  on
information  available to Cylink as of the date of this Report on Form 10-K, and
Cylink assumes no obligation to update any such forward-looking  statements,  or
to update the reasons why actual  results  could differ from those  projected in
the forward-looking statements.


ITEM 1.  BUSINESS

Cylink  develops and delivers  trusted  solutions  for secure  transactions  and
communications  over local area networks ("LANs"),  wide area networks ("WANs"),
public packet switched networks,  such as the Internet,  and broadcast networks.
Cylink's  products offer an integrated,  flexible  solution for transforming any
portion of an  enterprise's  network into a virtual  private  network ("VPN") by
utilizing   public  key  encryption   technologies   to  create  and  manage  an
enterprise's security infrastructure, and to provide secure access for local and
remote  authorized users of its proprietary  information and services.  Cylink's
network  security  portfolio  consists  of  hardware  and  software   encryption
platforms,   certificate  servers,  remote  access  gateways,  network  security
management systems, toolkits, public key processors, advanced smart cards, smart
card operating  systems,  easily  deployed card readers and  conditional  access
technology  for  broadcast  networks. 

Cylink was formed in 1983 and  commenced  operations  in 1984.  In February  and
March of 1996, Cylink completed its initial public offering and its Common Stock
began  trading on the Nasdaq  National  Market  under the  symbol  CYLK.

Cylink  operates  in one  industry  segment -- secure  communications  products.
Cylink's principal operations outside of the United States comprise research and
development in Israel,  as well as sales and service  offices located in Israel,
the United  Kingdom and several other  countries in Europe and the Far East. See
Note 10 of the Notes to  Consolidated  Financial  Statements for geographic area
information.

<TABLE>
The following table sets forth Cylink's principal products:
<CAPTION>

Product                                     Description
-------                                     -----------
<S>                                         <C>
PrivaCy Manager                             Unified Java-based Management Platform For Cylink's Global Network and
                                            Enterprise Security Product Families

                                            Global Network Product Family

CED Card                                    Signaling System Encryptor
CIDEC                                       Point to Point Encryptors
Link Encryptor                              Point to Point Encryptors
LSA                                         Remote Access Dial Up Encryptors
Secure ATM                                  ATM Network Encryptors

                                       1
<PAGE>

SecureFrame                                 Frame Relay Packet Encryptor
Secure X-25                                 X-25 Packet Encryptors

                                            Enterprise Security Product Family

CryptoKit                                   Cryptographic Software Development Tools
EPA Card                                    Encryption Processor for Cisco 7700 Series Router
PrivateCard                                 Public Key Smart Card
PrivateSafe                                 Portable Secure PIN Smart Card Reader
PrivateWire                                 Secure TCP/IP Communications, Remote Access
SecureDomain                                Router Domain Packet Encryptor
</TABLE>

Cylink and its wholly owned  subsidiary,  Algorithmic  Research Limited ("ARL"),
have developed  integrated  software toolkits which are incorporated in Cylink's
network security  products.  These software  libraries  implement the Public Key
cryptography techniques for Cylink's key management systems,  digital signatures
and  certificates to provide  complete,  and scaleable  enterprise-wide  network
security solutions.

Cylink also 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  network  security  products are designed to secure  existing  networks
without reducing  performance or requiring  modifications to customers' existing
network  hardware or software.  This ease of integration is accomplished  with a
broad range of hardware  and  software  implementations  of network  interfaces,
which enable Cylink's security products to connect to most networks in use today
throughout the world.

PrivaCy Manager. PrivaCy Manager consolidates Cylink's security management tools
for its CIDEC,  Link Encryptor,  SecureDomain  and  SecureFrame  products into a
single Java-based platform having an integrated Public Key certificate authority
to prevent  unauthorized  devices from masquerading as legitimate devices within
the  customer's  network.  With its  graphical  representation  of the network's
topology, and its point-and-click  interface, the network security structure can
be easily  visualized,  simplifying  the  tasks of  configuring,  modifying  and
managing the network's  security.  Furthermore,  PrivaCy Manager can implement a
broad range of security  policies  for  determining  access to network  security
devices. By periodically  polling each secure device,  PrivaCy Manager maintains
an  audit  trail  of  network  security  activities,   including   administrator
operations,  user logins,  logouts,  traps and alarms.  PrivaCy Manager remotely
configures, monitors and performs firmware downloads.

Global Networks  Product Family.  Cylink entered the network  security market in
1986 to secure  communications  within wide area networks  ("WANs") over private
leased lines. The CIDEC and Link Encryptor product families form a complete line
of link  encryptors  that utilize  Public Key  management  techniques to support
conventional encryption algorithms, such as the data encryption standard ("DES")
and its improved version, known as Triple DES.

Depending on the model,  Cylink's Link  Encryptors  and CIDEC models  operate at
varying data rates over private and public networks and support most widely used
data link protocols. Cylink's original CIDEC line of data encryption products 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")). Cylink believes that
its  CIDEC-VHS/VHX  products are the fastest data link  encryptors  commercially
available in the world today.

To support its  customers  who deploy their WANs over shared,  public  networks,
Cylink also developed  packet  encryptors  which enable secure  transmission  of
packets of data  between  two  points in X.25 and Frame  Relay  based  networks.
Cylink's Secure X-25 offers encryption for public switched packet networks based
on X.25 packet  transmission  technology  and supports data rates up to 64 kbps,
and up to 512 virtual circuits.

Cylink's SecureFrame products are 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.

                                       2
<PAGE>

The Cylink ATM  Encryptor  is an OC-3 (or T3/E3) rate  security  gateway for ATM
networks.  It creates a virtual  trusted  network that provides data privacy and
access  control for  connections  between  trusted ATM local area  networks  and
across public ATM wide area networks.

Enterprise  Security  Products  Family.  With  the  acquisition  of ARL,  Cylink
broadened  its remote  access  solutions  to include the  PrivateWire  family of
TCP/IP  based  software,  component  libraries,  smart card  tokens,  and easily
deployed card readers.  The PrivateWire family of components  includes a toolkit
for  integrating  all of  the  PrivateWire  products  with  customers'  existing
applications.

PrivateWire  provides low cost,  premium  security  services  for  authorization
management   and   remote   access,   as  well  as  a   comprehensive   security
infrastructure,  over  TCP/IP  communications.   Security  is  provided  at  the
application  as well as the  communications  level.  Application-level  security
allows for digital signing of sensitive transactions,  reciprocal authentication
is established using Public Key cryptography,  and  communications are encrypted
using one-time session keys. Changes to security policy can be easily configured
and defined from local or remote  locations by any  authorized  manager  using a
standard web browser.

CryptoKit  is a  platform-independent,  software  development  security  kit for
integrating   ARL's   security   modules  into   customers'   existing   network
applications.  CryptoKit  serves  either as a stand alone  toolkit for providing
cryptographic  services,  or as a tool to  upgrade  the  customer's  network  by
creating interoperability with Cylink's products, such as PrivateWire.

PrivateCard,  developed  by ARL, is an advanced,  electronic  smart card with an
on-board  Public  Key  processor.  In  combination  with ARL's  other  products,
PrivateCard   serves  as  a  fully   functional,   secure   personal  token  for
authenticated and encrypted transactions.

PrivateSafe is a highly  portable  secure PIN smart card reader and is simple to
install by merely  plugging in two cables  between the  keyboard  and the client
computer.

The SecureDomain  encryption unit is designed to provide  packet-based  security
solutions which enable  enterprises to use the Internet as part of their own VPN
by  creating  and  controlling   access  to  groups  within  the  network.   The
SecureDomain  product is a hardware  device that resides  between the router and
subnet in a LAN, and supports simultaneous secured TCP/IP and IPX communications
among networks and subnets.  By securing the payload portion of network traffic,
SecureDomain is transparent to the network and user  applications.  In addition,
packet  address  information is left intact,  allowing  traffic to flow over any
public or private network without compromising network performance.

Cylink's future results of operations will be highly dependent on the successful
marketing and customer  acceptance of Cylink's latest  products,  including both
PrivaCy Manager and PrivateWire.  To date, Cylink has made only modest shipments
of such  products.  These  products  may require  additional  development  work,
enhancement,  testing or further  refinement  before they can be introduced  and
made commercially available by Cylink or achieve market acceptance.  If such new
and recently introduced products have performance, reliability, quality or other
shortcomings,  then such products  could fail to achieve  market  acceptance and
Cylink 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 Cylink's  financial
condition  and results of  operations.  See  "Business - Risk  Factors  That May
Affect  Future  Results --  Dependence  on Recently  Introduced  and New Network
Security Products, and -- Product Liability Risks."

Sales, Marketing and Customer Support

Cylink,  including its subsidiary,  ARL, markets its products  primarily through
its direct sales force and, to a lesser extent,  through distributors.  Cylink's
direct sales force operates from Cylink's headquarters in Sunnyvale, California,
ARL's offices in Petach Tikva,  Israel, and other regional sales offices located
in the United States,  Europe, and the Far East. Cylink's sales force, engineers
and technical  personnel  must work closely with customers in order to determine
system security and network configurations that meet the customers' needs.

International  sales  are  made  primarily  through  Cylink's   headquarters  in
Sunnyvale,  CA, five foreign sales offices,  and numerous  distributors.  Cylink
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.

                                       3
<PAGE>

To date, the majority of Cylink's  customers for its network  security  products
have been Fortune 1000 companies,  financial  institutions,  government agencies
and  telecommunication  carriers who rely on Cylink's Global Network Products to
encrypt and secure their WANs operating over private leased lines.  

Cylink 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.  Cylink  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.

Cylink  offers  service and support from its  headquarters, and from service and
support  centers  in New  Jersey,  the  United  Kingdom,  Brussels,  Israel  and
Singapore.  Telephone support is available twenty-four hours per day, seven days
per week, through a toll-free hotline.

Cylink's products  developed or manufactured in the United States are subject to
the export control laws of the United States and regulations  promulgated by the
U.S.  Department  of  Commerce.  Certain  limitations  applied  by the  Commerce
Department  affect  the type and  functionality  of the  products  which  may be
exported.  Furthermore,  interpretation  and  compliance  with  these  licensing
regulations   are  clouded  by   disagreements   among  various   administrative
departments  of the United States  Government  concerning  their  application to
Cylink's encryption technology.  These disagreements tend to delay and interfere
with the  predictability  of the  licensing  process for Cylink's  products.  In
addition,  these United  States  export laws  prohibit the export of  encryption
products to a number of hostile  countries.  Similar  export  control  laws also
apply to  Cylink's  products  and  technology  developed  by ARL in Israel,  and
exported to customers outside of Israel.

Although to date Cylink has been able to secure the necessary export licenses to
compete effectively in the international market Cylink may not be able to secure
such  licenses in a timely manner in the future,  or at all. In certain  foreign
countries,  Cylink's  distributors  are  required  to secure  licenses or formal
permission  before  encryption  products  can be imported.  To date,  except for
certain limited cases,  Cylink's distributors have not been denied permission to
import  Cylink's  products.  See "Business - Risk Factors That May Affect Future
Results  -- Risks  Associated  with  International  Sales;  Reliance  Upon Local
Partners; Restrictions on Export."

Backlog

Orders for  Cylink's  products  are usually  placed by customers on an as-needed
basis and Cylink has  typically  been able to ship  products  within thirty days
after the customer  submits a firm purchase order.  Cylink'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,
Cylink's backlog as of any particular date may not be indicative of sales in any
future period.  Cylink does not generally maintain long-term  contracts with its
customers that require customers to purchase Cylink's products. Cylink's backlog
for  continuing  operations  as of December 31, 1997 and 1998 were approximately
$5.1 million and $3.1 million,  respectively.  See "Business - Risk Factors That
May Affect Future Results -- Lengthy Sales Cycle."

Manufacturing

Cylink's  manufacturing  operations consist primarily of component  procurement,
final  assembly  and test,  and quality  control of  subassemblies  and systems.
Cylink's  stand alone software  products  are  replicated  at Cylink's and ARL's
facilities.   Cylink   generally  uses  domestic   independent   contractors  to
manufacture  and assemble  printed  circuit boards.  The  manufacturing  process
enables Cylink to configure the hardware and software in  combinations to meet a
wide variety of customer  requirements.  Cylink  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 ensure the quality and reliability of its
products.

Cylink's   product   designs   are   proprietary   but   generally   incorporate
industry-standard   algorithms  and  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.

Cylink's   ability  to  timely  deliver  its  products  is  dependent  upon  the
availability of quality components and subsystems used in these products. Cylink
depends in part upon subcontractors to manufacture, assemble and deliver certain
items in a 

                                       4
<PAGE>

timely and satisfactory  manner.  A significant  interruption in the delivery of
such  items  could  have a  material  adverse  effect  on  Cylink'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, 1998,  Cylink had 325  employees,  of whom 91 were  primarily
engaged  in  research  and  development,  135 in sales,  marketing  and  related
customer support  services,  51 in administration  and 48 in  manufacturing.  Of
these employees  approximately 23 were located in Europe, 73 in Israel, and 9 in
Asia.  None of Cylink's  employees is  represented  by a  collective  bargaining
agreement  with  respect  to his or her  employment  by  Cylink,  nor has Cylink
experienced any organized work stoppage. Cylink 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.

Cylink incurred  losses from  continuing  operations in 1998 and for each of the
prior four years.  Cylink expects to incur net losses  through 1999.  Cylink may
not  increase or  maintain  its revenue or be  profitable  on a quarterly  or an
annual basis in the future.

Cylink has historically  experienced  significant  fluctuations in its operating
results on a  quarterly  basis and could  experience  such  fluctuations  in the
future.  Cylink's operating results are affected by a number of factors, many of
which are outside of Cylink's control, including: the timing of the introduction
of new or enhanced  products by Cylink or its competitors;  market acceptance of
new  products  of  Cylink,  its  customers  and  its  competitors;  the  timing,
cancellation  or delay of customer  orders,  including  cancellation or delay in
anticipation  of new product  introduction  or  enhancement  or  resulting  from
uncertainty  relating to  intellectual  property  claims;  competitive  factors,
including  pricing  pressures;  changes in operating  expenses,  including those
resulting from changes in available production capacity of independent foundries
and other suppliers and the availability of raw materials;  expenses  associated
with  obtaining,  enforcing  and defending  claims with respect to  intellectual
property rights; the mix of products sold; changes in the percentage of products
sold through Cylink's direct sales force;  personnel  changes;  general economic
conditions;  and fluctuations in foreign currency exchange rates. Cylink expects
to  introduce  a number of new  products  during  1999.  The failure of such new
products to achieve market  acceptance at the time anticipated by Cylink,  or at
all, would  materially and adversely  affect  Cylink's  financial  condition and
results of operations.


Pending Litigation

See Item 3. "Legal Proceedings."


Dependence on Key Personnel

On November 4, 1998, Cylink accepted the resignation of Mr. Fernand B. Sarrat as
a Director, President and Chief Executive Officer, along with the resignation of
Mr. John Daws, Chief Financial  Officer,  and Mr. Tom Butler,  Vice President of
Sales. On November 4, Mr. William C. Crowell, formerly Vice President of Product
Strategy, was promoted to President and Chief Executive Officer, and on November
16, Mr. Roger A. Barnes became Cylink's Chief Financial Officer.

Cylink's  future  success will depend on the  abilities  of Mr.  Crowell and the
contributions  by its other  executive  officers,  key  management and technical
personnel.  The  loss  of the  services  of one or more  of  Cylink's  executive
officers or key  personnel,  or the  inability to continue to attract and retain
qualified personnel,  could delay product development cycles or otherwise have a
material adverse effect on Cylink's  business and operating  results.  Retention
and  attraction of such  qualified  personnel may become even more difficult for
Cylink  following  Cylink's recent  restatement of its financial  statements and
recently determined losses.

                                       5
<PAGE>

Lengthy Sales Cycle

Sales of Cylink's products generally involve a significant commitment of capital
by customers, with the attendant delays frequently associated with large capital
expenditures.  For these and other  reasons,  the sales  cycle  associated  with
Cylink's  products is typically  lengthy and subject to a number of  significant
risks over which  Cylink has little or no control.  Cylink is often  required to
ship products shortly after it receives orders and, consequently,  order backlog
at the beginning of any period has in the past  represented only a small portion
of that period's expected revenue. As a result, product revenue in any period is
substantially  dependent  on orders  booked and shipped in that  period.  Cylink
typically plans its production and inventory levels based on internal  forecasts
of  customer  demand,   which  are  highly   unpredictable   and  can  fluctuate
substantially.  If revenue falls  significantly  below anticipated levels, as it
has at times in the past, Cylink's financial condition and results of operations
would be materially  and adversely  affected.  In addition,  Cylink's  operating
expenses  are based on  anticipated  revenue  levels  and a high  percentage  of
Cylink's expenses are generally fixed in the short term. Based on these factors,
a small  fluctuation in the timing of sales can cause operating  results to vary
significantly from period to period. For example,  on September 14, 1998, Cylink
announced  that  its  earnings  for the  third  quarter  of 1998  would be below
consensus  estimates.  It is  possible  that in the  future  Cylink's  operating
results  will  again  be below  the  expectations  of  securities  analysts  and
investors.  In such an event, or in the event that adverse conditions prevail or
are  perceived to prevail  generally or with respect to Cylink's  business,  the
price of Cylink's Common Stock would likely be materially adversely affected.


Dependence on Recently Introduced and New Information Security Products

Cylink's future results of operations will be highly dependent on the successful
completion of the design, development,  introduction,  marketing and manufacture
of the Link Encryptors,  PrivaCy Manager,  PrivateWire and SecureFrame products,
which were recently introduced. To date, Cylink has made only limited commercial
shipments  of  certain  of such  products  and no  commercial  shipments  of the
remainder of such products. Furthermore, Cylink relies on a third party original
equipment  manufacturer to supply Cylink's ATM Encryptor product,  and Cylink is
dependent  on this  supplier  to  complete  successful  integration  of Cylink's
PrivaCy  Manager with the ATM Encryptor.  These products may require  additional
development work, enhancement,  testing or further refinement before they can be
introduced  and  made  commercially   available  by  Cylink  or  achieve  market
acceptance.  If such new and  recently  introduced  products  have  performance,
reliability,  quality or other  shortcomings,  then such products  could fail to
achieve market  acceptance.  The failure by Cylink's new or existing products to
achieve or enjoy market  acceptance,  whether for these or other reasons,  could
cause Cylink to experience reduced orders, higher manufacturing costs, delays in
collecting  accounts  receivable and additional  warranty and service  expenses,
which in each case could have a material  adverse  effect on Cylink's  business,
financial condition and results of operations.


Competition

Competition is intense among providers of network security  systems,  and Cylink
expects  such  competition  to increase in the future.  Significant  competitive
factors in these markets  include the  development of new products and features,
product quality and performance,  the quality and experience of sales, marketing
and service  organizations,  product price,  name  recognition and perception of
Company  stability  and  long-term  viability.  Many of these factors are beyond
Cylink's control. In addition,  some factors, such as the perception of Cylink's
stability and viability over the long term may have been  adversely  affected by
the  recent  restatement  of  Cylink's  1997 and first and second  quarter  1998
financial  statements,  which could materially adversely impact Cylink's ability
to compete.

Cylink's  competitors in the information  security markets,  including companies
that offer products  similar to or as an alternative to the Company's  products,
include  Axent  Technologies,  Inc.,  Checkpoint  Software  Technologies,  Ltd.,
Network  Associates,  Inc.,  Secure  Computing  Corporation,  Security  Dynamics
Technologies, Inc., Racal-Guardata,  Inc., and Information Resource Engineering,
Inc.  Cylink's OEM supplier of its ATM  Encryptor  product  also  competes  with
Cylink, both directly and through other channels,  for sales of this product. In
addition,  Northern  Telecom  Limited,  AT&T,  Motorola  Corporation,   and  Sun
Microsystems,  Inc. offer certain information security products as part of their
overall  networking  solutions.  A  number  of  significant  vendors,  including
Microsoft Corporation,  Netscape  Communications  Corporation and Cisco Systems,
Inc., have embedded  security  solutions in their  software.  To the extent that
these embedded or optional 

                                       6
<PAGE>

security capabilities provide all or a portion of the functionality  provided by
Cylink's  products,  Cylink's products may no longer be required by customers to
attain network security.

Certicom  Corporation  and RSA Data  Security,  Inc., a  subsidiary  of Security
Dynamics  ("RSA  DSI"),  license  various  methods  of  implementing  public key
cryptography, including some that are different from (and incompatible with) the
method of implementing public key cryptography  currently used by Cylink in most
of its  products.  Although  Cylink  has a license  to use all of the public key
methods promoted by Certicom and RSA DSI, to the extent significant  segments of
the network  security  market adopt  technical  standards  different  from those
currently  used by  Cylink,  to the  exclusion  of  Cylink's  methods,  sales of
Cylink's  existing and planned  products in that market segment may be adversely
impacted,  which  could have a material  adverse  effect on  Cylink's  financial
condition and results of operations.

Many of Cylink's  competitors have substantially  greater financial,  technical,
marketing, distribution and other resources, greater name recognition and longer
standing  relationships  with  customers than Cylink.  Competitors  with greater
financial  resources are better able to engage in sustained price  reductions in
order to gain market share.  Any period of sustained price reductions would have
a  material  adverse  effect on  Cylink's  financial  condition  and  results of
operations.  Cylink  may not be able to compete  successfully  in the future and
competitive  pressures may result in price  reductions,  loss of market share or
otherwise  have a material  adverse effect on Cylink's  financial  condition and
results of operations.


Product Liability Risks

Customers rely on Cylink's  network  security  products to prevent  unauthorized
access to their networks and data transmissions. A malfunction or the inadequate
design of Cylink's  products could result in tort or warranty  claims.  Although
Cylink attempts to reduce the risk of such losses through  warranty  disclaimers
and  liability  limitation  clauses in its sales and license  agreements  and by
maintaining  product  liability  insurance,  there can be no assurance that such
measures will be effective in limiting Cylink's  liability for any such damages.
Any liability for damages  resulting from security breaches could be substantial
and could  have a  material  adverse  effect  on  Cylink's  business,  financial
condition and results of operations.

In  addition,  a  well-publicized  actual or  perceived  security  breach  could
adversely  affect the market's  perception of security  products in general,  or
Cylink's   products  in  particular,   regardless  of  whether  such  breach  is
attributable to Cylink's products.  This could result in a decline in demand for
Cylink's  products,  which  would have a  material  adverse  effect on  Cylink's
business, financial condition and results of operations.

Year 2000

The "Year 2000 Issue"  refers  generally  to the  problems  that some  software,
including  firmware embedded in Cylink's  products,  may have in determining the
correct  century  for  the  year.  For  example,  software  with  date-sensitive
functions that is not Year 2000 compliant may not be able to distinguish whether
"00"  means  1900 or 2000,  which may  result in  failures  or the  creation  of
erroneous results.

Cylink has developed a Year 2000 readiness plan for the current  versions of its
products.  The plan includes  development  of corporate  awareness,  assessment,
implementation  (including  remediation,  upgrading and  replacement  of certain
product versions),  validation testing,  and contingency  planning.  The Company
continues to respond to customer  concerns  about prior versions of its products
on a case-by-case basis.

Cylink has  largely  completed  all phases of its plan,  except for  contingency
planning,  with  respect to the current  versions of all of its  products.  As a
result,  the current versions of each of its products currently offered for sale
are  "Year  2000  Compliant"  as  defined  below  (with the  exception  of final
documentation of compliance for several such products), when configured and used
in accordance with the related  documentation,  and provided that the underlying
operating  system of the host machine and any other software used with or in the
host machine or Cylink's  products are also Year 2000 Compliant.  In some cases,
Cylink's  products require an upgrade provided by Cylink which is either sold as
a complete substitute or as a kit sold with the product in order to be Year 2000
Compliant.

Cylink has defined "Year 2000 Compliant" as the ability to: (i) correctly handle
date  information  needed  for the  December  31,  1999 to  January 1, 2000 date
change; (ii) function according to the product  documentation  provided for this
date

                                       7
<PAGE>

change, without changes in operation resulting from the advent of a new century,
assuming correct  configuration;  (iii) where appropriate,  respond to two-digit
date input in a way that  resolves  the  ambiguity as to century in a disclosed,
defined, and predetermined  manner, such as in certificate based products, or in
accordance  with Cylink's Year 2000 Compliant test plan; and (iv) recognize year
2000 as a leap year.  Cylink has not tested its products on all platforms or all
versions of operating  systems  that it  currently  supports and has advised its
customers  to verify that their  platforms  and  operating  systems  support the
transition to the year 2000.

Cylink  has  not  specifically  tested  software  obtained  from  third  parties
(licensed  software,  shareware,  and freeware)  that is  incorporated  into its
products,  but Cylink's test plan was designed to reveal Year 2000  deficiencies
with third party software incorporated in Cylink's products.

Despite  testing  by  Cylink  and  current  and  potential  customers,  and  any
assurances  from  developers of products  incorporated  into Cylink's  products,
Cylink's products may contain  undetected errors or defects associated with Year
2000 date functions.  Also, certain prior versions of the Company's products are
not fully Year 2000 Compliant,  and Cylink is working to address these issues by
offering for sale  upgrades to compliant  versions.  Known or unknown  errors or
defects in Cylink's products could result in delay or loss of revenue, diversion
of development  resources,  damage to Cylink's reputation,  or increased service
and warranty  costs,  any of which could  materially  adversely  affect Cylink's
business, operating results, or financial condition.

Cylink  does  not  currently  have any  information  concerning  the  Year  2000
compliance  status of its  customers.  If Cylink's  current or future  customers
suspend  investments in securing their existing networks while they achieve Year
2000  compliance,   or  if  they  divert  technology  expenditures   (especially
technology  expenditures that are reserved for enterprise  security products) to
address Year 2000 compliance problems, Cylink's business, results of operations,
or financial condition could be materially adversely affected.

Some  commentators  have predicted  significant  litigation  regarding Year 2000
compliance  issues.  Because  this type of  litigation  lacks  precedent,  it is
uncertain whether or to what extent Cylink may be affected by it.

Cylink has  initiated  a review of its  mission  critical  internal  information
systems  (including  the  third-party  software for its  management  information
systems, networks and desktop applications,  and its hardware telecommunications
technology).  Cylink  expects to complete that review by mid 1999. To the extent
that Cylink is not able to test the technology provided by third-party  vendors,
Cylink is purchasing  upgrades for versions  which have been  certified by their
vendors as compliant.  Although  Cylink is not  currently  aware of any material
operational  issues or costs associated with preparing its internal  information
systems for the Year 2000, Cylink may experience material unanticipated problems
and costs caused by undetected  errors or defects in the technology  used in its
information  systems Cylink has funded its Year 2000 plan from  operating  cash.
While  Cylink  does not expect  such  costs to be  material,  Cylink  will incur
additional amounts related to the Year 2000 plan for administrative personnel to
manage Cylink's readiness plans,  technical support for its product  engineering
and customer  satisfaction.  Cylink may experience  material  problems and costs
with Year 2000 compliance that could adversely affect Cylink's business, results
of operations, and financial condition.

Cylink has not developed a comprehensive  contingency plan to address situations
that may  result  if Cylink is unable  to  achieve  Year 2000  readiness  of its
critical  operations.  The cost of developing and  implementing  such a plan may
itself be  material.  Finally,  Cylink is also  subject to external  forces that
might generally affect industry and commerce,  such as utility or transportation
company Year 2000 compliance failures and related service interruptions.

Were Cylink to  experience an  unanticipated  Year 2000  interruption,  business
operations  could be seriously  impaired for an indefinite  period of time until
remedial efforts could be achieved.

                                       8
<PAGE>

Management of Growth And Reduction In Employees

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

With the sale of its Wireless  Communications  Group (the  "Wireless  Group") in
March,  1998,  Cylink has  experienced  a  significant  reduction in  employees,
including  Cylink's former Chief Technical  Officer,  Dr. Jim Omura. The sale of
its Wireless  Group,  the  uncertainty  created by Cylink's  recently  announced
restatements of its financial results, the initiation of highly publicized class
actions securities  litigation against Cylink, and the occasional  reductions in
specific engineering programs in the network security business, has created some
instability within the existing employee  population  resulting in departures of
certain key employees critical to sustaining growth in Cylink's network security
business.  Furthermore,  sudden  reductions in the number of Cylink's  employees
places greater  demands on the remaining  employees which may distract them from
fulfilling their responsibilities  necessary to accomplishing Cylink's financial
goals.

In September  1997,  Cylink  acquired  Algorithmic  Research,  Ltd.  ("ARL") and
assumed   responsibility  for  management  of  its  worldwide  operations  which
currently consists of approximately  seventy-three employees.  Cylink is heavily
dependent on ARL's success in continuing to develop  marketable  technology  and
products, such as the PrivateWire family, including PrivateSafe and PrivateCard,
toolkits  and other  components,  as well as Cylink's  next  generation  virtual
private network ("VPN") product.  Key factors which will determine ARL's success
include  whether Cylink can integrate  ARL's  management,  employee  culture and
organizational  practices into Cylink,  whether Cylink can adequately fund ARL's
development objectives,  whether Cylink can provide accurate information for ARL
to focus its technology on significant market opportunities,  and whether Cylink
can predict the most  attractive  features  and  functions  for ARL's  products.
Cylink's success in realizing the anticipated  return from its investment in ARL
also will be  determined  by Cylink's  ability to position and  introduce  ARL's
products into Cylink's  markets and  channels,  and Cylink's  ability to provide
adequate  sales and  customer  support  for ARL's  products.  To date,  Cylink's
efforts to market ARL's products  through Cylink's direct sales channel have not
met  Cylink's  expectations  due to  differences  between  the  sales  expertise
required  for selling the ARL products  and that  required  for  Cylink's  other
products. Consequently, Cylink has recently reorganized the management of ARL to
strengthen  ARL's  responsibility  for marketing  and sales of its products.  In
addition,  ARL's  improvements and development of new products have been delayed
by inadequate coordination between engineering departments located in Sunnyvale,
CA and Petach Tikva,  Israel.  This  inadequate  coordination  to date is due to
differing engineering practices concerning development planning and restrictions
imposed by U.S.  export  control laws  governing  the transfer of  cryptographic
expertise.  Cylink and ARL's  successful  working  relationship  may be hindered
significantly  by  differences  between the two  organizations  created by time,
distance,  language and  culture.  ARL operates  from its  principal  offices in
Israel,  a country which is vulnerable to disruption due to the sudden  outbreak
of hostilities with its neighbors and various indigenous factions. Many of ARL's
employees have extensive  commitments  to the country's  military  organizations
which may require a loss of their  services on the Company's  behalf in times of
political instability.

Intellectual Property and Other Proprietary Rights

Cylink relies on patents, trademarks,  copyrights, licenses and trade secret law
to establish and preserve its intellectual  property rights.  The Company owns a
number of U.S.  patents covering certain aspects of its network security product
designs,  and has additional U.S. patent applications  pending.  There can be no
assurance  that any patent,  trademark,  copyright  or license  owned or held by
Cylink will not be  invalidated,  circumvented  or  challenged,  that the rights
granted thereunder will provide competitive  advantages to Cylink or that any of
Cylink's pending or future patent  applications will 

                                       9
<PAGE>

be issued  with the scope of the claims  sought by Cylink,  if at all.  Further,
there can be no  assurance  that others will not develop  technologies  that are
similar or superior to Cylink's  technology,  duplicate  Cylink's  technology or
design  around  the  patents  owned by  Cylink.  Cylink may be subject to or may
initiate  interference  proceedings in the U.S. Patent Office, which can require
significant financial and management resources. In addition, the laws of certain
countries in which Cylink's  products are or may be developed,  manufactured  or
sold may not protect Cylink's  products and intellectual  property rights to the
same extent as the laws of the United States. The inability of Cylink to protect
its intellectual property adequately could have a material adverse effect on its
financial condition and results of operations.

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


Evolving Network Security Market; Market Acceptance Risks

The market for Cylink's network  security  products is only beginning to emerge.
This market is characterized by rapidly changing  technology,  emerging industry
standards,  new product  introductions and changes in customer  requirements and
preferences.  Cylink's future success will depend in part upon end users' demand
for network security  products in general,  and upon Cylink's ability to enhance
its existing products and to develop and introduce new products and technologies
that meet customer  requirements.  Cylink faces continuing challenges to educate
customers as to the value of its security  products.  Cylink  believes that many
potential  customers do not appreciate the need for high-end  security  products
unless and until they have faced a major security breach. If Cylink is unable to
successfully  educate potential customers as to the value of, and thereby obtain
broad market acceptance for, its products, it will continue to rely primarily on
selling new and existing products to its base of existing customers,  which will
significantly  limit any  opportunity for growth.  In addition,  any significant
advance in technologies for attacking cryptographic systems could render some or
all of Cylink's  existing  and new  products  obsolete or  unmarketable.  To the
extent that a specific method other than Cylink's is adopted as the standard for
implementing  network  security in any segment of the network  security  market,
sales of Cylink's  existing and planned  products in that market  segment may be
adversely  impacted,  which  could have a material  adverse  effect on  Cylink's
business,  financial  condition and results of  operations.  See  "Competition."
Network  security-related  products  or  technologies  developed  by others  may
adversely  affect  Cylink's  competitive  position  or render  its  products  or
technologies noncompetitive or obsolete.

In addition,  a portion of the sales of Cylink's network security  products will
depend upon a robust industry and  infrastructure for providing access to public
switched  networks,  such as the Internet.  The  infrastructure or complementary
products  necessary to make these networks into viable  commercial  marketplaces
may not be fully  developed,  and once developed,  these networks may not become
viable commercial marketplaces.


Rapid Technological Change

The  markets  for  Cylink's  products  are  characterized  by  rapidly  changing
technologies,  extensive research and new product introductions. Cylink believes
that its future  success  will  depend in part upon its  ability to  continue to
enhance  its  existing  products  and to  develop,  manufacture  and  market new
products.  As a  result,  Cylink  expects  to  continue  to  make a  significant
investment in engineering,  research and development.  Cylink may not be able to
develop and introduce new 

                                       10
<PAGE>

products or  enhancements  to its  existing  products in a timely  manner  which
satisfy  customer  needs,  achieve  market  acceptance or address  technological
changes in its target  markets.  The failure of Cylink to develop  products  and
introduce  them  successfully  and in a timely  manner  could  adversely  affect
Cylink's competitive position, financial condition and results of operations.


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

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

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

Due to U.S.  and  Israeli  government  regulations  restricting  the  export  of
cryptographic  devices  and  software,  including  certain of  Cylink's  network
security  products,   Cylink  is  often  at  a  disadvantage  in  competing  for
international  sales compared to companies located outside the United States and
Israel that are not subject to such restrictions.


Dependence  on  Component  Availability,   Subcontractor   Performance  and  Key
Suppliers

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



ITEM 2.  PROPERTIES

Cylink's  headquarters occupy 86,000 square feet in Sunnyvale,  California,  the
lease for which expires in June 1999.  During the second quarter of 1996, Cylink
signed a five-year  lease  agreement  for  approximately  35,000  square feet of
office  and  manufacturing  space,  also  in  Sunnyvale.  As  a  result  of  the
acquisition of ARL,  Cylink owns,  subject to an outstanding  mortgage,  a 7,500
square foot  office  building in Petach  Tikva,  Israel and leases a  production
facility of 2,000 square feet. Cylink leases facilities for sales offices in New
Jersey,  Virginia, North Carolina,  Belgium, the United Kingdom,  Singapore, and
Germany. Cylink believes that its current facilities are well maintained and are
adequate for the 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 March 7,  1997,  ten  former  employees  of Cylink  filed  suit in action No.
CV764647 in the Superior  Court of  California,  County of Santa Clara,  against
Cylink,  each of its Directors  and its General  Counsel,  asserting  claims for
wrongful  termination,  fraud, libel,  slander, age discrimination,  invasion of
privacy,  and  violation  of the federal  RICO  statute.  On July 11,  1997,  an
eleventh  employee  filed suit in action no.  CV767448 in the Superior  Court of
California,  County of Santa 

                                       11
<PAGE>

Clara,  alleging  similar  claims  against  the  Company  and its  former  Chief
Executive Officer. Cylink removed CV764647 to the Federal District Court for the
Northern  District of California and, after Cylink obtained an order  dismissing
certain  of the  plaintiffs'  claims,  including  the  claims  of libel and RICO
violations,  the Court  remanded  the action  back to the Santa  Clara  Superior
Court.  Following mediation efforts in October,  1998, the plaintiff in CV767448
accepted a settlement and dismissed his complaint with prejudice.  The remaining
plaintiffs subsequently dismissed,  with prejudice, all of the outside Directors
except the  Chairman.  On  December  4, 1998,  and  December  18, 1998 the Court
granted Cylink's motions for summary judgement and for dismissal,  respectively,
of numerous claims in CV764647.  Discovery with respect to the remaining  claims
is continuing, with trial currently scheduled for late 1999. Although Cylink has
placed its insurers on notice of these claims, all of its insurers have reserved
their rights and defenses under their policies,  and the extent of the insurers'
liability under their respective policies is undetermined.  Based on the Court's
decisions and discovery in the matter to date,  Cylink believes the terminations
were  lawful,  and in the best  interest  of Cylink,  and  intends  to  continue
defending  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 Cylink's
insurance  coverage,  if any, could also result in a material  adverse effect on
Cylink's results of operations, financial condition and cash flows.

After  asserting  certain  deductions  arising under a contract  dated March 27,
1998,  for  P-Com's  purchase of  Cylink's  Wireless  Group P-Com made a partial
payment on July 14, 1998, in the amount of $8.9 million on its  promissory  note
dated April 1, 1998. Cylink is presently  discussing with P-Com the basis of its
deductions  and,  failing an amicable  resolution  of P-Com's  contentions,  the
matter will proceed to litigation. See Note 9 of Notes to Condensed Consolidated
Financial Statements.

On September 3, 1998,  P-Com put Cylink on notice that certain  shipments in the
fourth  quarter of 1997 and the first  quarter of 1998 by the  Company's  former
Wireless  Group and having an invoice  value of  approximately  $3.5 million had
been seized by an agency of the United  States  Department  of the  Treasury and
that P-Com  intends to hold  Cylink  responsible  for the  consequences  of this
event.  P-Com is  currently  petitioning  for  release  of the  goods.  Based on
Cylink's  investigation to date, Cylink believes either that the grounds for the
seizure are  unfounded  or that P-Com  itself is  responsible  for this  action.
Cylink  has no reason  at this time to  believe  that it is the  subject  of any
official  investigation  and Cylink has been  informed  that P-Com is  presently
petitioning  for the release of the seized  goods.  A failure by P-com to obtain
release of the  shipment  due to a violation  of law by Cylink  might  adversely
affect the amount collected from P-Com on its outstanding  obligations under the
promissory note, including payment of any relevant fines or penalties.

On September 14, 1998,  Cylink announced that its earnings for the third quarter
would be below consensus estimates.  On November 5, 1998, Cylink announced that,
with the assistance of its independent accountants, it was reviewing its revenue
recognition  practices,  and Cylink  announced that its first and second quarter
earnings would have to be restated and that it would have  operating  losses for
each of the three quarters for the period ended  September 27, 1998.  During the
review,  certain  facts  became  known  indicating  errors  had been made in the
application  of revenue  recognition  policies  which also  impacted  the fourth
quarter of 1997,  and as a result,  1997  full-year  results have been  restated
along with first and second quarter 1998 results. Cylink has filed amended Forms
10-Q for the first and second  quarters  1998 and will file an amended Form 10-K
for 1997.  Between  November 6 and November 25, 1998,  several  securities class
action  complaints  were filed  against  Cylink and  certain of its  current and
former directors and officers in federal courts in California.  These complaints
allege, among other things, that Cylink's previously issued financial statements
were materially false and misleading and that the defendants knew or should have
known that these financial statements caused Cylink's common stock price to rise
artificially.  The actions  variously allege  violations of Section 10(b) of the
Securities  Exchange Act of 1934 (the "Exchange Act"), as amended,  and SEC Rule
10b-5 promulgated thereunder, and Section 20 of the Exchange Act.

Cylink  believes it has  meritorious  defenses  to these  actions and intends to
defend itself  vigorously.  However,  it is not feasible to predict or determine
the  final  outcome  of  these  proceedings,  and  if  the  outcome  were  to be
unfavorable,  Cylink's business,  financial condition, cash flows and results of
operations could be materially adversely affected.

                                       12
<PAGE>

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 Cylink as of December 31, 1998:

Name                        Age      Position

William P. Crowell           58      Chief Executive Officer and President

Roger A. Barnes              50      Vice President and Chief Financial Officer

Robert B. Fougner            46     Secretary and General Counsel

Sarah L. Engel               55      Vice President, Professional Services

Paul Massie                  44      Vice President, Information Systems

Peter J. Slocum              43      Vice President, Engineering


Mr. Crowell joined Cylink as Vice President, Product Development and Strategy in
January 1998. Prior to joining Cylink, Mr. Crowell served as the Deputy Director
at the National  Security  Agency,  and has also served as Vice President of the
Atlantic Aerospace Electronics Corporation.

Mr. Barnes joined Cylink as Vice President  Finance and Chief Financial  Officer
in November,  1998.  Prior to joining  Cylink,  Mr. Barnes served as Senior Vice
President and Chief Financial Officer, for Evolving Systems, Inc. and in various
senior  executive  positions for twenty  years,  beginning his career with eight
years at Peat Marwick, Mitchell & Co.

Ms. Engel  joined  Cylink in February  1997.  Before  joining  Cylink 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.  Fougner has been  Secretary and General  Counsel  since  joining  Cylink in
December  1989.  Prior to joining  Cylink,  he was a partner in the New York law
firm of Hill, Betts & Nash.

Mr. Massie joined Cylink in 1997.  Prior to joining  Cylink in 1997,  Mr. Massie
was employed by Bay Networks where he was the director of  information  systems.
He has also served as director of computing  for Sun  Microsystems,  Inc. and as
director of computer systems and telecommunications for Sterling Software.

Mr. Slocum joined  Cylink 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 also served as
Director of Engineering for Silicon  Graphics,  Inc., and MIPS Computer Systems,
Inc.

                                       13
<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 two years:

                         First        Second            Third           Fourth
                        Quarter       Quarter          Quarter          Quarter
                        -------       -------          -------          -------

Year Ended
December 31, 1998
High                    15 1/16       15 5/8           13 1/16           8 1/16
Low                      9 3/16        8 1/2            5 1/8            3 1/16

Year Ended
December 31, 1997
High                    13 5/8        12 1/4           15 5/16          17 1/2
Low                      8 3/8         7 1/2            8 13/16          8 13/32



As of March 29, 1999, the Company had  approximately 126 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.

The Company's  Registration  Statement on Form S-1 was declared effective by the
Securities and Exchange Commission on February 15, 1996 (Reg. No. 33-80719).  In
February and March 1996 the Company issued  5,750,000 shares of its common stock
to the public at a price of $15 per share.  The Company  received  approximately
$78.9 million net of underwriting  discounts and commissions of $6.0 million and
other offering  expenses of $1.4 million.  Through the period ended December 31,
1998, the net proceeds have been used as follows (in thousands):

Purchase and installation of equipment                     $  6,601
Acquisition of Algorithmic Research                          45,913
Repayment of indebtedness                                     1,000
Working capital                                              12,673
Temporary investment in money market accounts                12,677
                                                           --------
                                                           $ 78,864
                                                           ========

         None of the net  proceeds or expenses of issuance and  distribution  of
the securities  have been,  either  directly or indirectly,  paid to or invested
with any related party or shareholder of the Company.

                                       14

<PAGE>

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,
                                              -------------------------------------------------------------
                                                 1998          1997         1996        1995         1994   
                                              ----------   ----------   ---------    ---------    --------- 
                                                            (restated)
                                                                (in thousands, except per share amounts)
<S>                                           <C>          <C>          <C>          <C>          <C>       
Revenue                                       $  42,760    $  47,690    $  25,793    $  21,534    $  17,971 
Total operating expenses                         54,720      101,673       24,270       18,776       16,553 
Loss from continuing operations                 (17,356)     (64,955)      (5,522)      (4,260)      (4,143)
Loss from continuing
   operations per share - basic and diluted       (0.60)       (2.43)       (0.23)       (0.24)       (0.24)



                                                                        Year ended December 31,
                                              -------------------------------------------------------------
                                                 1998          1997         1996        1995         1994   
                                              ----------   ----------   ---------    ---------    --------- 
                                                            (restated)
                                                                             (in thousands)
Cash, cash equivalents and
  short-term investments                      $  46,575    $  22,977    $  78,849    $   6,098    $   6,626 
Working capital                                  60,587       47,985       93,518       12,604       12,042 
Total assets                                     94,318       76,555      107,088       22,725       20,663 
Long-term obligations                               147          256          241          291         --   
Shareholders' equity                          $  75,221    $  66,134    $  97,211    $  14,605    $  14,149 
</TABLE>


On March 28, 1998, the Company sold its Wireless Communications Group, which has
been reported as discontinued operations and, therefore,  the above consolidated
statements of operations  information excludes  discontinued  operations for all
periods presented.

The net loss for 1997 included a charge of  approximately  $63.9 million  ($2.39
per share) for purchased in-process technology resulting from the acquisition of
ARL.



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

         The  following  discussion  should  be read  in  conjunction  with  the
Consolidated Financial Statements and Notes thereto.

RESTATEMENT OF RESULTS FOR 1997 AND FIRST AND SECOND QUARTER, 1998

On November 5, 1998, the Company publicly  announced that it and its independent
accountants had initiated a review of revenue recognition  practices which would
result in a  restatement  of  previously  issued  first and second  quarter 1998
results and that all three  quarters of 1998 were  expected to show  substantial
operating  losses.  During the review,  certain  facts became  known  indicating
errors had been made in the  application of revenue  recognition  policies which
also  impacted  the fourth  quarter  of 1997,  and as a result,  1997  full-year
results have been restated along with first and second quarter 1998 results.

                                       15
<PAGE>

DISCONTINUED OPERATIONS

         On March 28, 1998, the Company sold its Wireless  Communications  Group
("Wireless")  to P-Com for $46.0  million in cash and an  unsecured  note in the
amount  of  $12.4  million  due 100  days  after  closing,  subject  to  closing
adjustments.  The sale  resulted  in an after  tax gain of  approximately  $22.8
million.  See Notes 3 and 9 of Notes to  Consolidated  Financial  Statements and
Part I, Item 3 "Legal Proceedings."

         As a  result,  the  operations  of  Wireless  have been  classified  as
discontinued  operations in the accompanying  Consolidated  Financial Statements
and related Notes.

RESULTS OF CONTINUING OPERATIONS
<TABLE>
         Except where noted, the comments herein are associated with the results
of  Cylink's  continuing  operations.  The  following  table sets forth  certain
consolidated  statement of  operations  data as a percentage  of revenue for the
periods indicated:
<CAPTION>

                                                           Year ended December 31,
                                               --------------------------------------------
                                                   1998             1997           1996    
                                               -------------    ------------    -----------
                                                                   (restated)
<S>                                                <C>              <C>            <C>
 Revenue                                           100.0 %          100.0 %        100.0 % 
 Cost of revenue                                    39.5             29.3           37.7   
                                               -------------    ------------    -----------
 Gross profit                                       60.5             70.7           62.3   

 Operating expenses:
   Research and development, net                    37.0             26.2           31.8   
   Selling and marketing                            56.4             33.6           36.7   
   General and administrative                       28.2             17.7           25.6   
   Amortization of purchased intangibles             6.4              1.7              -   
   Purchased in-process technology                     -            134.0              -   
                                               -------------    ------------    -----------
      Total operating expenses                     128.0            213.2           94.1   
                                               -------------    ------------    -----------
 Loss from operations                              (67.5)          (142.5)         (31.8)  

 Other income, net                                   5.5              6.3           10.4   
                                               -------------    ------------    -----------
 Loss from continuing operations
      before income taxes                          (62.0)          (136.2)         (21.4)  
 Benefit from income taxes                         (21.4)               -              -   
                                               -------------    ------------    -----------
 Loss  from continuing operations                  (40.6)%         (136.2)%        (21.4)% 
                                               =============    ============    ===========
</TABLE>

         Revenue.  Revenues  decreased 10% from $47.7 million for the year ended
December 31, 1997 to $42.8  million for the year ended  December  31, 1998.  The
decreased  revenue was primarily due to the disruption caused by the 4th quarter
reorganization,  which  encompassed  both  executive  management  as well as the
reorganization  of the mid-level sales staff, and continued  integration of ARL.
Overall  average  selling  prices  decreased  marginally.  Information  security
product  revenue  for 1997 and 1998  includes  $2.9  million  and $3.7  million,
respectively, attributable to ARL.

The Company's revenue increased 85% from $25.8 million in 1996 to $ 47.7 million
in 1997. The increased  revenue was primarily due to increased unit sales of the
Company's  SecureWAN  products,  including  the Company's  core link  encryption
products,  and SecureLAN  encryption product lines, which are used in public and
private linked networks. Overall average-selling prices decreased marginally.

International product revenue was 41%, 43% and 47% of revenue for 1998, 1997 and
1996, respectively.

                                       16
<PAGE>

         Gross Profit.  Gross profit decreased 23% from $33.7 million in 1997 to
$25.9  million in 1998,  and decreased as a percentage of sales from 71% to 61%.
The  decrease  in dollars  was a  combination  of a  decrease  in  revenue,  the
introduction  of OEM products  with greatly  reduced gross profit  margins,  and
unplanned  excess  manufacturing  capacity.  The  decrease in gross  profit as a
percentage of revenue resulted from reduced profit margins from OEM products and
manufacturing vaiances generated by excess manufacturing capacity.

Gross  profit  increased  109% from $16.1  million in 1996 to $ 33.7  million in
1997,  and  increased as a percentage  of sales from 62% to 71%. The increase in
dollars was primarily  the result of the  significant  increase in revenue.  The
increase in gross profit as a percentage of revenue  resulted from lower average
unit costs and a decrease in expenses for maintenance and support services.

         Research and  Development.  Research and development  expenses  consist
primarily  of salaries and other  personnel-related  expenses,  depreciation  of
development  equipment,  facilities  costs  and  supplies.  Gross  research  and
development expenses decreased 3% from $14.3 million in 1996 to $13.9 million in
1997, and increased 24% from $13.9 million in 1997 to $17.7 million in 1998. The
increase  in dollars  and as a percent of sales for 1998 as compared to 1997 was
primarily a result of a one-time  expense of $3.0 million,  which represents the
write-off of a minority  investment in an unaffiliated,  emerging stage company.
The  decrease  in dollars and as a percent of sales for 1997 as compared to 1996
resulted from reduced contract and other variable expenses related to externally
funded research and development and to a substantially increased revenue base.

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 that were recognized
under non-recurring engineering contracts totaled $6.1 million, $1.4 million and
$1.9 million in 1996, 1997 and 1998, 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  68% from $9.5  million in 1996 to $16.0  million in 1997 and 51% from
$16.0 million in 1997 to $24.1 million in 1998.  The increases were primarily to
support the launch of new  products as well as the  continued  expansion  of the
Company's direct field operations,  product line management, market development,
channel and distribution development, and international operations.

         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 27% from $6.6 million in 1996 to $8.4 million
in 1997 and 44% to $12.1 million in 1998. The dollar increases are primarily due
to increased  staffing and professional fees necessary to manage and support the
Company's  anticipated growth.  Though the Company continues to make progress in
overall  cost  controls,  the  increase as a  percentage  of revenue in 1998 was
primarily due to general and  administrative  expenses  allocated over a smaller
revenue base, and one-time  charges of  approximately  $3.6 million  incurred in
connection with the executive and sales management  reorganization in the fourth
quarter of 1998.

         Amortization  of  Purchased  Intangibles.  On  September  8, 1997,  the
Company acquired ARL, an information  security  company  providing remote access
network  security  products  and smart  card  technology.  The  amortization  of
capitalized intangibles was $2.7 million in 1998 and $0.8 million in 1997.

         Purchased  In-Process  Technology.  Approximately  $63.9 million of the
total  purchase  price  for the  acquisition  of ARL  represented  the  value of
in-process technology that had not yet reached technological feasibility, had no
alternative future uses and was charged to the Company's operations in the third
quarter ended  September 26, 1997.  See further  discussion  under Note 4 to the
Consolidated Financial Statements.


         Other Income  (Expense),  Net. Other income (expense),  net,  primarily
consists of royalties,  interest  income,  interest expense and investment gains
and losses.  The Company  generated  other income of $2.7 million in 1996,  $3.0
million in 1997 and $2.3  million in 1998.  Other  expenses in 1996  include the
sale of  marketable  securities  at a loss of $432,000.  Interest  income,  net,
decreased  from $3.3  million in 1996 to $2.7  million in 1997 due  primarily to
cash used for the acquisition of ARL. Additionally, in 1997 the Company recorded
a benefit of $632,000 primarily related to the reversal of an allowance provided
on the receivable  related to the Company's  joint venture  interest in a former
partnership with RSA DSI known as Public Key Partners.  Management considers the
uncertainty  regarding  ultimate  collection  of the  receivable  to  have  been
resolved as a result of the settlement agreement between the Company and RSA DSI
in 1997.

                                       17
<PAGE>

         Other  income  decreased  from $3.0  million in 1997 to $2.3 million in
1998. Royalty,  and other income, net decreased from $317,000 in 1997 to $66,000
in 1998 due to certain  patents held by the Company  becoming public domain upon
their  expiration.  Interest income,  net decreased from $2.7 million in 1997 to
$2.3  million in 1998 due to the  decrease  in average  balances  of cash,  cash
equivalents,  and marketable  securities after the September 8, 1997 acquisition
of ARL. The decrease in interest income would have been more significant, if not
for the cash proceeds  arising from the March 28th 1998  divestiture of Cylink's
Wireless Communications Group to P-Com.

         Benefit from Income Taxes.  The  Company's  effective tax rate for 1998
was  approximately  35%. No provision or benefit for income taxes for continuing
operations was recorded in 1997 or 1996. Net deferred tax assets of $4.5 million
at December 31, 1998,  were based on available  carryback  capacity.  See Item I
"Business  - Risk  Factors  That May Affect  Future  Results  -- Recent  Losses;
Potential   Fluctuations  in  Operating   Results,   Future  Operating   Results
Uncertain."

         Loss from Continuing Operations. The Company had losses from continuing
operations  of $5.5 million in 1996,  $65.0 million in 1997 and $17.4 million in
1998. In 1994, the Company began a strategic  research and  development  program
designed to create new products and enhance  existing  products which  continued
through  1998.  In 1998,  the  Company  incurred  a net loss due to a decline in
revenues  versus 1997 levels,  continued high levels of research and development
expenses related to the Company's  strategic research and development  projects,
amortization  related to the acquisition of Algorithmic  Research Ltd,  employee
severance  and  reorganization  charges,  and  the  write-off  of  its  minority
investment in an unaffiliated emerging stage company.

LIQUIDITY AND CAPITAL RESOURCES

         At December  31,  1998,  the Company had cash and cash  equivalents  of
$46.6  million,   working  capital  of  $60.6  million  and  minimal   long-term
obligations. The Company has reported net losses from continuing operations each
year since  1994.  Net cash used by  operating  activities  for the years  ended
December 31,  1996,  1997 and 1998 was $3.7  million,  $4.3  million,  and $25.8
million,   respectively.   Net  cash  used  in  operating  activities  increased
significantly  in  1998  primarily  to fund  operating  losses  from  continuing
operations. Net cash used in operating activities in 1997 and 1996 was primarily
to fund  increases  in accounts  receivable  and  inventory  in order to support
increased revenue.

         Net cash provided by investing  activities  in 1998 was $47.8  million,
arising  principally  from cash  proceeds of $54.9  million from the sale of the
Wireless  Communications Group offset in part by the acquisition of property and
equipment of $2.0 million,  long-term  loans to employees of $2.1 million and an
investment of $3.0 million in an emerging stage company.  Cash used in investing
activities  in 1997 was $52.1  million,  of which $44.9 million was used for the
acquisition  of ARL.  The  Company  also  made  expenditures  for  property  and
equipment  of $3.8  million and  provided  long-term  loans to employees of $3.5
million.  The  Company  made  capital  expenditures  of $2.8  million  in  1996.
Expenditures for property and equipment for all periods presented have generally
consisted of computer workstations,  networking equipment,  office furniture and
equipment,  and  leasehold  additions  and  improvements.  In 1996,  the Company
received $2.8 million from the sale of marketable securities acquired in 1994.

         Cash provided by financing  activities was $79.7 million,  $0.6 million
and $1.6 million for the years ended  December 31, 1996,  1997 and 1998. For the
year ended  December 31, 1998,  cash provided by financing  activities  resulted
primarily  from the  proceeds  from the  issuance  of  common  stock  under  the
Company's stock option plans. 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 $80.0 million
in cash, net of underwriting discounts, commissions and other offering costs.

         The Company  believes that  existing  cash balances and cash  generated
from  operations,  if any,  will be sufficient  to fund  necessary  purchases of
capital  equipment and to provide  working capital  through 1999.  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."


Year 2000 Compliance

         "Year 2000  Compliance"  refers  generally  to the  problems  that some
software,  including  firmware  embedded  in  Cylink's  products,  may  have  in
determining  the  correct  century  for the year.  For  example,  software  with
date-sensitive  

                                       18
<PAGE>

functions that is not Year 2000 compliant may not be able to distinguish whether
"00"  means  1900 or 2000,  which may  result in  failures  or the  creation  of
erroneous  results.  Cylink has defined "Year 2000 Compliant" as the ability to:
(i)  correctly  handle  date  information  needed for the  December  31, 1999 to
January  1,  2000  date  change;   (ii)   function   according  to  the  product
documentation  provided  for this date  change,  without  changes  in  operation
resulting  from the advent of a new  century,  assuming  correct  configuration;
(iii) where appropriate,  respond to two-digit date input in a way that resolves
the ambiguity as to century in a disclosed,  defined, and predetermined  manner,
such as in certificate based products,  or in accordance with Cylink's Year 2000
Compliant test plan; and (iv) recognize year 2000 as a leap year.

         Cylink  has  developed  a Year  2000  readiness  plan  for the  current
versions of its products.  Cylink has largely  completed all phases of its plan,
except for contingency planning,  with respect to the current versions of all of
its  products.  As a  result,  the  current  versions  of each  of its  products
currently  offered for sale are "Year 2000  Compliant." In some cases,  Cylink's
products  require  an  upgrade  provided  by Cylink  which is  either  sold as a
complete  substitute  or as a kit sold with the product in order to be Year 2000
Compliant.

         Cylink  has  initiated  a  review  of  its  mission  critical  internal
information  systems  (including  the  third-party  software for its  management
information  systems,  networks  and  desktop  applications,  and  its  hardware
telecommunications  technology).  Cylink  expects to complete that review by mid
1999.  When  deficiencies  are  identified  in  critical  components,  Cylink is
purchasing  new or upgraded  versions which have been certified by their vendors
as compliant.

         Cylink has funded its Year 2000 plan from operating cash.  While Cylink
does not expect such costs to be material,  Cylink will incur additional amounts
related to the Year 2000 plan for  administrative  personnel to manage  Cylink's
readiness  plans,  technical  support for its product  engineering  and customer
satisfaction.

         Cylink has not developed a  comprehensive  contingency  plan to address
situations that may result if Cylink is unable to achieve Year 2000 readiness of
its critical operations. The cost of developing and implementing such a plan may
itself be material.

         Despite testing by Cylink and current and potential customers,  and any
assurances from developers of products incorporated into Cylink's products or in
use in Cylink's business  operations,  Cylink's products may contain  undetected
errors or defects associated with Year 2000 date functions.  Further, Cylink may
be using products in its business  operations which are not Year 2000 compliant.
An unanticipated  Year 2000  interruption  could have material adverse financial
consequences  to the Company or  seriously  impair  business  operations  for an
indefinite period of time.

         For a more  comprehensive  discussion  of Cylink's  Year 2000 plans and
exposures,  see the "Year 2000" topic under Part I, Item 1, "Risk  Factors  That
May Affect Future Results."


ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          As of December 31, 1998,  the Company held a total of $46.6 million of
cash, cash  equivalents and short-term  investments.  These  securities  consist
primarily   of  money  market  funds  and   high-grade,   short-term   corporate
obligations.  Certain of these  securities are subject to interest rate risk and
will decline in value if market  interest  rates  increase.  If market  interest
rates were to increase immediately and uniformly by 10 percent from levels as of
December  31,  1998,  the  decline in fair value of the  portfolio  would not be
material.

         The Company  transacts  substantially  all of its revenues and costs in
U.S. dollars and its results of operations  would not be materially  affected by
fluctuations in foreign  exchange rates.  Accordingly,  to date, the Company has
not used material amounts of derivative  financial  instruments.  As of December
31,  1998,  the Company  had no fixed rate  obligations  except for  capitalized
leases and long-term debt of approximately  $267.000. As such, the fair value of
the Company's fixed rate obligations is not subject to a material adverse impact
from changes in interest rates.

                                       19
<PAGE>

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
Index to Consolidated Financial Statements and Financial Statement Schedule
<CAPTION>
                                                                                          Page
Financial Statements:                                                                     ----
<S>                                                                                         <C>
    Report of Independent Accountants                                                       20
    Consolidated Balance Sheets at December 31, 1998 and 1997                               21
    Consolidated Statements of Operations for the years ended
       December 31, 1998, 1997 and 1996                                                     22
    Consolidated Statements of Shareholders' Equity for the years ended
       December 31, 1998, 1997 and 1996                                                     23
   Consolidated Statements of Cash Flows for the years ended
       December 31, 1998, 1997 and 1996                                                     24
   Notes to Consolidated Financial Statements                                               25

Financial Statement Schedule:

   Schedule II - Valuation and Qualifying Accounts for the years ended
   December 31, 1998, 1997 and 1996                                                         44
</TABLE>

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, 1998
        and 1997,  and the results of their  operations and their cash flows for
        each of the three  years in the  period  ended  December  31,  1998,  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.

        As  indicated  in  Note 2,  the  Company  restated  its  1997  financial
        statements with respect to revenue recognition.


        PricewaterhouseCoopers LLP
        San Jose, California
        February 26, 1999

                                       20
<PAGE>

<TABLE>
                                                   Cylink Corporation
                                               Consolidated Balance Sheets
                                 (dollars in thousands, except share and per share data)
<CAPTION>
                                                                                                  December 31,
                                                                                        --------------------------------
                                                                                             1998             1997
                                                                                        ---------------  ---------------
                                                                                                            (restated-
                                   Assets                                                                   See Note 2)
<S>                                                                                     <C>              <C>
Current assets:
   Cash and cash equivalents                                                            $        46,575  $        22,977
   Accounts receivable, net of allowances of $1,251 and $278                                      7,958           13,914
   Note receivable                                                                                3,545                -
   Inventories                                                                                   10,289            6,224
   Net assets of discontinued operations                                                              -           11,299
   Deferred income taxes                                                                          4,495            1,533
   Other current assets                                                                           6,675            2,190
                                                                                        ---------------  ---------------
            Total current assets                                                                 79,537           58,137
                                                                                                
Property and equipment, net                                                                       5,731            6,003
Acquired technology, goodwill and other intangibles                                               5,341            8,017
Notes receivable from employees or former employees                                               2,558            3,473
Other assets                                                                                      1,151              925
                                                                                        ---------------  ---------------
                                                                                        $        94,318  $        76,555
                                                                                        ===============  ===============
                    Liabilities and Shareholders' Equity                                    
Current liabilities:
   Current portion of lease obligations and long-term debt                              $           120  $           210
   Accounts payable                                                                               3,656            2,238
   Accrued liabilities                                                                            8,230            6,194
   Accrued liabilities related to discontinued operations                                         3,878                -
   Income taxes payable                                                                           1,091            1,304
   Deferred revenue                                                                               1,975              206
                                                                                        ---------------  ---------------
         Total current liabilities                                                               18,950           10,152
                                                                                        ---------------  ---------------

Capital lease obligations and long-term debt                                                        147              256
                                                                                        ---------------  ---------------

Deferred income taxes                                                                                 -               13
                                                                                        ---------------  ---------------
Commitments and contingencies (Notes 4, 9 and 11)

Shareholders' equity:
   Preferred stock, $0.01 par value; 5,000,000 shares authorized;
      none issued and outstanding                                                                     -                -
   Common stock, $0.01 par value; 40,000,000 shares authorized;
      29,115,000 and 28,695,000 shares issued and outstanding                                       291              287
   Additional paid-in capital                                                                   123,929          120,092
   Deferred compensation related to stock options                                                  (167)            (250)
   Accumulated other comprehensive loss                                                             (61)             (63)
   Accumulated deficit                                                                          (48,771)         (53,932)
                                                                                        ---------------  ---------------
            Total shareholders' equity                                                           75,221           66,134
                                                                                        ---------------  ---------------
                                                                                        $        94,318  $        76,555
                                                                                        ===============  ===============
<FN>
                       The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>

                                                           21
<PAGE>

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


                                                                          Year ended December 31,
                                                              ------------------------------------------
                                                                 1998            1997           1996
                                                              -----------    -----------     -----------
                                                                            (restated-
                                                                            See Note 2)
<S>                                                           <C>            <C>             <C>        
Revenue                                                       $    42,760    $    47,690     $    25,793
Cost of revenue                                                    16,898         13,986           9,731
                                                              -----------    -----------     -----------
Gross profit                                                       25,862         33,704          16,062
                                                              -----------    -----------     -----------

Operating expenses:
   Research and development, net                                   15,809         12,488           8,198
   Selling and marketing                                           24,111         16,036           9,475
   General and administrative                                      12,082          8,422           6,597
   Amortization of purchased intangibles                            2,718            807               -
   Purchased in-process technology                                      -         63,920               -
                                                              -----------    -----------     -----------
            Total operating expenses                               54,720        101,673          24,270
                                                              -----------    -----------     -----------

Loss from operations                                              (28,858)       (67,969)         (8,208)

Other income (expense):
   Interest income, net                                             2,281          2,697           3,303
   Royalty and other income (expense), net                             66            317            (617)
                                                              -----------    -----------     -----------

Loss from continuing operations before income taxes               (26,511)       (64,955)         (5,522)
Benefit from income taxes                                          (9,155)            -                -
                                                              -----------    -----------     -----------
Loss from continuing operations                                   (17,356)       (64,955)         (5,522)

Income (loss) from discontinued operations, net of income tax
   expense (benefit) of ($139), $1,439 and $257                      (259)         3,210           6,719
Gain on disposal of discontinued operations, net
   of income tax expense of $12,358                                22,776              -               -
                                                              -----------    -----------     -----------
Net income (loss)                                             $     5,161    $   (61,745)    $     1,197
                                                              ===========    ===========     ===========

Earnings (loss) per share - basic:
   Continuing operations                                      $     (0.60)   $     (2.43)    $     (0.23)
   Discontinued operations                                           0.78           0.12            0.28
                                                              -----------    -----------     -----------
   Net income (loss)                                          $      0.18    $     (2.31)    $      0.05
                                                              ===========    ===========     ===========
Earnings (loss) per share - diluted:
   Continuing operations                                      $     (0.60)   $     (2.43)    $     (0.23)
   Discontinued operations                                           0.78           0.12            0.28
                                                              -----------    -----------     -----------
   Net income (loss)                                          $      0.18    $     (2.31)    $      0.05
                                                              ===========    ===========     ===========
Shares used in per share calculation - basic                       29,009         26,703          24,412
                                                              ===========    ===========     ===========
Shares used in per share calculation - diluted                     29,009         26,703          24,412
                                                              ===========    ===========     ===========

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

                                                   22
<PAGE>

<TABLE>
Cylink Corporation
Consolidated Statements of Shareholders' Equity
(dollars in thousands)
<CAPTION>

                                                                                                     Deferred
                                                                                         Notes     Compensation
                                                                        Additional     Receivable   Related to
                                                 Common Stock            Paid-in         from          Stock
                                           Shares          Amount        Capital     Shareholders     Options
                                      -------------  -------------  --------------  -------------   -------------
<S>                                      <C>            <C>             <C>         <C>             <C>        
Balance at December 31, 1995             19,087,000     $      191      $    9,281  $        (515)  $        (417)
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 stock options                    -              -             597              -               - 
Payments on notes receivable                                                                      
   from shareholders                              -              -               -            214               - 
Amortization of deferred                                                                          
   compensation                                   -              -               -              -              83 
Reversal of unrealized loss on                                                                    
   investments upon disposition                   -              -               -              -               - 
Translation adjustment                            -              -               -              -               - 
Net income                                        -              -               -              -               - 
   Comprehensive income                           -              -               -              -               -  
                                      -------------  -------------  --------------  -------------   -------------
Balance at December 31, 1996             25,597,000            257          89,772           (301)           (334)
Issuance of common stock                                                                          
   under stock option plans                 505,000              4             525              -               - 
Issuance of common stock for                                                                      
   acquisition of Algorithmic                                                                     
   Research                               2,593,000             26          29,499              -               - 
Tax benefit from stock options                    -              -             296              -               - 
Payments on notes receivable                                                                      
   from shareholders                              -              -               -            301               - 
Amortization of deferred                                                                          
   compensation                                   -              -               -              -              84 
Translation adjustment                            -              -               -              -               - 
Net loss                                          -              -               -              -               - 
   Comprehensive loss                             -              -               -              -               -  
                                      -------------  -------------  --------------  -------------   -------------
Balance at December 31, 1997             28,695,000            287         120,092              -            (250)
Issuance of common stock                                                                          
   under stock option plans                 420,000              4           1,813                                
Charge due to 
   acceleration of options 
   upon disposal
   of Wireless Group                                                           725                                
Tax benefit from stock options                                               1,299                                       
Amortization of deferred                                                                          
   compensation                                                                                                83 
Translation adjustment                                                                                            
Net income                                        -              -               -              -               - 
Comprehensive income                              -              -               -              -               -     
                                      -------------  -------------  --------------  -------------   -------------
Balance at December 31, 1998             29,115,000     $      291      $  123,929  $           -   $        (167)
                                      =============  =============  ==============  =============   =============



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


                                       Accumulated      Retained                                 
                                         Other          Earnings                    Comprehensive
                                      Comprehensive   (Accumulated                     Income    
                                      Income (loss)     Deficit)         Total         (Loss)    
                                      -------------  -------------  --------------  -------------
                                                          (restated-See Note 2)
                                                                                                 
Balance at December 31, 1995             $     (551)    $    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 stock options                    -              -             597               
Payments on notes receivable                                                                     
   from shareholders                              -              -             214               
Amortization of deferred                                                                         
   compensation                                   -              -              83               
Reversal of unrealized loss on                                                                   
   investments upon disposition                 416              -             416  $         416
Translation adjustment                          139              -             139            139
Net income                                        -          1,197           1,197          1,197
                                                                                    -------------
   Comprehensive income                           -              -               -  $       1,752 
                                      -------------  -------------  --------------  =============
Balance at December 31, 1996                      4          7,813          97,211               
Issuance of common stock                                                                         
   under stock option plans                       -              -             529               
Issuance of common stock for                                                                     
   acquisition of Algorithmic                                                                    
   Research                                       -              -          29,525               
Tax benefit from stock options                    -              -             296               
Payments on notes receivable                                                                     
   from shareholders                              -              -             301               
Amortization of deferred                                                                         
   compensation                                   -              -              84               
Translation adjustment                          (67)             -             (67) $         (67)
Net loss                                          -        (61,745)        (61,745)       (61,745)
                                                                                    -------------
   Comprehensive loss                             -              -               -  $     (61,812)
                                      -------------  -------------  --------------  =============
Balance at December 31, 1997                    (63)       (53,932)         66,134               
Issuance of common stock                                                                         
   under stock option plans                                                  1,817               
Charge due to 
   acceleration of options 
   upon disposal 
   of Wireless Group                                                           725               
Tax benefit from stock options                                               1,299               
Amortization of deferred                                                                         
   compensation                                                                 83               
Translation adjustment                            2                              2  $           2
Net income                                        -          5,161           5,161          5,161
                                                                        ----------  -------------
Comprehensive income                              -              -               -        $ 5,163
                                      -------------  -------------  --------------  =============
Balance at December 31, 1998          $         (61) $     (48,771) $       75,221
                                      =============  =============  ==============  

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

                                                        23
<PAGE>

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


                                                                                                Year ended December 31,
                                                                                    -----------------------------------------------
                                                                                        1998              1997            1996
                                                                                    ------------      -----------      ------------
                                                                                                      (restated-
                                                                                                      See Note 2)
<S>                                                                                 <C>               <C>              <C>
Cash flows from operating activities:
   Net income (loss)                                                                $      5,161      $   (61,745)     $     1,197
   Adjustments to reconcile net income (loss) to net                                 
      cash used in operating activities:                                             
         Gain on sale of discontinued operations                                         (22,776)               -                -
         Write-off of minority interest in unaffiliated company                            3,000                -                -
         Purchased in-process technology                                                       -           63,920                -
         Depreciation                                                                      2,630            2,107            1,350
         Amortization                                                                      2,676              807                -
         Bonuses applied against employee notes receivable                                 1,253                -                -
         Amortization of imputed interest on employee notes receivable                     1,006                -                -
         Deferred compensation related to stock options                                       83               84               83
         Deferred income taxes                                                            (2,975)            (100)            (516)
         Realized loss on sale of investments                                                  -                -              432
         Tax benefit from stock options                                                    1,299              296              597
         Changes in assets and liabilities (net of effects of ARL acquisition):
            Accounts receivable                                                            7,455           (7,627)          (6,669)
            Inventories                                                                   (6,134)          (2,662)          (2,732)
            Other assets                                                                  (4,370)            (376)            (405)
            Accounts payable                                                                 653              (22)           2,576
            Accrued liabilities                                                           (3,892)              90            1,349
            Income taxes payable                                                         (12,571)           1,244              (30)
            Deferred revenue                                                               1,769             (332)            (936)
                                                                                    ------------      -----------      ------------
               Net cash used in operating activities                                     (25,733)          (4,316)          (3,704)
                                                                                    ------------      -----------      ------------
Cash flows from investing activities: 
   Acquisition of property and equipment                                                  (2,060)          (3,786)          (2,815)
   Purchase of ARL, net of cash acquired                                                       -          (44,890)               -
   Loans to employees in exchange for notes receivable                                    (2,108)          (3,473)               -
   Proceeds from sale of short-term investments                                                -                -            2,842
   Proceeds from sale of discontinued operations                                          54,879                -                -
   Acquisition of minority interest in unaffiliated company                               (3,000)               -                -
                                                                                    ------------      -----------      ------------
               Net cash provided by (used in) investing activities                        47,711          (52,149)              27
                                                                                    ------------      -----------      ------------
Cash flows from financing activities:
   (Repayments) borrowings under bank line of credit                                                            -           (1,000)
   Proceeds from issuance of common stock, net                                             1,817              529           79,960
   Payments on notes receivable from shareholders                                              -              301              214
   Repayments of capital lease obligations and long-term debt                               (199)            (170)             (27)
                                                                                    ------------      -----------      ------------
               Net cash provided by financing activities                                   1,618              660           79,147
                                                                                    ------------      -----------      ------------
Effect of exchange rate changes on
   cash and cash equivalents                                                                   2              (67)             139
                                                                                    ------------      -----------      ------------
Net increase (decrease) in cash and cash equivalents                                      23,598          (55,872)          75,609
Cash and cash equivalents at beginning of year                                            22,977           78,849            3,240
                                                                                    ------------      -----------      ------------
Cash and cash equivalents at end of year                                            $     46,575      $    22,977      $    78,849
                                                                                    ============      ===========      ============
                                                                                                                        
Supplemental disclosures:                                                                                               
   Cash paid for income taxes                                                       $      8,117      $        31      $       184
   Cash paid for interest                                                                     60              159              110
   Equipment acquired under capital lease obligations                                          -                -              256
   Equity issued for purchase of ARL                                                           -           29,525                -
   Note receivable from disposition of Wireless Communications                                                          
        Group                                                                             12,424                -                -

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


                                                                24
<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")  develops,  markets  and  supports  a
comprehensive family of secure electronic commerce and communications  solutions
used by  organizations  worldwide to protect and manage the access,  privacy and
integrity  of  information  transmitted  globally.  The  Company's  products are
incorporated  into local area networks (LANs),  wide area networks  (WANs),  and
packet switched networks,  such as the Internet. The Company was incorporated in
California in October 1989 to engage in the  development,  manufacture,  license
and marketing of secure  electronic  communications  solutions and in 1990 began
developing  wireless  communications  products.  The Company  sold its  Wireless
Communications  Group  (the  "Wireless  Group")  in  March  1998  (see  Note 3).
Accordingly,   the  results  of  the  Wireless   Group  have  been  reported  as
discontinued operations for all periods presented.

     The Company has one reporting segment based on its management structure.

Basis of presentation

     The consolidated  financial  statements include the accounts of the Company
and its wholly owned  subsidiaries.  Investments of 20% to 50% are accounted for
using the equity method of accounting. Other investments are accounted for using
the cost method.  All significant  intercompany  accounts and transactions  have
been eliminated.

     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.

Foreign currency

     The  functional  currency of the Company's  Israeli  operations is the U.S.
dollar. The functional  currencies of the Company's other foreign operations are
the local  currencies.  The effects of  translating  the financial  position and
results of operations of local functional  currency operations are included as a
component of shareholders'  equity. The effects of foreign currency transactions
and of remeasuring the financial position and results of Israeli operations into
the functional currency are included in the statements of operations.  Net gains
and losses from foreign currency transactions 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.

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  three-to-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.

                                       25
<PAGE>

Amortization of goodwill and other intangibles

     Goodwill  related  to  the  acquisition  of  ARL is  being  amortized  on a
straight-line   basis  over  seven  years.   Amounts  allocated  to  capitalized
intangibles   other  than  goodwill  are  being   amortized  over  three  years.
Accumulated  amortization  relating to goodwill and other  intangibles  was $3.5
million and $0.8 million at December 31, 1998 and 1997, respectively.

Impairment of long-lived Assets

     The  Company  periodically  reviews  the  recoverability  of all  long-term
assets, including the related amortization period, whenever events or changes in
circumstances  indicate  that  the  carrying  amount  of an asset  might  not be
recoverable.  The Company  determines  whether  there has been an  impairment by
comparing  the  anticipated  undiscounted  future net cash flows to the  related
asset's carrying value. If an asset is considered impaired, the asset is written
down to fair value which is either  determined based on discounted cash flows or
appraised values, depending on the nature of the asset.

Revenue recognition

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

     The Company also derives revenue from the license of its software  products
as well as fees for software  maintenance and support.  Fees for maintenance and
support  services  are  charged  separately  from the  license of the  Company's
software products.  License revenues are recognized upon shipment of the product
if no  significant  vendor  obligations  remain and  collection of the resulting
receivable  is probable.  In instances  where a  significant  vendor  obligation
exists,  revenue recognition is delayed until the obligation has been satisfied.
Allowances for estimated future returns, which to date have been immaterial, are
provided upon shipment.  Maintenance and support fees consist of ongoing support
and product  updates and are  recognized  ratably over the term of the contract,
which is typically twelve months. The Company has recognized software revenue in
accordance   with  Statement  of  Position  97-2  entitled   "Software   Revenue
Recognition." Software revenue,  including related maintenance and support fees,
was not material in any period presented.

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.

     During the years  ended  December  31,  1998,  1997 and 1996,  the  Company
performed research and development under several government funded  arrangements
aggregating $445,000, $1,201,000, and $3,777,000,  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  during  1998,  1997 and 1996 which  provide for the
development and transfer of technology in exchange for development  funding.

                                       26
<PAGE>

The Company  recorded  as a  reduction  of  research  and  development  expenses
$1,455,000,  $225,000 and $2,363,000 under such  arrangements in the years ended
December 31, 1998, 1997 and 1996, respectively.


Stock-based compensation

     The Company accounts for stock based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion 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.

Earnings (loss) per share

     Basic earnings (loss) per share is based on the weighted-average  number of
common shares  outstanding.  Diluted  earnings  (loss) per share is based on the
weighted-average  number of common  shares  outstanding  and dilutive  potential
common shares  outstanding.  The Company's only potentially  dilutive securities
are stock options (See Note 7). All  potentially  dilutive  securities have been
excluded from the  computation of diluted  earnings per share as their effect is
anti-dilutive on the loss from continuing operations for all periods presented.

Concentrations of credit risk

     Financial  instruments that potentially  subject the Company to significant
concentration  of credit risk consist  primarily  of cash and cash  equivalents,
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 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 accounts  receivable at December
31, 1998 and 1997. One customer  accounted for 14% of revenue for the year ended
December 31, 1998.  No customer  accounted  for more than 10% of revenue for the
years ended December 31, 1997 and 1996.

Fair value of financial instruments

     The carrying amount of cash, cash equivalents, and other current assets and
liabilities   such  as  accounts   receivable,   accounts  payable  and  accrued
liabilities,  as presented in the financial statements,  approximates fair value
based on the  short-term  nature of these  instruments.  The recorded  amount of
long-term debt  approximates fair value as the actual interest rates approximate
current competitive rates.


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.

Comprehensive Income (Loss)

     Effective  January 1, 1998,  the Company  adopted  Statement  of  Financial
Accounting Standards No. 130, "Reporting  Comprehensive Income" ("FAS130").  FAS
130  requires  that  all  items  recognized   under   accounting   standards  as
comprehensive  income be  reported  in an  annual  financial  statement  that is
displayed  with  the  same  prominence  as other  annual  financial  statements.
Comprehensive income (loss) includes all changes in equity (net assets) during a
period from nonowner sources.  Examples of items to be included in comprehensive
income,  which are excluded from net income  (loss),  

                                       27
<PAGE>

include foreign  currency  translation  adjustments and unrealized  gain/loss on
available-for-sale  securities  The Company has presented  comprehensive  income
(loss)  for  each  period  presented  within  the  Consolidated   Statements  of
Shareholder's Equity.

New Accounting Pronouncement

     In June 1998, the Financial  Accounting Standards Board issued Statement of
Financial Accounting  Standards No. 133, "Accounting for Derivative  Instruments
and Hedging  Activities"  ("FAS 133").  The new standard  requires  companies to
record  derivatives on the balance sheet as assets or  liabilities,  measured at
fair value.  Under FAS 133, gains or losses resulting from changes in the values
of  derivatives  are to be  reported  in the  statement  of  operations  or as a
deferred item,  depending on the use of the derivatives and whether they qualify
for  hedge  accounting.  The key  criterion  for  hedge  accounting  is that the
derivative  must be highly  effective  in achieving  offsetting  changes in fair
value or cash  flows of the  hedged  items  during  the term of the  hedge.  The
Company is required to adopt FAS 133 in the first  quarter of 2000.  The Company
currently transacts  substantially all of its revenues and costs in U.S. dollars
and to date has not entered into any material amounts of derivative instruments.
Accordingly,  management does not currently expect adoption of this new standard
to have a significant impact on the Company.

Reclassifications

     Certain  reclassifications  have been made to the  financial  statements in
order to conform to the 1998 presentation.

2.   Restatement of Financial Results

     On  November  5,  1998,  the  Company  publicly  announced  that it and its
independent  accountants had initiated a review of revenue recognition practices
which  would  result in a  restatement  of  previously  issued  first and second
quarter 1998 results and that the first three quarters of 1998 were all expected
to show substantial  operating losses.  During the review,  certain facts became
known indicating errors had been made in the application of revenue  recognition
policies which also impacted the fourth quarter of 1997.  These restated results
were announced in a press release dated December 16, 1998.

     As a  result,  the 1997  results  contained  in this  Form  10-K  have been
restated as follows:

                                                      Year ended
                                           -------------------------------
                                                  December 31, 1997
                                                  -----------------
                                           As Originally
                                           -------------
                                             Reported           As Restated
                                           --------------------------------
                                                   (in thousands,
                                              except per share amounts)
Revenue                                    $   49,333           $   47,690

Total Operating expenses                      101,673              101,673

Loss from
    continuing operations                     (63,312)            ( 64,955)




Earnings (loss) per share - diluted
   Continuing operations                   $   (2.37)           $    (2.43)
   Discontinued operations                      0.17                  0.12
                                           ================ ===============
   Net income (loss)                       $   (2.20)           $    (2.31)
                                           ================ ===============

 
                                       28
<PAGE>
The  restatement  of results  for 1997  resulted in a  reduction  of  previously
reported  amounts at December 31, 1997 for accounts  receivable of $1.6 million,
net assets of  discontinued  operations of $1.9 million and income taxes payable
of  $0.6  million,  and a  corresponding  increase  in the  previously  reported
accumulated deficit of $3.0 million, resulting in a restated accumulated deficit
of $53.9 million.

3.   Discontinued Operations

     On March 28,  1998,  the Company  sold its  Wireless  Communications  Group
("Wireless") to P-Com for an originally reported $60.5 million ($46.0 million in
cash and an  unsecured  note in the amount of $14.5  million  due 100 days after
closing, subject to closing adjustments). The sale resulted in an after tax gain
of  approximately  $22.8 million.  As a result,  the operations of Wireless have
been  classified as  discontinued  operations in the  accompanying  Consolidated
Financial  Statements  and  related  Notes.  Accrued  expenses  in the amount of
approximately  $6.8 million,  primarily for professional  services,  anticipated
excess facilities expenses, and certain other transaction-related  accruals were
charged to discontinued operations and reduced the gain on disposal. Pursuant to
the  restatement,  certain  revenues of Wireless  previously  recognized  in the
fourth quarter of 1997 and the first quarter of 1998 were adjusted. Based on the
net  assets of  Wireless  as of March 28,  1998,  after  restatement,  the sales
proceeds  would  have  been  approximately  $58.4  million  resulting  in a note
receivable  of  approximately  $12.4 million (a reduction of $2.1 million in the
initial note receivable). On July 14, 1998, P-Com made a partial payment of $8.9
million on its  promissory  note and is disputing the  remaining  balance of the
note and certain other amounts which the Company  believes are  receivable  from
P-Com.  (See Note 9) Wireless revenues were $26.2 million in 1996, $28.0 million
in 1997 and $4.4 million in 1998 through the date of disposal.


4.   Acquisition of Algorithmic Research

     On September 8, 1997, the Company acquired all of the outstanding shares of
Algorithmic Research, Ltd. and Algart Holdings, Ltd. (hereafter referred to on a
combined basis as "ARL"),  both limited liability  companies organized under the
laws of the State of Israel.  ARL is an information  security company  providing
remote access software products and smart-card technology focusing on the market
for Internet-based (TCP/IP) communications.  ARL also provides security products
to broadcast  networks.  Consideration  for this  purchase was $44.9  million in
cash, net of cash acquired,  including transaction expenses of $3.5 million; and
2,593,169  shares of the Company's common stock and 409,641 fully vested options
to purchase  common  stock of the  Company for $0.01 per share.  The total value
placed on the common stock and options  issued by the Company was $29.5 million.
The common stock and options  issued are subject to decreasing  restrictions  on
trading and exercise,  respectively,  for three years from the transaction date.
The  acquisition  was recorded  under the  purchase  method of  accounting;  and
accordingly,  the results of operations of ARL are included in the  consolidated
financial  statements from the date of acquisition.  The purchase price has been
allocated  to the  assets  acquired  and  liabilities  assumed  based  upon  the
estimated fair market values at the date of acquisition, as summarized below (in
thousands):

Current assets (including cash and cash equivalents of $1,857)        $   4,380
Property and equipment                                                    1,261
In-process technology                                                    63,920
Developed technology and other intangibles                                7,498
Goodwill                                                                  1,326
Other non-current assets                                                     96
Current liabilities assumed                                              (2,021)
Long-term debt assumed                                                     (188)
                                                                      ----------
                                                                      $  76,272
                                                                      ==========

     The amounts  allocated to technology  were estimated  using a risk adjusted
income approach  applied to  specifically  identified  technologies.  In-process
technology was expensed upon acquisition because  technological  feasibility had
not been established and no alternative  future uses existed.  Amounts allocated
to  capitalized  intangibles  other  than  goodwill  are  being  amortized  on a
straight-line  basis  over  three  years.  Goodwill  is  being  amortized  on  a
straight-line basis over seven years.

     In connection  with the  acquisition of ARL in September  1997, the Company
allocated  $63.9  million  of the  purchase  price to  in-process  research  and
development  ("IPR&D"),  and in accordance  with generally  accepted  accounting
principles  recorded  an  immediate  charge  off of that  amount  on the date of
acquisition. The amount allocated to IPR&D was

                                       29
<PAGE>

determined in a manner consistent with widely recognized appraisal practices and
reviewed by our independent  accountants in the context of their  examination of
the financial statements taken as a whole.

     In a letter dated September 15, 1998 to the American Institute of Certified
Public  Accountants,  the  Chief  Accountant  of  the  Securities  and  Exchange
Commission  ("SEC")  indicated  the SEC  Staff's  concerns  related  to  certain
appraisal  practices  generally employed in determining the fair value of IPR&D.
As a result,  it is possible that the SEC staff may require that any  enterprise
that recorded an IPR&D charge revise its estimate of the value of the IPR&D.  To
the extent the Company is required by the SEC Staff to retroactively  revise its
estimate of the value of IPR&D, such revision could result in the capitalization
of additional goodwill,  the amortization of which would reduce future operating
results.
<TABLE>
     The following  unaudited pro forma  financial  information  relating to the
Company's  continuing  operations  gives effect to the  acquisition as if it had
occurred  on  January  1,  1996,  excluding  the  charge  related  to  purchased
in-process   technology.   These  pro  forma  results  have  been  prepared  for
comparative  purposes only and do not purport to be indicative of the results of
continuing  operations  which actually  would have resulted had the  acquisition
occurred on the date indicated, or which may result in the future.
<CAPTION>
                                                                                Year ended December 31,
                                                                    -----------------------------------------------
                                                                              1997                    1996
                                                                    -----------------------    --------------------
                                                                    (restated-See Note 2)
                                                                    (in thousands, except per share data, unaudited)
<S>                                                                 <C>                        <C>             
Revenue                                                             $           51,900         $         32,999
Net income (loss)                                                               (4,010)                  (9,552)
Net income (loss) per share - (basic and diluted)                                (0.14)                   (0.35)
Shares used to compute net income (loss) per share
   (basic and diluted)                                                          29,296                   27,005

</TABLE>
<TABLE>
5.   Details of Balance Sheet Components
<CAPTION>
                                                                                 December 31,
                                                                    ---------------------------------------
                                                                        1998                   1997
                                                                        ----                   ----
                                                                                            (restated)
                                                                               (in thousands)
<S>                                                                 <C>                    <C>
Inventories:
   Raw materials                                                    $         2,813        $         2,191
   Work in process and subassemblies                                          1,877                  1,858
   Finished goods                                                             5,599                  2,175
                                                                    ---------------        ----------------
                                                                    $        10,289        $         6,224
                                                                    ===============        ================
Property and equipment:
   Machinery and equipment                                          $         9,674        $         9,711
   Furniture and fixtures                                                     1,478                  1,246
   Land and building                                                            814                    814
   Leasehold improvements                                                       821                    680
                                                                    ---------------        ----------------
                                                                             12,787                 12,451
   Less:  accumulated depreciation and amortization                          (7,056)                (6,448)
                                                                    ---------------        ----------------
                                                                    $         5,731        $         6,003
                                                                    ===============        ================
Accrued liabilities:
   Compensation and benefits                                        $         2,341        $         2,433
   Royalties                                                                    768                    982
   Employee severance costs                                                   1,556                  1,313
   Distributor commissions                                                      636                    380
   Other                                                                      2,929                  1,086
                                                                    ---------------        ----------------
                                                                    $         8,230        $         6,194
                                                                    ===============        ================
</TABLE>


                                                     30
<PAGE>


6.   Income Taxes

     The  Company  recorded  a  benefit  for  income  taxes of $9.2  million  on
continuing  operations  and a  provision  for income  taxes of $12.2  million on
discontinued  operations  for 1998.  No provision or benefit for income taxes on
continuing  operations  was  recorded for 1997 or 1996.  The Company  recorded a
provision  for income  taxes on  discontinued  operations  of $1.4  million  and
$257,000 for 1997 and 1996, respectively.

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


                                        Year ended December 31,
                                   ----------------------------------
                                       1998      1997         1996    
                                   ----------  --------    ----------  
                                              (restated)
                                            (in thousands)

Current:
   Federal                         $  (4,506)  $     -     $     -   
   State                              (1,722)        -           -   
   Foreign                                48         -           -   
                                   ----------- ----------  ----------
                                   $  (6,180)  $     -     $     -   
                                   =========== ==========  ==========

Deferred:
   Federal                         $  (3,233)  $     -     $     -   
   State                                 258         -           -   
                                   ----------- ----------  ----------
                                      (2,975)        -           -   
                                   ----------- ----------  ----------
                                   $  (9,155)  $     -     $     -   
                                   =========== ==========  ==========


                                       31
<PAGE>

<TABLE>
     Deferred tax assets (liabilities) comprise the following:
<CAPTION>

                                                                        December 31,
                                                         ----------------------------------------
                                                              1998          1997         1996
                                                         ------------- -------------- -----------
                                                                        (restated)
                                                                        (in thousands)
<S>                                                      <C>          <C>          <C>
Assets:

Net operating loss and credit carryforwards              $         -  $     1,109  $      984
Unrealized capital loss                                        1,057          270         166
Bad debt reserve                                                 172          151         230
Inventory reserves and basis differences                       1,563        1,492       1,382
Accrued expenses                                               1,508          368         448
Warranty reserve                                                 218           71          60
Reserve for discontinued operations                            1,504            -           -
Other                                                          1,073           41         132
                                                         -----------  -----------  ----------
         Total deferred tax assets                             7,095        3,502       3,402
                                                         -----------  -----------  ----------

Liabilities:
Depreciation                                                       -          (13)         (5)
Other liabilities                                                  -            -          (7)
                                                         -----------  -----------  ----------
         Total deferred tax liabilities                            -          (13)        (12)
                                                         -----------  -----------  ----------
Valuation allowance                                           (2,600)      (1,969)     (1,970)
                                                         -----------  -----------  ----------
Net deferred tax assets                                  $     4,495  $     1,520  $    1,420
                                                         ===========  ===========  ==========
</TABLE>

     Net  deferred tax assets of  $4,495,000  at December 31, 1998 were based on
the  Company's  available  carryback  capacity.  The Company  recorded a partial
valuation allowance against the remainder of its deferred tax assets.
<TABLE>
     The  provision  (benefit)  for  income  taxes  for  continuing   operations
reconciles  to the  amount  computed  by  applying  the  United  States  federal
statutory rate to income before taxes as follows:
<CAPTION>
                                                                          Year ended December 31,
                                                        ------------------------------------------------------
                                                              1998              1997               1996
                                                        ---------------    ---------------    ----------------
<S>                                                               <C>                   <C>                <C>
U.S. federal statutory income tax rate                            (35.0)%               -  %               -  %
State taxes, net of federal tax benefit                            (3.2)                -                  -
Research and development tax credits                              (10.1)                -                  -
Change in valuation allowance                                       2.4                 -                  -
Foreign losses not benefitted                                       5.2                 -                  -
Other                                                               6.2                 -                  -
                                                        ---------------    ---------------    ----------------
Effective Tax Rate                                                (34.5)%               -  %               -  %
                                                        ===============    ================   ================
</TABLE>

                                       32
<PAGE>

7. Capital Structure

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 $80 million of cash, net of
underwriting discounts, commissions and other offering costs.

Preferred stock

     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, 1998

Stock option plans

     The Company has two stock option plans:  the 1994 Flexible Stock  Incentive
Plan  which  was the  successor  plan to the 1987  plan  ("1994  Plan")  and the
Cylink/ARL 1997 Stock Option Plan ("1997 Plan").  The 1994 Plan provides for the
grant of incentive stock options and  nonqualified  stock options to executives,
employees  and  consultants  to purchase up to 8,050,000  common  shares.  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, 1998, 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 1994 Plan 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.

     The Company  adopted the 1997 Plan in conjunction  with the  acquisition of
ARL. The 1997 Plan provides for the grant of  nonqualified  stock options to the
employees and  consultants of ARL to purchase up to 410,000  common  shares.  On
September 8, 1997,  the Company  issued 409,641 fully vested options to purchase
common  stock for  $0.01 per  share.  The  options  are  subject  to  decreasing
restrictions  on exercise  for three years from the grant date and expire in ten
years.

                                       33
<PAGE>

     Option  activity  under the 1994 Plan and the 1997  Plan is  summarized  as
follows:
                                                                       Weighted
                                         Shares                         Average
                                       Available       Options         Exercise
                                       for grant     Outstanding         Price
                                      ----------     -----------       --------
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
   Approved                              410,000              -      
   Granted at market price            (2,519,157)     2,519,157          10.38
   Granted below market price           (409,641)       409,641            .01
   Exercised                                   -       (504,144)          1.64
   Canceled                              537,187       (537,187)         12.17
                                      ----------     -----------
Balance at December 31, 1997                 359      5,265,220           8.52
   Approved                            2,100,000
   Granted at market price            (4,974,586)     4,974,586           5.55
   Exercised                                           (419,574)          4.27
   Canceled                            3,720,264     (3,720,264)         10.25
                                      ----------     -----------

Balance at December 31, 1998             846,037      6,099,968           5.58
                                      ==========     ===========


     On  December 11 and 14,  1998,  the  Company  canceled  options to purchase
2,346,999  shares of common  stock with  exercise  prices  ranging from $2.00 to
$23.50 per share previously granted to employees,  and reissued all such options
at prices ranging from $4.25 to $4.625 per share,  representing  the fair market
values on the dates of  reissuance.  The issued options have a six-year term and
vest over three years from the date of reissuance. In February 1997, the Company
canceled options to purchase 225,100 shares of common stock with exercise prices
ranging from $13.13 to $23.50 per share  previously  granted to  employees,  and
reissued all such options at $11.00 to $11.63 per share,  representing  the fair
market value of the stock on the date of reissuance. The reissued options have a
ten-year term and vest over five years from the date of reissuance.

                                       34

<PAGE>

<TABLE>
     Significant  option groups  outstanding  at December 31, 1998,  and related
weighted average exercise price and contractual life information are as follows:
<CAPTION>

                                       Options Outstanding                          Options Exercisable
                     --------------------------------------------------- --------------------------------------
                                           Weighted
                                           Average
                                           Remaining          Weighted                             Weighted
      Range of            Number        Contractual Life       Average            Number            Average
  Exercise Prices      Outstanding        (in years)        Exercise Price      Outstanding      Exercise Price
  -----------------    -----------      -----------------   --------------      -----------      --------------

<S>                     <C>                          <C>    <C>                   <C>            <C>           
  $ 0.01 to $ 3.19      1,399,353                    6.0    $         1.94          749,952      $         1.10
  $ 4.25 to $4.625      3,056,332                    6.0              4.36                -                   -
  $ 4.80 to $9.875        771,163                    7.9              8.59          256,345                8.22
  $10.875 to $23.50       873,120                    1.6             11.58          739,727               11.35
                       ----------                                               -----------
                        6,099,968                    5.6    $         5.37        1,746,024      $         6.49
                       ==========                                               ===========
</TABLE>


Pro forma stock compensation disclosures

     The weighted  average  estimated  grant date fair value, as defined by SFAS
123, for options  granted at market price during 1998,  1997 and 1996 was $3.80,
$4.70 and $6.03,  respectively. Options  granted  below market price during 1997
were granted in  connection  with the ARL acquisition  as  described  below. 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 tradable, 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.

     The following  weighted  average  assumptions are included in the estimated
grant date fair value  calculations  for the Company's stock option awards under
the 1994 Plan:


                                        1998             1997          1996
                                       ------           ------        ------
Expected life (years)                   3.10             3.10          3.04
Risk-free interest rate                 4.55%            5.98%         5.93%
Volatility                             80.00%           64.16%        69.46%
Dividend yield                          0.00%            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 1994 Plan,
the  Company's net income (loss) and net income (loss) per share would have been
reduced  to  (increased  by) the pro forma  amounts  below  for the years  ended
December 31, 1998, 1997 and 1996 (in thousands, except for per share amounts):

                                       35
<PAGE>

<TABLE>
<CAPTION>
                                                                   1998            1997            1996
                                                                ------------- --------------- --------------
                                                                                 (restated)
<S>                                                             <C>           <C>             <C>          
Net income (loss)                         As reported           $      5,161  $      (61,745) $       1,197
                                          Pro forma                    1,714         (65,243)          (325)

Net income (loss) per share               As reported           $       0.18  $        (2.31) $        0.05
                                          Pro forma                     0.06           (2.44)         (0.01)
</TABLE>

     The pro forma effect on net income  (loss) and net income  (loss) per share
for 1998,  1997 and 1996 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.

     The estimated  grant date fair value for options granted in connection with
the ARL  acquisition  under  the 1997  Plan was  $9.82  based on an  independent
appraisal. The aggregate value of the options issued was included as a component
of the  purchase  price of ARL and has been  excluded  from the  above pro forma
disclosures.

     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 Employees

     During  1997 and 1998,  the Company  made loans to certain of its  officers
towards the purchase of their principal  residences.  Some of these officers are
no longer employed by the Company. The notes are generally interest free and are
secured by deeds of trust on the  related  residences. The  Company  has imputed
interest on the notes  based on an assumed  interest  rate of 8% per annum.  The
notes are carried at their  discounted  value which  aggregated  $3.3 million at
December 31, 1998. As of December 31, 1998, the remaining  unamortized  discount
on the notes was $1.0  million.  The notes  mature as follows:  $1.0  million in
1999; $1.0 million in 2002, and $2.5 million in 2003.

9. Contingencies

     On March 7, 1997,  ten former  employees of Cylink filed suit in action No.
CV764647 in the Superior  Court of  California,  County of Santa Clara,  against
Cylink,  each of its Directors  and its General  Counsel,  asserting  claims for
wrongful  termination,  fraud, libel,  slander, age discrimination,  invasion of
privacy,  and  violation  of the federal  RICO  statute.  On July 11,  1997,  an
eleventh former employee filed suit in action no. CV767448 in the Superior Court
of  California,  County of Santa  Clara,  alleging  similar  claims  against the
Company and its former Chief Executive  Officer.  Cylink removed CV764647 to the
Federal District Court for the Northern District of California and, after Cylink
obtained an order dismissing  certain of the plaintiffs'  claims,  including the
claims of libel and RICO  violations,  the Court remanded the action back to the
Santa Clara Superior Court.  Following  mediation efforts in October,  1998, the
plaintiff in CV767448  accepted a settlement  and dismissed  his complaint  with
prejudice. The remaining plaintiffs subsequently dismissed,  with prejudice, all
of the outside Directors except the Chairman.  On December 4, 1998, and December
18,  1998 the Court  granted  Cylink's  motions for  summary  judgement  and for
dismissal,  respectively, of numerous claims in CV764647. Discovery with respect
to the remaining claims is continuing,  with trial currently  scheduled for late
1999.  Although Cylink has placed its insurers on notice of these claims, all of
its insurers have reserved their rights and defenses under their  policies,  and
the  extent of the  insurers'  liability  under  their  respective  policies  is
undetermined.  Based on the Court's  decisions  and  discovery  in the matter to
date, Cylink believes the terminations were lawful,  and in the best interest of
Cylink, and intends to continue defending 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  Cylink's  insurance  coverage,  if any,  could also  result in a
material adverse effect on Cylink's results of operations,  financial  condition
and cash flows.

     After asserting certain  deductions  arising under the contract dated March
28, 1998,  for the  purchase of Cylink's  Wireless  Group,  P-Com made a partial
payment on July 14, 1998, in the amount of $8.9 million on its  promissory  note

                                       36
<PAGE>

dated April 1, 1998. Cylink is presently  discussing with P-Com the basis of its
deductions  and,  failing an amicable  resolution  of P-Com's  contentions,  the
matter will proceed to litigation

     On September 3, 1998, P-Com put Cylink on notice that certain  shipments in
the fourth quarter of 1997 and the first quarter of 1998 by the Company's former
Wireless  Group and having an invoice  value of  approximately  $3.5 million had
been seized by an agency of the United  States  Department  of the  Treasury and
that P-Com  intends to hold  Cylink  responsible  for the  consequences  of this
event.  P-Com is  currently  petitioning  for  release  of the  goods.  Based on
Cylink's  investigation to date, Cylink believes either that the grounds for the
seizure are  unfounded  or that P-Com  itself is  responsible  for this  action.
Cylink  has no reason  at this time to  believe  that it is the  subject  of any
official  investigation  and Cylink has been  informed  that P-Com is  presently
petitioning  for the release of the seized  goods.  A failure by P-com to obtain
release of the  shipment  due to a violation  of law by Cylink  might  adversely
affect the amount collected from P-Com on its outstanding  obligations under the
promissory note, including payment of any relevant fines or penalties.

     On September  14, 1998,  Cylink  announced  that its earnings for the third
quarter  would be  below  consensus  estimates.  On  November  5,  1998,  Cylink
announced  that,  with the  assistance of its  independent  accountants,  it was
reviewing its revenue recognition practices, and Cylink announced that its first
and second  quarter  earnings  would have to be restated  and that it would have
operating  losses for each of the three quarters for the period ended  September
27, 1998.  During the review,  certain facts became known indicating  errors had
been made in the application of revenue recognition policies which also impacted
the fourth  quarter of 1997, and as a result,  1997 full-year  results have been
restated  along with first and second  quarter  1998  results.  Cylink has filed
amended  Forms  10-Q for the first  and  second  quarters  1998 and will file an
amended Form 10-K for 1997.  Between  November 6 and November 25, 1998,  several
securities class action  complaints were filed against Cylink and certain of its
current and former directors and officers in federal courts in California. These
complaints allege, among other things, that Cylink's previously issued financial
statements were materially  false and misleading and that the defendants knew or
should have known that these financial  statements  caused Cylink's common stock
price to rise  artificially.  The actions variously allege violations of Section
10(b) of the Securities  Exchange Act of 1934 (the "Exchange  Act"), as amended,
and SEC Rule 10b-5 promulgated thereunder, and Section 20 of the Exchange Act.

     Cylink believes it has meritorious defenses to these actions and intends to
defend itself  vigorously.  However,  it is not feasible to predict or determine
the  final  outcome  of  these  proceedings,  and  if  the  outcome  were  to be
unfavorable,  Cylink's business,  financial condition, cash flows and results of
operations, could be materially adversely affected.

                                       37
<PAGE>

10.  Geographic Information
<TABLE>
     The  Company  operates  in one  industry  segment  based on its  management
structure.  Revenue from continuing operations and long-lived assets, classified
by the major geographic areas in which the Company operates, were as follows:
<CAPTION>
                                                                               Year ended December 31,
                                                              ----------------------------------------------------

                                                                     1998              1997             1996
                                                              -----------------  ----------------  ---------------
                                                                             (restated-See Note 2)
                                                                                 (in thousands)
<S>                                                           <C>                <C>               <C>
Revenue:
   Sales to unaffiliated customers:
      From United States to:
         Customers in United States                           $          25,334  $        26,970   $        13,744
         Customers in Central and                              
            South America                                                 1,752            2,340               911
         Customers in Europe                                              3,855            7,996             5,694
         Customers in Asia                                                1,303            2,326             1,592
      From Europe to customers in Europe                                  6,855            5,113             3,852
      From Israel to:                                          
         Customers in Europe                                              1,710              530                 -
         Customers in Asia                                                1,194            2,332                 -
         Other                                                              757               83                 -
                                                              -----------------  ---------------   ----------------
                                                              $          42,760  $        47,690   $        25,793
                                                              =================  ===============   ================
Intercompany sales among geographic                            
   entities eliminated in consolidation                       $           4,322  $         2,266   $         2,233
                                                              =================  ===============   ================
</TABLE>


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





                                                  December 31,
                                           1998                  1997
                                   --------------------  ---------------------
                                                         (restated-See Note 2)
                                                 (in thousands)


Long-lived assets:
   United States                   $              3,759  $               4,890
   Europe                                           254                    215
   Israel                                         7,060                  9,356
                                   --------------------  ---------------------
                                                 11,073                 14,461
                                   ====================  =====================
 
     Long-lived  assets  attributed  to  Israel  include  acquired   technology,
goodwill and other  intangibles of $5.3 million and $8.0 million at December 31,
1998 and 1997  respectively,  related  to the  Company's  acquisition  of ARL in
September 1997.

11.  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 April 2003 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

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


                                       38
<PAGE>

                                                                    Operating
Year ending December 31,                                             Leases
                                                               -----------------
   1999                                                        $           1,524
   2000                                                                    1,169
   2001                                                                      905
   2002                                                                      257
   2003                                                                       44
                                                               -----------------
   Total minimum payments                                      $           3,899
                                                               =================

     Rent expense under operating  leases totaled  $1,473,000,  $1,720,000,  and
$1,207,000 for the years ended December 31, 1998, 1997 and 1996, respectively.



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

     Not applicable


                                       39
<PAGE>

                                    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 Cylink's Proxy Statement for the 1999 annual meeting of shareholders
to be held on or about May 14,  1999 (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 1998,  is  incorporated  herein by
reference.  The information  required by this Item concerning Cylink'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 Cylink'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 Cylink'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 Cylink'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 20 of this Form 10-K.

      2. Financial  Statement  Schedule -- See Index to  Consolidated  Financial
         Statements  and  Financial  Statement  Schedule at page 20 of this Form
         10-K.

      3. Exhibits Index:

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

          2.1        Stock  Purchase  Agreement,  dated as of September 7, 1997,
                     between Registrant, A.R. Data Security Ltd. And Algorithmic
                     Research Ltd. (4)

          2.2        Seller's  Agreement,  dated as of September 8, 1997,  among
                     Registrant,  A.R. Data Security Ltd.,  Algorithmic Research
                     Ltd., Amos Fiat,  Yossi Cohen,  Yossi Tulpan,  Koor Capital
                     Markets, and Telrad Holdings Ltd. (4)

                                       40
<PAGE>

          2.3        Parent  shareholders  Indemnity  Agreement,   dated  as  of
                     September  8, 1997 among  registrant,  A.R.  Data  Security
                     Ltd., Amos Fiat,  Yossi Cohen,  Yossi Tulpan,  Koor Capital
                     Markets, and Telrad Holdings Ltd. (4)



          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 the Bylaws  dated March 26,
                     1997. (3)

          4.1        Reference is made to Exhibits 3.1, 3.2, and 3.3.

          4.2        Specimen certificate for Common Stock.  (1)



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

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

         10.3        Employment  Agreement  between  the  Company  and  Jimmy K.
                     Omura,  dated as of April 1, 1989, and amendments  thereto,
                     and  termination  agreement  entered  into as of March  28,
                     1998. (1) (2)

         10.4        Employment  Agreement  between  the  Company and Fernand B.
                     Sarrat,  dated as of November 6, 1996,  and  Severance  and
                     Consulting Agreement entered into November 3, 1998. (2) (3)

         10.5        Employment  Agreement  between  the  Company and William C.
                     Crowell dated December 18, 1997 (2)


         10.6        Employment  Agreement  between  the Company and Sarah Engel
                     dated February 14, 1997 (2)

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

         21.1        Subsidiaries of the Company.

         23.1        Consent of PricewaterhouseCoopers LLP.

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

         27.1        Financial Data Schedule. (5)

         ----------------------------------------
         (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).

         (3) Incorporated  by reference  from the Company's  report on Form 10-K
             filed as of March 31, 1997 for the fiscal year ended  December  31,
             1996.

         (4) Incorporated  by reference  from the  Company's  report on Form 8-K
             filed as of September  23, 1997,  and report on Form 8-K/A filed as
             of November 24, 1997.

         (5) To be filed by amendment to this report on Form 10-K.

                                       41
<PAGE>

(b)  On November 24, 1997, the Company filed a report on Form 8-K/A amending the
     report on Form 8-K filed as of September 23, 1997, reporting under Items 2,
     7, and 9 the Company's  acquisition  of ARL, by reporting  under Item 7 the
     consolidated  financial statements of A.R. Data Security Ltd. and pro forma
     financial information for the Company and ARL.


                                       42
<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 30, 1999                By:   /s/ William P. Crowell 
                                           -----------------------
                                           William P. Crowell
                                           President and Chief Executive Officer
                                           (as of November 4, 1998)

         KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature
appears below  constitutes  and appoints  Roger A. Barnes 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/ WILLIAM P. CROWELL                          President, Chief executive Officer                   March 30, 1999
    ------------------------------                   (Principal Executive Officer) and
    William P. Crowell                               Director


    /s/ ROGER A. BARNES                              Vice President of Finance and Administration         March 30, 1999
    ------------------------------                   and Chief Financial Officer (Principal Financial
    Roger A. Barnes                                  and Accounting Officer)                         
                                                     (as of November 16, 1998)                       

    /s/ LEO A. GUTHART                               Chairman of the Board                                March 30, 1999
    ------------------------------
    Leo A. Guthart


    /s/ ELWYN BERLEKAMP                              Director                                             March 30, 1999
    ------------------------------
    Elwyn Berlekamp


    /s/ WILLIAM W. HARRIS                            Director                                             March 30, 1999
    ------------------------------
    William W. Harris


    /s/ HOWARD L. MORGAN                             Director                                             March 30, 1999
    ------------------------------
    Howard L. Morgan
</TABLE>


                                                              43
<PAGE>

<TABLE>
                                                    SCHEDULE II

                                                CYLINK CORPORATION
                                         VALUATION AND QUALIFYING ACCOUNTS
                                   Years ended December 31, 1996, 1997 and 1998
                                                  (in thousands)
<CAPTION>

                                                                         Additions
                                                         Balance at      Charged to      Deductions        Balance
                                                         Beginning      Statement of        from           at end
                                                         of Year         Operations       Reserves         of Year
<S>                                                       <C>              <C>              <C>             <C>
Allowance for doubtful accounts:
Year ended December 31, 1996                              $483             $ 269            $108            $  644
Year ended December 31, 1997                              $644             $(211)           $  -            $  433
Year ended December 31, 1998                              $433             $ 874            $ 56            $1,251
</TABLE>


                                                        44