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, 1997          Commission File No. 0-27742


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



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


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

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


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

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


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  Registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.
       Yes  X     No
          -----     -----

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


The  aggregate  market  value of  voting  stock  held by  non-affiliates  of the
Registrant,  based upon the closing  sale price of the Common Stock on March 13,
1998, as reported by the Nasdaq National Market, was approximately $192,160,000.
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 13, 1998, there were 28,810,085  shares of the  Registrant's  Common
Stock outstanding.


                       DOCUMENTS INCORPORATED BY REFERENCE

Parts of the Registrant's Proxy Statement for its Annual Meeting of Shareholders
(the  "Proxy  Statement")  to be held  on May  22,  1998,  are  incorporated  by
reference in Part III of this Form 10-K to the extent stated herein.

                                       1
<PAGE>

                                     PART I

The  statements  contained  in this  Report  on Form  10-K  that are not  purely
historical are  forward-looking  statements within the meaning of Section 27A of
the  Securities  Act of 1933 and Section 21E of the  Securities  Exchange Act of
1934,  including  statements  regarding  Cylink  Corporation's  ("Cylink" or the
"Company") expectations,  hopes, intentions, beliefs or strategies regarding the
future.  Forward-looking statements include: the Company's statements in Part I,
Item 1 "Business"  regarding (i) its strategies for being a leading  provider of
enterprise-wide  network  security  products and to establish  network  security
standards  for the secure  exchange  of  information,  (ii) its plans to develop
domestic  and  international   strategic   marketing  and  product   development
relationships  with key members of the  industries  addressed  by the  Company's
products,  (iii) its expected  research  and  development  expenditures  for the
enhancement  and extension of the  Company's  existing  products,  including its
PrivateWire  and  PrivaCy  Manager   products,   and  for  the  development  and
introduction  of new products,  (iv) the Company's  intention to expand  foreign
sales channels and enter additional international markets, and (v) the Company's
belief that its  CIDEC-VHS/VHX  products  are  currently  the fastest  data link
encryptors  available  in the world  today for  commercial  use;  the  Company's
statement in Item 2 "Properties" that it believes its current facilities are and
will be adequate for the foreseeable future; the Company's  statements in Item 7
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations"  regarding  (i) the Company's  expectation  that it will more likely
than not realize a portion of its net deferred tax assets based on future income
in the next  twelve  months,  (ii) the  sufficiency  of the  Company's  existing
liquidity and capital  resources;  and  management's  belief that  resolution of
certain  litigation  described in Note 9 of the Notes to Consolidated  Financial
Statements  contained in Item 8 "Financial  Statements and  Supplementary  Data"
will not have a material adverse effect on the Company's financial position. All
forward-looking  statements  included in this document are based on  information
available  to the  Company as of the date of this  Report on Form 10-K,  and the
Company assumes no obligation to update any such forward-looking  statements, or
to update the reasons why actual  results  could differ from those  projected in
the  forward-looking  statements.  It is  important  to note that the  Company's
actual  results  could  differ  materially  from  those in such  forward-looking
statements for the reasons detailed in Item 1 "Business - The Cylink Strategy, -
Network Security Products,  - Research and Development,  and - Risk Factors That
May Affect Future  Results," and other sections of this Report on Form 10-K. You
should also consult the risk factors  listed from time to time in the  Company's
Reports on Form 10-Q, 8-K, 10-K and Annual Reports to the Shareholders.


ITEM 1.  BUSINESS

         The Company  develops,  markets and supports network security  products
that enable and manage the secure transmission and authentication of information
over local area networks ("LANs"),  wide area networks  ("WANs"),  public packet
switched networks,  such as the Internet,  and broadcast networks. The Company'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.  The  Company'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  intelligent  smart cards,
smart card  operating  systems,  easily  deployed  card readers and  conditional
access  technology  for  broadcast  networks.  The  Company  is also  conducting
advanced  research and  development  in the field of digital  water  marking for
protection of intellectual property.

         The  Company  was  formed  in 1984 as a  partnership  and  subsequently
incorporated  in California in 1989. In February and March of 1996,  the Company
completed its initial public  offering and its Common Stock began trading on the
Nasdaq National Market under the symbol CYLK. Through the offering,  the Company
sold 5,750,000  shares of its Common Stock which generated  approximately  $78.9
million of cash, net of underwriting  discounts,  commissions and other offering
costs.

         On  September 8, 1997,  the Company  purchased  all of the  outstanding
shares of Algorithmic Research Ltd., an Israeli Company  ("ARL"), as well as one
of its shareholders, Algart Holdings Ltd., an Israeli Company, in exchange for a
total  consideration of 3,002,810 shares,  including options to purchase shares,
of Cylink  Common  Stock and $46.7  million  in cash,  including  assumption  of
certain sellers' expenses.

         Cylink  further  offers a line of spread  spectrum  radio  products for
wireless  transmission  of voice and data  communications  which  operate in the
unlicenced  spread  spectrum  bands adopted by the U.S.  Federal  Communications
Commission  ("FCC") in 1985 and  subsequently  adopted  in many other  countries
throughout the world. The Company's

                                       2
<PAGE>


spread spectrum radio products focus  primarily on the fixed location,  outdoor,
wireless  communications  infrastructure  market. On March 28, 1998, the Company
sold all of the assets  comprising its Wireless  Communications  Group to P-Com,
Inc.,  a Delaware  Corporation  located  in  Campbell,  California,  for a total
consideration of $60.5 million, subject to final closing adjustments, consisting
of $46.0  million in cash and a promissory  note in the amount of $14.5  million
due 100 days after closing.

         The Company operates in one industry  segment -- secure  communications
products.  The  Company's  principal  operations  outside of the  United  States
comprise  research  and  development  in  Israel,  as well as sales and  service
offices  located in 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.

Industry Background

         The market for the Company's  network  security  products  continues to
expand due to the steady growth of private  leased  lines,  the growth of packet
switched networks, and the increasing deployment of applications and systems for
transmitting  proprietary  information and commercial  transactions over various
network  topologies.  Commercial and government  enterprises  continue to expose
increasing amounts of their proprietary  information to the security  weaknesses
inherent  to  their  electronic  communication  networks,  with  a  commensurate
escalation in the risk of misappropriation  of their enterprises'  resources and
the ensuing demand for verifiable  identification  of its authorized  users. The
Company believes that the rate of penetration for all network security  products
offered today lags well behind the growth in the addressable market.

         During the last twelve to eighteen  months,  the  consolidation  of the
network security industry has accelerated as the leading vendors seek to acquire
more  rapidly the core  technologies  required  for a  comprehensive  enterprise
security  solution.  This  consolidation  reflects the market's consensus that a
broad,  flexible portfolio of network security products from a limited number of
suppliers is preferable to the procurement and integration of products  supplied
by numerous vendors, each of which specializes only in partial solutions for the
customer's  data  communications  infrastructure.  Consequently,  vendors  which
initially  entered  the market by  addressing  a specific  requirement,  are now
expanding  their product  lines by licensing  technologies  from third  parties,
enhancing  the   interoperability   of  their   products   through   cooperative
arrangements,  and acquiring  technology  through  mergers and  acquisitions  of
vendors having complementary offerings.

         Examples of such  partial  solutions  include  stand  alone  "Firewall"
products,  which offer access control  primarily by filtering packet  addresses,
virus   protection,   and  password  based  tokens  based  on  time-varying  and
challenge-response  protocols. These tokens and access control systems generally
provide some level of user  authentication,  but lack the capability of ensuring
privacy  of  communications,  integrity  of the data or  non-repudiation  of the
transaction.  Many other encryption products provide privacy, but do not perform
the other security functions, nor are they easily controlled or managed from one
central location. New techniques for auditing network security are also entering
the market,  such as intrusion  detection  tools which,  by  themselves,  do not
enable security within the enterprise.  Although several entities have commenced
offering  services as  certificate  authorities  to verify the  authenticity  of
network  correspondents' public keys, the enterprise's management of its private
keys has received comparably less attention. As customers demand greater ease of
management for their security solutions,  a uniform method of key management for
both private as well as public keys, across applications, will be required.

         Along with this consolidation in the network security  industry,  major
participants  in the  networking,  computing  and operating  systems  industries
continue to make their presence felt by offering  security  related  products of
their own, by licensing and incorporating base encryption  technology into their
own core products,  and by promoting or endorsing various standards initiatives.
It remains to be seen whether these entities will make a significant,  strategic
investment in security  technologies,  or whether their  involvement  to date is
merely symptomatic of the increased  awareness of enterprise  security issues by
customers of these computing and networking participants.

The Cylink Solution

         Through  its  products  introduced  over the  last  five  years,  those
recently added by virtue of the Company's acquisition of ARL, and those products
presently under development, Cylink offers a comprehensive, system-wide solution
that  delivers the critical  services  for both  network  level and  application
security: authentication, authorization, audit,

                                       3
<PAGE>

integrity and privacy,  all within a scaleable,  centrally-managed  system.  For
over twelve years,  the Company has pioneered the use of Public Key cryptography
as one of its core  technologies by, among other  accomplishments,  becoming the
first commercially  successful  supplier of network security  encryption devices
incorporating the Diffie-Hellman  automated key management solution.  Today, the
Company's   products    incorporate    state-of-the-art    commercial   security
technologies,   including  Public  Key  cryptography-based  digital  signatures,
certificates  and key management  techniques,  which enable the Company to offer
broad, flexible solutions for creating VPNs for local and remote users.

The Cylink Strategy

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

   o  Offer  Comprehensive   Enterprise-Wide  Network  Security  Solutions.  The
      Company's  strategy is to offer a broad,  centrally  managed and  flexible
      line of network  security  products to create VPNs within both enterprises
      and global networks.  For example,  the Company recently  introduced ARL's
      PrivateWire  family of  components  for  securing  remote  access over the
      Internet, including both software and smart card tokens for clients, and a
      highly portable,  easily installed card reader.  By offering a toolkit for
      integrating  the  customer's  applications  with  the  entire  PrivateWire
      family,  including  a public  key  smart  card and an ISO  compliant  card
      reader,  the Company believes the PrivateWire  family delivers a complete,
      scalable,  and  expandable  public key security  solution  for  customers'
      existing  applications.  In addition, the Company continues to improve its
      Secure Manager by  consolidating  management of all Company products under
      one Java-based,  browser-enabled platform, branded "PrivaCy Manager". When
      coupled with ARL's component technologies,  PrivaCy Manager may be offered
      as a key management  infrastructure  for third party products,  as well as
      the Company's own solutions.

   o  Maintain and Leverage Its Expertise in Public Key Technology.  The Company
      plans  to  maintain  its  expertise  in  the  application  of  Public  Key
      cryptography  through a combination of internal  research and  development
      efforts.  On  occasion,  the Company will also accept  funded  development
      contracts  when the Company  believes such projects will yield  commercial
      applications  for  the  Company's  own   technologies.   With  the  recent
      acquisition  of  ARL,  the  Company  has  enhanced  its  expertise  in the
      application  of Public Key  technology to smart cards,  including on board
      operating  systems  and  applications,  remote  access  services  and  the
      emerging field of conditional  access  encryption for broadcast  networks.
      ARL's security  operating system is incorporated in one of the most widely
      deployed  public key tokens in the world today for  conditional  access to
      broadcast networks.  In 1997, the Company had net research and development
      expenses of approximately $12.5 million.

   o  Broaden   Acceptance  of  the  Company's  Public  Key  Technology  through
      Licensing.  The  Company  actively  seeds  the  computer,  networking  and
      telecommunications  industries  with its specific  methods of implementing
      Public Key to ensure a compatible market for the Company's  technology and
      products.  During 1997 the Company  licensed to Microsoft  Corporation the
      right to  incorporate  certain of the Company's core Public Key components
      in Microsoft's products,  including NT and Internet Explorer. In addition,
      the Company  licensed to JavaSoft the right to  incorporate  the Company's
      certificate  technology in the Java  development  kit. By licensing  these
      technologies to Microsoft and JavaSoft on  royalty-free  terms the Company
      is  encouraging  the  broadest   possible   dissemination   of  this  base
      technology,  thereby creating  opportunities for greater acceptance of the
      Company's  products.  Prior to their  expiration in 1997, the Company also
      held exclusive  sublicensing  rights to the fundamental Public Key patents
      owned by Stanford  University  (the "Stanford  Patents").  Pursuant to its
      agreement with Stanford University,  the Company successfully  sublicensed
      over  thirty  other  companies  to adopt  methods of Public Key similar to
      those developed by the Company. In the meantime,  the Company continues to
      offer developers a suite of  cryptographic  libraries and tools to utilize
      components of the Company's Public Key technology.

   o  Continue  Expansion  into Emerging  Public  Network  Markets.  The Company
      intends to leverage its expertise in securing private networks by offering
      security  solutions which address the emerging demand for both VPNs within
      public  networks and secure,  remote  access to enterprise  networks.  The
      Company's  acquisition  of ARL and  the  introduction  of its  PrivateWire
      family of products  demonstrate the Company's  commitment to meeting these
      requirements.

                                       4

<PAGE>

   o  Build and Foster Strategic Relationships.  The Company intends to continue
      to develop strategic marketing and product development  relationships with
      key members of the industries it serves.  Applying its expertise in Public
      Key technology, the Company has developed applications for parties such as
      AT&T, Cisco Systems,  Inc., the Society for Worldwide  Interbank Financial
      Telecommunications  ("S.W.I.F.T."),  and  the  Federal  Reserve  Bank.  In
      addition, the Company believes its open licensing of certain components to
      Microsoft  and JavaSoft,  as well as the  Company's  offerings of software
      security  toolkits  and  developers'  libraries,  will attract and enhance
      future development opportunities. With its PrivateWire and PrivaCy Manager
      offerings,  the Company also believes it has an attractive  key management
      solution for potential partners.

         Note,  however,  that the market  for the  Company's  network  security
products  is  continuing  to emerge.  This  market is  characterized  by rapidly
changing technology,  evolving industry standards, new product introductions and
changes in customer  requirements  and  preferences.  The Company's  future will
depend in part upon end users' demand for network security  products in general,
and upon the Company's  ability to enhance its existing  products and to develop
and introduce new products and technologies that meet customer requirements. Any
significant  advance in  techniques  for attacking  cryptographic  systems could
render  some or all of the  Company's  existing  and new  products  obsolete  or
unmarketable.  To the extent that the Company is unable to adopt and incorporate
emerging standards for implementing network security in a market segment,  sales
of the Company's  existing and planned  products in that market segment would be
significantly less than the levels currently  anticipated by the Company.  There
can be no  assurance  that  network  security-related  products or  technologies
developed by others will not adversely affect the Company's competitive position
or render its products or technologies noncompetitive or obsolete. See "Business
- Risk  Factors  That May Affect  Future  Results --  Competition,  --  Evolving
Network Security Market, and -- Rapid Technological Change."

Technology

         The  Company's  network  security  products  are  based on  Public  Key
cryptography  techniques,  which  were  first  developed  in  1976  at  Stanford
University  by Drs.  Diffie and  Hellman.  The Public Key  cryptography  methods
adopted by the Company require that each user be assigned both a private number,
which is confidential,  and a mathematically related public number, which can be
revealed  without  compromising  the user's private number.  Diffie-Hellman  key
exchange  provides  for two users in a data  network to  exchange  their  public
numbers and then  compute a shared  secret  number that is unique to them.  This
shared  secret  number  can  then  be  used as the  secret  encryption  key in a
conventional  encryption  system to maintain  the  privacy of the  communication
between two users.

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

         The  Company's  products  enable  network   administrators  to  act  as
certificate  authorities  that permit  each  authorized  device in the  network,
including an  individual's  software and hardware  tokens,  to have the device's
public number  validated for the purpose of  establishing  its  authenticity  to
others.  The  certification  authority  provides  each  authorized  user with an
electronic message, known as a certificate,  containing that user's name, public
number,   unique  privileges  within  the  network  and  expiration  date.  Such
privileges,  for example,  can define the portions of the network which the user
is  authorized  to  enter,   the  level  of  the  user's  authority  to  conduct
transactions within those portions of the network,  and the network services the
user may enjoy. This message is digitally signed by the network administrator to
create the user's  certificate,  which in effect  serves to notarize  the user's
public number and enable that user to conduct secure  communications  with other
certified users within the network.

         The Company's Public Key certificate  technology is incorporated in the
Company's  network  management  systems  for  its  products.   The  Company  has
consolidated its network  management  technologies into one Java-based  platform
which the Company intends to offer as a remote,  centralized  management  system
for its products,  as well as third party products which integrate the Company's
management solutions.

         The Company and its newly  acquired  subsidiary,  ARL,  have  developed
integrated  software  modules which are  incorporated  in the Company's  network
security   products.   These  software   libraries   implement  the  Public  Key
cryptography  techniques  for the  Company's  key  management  systems,  digital
signatures  and  certificates  to provide  complete,  scaleable  enterprise-wide
network security  solutions.  For example,  by combining ARL's software toolkits
with

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<PAGE>

the  Company's  network  management  system,  the  Company may offer a complete,
integrated key management infrastructure. In addition, ARL's software components
are compatible with most  off-the-shelf  third party applications which can then
utilize the security services of ARL's PrivateWire  family of software and smart
card tokens.

         The Company  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  significant
technical achievements in the area of proprietary ASIC design include encryption
chips  with  speeds up to 155  megabits  per  second  ("Mbps")  and  Public  Key
co-processor chips that have the capability of handling 1,024 bit numbers.

         The Company'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 the  Company's  security  products to connect to most
networks  in use  today  throughout  the  world.  The  current  list of  network
interfaces used in Company  products  include:  T1 (1.5 Mbps), T2 (6.2 Mbps), T3
(45 Mbps),  E1 (2 Mbps), E3 (34 Mbps),  X.25,  V.35,  X.21,  Frame Relay (FRF.1,
FRF.3 and FRF.4), NTT T1 (Japan),  10 Base 2, 10 Base 5, 10 Base T, HSSI, RS-232
and RS-422.

Network Security Products

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


                                                                        Year
  Product                          Description                       Introduced
---------------            --------------------------                ----------
                             Global Network Security
Cidec Line
----------
CIDEC-HS                   High Speed T1 Link Encryption                1986
CIDEC-MS                   Medium Speed Link Encryption                 1987
CIDEC-LS                   Low Speed Link Encryption                    1987
CIDEC-VHS                  Very High Speed T3 Encryption                1990
CIDEC-MLS                  Integrated Link Cards                        1993
CED Card (AT&T)            Encryption Signaling System                  1997
SecureLink Line            Next Generation Link Encryptors              *

X-25
----
SecureX25L                 Low Speed X.25 Packet Encryption             1993
SecureX25H                 High Speed X.25 Packet Encryption            1994

SecureFrame
-----------
SecureFrame                Frame Relay Packet Encryption                1996
SecureFrame - LS           Low Speed Frame Relay Encryption             1997

                               Enterprise Security

SecureLAN Family
----------------
SecureDomain               Router Domain Packet Encryption/Access       1996
EPA Card (Cisco)           Encryption Processor for Cisco 7700 Series   1997
                           Router
SecureAccess Family
-------------------
SecureGate                 Dial Up Remote Access, PSTN                  1996
SecureTraveler             SecureGate Encryption Software Client        1997

PrivateWire Family
-------------------
PrivateWire                Remote Access, Secure TCP/IP Communications  1997
                           Firewall, and Authorization Management
PrivateCard                Full On Board Public Key Smart Card          *

------------------
* Indicates products under development and scheduled for introduction in 1998

                                       6
<PAGE>

PrivateSafe                Portable Card Reader                         *

                                  SecureManager

CSMS                       SecureX25 Network Management                 1994
SecureManager              Manager For SecureDomain                     1996
PrivaCy Manager            Unified Management Platform                  1997

                                       ARL

CryptoServer               Cryptographic Security Server           As of 9/8/97
CryptoLAN                  Remote LAN access                       As of 9/8/97
CryptoKit                  Software Development Toolkit            As of 9/8/97

         Global  Network  Products  Family.  The  Company  entered  the  network
security market in 1986 to secure communications within WANs over private leased
lines.  The SecureWAN  product family is a complete line of link encryptors that
utilize  Diffie-Hellman 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 product  model,  the  Company's  CIDEC and  SecureLink
encryptors  operate at varying data rates over  private and public  networks and
support most widely used data link protocols.  The Company's original CIDEC line
of data  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")).  The Company 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,  the Company also  developed  packet  encryptors  which enable  secure
transmission of packets of data between two points in X.25 and Frame Relay based
networks.  The Company's high speed  SecureX25H and low speed  SecureX25L  offer
encryption for public switched packet networks based on X.25 packet transmission
technology and support data rates up to 64 kbps and up to 512 virtual  circuits.
The Company's  SecureFrame  product is designed to operate as a dedicated  Frame
Relay encryptor capable of operations on any public or private Frame Relay-based
network.  The  SecureFrame is designed to support data rates of up to 2.048 Mbps
and up to 1,024 user addresses.

         Enterprise  Security Products Family.  With the acquisition of ARL, the
Company 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  including WWW, FTP, Telnet, e-mail
and  any  TCP/IP  client/server   application.   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.

         PrivateWire  is transparent to the  organization  and the end-user.  No
specific  proxies need to be  configured,  defined or  publicized  and,  because
PrivateWire  supports  any Winsock  application,  no  integration  or changes to
applications  are  required.  Users are  controlled,  managed  and logged at the
network gateway. Changes to security policy can be easily configured and defined
from local or remote  locations by any  authorized  manager using a standard web
browser,  such as Microsoft IE,  Netscape  Navigator,  or the Company's  PrivaCy
Manager.

         PrivateCard,  developed by ARL, is the advanced,  electronic smart card
in the  PrivateWire  family which has a complete,  on-board Public Key processor
which, in combination with the remaining  PrivateWire  products,  can serve as a
fully  functional,   secure  personal  token  for  authenticated  and  encrypted
transactions.  PrivateSafe is ARL's latest smart card reader in the  PrivateWire
family which is highly  portable and simple to install by merely plugging in two
cables between the keyboard and the client computer.  This patented,  secure PIN
card reader  transfers all Public Key  operations  onto  PrivateCard's  on board
processor.

                                       7
<PAGE>

         The SecureDomain  encryption unit and its network management system are
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.  Pursuant to its license from the Company,  Cisco is
authorized to embed the SecureDomain  cryptographic  software modules in Cisco's
router products as part of Cisco's IOS operating system.

         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.

         The Company also developed its SecureGate and  SecureTraveler  products
to provide  secure  access  for  authorized  remote  and  mobile  users to their
corporate  computing  resources  over  the dial up,  public  switched  telephone
network ("PSTN").  The SecureGate  Server,  which physically resides between the
customer's  communications  server and modems, can monitor and protect corporate
information resources by controlling incoming and outgoing calls to and from the
network. SecureGate provides centralized management and tracking of remote users
and  their  individual  security  profiles,  with  audit  trails  of all  system
activities. SecureGate also acts as the certificate authority for its authorized
remote SecureTraveler clients.

         SecureManager  Family.  The  Company's  latest  SecureManager  product,
branded PrivaCy Manager, consolidates the Company's existing security management
tools with a Java-based  management  platform designed for enterprise and global
networks.  PrivaCy Manager remotely  configures,  monitors and performs firmware
downloads  for certain of the Company's  network  security  products,  including
SecureFrame,  and SecureDomain.  The Company intends to extend PrivaCy Manager's
management services to all of Cylink's enterprise security products,  as well as
third party products which integrate the Company's management tools.

         PrivaCy  Manager's  automated  Public  Key  authentication   procedures
prevent  unauthorized  products from  masquerading as legitimate  devices on the
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.

         ARL's  Offerings.   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 the  Company's  products,  such as
PrivateWire. CryptoServer is a cryptographic security server which provides data
security services, such as certificate authorization, for networked environments
handling large volumes of transactions.  ARL also offers security  solutions for
LAN remote access  ("CryptoLAN"),  PC to mainframe  connections  ("Crypto3270"),
laptops  and PCs  ("Diskrete"),  e-mail  ("CryptoMail")  and files and  messages
("CryptoCom").  Following  the  addition of ARL's  products  into the  Company's
portfolio,  the  Company  has  realized  some  efficiencies  in its own  product
development by  discontinuing  development and support of certain other products
which are redundant with those of ARL.

         The Company's  future results of operations will be highly dependent on
the  successful  marketing  and  customer  acceptance  of the  Company's  latest
products,  including both PrivaCy Manager and PrivateWire.  To date, the Company
has made only modest shipments of such products.  No assurance can be given that
these  products  will not  require  additional  development  work,  enhancement,
testing  or  further   refinement   before  they  can  be  introduced  and  made
commercially  available  by  the  Company  or  that  they  will  achieve  market
acceptance.  If such new and  recently  introduced  products  have  performance,
reliability,  quality or other  shortcomings,  then such products  could fail to
achieve market acceptance and the Company may experience reduced orders,  higher
manufacturing  costs,  delays in collecting  accounts  receivable and additional
warranty and service expenses,  which in each case could have a material adverse
effect on the  Company's  financial  condition  and results of  operations.  See
"Business  - Risk  Factors  That May  Affect  Future  Results --  Dependence  on
Recently Introduced and New Network Security Products,  and -- Product Liability
Risks."

                                       8
<PAGE>

Sales, Marketing and Customer Support

         The Company markets its network security products primarily through its
direct sales force and, to a lesser extent, through distributors.  The Company's
direct sales force for its network security products operates primarily from the
Company's headquarters in Sunnyvale,  California and from three sales offices in
the United States. The Company'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 of network  security  products are made  primarily
through the Company's five foreign sales offices and numerous distributors.  The
Company  does  not  have  long-term  contractual  relationships  with any of its
distributors  and,  therefore,  has no assurance  of a  continuing  relationship
within a given market.

         To date,  the  majority  of the  Company's  customers  for its  network
security  products  have been Fortune 1000  companies,  financial  institutions,
government  agencies and  telecommunication  carriers who rely on the  Company's
Global Network  Products to encrypt and secure their WANs operating over private
leased lines.  From inception  through  December 31, 1997, the Company sold over
$175 million of network  security  products in the United States and abroad.  In
1997, seventeen customers accounted for approximately 65% of the orders received
by the Company for its network security  products,  and two customers  accounted
for approximately 24% of such orders.

         A  representative  list  of the  end  users  of the  Company's  network
security products is set forth below:

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

         The Company  believes that customer  support is essential to developing
and  maintaining  good  relationships  with  its  customers.   Cylink's  support
personnel  are  responsible  for  providing  installation,  technical  training,
technical  support,  on-site support and repair services.  The Company sells end
users a number of different levels of support,  maintenance and service options,
including extended warranties,  emergency replacement services, product upgrades
and on-site support.

         The  Company  offers  service  and  support  for its  network  security
products  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.

Wireless Communications Product Line

         During 1995,  1996, and 1997 sales of Wireless  products  accounted for
approximately 38%, 50%, and 39%,  respectively,  of the Company's total revenue,
including discontinued  operations.  The Wireless Communications Group completed
its formation of an independent  organization  in 1997,  including  order entry,
sales and marketing, engineering services and technical publications, as well as
opening service centers in Beijing and New Dehli. On March 28, 1998, the Company
sold all of the assets  comprising its Wireless  Communications  Group to P-Com,
Inc.,  a Delaware  corporation  located  in  Campbell,  California,  for a total
consideration of $60.5 million, subject to final closing adjustments, consisting
of $46.0  million in cash and a promissory  note in the amount of $14.5  million
due 100 days after closing.

Research and Development

         The  Company's   research  and  development   efforts  are  focused  on
developing  new  products,   core  technologies  and  enhancements  to  existing
products.  For  its  network  security  products,  the  Company's  research  and
development strategy has in recent periods focused on the development of modular
software and hardware products that can be readily integrated

                                       9
<PAGE>

and adapted to the changing standards and requirements of the communications and
internetworking  industries.  A focus of the Company's  research and development
efforts in 1997 has been the development of the SecureLink and PrivaCy  Manager,
as well as integration of PrivateWire  and ARL  technologies  into the Company's
product  portfolio.  The  Company  expects  that  it  will  continue  to  devote
substantial  research and  development  resources to the  enhancement of PrivaCy
Manager and ARL's products for the foreseeable future.

         In 1995,  1996 and 1997, the Company's  gross research and  development
expenses from continuing  operations were $9.2 million,  $14.3 million and $13.9
million,  respectively.  From time to time,  the  Company  receives  engineering
funding for development projects to apply or enhance the Company's technology to
a  particular  customer's  need.  Amounts  recognized  under these  research and
development  contracts  are offset  against  research and  development  expense.
Amounts  recognized  under  non-recurring  engineering  contracts  totaled  $1.1
million, $6.1 million and $1.4 million, in 1995, 1996 and 1997, respectively.

         The Company  believes that its ability to attract and retain  qualified
development personnel is essential to the success of its development programs in
the  United  States  and  Israel.  The  market  for  such  personnel  is  highly
competitive and the Company's development activities could be adversely affected
if the Company is  unsuccessful  in attracting and retaining  skilled  technical
personnel.  See  "Business  - Risk  Factors  That May Affect  Future  Results --
Dependence  on Key  Personnel,  and  --Management  of Growth." In addition,  the
markets  for the  Company's  products  are  characterized  by  rapidly  changing
technologies, extensive research and new product introductions.

         The Company  believes that its future  success will depend in part upon
its  ability to continue to enhance  its  existing  products  and to develop and
introduce new products.  As a result,  the Company expects to continue to make a
significant investment in engineering, research and development. There can be no
assurance that the Company will be able to develop and introduce new products or
enhancements to its existing  products in a timely manner which satisfy customer
needs, achieve market acceptance or address  technological changes in its target
markets.  The failure of the Company to develop products and introduce them in a
timely  manner  could  adversely  affect  the  Company's  competitive  position,
financial condition and results of operations. See "Business - Risk Factors That
May Affect Future Results -- Competition,  -- Dependence on Recently  Introduced
and New Network Security Products, -- Evolving Network Security Market, -- Rapid
Technological  Change,  and  --  Wireless   Communications  Industry  Regulatory
Environment."

Regulatory Matters

         The Company's  network security  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
technical  restrictions  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
within and between the United States  legislative  and  administrative  branches
concerning their application to encryption technology.  These disagreements tend
to delay and interfere with the  predictability of the licensing process for the
Company'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 the Company's products and technology  distributed by
ARL in Israel.

         Although  to date the  Company  has been able to secure  the  necessary
export licenses to compete effectively in the international market, there can be
no assurance  that the Company will  continue to be able to secure such licenses
in a timely manner in the future, or at all. In certain foreign  countries,  the
Company's  distributors  are  required to secure  licenses or formal  permission
before encryption products can be imported.  To date, except for certain limited
cases, the Company's  distributors have not been denied permission to import the
Company's products.  See "Business - Risk Factors That May Affect Future Results
-- Risks  Associated  with  International  Sales;  Reliance Upon Local Partners;
Restrictions on Export."

                                       10
<PAGE>

Backlog

         Orders for the Company's products are usually placed by customers on an
as-needed  basis and the Company has typically been able to ship products within
thirty days after the customer  submits a firm  purchase  order.  The  Company's
backlog consists of all orders received,  regardless of the anticipated shipping
date.  Because of the possibility of customer  changes in delivery  schedules or
cancellation of orders,  the Company's backlog as of any particular date may not
be  indicative  of sales in any future  period.  The Company does not  generally
maintain  long-term  contracts  with its  customers  that  require  customers to
purchase the Company's products. The Company's backlog for continuing operations
as of  December  31,  1996 and  1997 was  approximately  $4.1  million  and $4.2
million,  respectively.  See  "Business - Risk  Factors  That May Affect  Future
Results -- Lengthy Sales Cycle."

Manufacturing

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

         The Company's product designs are proprietary but generally incorporate
industry-standard   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.

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

Employees

         As of December 31,  1997,  the Company had 432  employees,  of whom 140
were primarily engaged in research and development,  165 in sales, marketing and
related customer support services, 42 in administration and 85 in manufacturing.
Of these employees,  approximately 23 were located in Europe, 55 in Israel,  and
10 in Asia.  None of the  Company's  employees  is  represented  by a collective
bargaining  agreement with respect to his or her employment by the Company,  nor
has the Company  experienced any organized work stoppage.  The Company considers
its relations  with its existing  employees to be good. As part of the March 28,
1998 sale of the Company's  Wireless  Communications  Group to P-Com,  Inc., the
Company expects  approximately  100 employees to terminate their employment with
Cylink.

Year 2000

The Company's  customer service  organization is engaged in an ongoing review of
the  Company's   products  to  determine   which  products  are  susceptible  to
malfunction  when processing  dates which are later than December 31, 1999 ("YK2
Errors").  With respect to those products which are no longer within the term of
the Company's  standard warranty and vulnerable to YK2 Errors,  the Company will
offer upgrade kits or trade-ins for comparable  products which are free from YK2
Errors.  In the meantime,  with respect to products  which are vulnerable to YK2
Errors,  the  Company is  reworking  its  products  to cure any YK2  Errors,  or
declaring  such  products  at the end of life  ("EOL")  with  the  intention  of
discontinuing their sale prior to December 31, 1998.

                                       11
<PAGE>

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

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

          The Company incurred losses from continuing  operations in 1994, 1995,
1996 and 1997.  There can be no  assurances  that the Company  will  increase or
maintain its revenue or be  profitable  on a quarterly or an annual basis in the
future.

         The Company has historically  experienced  significant  fluctuations in
its operating  results on an annual and a quarterly  basis and could  experience
such fluctuations in the future. The Company's operating results are affected by
a number  of  factors,  many of which  are  outside  of the  Company's  control,
including:  the timing of the  introduction  of new or enhanced  products by the
Company or its  competitors;  market  acceptance of new products of the Company,
its customers and its competitors; the timing, cancellation or delay of customer
orders,   including  cancellation  or  delay  in  anticipation  of  new  product
introductions  or  enhancement  or  resulting  from   uncertainty   relating  to
intellectual property claims;  competitive factors, including pricing pressures;
changes  in  operating  expenses,  including  those  resulting  from  changes in
available  production capacity of independent  foundries and other suppliers and
the availability of raw materials; expenses associated with obtaining, enforcing
and defending claims with respect to intellectual  property  rights;  the mix of
products sold;  changes in the percentage of products sold through the Company's
direct  sales  force;  personnel  changes;  general  economic  conditions;   and
fluctuations  in  foreign  currency  exchange  rates.  The  Company  expects  to
introduce a number of new products in 1998.  The failure of such new products to
achieve market  acceptance at the time  anticipated  by the Company,  or at all,
would  materially  and adversely  affect the Company's  financial  condition and
results of operations.

Pending Litigation

See Item 3. "Legal Proceedings."

Dependence on Key Personnel

         On November 13, 1996, the Company  announced the appointment of Fernand
B. Sarrat as President and Chief Executive  Officer ("CEO") and during the first
half of 1997 the Company hired a number of executives to fill senior  management
positions within the Company.

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

Lengthy Sales Cycle

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

                                       12
<PAGE>
Dependence on Recently Introduced and New Network Security Products

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

Competition

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

         The Company's  competitors in the network security  markets,  including
companies which 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. In addition, Northern Telecom Limited, AT&T, Motorola Corporation,  Digital
Equipment Corporation and Sun Microsystems,  Inc. offer certain network security
products as part of their overall networking solutions.  A number of significant
vendors,  including Microsoft Corporation,  Netscape Communications  Corporation
and Cisco Systems,  Inc. have embedded security solutions in their software.  To
the extent that these embedded or optional security  capabilities provide all or
a portion of the functionality provided by the Company's products, the Company'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 than (and incompatible with)
the  methods of  implementing  Public  Key  cryptography  currently  used by the
Company in most of its products. Although the Company has licenses 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  than those  currently  used by the Company,  to the  exclusion of the
Company's methods,  sales of the Company's existing and planned products in that
market segment may be adversely  impacted,  which could have a material  adverse
effect on the Company's financial condition and results of operations.

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

Product Liability Risks

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

                                       13
<PAGE>

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

Year 2000

         Although the Company believes it has identified all risks of YK2 Errors
in its  products,  and is taking  steps to repair,  replace or EOL all  products
which contain YK2 Errors,  there is a continuing  risk that some YK2 Errors will
go undetected  until after December 31, 1999. The Company  intends to attempt to
protect  itself from  liability  with  appropriate  disclaimers in its terms and
conditions of sale, by encouraging  customers to upgrade their products to those
which have proven to be YK2  compliant,  and by  discouraging  continued  use of
those products known to have YK2 Errors. However, the Company may be met with an
unanticipated liability for an undiscovered YK2 Error which cannot be limited by
any of the  foregoing  preventive  actions,  and  conceivably  could  include an
allegation  of damages  which  exceeds the terms or the amount of the  Company's
insurance policies covering product liability.

Management of Growth And Reduction In Employees

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

         With the sale of its Wireless  Communications  Group,  the Company will
also  experience a significant  reduction in employees,  including the Company's
Chief  Technical  Officer,  Dr. Jim Omura.  The sale of the  Company's  Wireless
Communications  Group, along with occasional  reductions in specific engineering
programs  in the network  security  business,  may create a risk of  instability
within the existing employee population resulting in departures of key employees
critical  to  sustaining  growth in the  Company's  network  security  business.
Furthermore,  sudden reductions in the number of the Company's  employees places
greater  demands  on the  remaining  employees  which  may  distract  them  from
fulfilling  their  responsibilities  necessary to  accomplishing  the  Company's
financial goals.

         On   September   8,  1997,   the  Company   acquired  ARL  and  assumed
responsibility  for  management  of its  worldwide  operations  and  fifty-seven
employees.  The Company 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.  Key
factors  which will  determine  ARL's  success  include  whether the Company can
integrate ARL's management,  employee culture and organizational  practices into
the Company,  whether the Company can provide ARL with  appropriate  guidance in
allocating its development  priorities,  whether the Company can adequately fund
ARL's  development   objectives,   whether  the  Company  can  provide  accurate
information for ARL to focus its technology on significant market opportunities,
and whether the Company can predict the most  attractive  features and functions
for ARL's finished products.  The Company's success in realizing the anticipated
return  from its  investment  in ARL also will be  determined  by the  Company's
ability to position and introduce ARL's products into the Company's  markets and
channels,  and the  Company's  ability to provide  adequate  sales and  customer
support  for  ARL's  products.   The  Company's  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.

                                       14
<PAGE>

Intellectual Property and Other Proprietary Rights

         The Company  relies on patents,  trademarks,  copyrights,  licenses and
trade secret law to establish and preserve its intellectual property rights. The
Company owns six 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 the Company will not be  invalidated,  circumvented  or challenged,  that the
rights granted thereunder will provide competitive  advantages to the Company or
that any of the Company's  pending or future patent  applications will be issued
with the scope of the claims sought by the Company,  if at all.  Further,  there
can be no assurance that others will not develop  technologies  that are similar
or superior to the Company's  technology,  duplicate the Company's technology or
design around the patents owned by the Company. The Company may be subject to or
may initiate  interference  proceedings  in the U.S.  Patent  Office,  which can
require significant financial and management resources. In addition, the laws of
certain  countries  in which the  Company's  products  are or may be  developed,
manufactured  or sold may not protect the  Company's  products and  intellectual
property  rights  to the same  extent  as the  laws of the  United  States.  The
inability of the Company to protect its intellectual  property  adequately could
have a  material  adverse  effect on its  financial  condition  and  results  of
operations.

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

Evolving Network Security Market

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

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

Rapid Technological Change

         The markets for the  Company's  products are  characterized  by rapidly
changing  technologies,  extensive research and new product  introductions.  The
Company believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop, manufacture and market
new products. As a result, the Company

                                       15
<PAGE>

expects to continue to make a significant  investment in  engineering,  research
and  development.  There can be no  assurance  that the Company  will be able to
develop and introduce new products or enhancements to its existing products in a
timely manner which satisfy customer needs, achieve market acceptance or address
technological  changes  in its target  markets.  The  failure of the  Company to
develop  products and introduce them  successfully  and in a timely manner could
adversely affect the Company's  competitive  position,  financial  condition and
results of operations.

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

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

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

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

Dependence  on  Component  Availability,   Subcontractor   Performance  and  Key
Suppliers

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


ITEM 2.  PROPERTIES

         The Company's  headquarters  occupies  86,000 square feet in Sunnyvale,
California,  the lease for which expires in June 1999. During the second quarter
of 1996, the Company signed a five-year lease agreement for approximately 35,000
square feet of office and manufacturing space, also in Sunnyvale. As a result of
the  acquisition of ARL, the Company owns,  subject to outstanding  mortgage,  a
7,500  square  foot  office  building  in  Givat-Shmuel,  Israel  and  leases  a
production  facility of 2,000 square feet.  The Company  leases  facilities  for
sales  offices in New Jersey,  Virginia,  North  Carolina,  Belgium,  the United
Kingdom,   Singapore,  and  Germany.  The  Company  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  September  6, 1995,  the  Company  obtained  an  arbitration  award
dissolving a former partnership,  known as Public Key Partners ("PKP"),  between
the  Company's  wholly-owned  subsidiary,  Caro-Kann  Corporation,  and RSA DSI.
Although various claims between the Company and RSA DSI were settled on December
31, 1996, a third party continues

                                       16
<PAGE>

to pursue various claims against PKP and RSA DSI for wrongful business practices
in action C-94-20512 SW before the United States District Court for the Northern
District of  California.  A summary  judgement  favorable  to PKP was entered on
August 29, 1997, and the matter has been appealed by the plaintiff to the United
States Court of Appeals for the Federal  Circuit.  In the event the judgement of
the district court is reversed, an unfavorable outcome at trial might affect the
residual value of the Company's interest in PKP.

         On March 7, 1997,  ten former  employees  of the Company  filed suit in
action No. CV764647 in the Superior Court of California,  County of Santa Clara,
against the Company,  each of its Directors and its General  Counsel,  asserting
claims for wrongful  termination,  fraud,  libel,  slander,  age discrimination,
invasion of privacy,  and  violation  of the federal RICO  statute.  On July 11,
1997,  an eleventh  employee  filed suit in action No.  CV767448 in the Superior
Court of California,  County of Santa Clara, alleging similar claims against the
Company and its Chief Executive  Officer.  The Company  removed  CV764647 to the
Federal  District Court for the Northern  District of California  and, after the
Company  obtained  an  order  dismissing  certain  of  the  plaintiffs'  claims,
including the claims of libel and RICO violations, the Court remanded the action
back to Santa Clara  Superior  Court.  Following  the remand,  the Company  then
obtained an order consolidating CV764647 with CV767448 for purposes of discovery
and trial.  Both  matters  are  currently  in the  discovery  phase,  with trial
scheduled  for  December  1998.  Although the Company has placed its insurers on
notice of these  claims,  all of its  insurers  have  reserved  their rights and
defenses under their policies,  and the extent of the insurers'  liability under
their respective policies is undetermined. The Company believes the terminations
were  lawful,  in the best  interests  of the  Company and intends to defend the
matter  vigorously.  The defense of this matter may divert a material  amount of
management's attention and require the expenditure of significant legal fees and
costs. An unfavorable outcome which exceeds the Company's insurance coverage, if
any, may also result in a material  adverse  effect on the  Company's  financial
condition.


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

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


EXECUTIVE OFFICERS OF THE REGISTRANT

The following  table sets forth  certain  information  concerning  the executive
officers of the Company:

Name                    Age     Position
----                    ---     --------
Fernand Sarrat          46      Director, Chief Executive Officer and President

John H. Daws            54      Vice President and Chief Financial Officer

Robert B. Fougner       45      Secretary and General Counsel

Thomas Butler           50      Senior Vice President Sales and Marketing

Sarah L. Engel          54      Vice President, Human Resources and
                                Organizational Development

John Kalb               50      Vice President, Business Development

Paul Massie             43      Vice President, Information Systems

Peter J. Slocum         42      Vice President, Engineering

Reed B. Byrum           49      Vice President, Communications

William P. Crowell      57      Vice President, Product Development and Strategy

                                       17
<PAGE>

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

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

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

         Mr. Butler joined the Company in April 1997 as Senior Vice President of
Sales and  Marketing.  Prior to  joining  the  Company  he served as group  vice
president of sales and marketing for electronic  commerce for Sterling Software.
Prior to his work at  Sterling,  he was a senior  vice  president  of sales  and
marketing at Bank Automation Systems.

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

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

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

         Mr.  Byrum  joined the  Company as Vice  President,  Communications  in
January 1998. Prior to joining the Company, Mr. Byrum held positions or provided
services to GE Capital, Measurex, Gannett, N.E.T., The Johns Hopkins University,
and Ruder Finn & Rotman.

         Mr. Crowell joined the Company as Vice President,  Product  Development
and Strategy in January 1998. Prior to joining the Company, 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.

                                       18
<PAGE>

                                     PART II


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

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

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

Fiscal 1996
-----------
High                  26 1/4          23 1/2          17 1/2           15 1/16
Low                   17              17               9 13/16         10 15/16

         As of March 13, 1998, the Company had approximately 136 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,  1997,  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.

                                       19
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA
<TABLE>
         The following selected financial  information has been derived from the
Company's 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,
                                                     ----------------------------------------------------------------
                                                          1997         1996         1995         1994          1993
                                                     ----------    ----------   ----------    ----------   ----------
                                                               (in thousands, except per share amounts)
<S>                                                  <C>           <C>          <C>           <C>          <C>
 Revenue                                             $   49,333    $   25,793   $   21,534    $   17,971   $   21,373
 Research and development expense, net                   12,488         8,198        8,142         7,275        4,611
 Income (loss) from continuing operations               (63,312)       (5,522)      (4,260)       (4,143)       1,481
 Income (loss) from continuing
    operations per share - basic                          (2.37)        (0.23)       (0.24)        (0.24)        0.08
 Income (loss) from continuing
    operations per share - diluted                   $    (2.37)   $    (0.23)  $    (0.24)   $    (0.24)  $     0.08


                                                                           As of December 31,
                                                     ----------------------------------------------------------------
                                                          1997         1996         1995         1994          1993
                                                     ----------    ----------   ----------    ----------   ----------
                                                                               (in thousands)
 Cash, cash equivalents and
   short-term investments                            $   22,977    $   78,849   $    6,098    $    6,626   $    7,193
 Working capital                                         50,250        93,518       12,604        12,042       14,057
 Total assets                                            82,593       107,088       22,725        20,663       19,777
 Long-term obligations                                      256           241          291             -            -
 Shareholders' equity                                $   69,102    $   97,211   $   14,605    $   14,149   $   15,481
</TABLE>

On March 28,  1998,  the Company  sold its  Wireless  Communications  Group and,
therefore,  the above consolidated statements of operations information excludes
this business for all periods.

Net income 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. Net income for 1996 included a charge of approximately  $0.6 million ($0.02
per share) for employee severance costs.


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.

BUSINESS ACQUISITION

         On September 8, 1997, the Company acquired ARL, an Israeli company. ARL
is an information  security  company  providing  remote access network  security
products and  smart-card  technology  focusing on the market for  Internet-based
(TCP/IP)  communications.  ARL also  provides  security  products  to  broadcast
networks.  See Note 2 of Notes to Consolidated  Financial Statements.  The total
acquisition  price of approximately  $76.3 million was funded from a combination
of the Company's existing working capital, newly issued common stock and options
to purchase  common stock.  Approximately  $63.9  million of the total  purchase
price  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.  The
amortization  of capitalized  intangibles of $0.8 million in 1977 and the charge
resulting from in-process technology are not deductible for income

                                       20
<PAGE>

tax purposes.  The  acquisition  was accounted for 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.

DISCONTINUED OPERATIONS

         On March 28, 1998, the Company sold its Wireless  Communications  Group
for  approximately  $46.0  million in cash and a $14.5  million  unsecured  note
receivable,  subject  to  final  closing  adjustments.  See  Note 12 of Notes to
Consolidated  Financial  Statements.  The sale is expected to result in an after
tax gain of approximately $25.0 million.

RESULTS OF CONTINUING OPERATIONS

         Except where noted, the comments herein are associated with the results
of the  information  security  business.  The following table sets forth certain
consolidated  statement of  operations  data as a percentage  of revenue for the
periods indicated:

                                            Year ended December 31,
                                        -------------------------------
                                         1997        1996        1995
                                        -------     ------     -------

Revenue                                  100.0 %    100.0 %     100.0 %
Cost of revenue                           28.4       37.7        32.0
                                        -------     ------     -------
Gross profit                              71.6       62.3        68.0

Operating expenses:
  Research and development, net           25.3       31.8        37.8
  Selling and marketing                   32.5       36.7        26.5
  General and administrative              17.1       23.1        22.9
  Amortization of purchased intangibles    1.6          -           -
  Purchased in-process technology        129.5          -           -
  Employee severance costs                   -        2.5           -
                                        -------     ------     -------

     Total operating expenses            206.0       94.1        87.2

Loss from operations                    (134.4)     (31.8)      (19.2)

Other income, net                          6.1       10.4        (0.6)
                                        -------     ------     -------

Loss before income taxes                (128.3)     (21.4)      (19.8)
Provision (benefit) for income taxes       --         --          --
                                        -------     ------     -------
Net loss                                (128.3)%    (21.4)%     (19.8)%
                                        =======     ======     =======


         Revenue. The Company's revenue increased 91% from $25.8 million in 1996
to $49.3 million in 1997.  The increased  revenue was primarily due to increased
unit  sales of the  Company's  SecureWAN,  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.  Information security product revenue for 1997 includes $4.6 million
attributable to ARL.

         The Company's revenue increased 20% from $21.5 million in 1995 to $25.8
million in 1996. The increased revenue was primarily due to increased unit sales
of the Company's SecureWAN, SecureLAN and SecureAccess encryption product lines.
Unit sales of the Company's core link encryption  product line were  essentially
flat in comparison with 1995.

         International product revenue was 36%, 42% and 43% of revenue for 1995,
1996 and 1997, respectively.

                                       21
<PAGE>

         Gross Profit. Gross profit increased 120% from $16.1 million in 1996 to
$35.3  million in 1997,  and increased as a percentage of sales from 62% to 72%.
The increase in dollars was primarily the result of the significant  increase in
revenue. The increase in gross margin resulted from lower average unit costs and
a decrease in expenses for maintenance and support services.

         Gross profit  increased 10% from $14.6 million in 1995 to $16.1 million
in 1996,  but decreased as a percentage  of sales from 68% to 62%.  Gross margin
declined as some of the newly  introduced  products had lower gross margins than
the Company's core link encryption  products and these new products  represented
an increased percentage of revenue.

         Research and  Development.  Research and development  expenses  consist
primarily  of salaries and other  personnel-related  expenses,  depreciation  of
development equipment,  facilities and supplies.  Gross research and development
expenses  increased  55% from $9.2 million in 1995 to $14.3  million in 1996 and
decreased 3% to $13.9 million in 1997.  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 recognized under non-recurring  engineering  contracts totaled
$1.1  million,   $6.1  million  and  $1.4  million  in  1995,   1996  and  1997,
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 66% from $5.7 million in 1995 to $9.5 million in 1996 and 69% to $16.0
million in 1997. The increases were  primarily due to expenses  associated  with
expansion  of the  Company's  direct  sales  force,  personnel  increases in the
marketing  group,  and  increased  costs  associated  with  advertising,  public
relations and trade shows.

         General and Administrative. General and administrative expenses consist
primarily of personnel  and related  costs,  recruitment  expenses,  information
system costs, and audit, legal and other professional  service fees. General and
administrative  expenses increased 21% from $4.9 million in 1995 to $6.0 million
in 1996 and 41% to $8.4 million in 1997. The dollar  increases are primarily due
to increased  staffing and professional fees necessary to manage and support the
Company's  recent  growth.  The decrease as a percentage  of revenue in 1997 was
primarily due to a larger revenue base.

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

         Other Income  (Expense),  Net.  Other income  (expense),  net primarily
consists of royalties,  interest  income,  interest expense and investment gains
and  losses.  The  increase  in other  income to $2.7  million for 1996 from net
expense of $0.1 million in 1995 was  principally  due to an increase in interest
income  resulting from funds derived from the Company's  initial public offering
in February  and March  1996.  Other  expenses  increased  as the  Company  sold
marketable  securities  at a loss of $432,000  in 1996.  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 interest in a former partnership with
RSA DSI known as PKP.  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. The assets of the former partnership,
consisting  primarily of cash, are being held in trust pending the resolution of
certain litigation described in Part I, Item 3 "Legal  Proceedings."  Management
does not believe  the  ultimate  resolution  of this matter will have a material
adverse impact on the Company's financial position or results of operations.

         Provision  (Benefit)  for  Income  Taxes.  Excluding  the  charges  for
purchased in-process technology and amortization of capitalized intangibles, the
Company's  effective tax rate for 1997 was  approximately  25%. Net deferred tax
assets  of $1.5  million  at  December  31,  1997,  were  based on  management's
determination  that the Company  will more  likely than not realize  such assets
based on expected future income in the next twelve months. However, there can be
no assurance that the Company will be profitable in future  periods.  See Item I
"Business  - Risk  Factors  That May Affect  Future  Results  -- Recent  Losses;
Potential Fluctuations in Operating Results,

                                       22
<PAGE>

Future Operating Results  Uncertain."

         Net income (loss). The Company had losses from continuing operations of
$4.3 million in 1995,  $5.5 million in 1996 and $63.3  million in 1997. In 1994,
the Company  began a strategic  research  and  development  program  designed to
create new products and enhance existing  products.  While revenue  increased in
1995,  the Company  incurred a net loss due to continued high levels of research
and  development  expenses  related  to the  Company's  strategic  research  and
development  projects.  In 1996,  increased  gross profit  resulting  from newer
information  security  products  was more than  offset by  higher  spending  for
selling  and  marketing,  resulting  in a loss from  operations.  Excluding  the
nonrecurring  charge  related to purchased  in-process  technology,  the Company
reported income from  operations in 1997 due primarily to significant  increases
in revenue as well as improved gross margins.

LIQUIDITY AND CAPITAL RESOURCES

         At December  31,  1997,  the Company had cash and cash  equivalents  of
$23.0  million,   working  capital  of  $50.3  million  and  minimal   long-term
obligations.  For  1997,  the  Company  reported  a  net  loss  from  continuing
operations of $63.3 million due to the aforementioned  nonrecurring  charge from
the acquisition of in-process technology.  Net cash used by operating activities
for the years ended  December 31,  1995,  1996 and 1997  consisted  primarily of
significant  increases in accounts  receivable and inventory in order to support
increased revenue.

         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
$614,000 and $2.8 million in 1995 and 1996, respectively.  Additionally, in 1995
and 1996 the Company  acquired  $493,000 and  $256,000 of equipment  financed by
capital leases. Expenditures for property and equipment 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 were $2.2 million,  $79.7 million
and $1.0  million for the years  ended  December  31,  1995,  1996 and 1997.  In
February and March 1996, the Company  completed its initial public  offering and
its Common Stock began  trading on the Nasdaq  National  Market under the symbol
CYLK.  Through the  offering,  the Company sold  5,750,000  shares of its Common
Stock which generated  approximately  $79.3 million in cash, net of underwriting
discounts, commissions and other offering costs.

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

         The Company is in the process of evaluating and  implementing  changes,
as necessary, to its information systems and accordingly does not anticipate any
material  "year 2000  issues"  from its own  information  systems, databases  or
programs.  Management  also  believes  that it has  identified  all risks of YK2
Errors in the Company's  products.  See Item 1.  "Business--Year 2000 and --Risk
Factors  That May Affect  Future  Results."  However,  the  Company's  financial
position  and results of  operations  could be  adversely  impacted by year 2000
issues  faced by  distributors,  suppliers,  customers,  vendors  and  financial
service organizations with which the Company interacts.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
         Not applicable.

                                       23
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements and Financial Statement Schedules


Financial Statements:                                                       Page
                                                                            ----

    Report of Price Waterhouse LLP, Independent Accountants                  24

    Consolidated Balance Sheets at December 31, 1997 and 1996                25

    Consolidated Statements of Operations for the years ended
       December 31, 1997, 1996 and 1995                                      26

    Consolidated Statements of Shareholders' Equity for the years ended
       December 31, 1997, 1996 and 1995                                      27

   Consolidated Statements of Cash Flows for the years ended
       December 31, 1997, 1996 and 1995                                      28

   Notes to Consolidated Financial Statements                                29

Financial Statement Schedule:

   Schedule II - Valuation and Qualifying Accounts                           43

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, 1997
        and 1996,  and the results of their  operations and their cash flows for
        each of the three  years in the  period  ended  December  31,  1997,  in
        conformity  with  generally  accepted   accounting   principles.   These
        financial statements are the responsibility of the Company's management;
        our   responsibility  is  to  express  an  opinion  on  these  financial
        statements  based  on our  audits.  We  conducted  our  audits  of these
        statements in accordance  with  generally  accepted  auditing  standards
        which  require  that we plan and perform the audit to obtain  reasonable
        assurance  about whether the financial  statements  are free of material
        misstatement.  An audit includes  examining,  on a test basis,  evidence
        supporting  the amounts and  disclosures  in the  financial  statements,
        assessing the accounting  principles used and significant estimates made
        by  management,   and  evaluating   the  overall   financial   statement
        presentation.  We believe that our audits provide a reasonable basis for
        the opinion expressed above.


        PRICE WATERHOUSE LLP
        San Jose, California
        February  12,  1998,  except  as  to  the  effect  of  the  discontinued
        operations described in Note 12, which is as of March 28, 1998.

                                       24
<PAGE>
<TABLE>
Cylink Corporation
Consolidated Balance Sheets
(dollars in thousands, except per share data)
<CAPTION>

                                                                          December 31,
                                                                    ----------------------
                                                                       1997         1996
                                                                    ---------    ---------
                                     Assets
<S>                                                                 <C>          <C>
Current assets:
   Cash and cash equivalents                                        $  22,977    $  78,849
   Accounts receivable, net of allowances of $433 and $644             26,245       12,682
   Inventories                                                         10,522        8,828
   Deferred income taxes                                                1,533        1,432
   Other current assets                                                 2,195        1,351
                                                                    ---------    ---------
            Total current assets                                       63,472      103,142

Property and equipment, net                                             6,699        3,760
Acquired technology, goodwill and other intangibles                     8,017         --
Notes receivable from employees                                         3,473         --
Other assets                                                              932          186
                                                                    ---------    ---------
                                                                    $  82,593    $ 107,088
                                                                    =========    =========
                      Liabilities and Shareholders' Equity

Current liabilities:
   Current portion of lease obligations and long-term debt          $     210    $     167
   Accounts payable                                                     4,112        3,954
   Accrued liabilities                                                  6,796        5,090
   Income taxes payable                                                 1,898           60
   Deferred revenue                                                       206          353
                                                                    ---------    ---------
         Total current liabilities                                     13,222        9,624
                                                                    ---------    ---------

Capital lease obligations and long-term debt                              256          241
                                                                    ---------    ---------

Deferred income taxes                                                      13           12
                                                                    ---------    ---------
Commitments and contingencies (Notes 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;
      28,695,000 and 25,597,000 shares issued and outstanding             287          257
   Additional paid-in capital                                         120,092       89,772
   Notes receivable from shareholders                                    --           (301)
   Deferred compensation related to stock options                        (250)        (334)
   Cumulative translation adjustment                                      (63)           4
   Retained earnings                                                  (50,964)       7,813
                                                                    ---------    ---------
            Total shareholders' equity                                 69,102       97,211
                                                                    ---------    ---------
                                                                    $  82,593    $ 107,088
                                                                    =========    =========


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

                                       25

<PAGE>
<TABLE>
Cylink Corporation
Consolidated Statements of Operations
(in thousands, except per share data)
<CAPTION>
                                                               Year ended December 31,
                                                      ------------------------------------
                                                         1997         1996         1995
                                                      ---------    ---------    ----------
<S>                                                   <C>          <C>          <C>
Revenue                                               $  49,333    $  25,793    $  21,534
Cost of revenue                                          13,986        9,731        6,890
                                                      ---------    ---------    ----------
Gross profit                                             35,347       16,062       14,644
                                                      ---------    ---------    ----------

Operating expenses:
   Research and development, net                         12,488        8,198        8,142
   Selling and marketing                                 16,036        9,475        5,698
   General and administrative                             8,422        5,963        4,937
   Amortization of purchased intangibles                    807         --           --
   Purchased in-process technology                       63,920         --           --
   Employee severance costs                                --            634         --
                                                      ---------    ---------    ----------
            Total operating expenses                    101,673       24,270       18,777
                                                      ---------    ---------    ----------

Loss from operations                                    (66,326)      (8,208)      (4,133)

Other income (expense):
   Interest income, net                                   2,697        3,303           50
   Royalty and other income (expense), net                  317         (617)        (177)
                                                      ---------    ---------    ----------

Loss from continuing operations before income taxes     (63,312)      (5,522)      (4,260)
Provision (benefit) for income taxes                         --           --           --
                                                      ---------    ---------    ----------
Loss from continuing operations                         (63,312)      (5,522)      (4,260)
Income from discontinued operations, net
   of income tax expense (benefit) of $2,033, $257
   and $(755) (Note 12)                                   4,535        6,719        3,181
                                                      ---------    ---------    ----------
Net income (loss)                                     $ (58,777)   $   1,197    $  (1,079)
                                                      =========    =========    ==========

Earnings (loss) per share - basic:
   Continuing operations                              $   (2.37)   $   (0.23)   $   (0.24)
   Discontinued operations                                 0.17         0.28         0.18
                                                      ---------    ---------    ----------
   Net income (loss)                                  $   (2.20)   $    0.05    $   (0.06)
                                                      =========    =========    ==========
Earnings (loss) per share - diluted:
   Continuing operations                              $   (2.37)   $   (0.23)   $   (0.24)
   Discontinued operations                                 0.17         0.28         0.18
                                                      ---------    ---------    ----------
   Net income (loss)                                  $   (2.20)   $    0.05    $   (0.06)
                                                      =========    =========    ==========

Shares used in per share calculation - basic             26,703       24,412       17,862
                                                      =========    =========    ==========

Shares used in per share calculation - diluted           26,703       24,412       17,862
                                                      =========    =========    ==========

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

                                       26
<PAGE>

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

                                                                              Notes
                                                             Additional    Receivable
                                       Common Stock           Paid-in         from
                                   Shares         Amount      Capital      Shareholders
                                 -----------     --------    ----------    ------------
<S>                               <C>            <C>          <C>           <C>
Balance at December 31, 1994      17,624,000     $    176     $  7,063      $   --
Issuance of common stock
   under stock option plans        1,463,000           15        1,801          (515)
Deferred compensation related
   to stock options                     --           --            417          --
Unrealized gain on investments          --           --           --            --
Translation adjustment                  --           --           --            --
Net loss                                --           --           --            --
                                 -----------     --------    ----------    ------------
Balance at December 31, 1995      19,087,000          191        9,281          (515)
Issuance of common stock
   under stock option plans          760,000            8        1,088          --
Issuance of common stock in
   initial public offering, net    5,750,000           58       78,806          --
Tax benefit from exercise of
   nonqualified stock options           --           --            597          --
Payment on notes receivable
   from shareholders                    --           --           --             214
Amortization of deferred
   compensation                         --           --           --            --
Reversal of unrealized loss on
   investments upon disposition         --           --           --            --
Translation adjustment                  --           --           --            --
Net income                              --           --           --            --
                                 -----------     --------    ----------    ------------
Balance at December 31, 1996      25,597,000          257       89,772          (301)
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 exercise of
   nonqualified stock options           --           --            296          --
Payment on notes receivable
   from shareholders                    --           --           --             301
Amortization of deferred
   compensation                         --           --           --            --
Translation adjustment                  --           --           --            --
Net loss                                --           --           --            --
                                 -----------     --------    ----------    ------------
Balance at December 31, 1997      28,695,000     $    287     $120,092      $   --
                                 ===========     ========    ==========    ============
</TABLE>
<TABLE>
Cylink Corporation
Consolidated Statements of Shareholders' Equity
(dollars in thousands)
<CAPTION>

                                   Deferred
                                Compensation   Unrealized                 Retained
                                 Related to      Gain       Cumulative    Earnings
                                    Stock     (Loss) on    Translation   (Accumulated
                                   Options    Investments   Adjustment     Deficit)      Total
                                 -----------  -----------  ------------   ---------   ---------
<S>                                <C>          <C>          <C>          <C>          <C>
Balance at December 31, 1994       $   --       $   (679)    $   (106)    $  7,695     $ 14,149
Issuance of common stock
   under stock option plans            --           --           --           --          1,301
Deferred compensation related
   to stock options                    (417)        --           --           --           --
Unrealized gain on investments         --            263         --           --            263
Translation adjustment                 --           --            (29)        --            (29)
Net loss                               --           --           --         (1,079)      (1,079)
                                 -----------  -----------  ------------   ---------   ---------
Balance at December 31, 1995           (417)        (416)        (135)       6,616       14,605
Issuance of common stock
   under stock option plans            --           --           --           --          1,096
Issuance of common stock in
   initial public offering, ne         --           --           --           --         78,864
Tax benefit from exercise of
   nonqualified stock options          --           --           --           --            597
Payment on notes receivable
   from shareholders                   --           --           --           --            214
Amortization of deferred
   compensation                          83         --           --           --             83
Reversal of unrealized loss on
   investments upon dispositio         --            416         --           --            416
Translation adjustment                 --           --            139         --            139
Net income                             --           --           --          1,197        1,197
                                 -----------  -----------  ------------   ---------   ---------
Balance at December 31, 1996           (334)        --              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 exercise of
   nonqualified stock options          --           --           --           --            296
Payment on notes receivable
   from shareholders                   --           --           --           --            301
Amortization of deferred
   compensation                          84         --           --           --             84
Translation adjustment                 --           --            (67)        --            (67)
Net income                             --           --           --        (58,777)     (58,777)
                                 -----------  -----------  ------------   ---------   ---------
Balance at December 31, 1997       $   (250)    $   --       $    (63)    $(50,964)    $ 69,102
                                 ===========  ===========  ============   =========   =========

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

                                       27
<PAGE>

<TABLE>
Cylink Corporation
Consolidated Statements of Cash Flows
(dollars in thousands)
<CAPTION>
                                                                                    Year ended December 31,
                                                                       ---------------------------------------------
                                                                           1997               1996              1995
                                                                       ---------         ---------          --------
<S>                                                                    <C>               <C>                <C>
Cash flows from operating activities:
   Net income (loss)                                                   $ (58,777)        $   1,197           $ (1,079)

   Adjustments to reconcile  net income (loss) to net
    cash provided by (used in) operating activities:
         Purchased in-process technology                                  63,920                 -                 -
         Depreciation and amortization                                     2,914             1,350                919
         Deferred compensation related to stock options                       84                83                 -
         Deferred income taxes                                              (100)             (516)              (383)
         Realized loss on sale of investments                                  -               432                 -
         Changes in assets and liabilities (net of effects of
          ARL acquisition):
            Accounts receivable                                          (12,580)           (6,669)            (1,269)
            Inventories                                                   (1,271)           (2,732)            (1,451)
            Other assets                                                    (376)             (405)               573
            Accounts payable                                                 (22)            2,576                252
            Accrued liabilities                                               90             1,349                414
            Income taxes payable                                           1,838               (30)              (314)
            Deferred revenue                                                (332)             (936)               (77)
                                                                       ---------         ---------          ---------
               Net cash used in operating activities                      (4,612)           (4,301)            (2,415)
                                                                       ---------         ---------          ---------
Cash flows from investing activities:
   Acquisition of property and equipment                                  (3,786)           (2,815)              (614)
   Purchase of Algorithmic Research, net of cash acquired                (44,890)                -                  -
   Loans to employees in exchange for notes receivable                    (3,473)                -                  -
   Proceeds from sale of short-term investments                                -             2,842                  -
                                                                       ---------         ---------          ---------
               Net cash provided by (used in)
                   investing activities                                  (52,149)               27               (614)
                                                                       ---------         ---------          ---------
Cash flows from financing activities:
   (Repayment) borrowings under bank line of credit                            -            (1,000)             1,000
   Proceeds from issuance of common stock, net                               529            79,960              1,301
   Payment on notes receivable from shareholders                             301               214                  -
   Repayment of capital lease obligations and long-term debt                (170)              (27)               (58)
   Tax benefit from exercise of stock options                                296               597                  -
                                                                       ---------         ---------          ---------
               Net cash provided by financing activities                     956            79,744              2,243
                                                                       ---------         ---------          ---------
Effect of exchange rate changes on cash
   cash and cash equivalents                                                 (67)              139                 (5)
                                                                       ---------         ---------          ---------
Net increase (decrease) in cash and cash equivalents                     (55,872)           75,609               (791)
Cash and cash equivalents at beginning of year                            78,849             3,240              4,031
                                                                       ---------         ---------          ---------
Cash and cash equivalents at end of year                               $  22,977         $  78,849          $   3,240
                                                                       =========         =========          =========

Supplemental disclosures:
   Cash paid for income taxes                                          $      31         $     184          $      58
   Cash paid for interest                                                    159               110                 32
   Equipment acquired under capital lease obligations                          -               256                493
   Common stock issued for notes receivable                                    -                 -                515
   Equity issued for purchase of ARL                                      29,525                 -                  -

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

                                       28
<PAGE>


Cylink Corporation
Notes to Consolidated Financial Statements


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

     The Company

         Cylink  Corporation  (the "Company") was  incorporated in California in
     October  1989  to  engage  in the  development,  manufacture,  license  and
     marketing of  electronic  encryption  devices and in 1990 began  developing
     wireless  communication  products (see Note 12 for operations  discontinued
     subsequent to year end).

     Basis of presentation

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

         Through 1997, the Company's  interim  quarters ended on the last Friday
     preceding the calendar quarter end. The Company's year end is December 31.

     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
     statement  or  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
     an original 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 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.

     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.

     Revenue recognition

         Revenue  is   recognized   upon   shipment  of  product  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.

     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

                                       29
<PAGE>

     percentage of completion method. Receipts, which are refundable pending the
     achievement of certain results, are deferred and recognized upon acceptance
     by the customer.  Amounts billed on contracts and collected  prior to being
     earned  are  recorded  as  deferred  revenue.  At the time of  recognition,
     amounts  received  under  research  and  development  contracts  are offset
     against research and development expenses.

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

     Stock-based compensation

         The Company  accounts for stock based employee  compensation  using the
     intrinsic value method  prescribed in Accounting  Principles  Board Opinion
     (APB) No. 25,  "Accounting  for Stock  Issued to  Employees,"  and  related
     Interpretations.  The Company provides  additional pro forma disclosures as
     required  under  Statement of Financial  Accounting  Standard No. 123 (SFAS
     123), "Accounting for Stock-Based Compensation" (see Note 6).

     Income taxes

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

     Net income (loss) per share

         Effective  December 31, 1997,  the Company  adopted the  provisions  of
     Statement of Financial  Accounting  Standards No. 128, "Earnings per Share"
     ("SFAS 128").  SFAS 128 requires the Company to report both basic  earnings
     per share, which is based on the  weighted-average  number of common shares
     outstanding,  and  diluted  earnings  per  share,  which  is  based  on the
     weighted-average number of common shares outstanding and dilutive potential
     common shares  outstanding.  All prior years'  earnings per share data have
     been restated to reflect the  provisions  of SFAS 128. The  Company's  only
     potentially dilutive securities are stock options (see Note 6).  All common
     stock  equivalents  have been  excluded  from the  computation  of  diluted
     earnings  per  share as  their  effect  is  antidilutive  on the loss  from
     continuing  operations.

     Concentrations of credit risk

         Financial   instruments  that   potentially   subject  the  Company  to
     significant  concentrations  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.

         One  customer   accounted  for  approximately  14%  of  total  accounts
     receivable at December 31, 1997. No Customer accounted for more than 10% of
     accounts  receivable  at December 31, 1996,  and no customer  accounted for
     greater than 10% of revenue in any period presented.

     Use of estimates

         The  preparation of financial  statements in conformity  with generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions that affect the reported amounts of assets and liabilities and

                                       30
<PAGE>

     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.

     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.

     Recent Accounting Pronouncements

         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
     Standards No. 130 ("SFAS 130"), "Reporting  Comprehensive Income." SFAS 130
     establishes standards for reporting comprehensive income and its components
     in a financial  statement  that is displayed  with the same  prominence  as
     other financial  statements.  Comprehensive  income as defined 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, include foreign currency translation  adjustments
     and unrealized  gain/loss on available for sale securities.  The disclosure
     prescribed  by SFAS 130 must be made  beginning  with the first  quarter of
     1998.

         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
     Standards  No.  131  ("SFAS  131"),   "Disclosures  about  Segments  of  an
     Enterprise and Related  Information." This statement  establishes standards
     for the way companies report information about operating segments in annual
     financial statements. It also establishes standards for related disclosures
     about products and services,  geographic  areas, and major  customers.  The
     Company has not yet  determined  the impact of adopting  this new standard.
     The disclosures prescribed by SFAS 131 are effective for 1998.

2.   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. Algorithmic Research is an
     information  security company providing remote access software products and
     smart-card  technology  focusing on the market for Internet-based  (TCP/IP)
     communications.  Algorithmic  Research also provides  security  products to
     broadcast  networks.  Consideration  for this purchase was  $44,890,000  in
     cash, net of cash acquired,  including  transaction expenses of $3,536,000;
     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  $29,525,000.  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 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.

                                       31
<PAGE>

         The following unaudited pro forma financial information 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  operations  which  actually  would have resulted had the
     acquisition  occurred  on the date  indicated,  or which may  result in the
     future.


                                                  Year ended December 31,
                                                  -----------------------
                                                     1997        1996
                                                  ---------    ----------
                                           (in thousands, except per share data,
                                                       unaudited)

Revenue                                            $53,543     $32,999
Net loss                                             2,367       9,552
Net loss per share (basic and diluted)                0.08        0.35
Shares used to compute net loss per
   share (basic and diluted)                        28,522      27,005

3.    Initial Public Offering

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

         In connection with the Company's initial public offering,  the Board of
     Directors authorized the issuance of up to 5,000,000 shares of undesignated
     preferred  stock and the Board has the authority to issue the  undesignated
     preferred  stock in one or more series and to fix the rights,  preferences,
     privileges and restrictions  thereof. No preferred stock had been issued as
     of December 31, 1997.

4.   Details of Balance Sheet Components

                                                                December 31,
                                                           ---------------------
                                                             1997        1996
                                                           --------    ---------
                                                                (in thousands)

Inventories:
   Raw materials                                           $  4,781    $  4,126
   Work in process and subassemblies                          3,332       3,196
   Finished goods                                             2,409       1,506
                                                           --------    ---------
                                                           $ 10,522    $  8,828
                                                           ========    =========
Property and equipment:
   Machinery and equipment                                 $ 11,151    $  7,068
   Furniture and fixtures                                     1,246         624
   Land and building                                            814        --
   Leasehold improvements                                       680         564
                                                           --------    ---------
                                                             13,891       8,256
   Less:  accumulated depreciation and amortization          (7,192)     (4,496)
                                                           --------    ---------
                                                           $  6,699    $  3,760
                                                           ========    =========
Accrued liabilities:
   Compensation and benefits                               $  3,035    $  2,116
   Royalties                                                    982         665
   Employee severance costs                                   1,313         634
   Distributor commissions                                      380         543
   Other                                                      1,086       1,132
                                                           --------    ---------
                                                           $  6,796    $  5,090
                                                           ========    =========

                                       32
<PAGE>

5.   Income Taxes

         In computing the separate  provision for (benefit from) income taxes on
     continuing  and  discontinued  operations,  no benefit was allocated to the
     losses from continuing  operations since on a stand alone basis the Company
     would not have recognized the tax benefit of such losses due to uncertainty
     of  realization.  Any  benefits  realized  from these losses as a result of
     taxable  income generated by the  discontinued  operations have been netted
     against the provisions associated with discontinued operations. There is no
     obligation  on the  part of the  discontinued  operations  to  refund  such
     benefits to the continuing  operations.  The provision (benefit) for income
     taxes on discontinued operations consists of the following:

                                                 Year ended December 31,
                                         --------------------------------------
                                         1997              1996            1995
                                         ----              ----            ----
                                                     (in thousands)
Current:
   Federal                           $  1,887           $   709         $  (403)
   State                                    6                58             (92)
   Foreign                                240                --             123
                                     --------           -------         --------
                                        2,133               767            (372)
                                     --------           -------         --------

Deferred:
   Federal                                (24)             (478)           (348)
   State                                  (76)              (38)            (35)
                                     --------           -------         --------
                                         (100)             (516)           (383)
                                     --------           -------         --------
                                     $  2,033           $   251         $  (755)
                                     ========           =======         ========

         Deferred tax assets (liabilities) comprise the following:

Net operating loss and credit carryforwards              $  1,109       $   984
Unrealized capital loss                                       270           166
Bad debt reserve                                              151           230
Inventory reserves and basis differences                    1,492         1,382
Accrued expenses                                              368           448
Deferred rent                                                   -            30
Warranty reserve                                               71            60
Other                                                          41           102
                                                         --------       -------
         Total deferred tax assets                          3,502         3,402
                                                         --------       -------

Liabilities:
Depreciation                                                  (13)           (5)
Other liabilities                                               -            (7)
                                                         --------       -------
         Total deferred tax liabilities                       (13)          (12)
                                                         --------       -------
Valuation allowance                                        (1,969)       (1,970)
                                                         --------       -------
Net deferred tax assets                                  $  1,520       $ 1,420
                                                         ========       =======


         Net deferred tax assets of  $1,520,000  at December 31, 1997 were based
     on the  Company's  expected  future income in the next twelve  months.  The
     Company has recorded a partial valuation allowance against the remainder of
     its deferred tax assets.

                                       33
<PAGE>

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

                                                Year ended December 31,
                                         -----------------------------------
                                         1997            1996          1995
                                         ------       -------        -------
U.S. federal statutory income tax rate    (34.0)%        34.0 %        (34.0) %
State taxes, net of federal tax benefit     -             0.9           (4.6)
Research and development tax credits       (0.6)        (24.2)             -
Change in valuation allowance               -             7.4              -
Purchased in-process technology            38.3             -              -
Foreign losses not benefitted              (0.8)          5.2              -
Other                                       0.4          (6.0)          (2.6)
                                         ------       -------        -------
   Effective tax rate                       3.3 %        17.3 %        (41.2) %
                                         ======       =======        =======

         The Company has not provided  United States federal income taxes on the
     undistributed  earnings of foreign subsidiaries because it is the Company's
     intention to permanently reinvest such earnings. At December 31, 1997, 1996
     and  1995,  total   undistributed   earnings  of  these  subsidiaries  were
     approximately $3,395,000, $1,846,000 and $1,579,000, respectively.

         The Company had  research  and  development  credit  carry  forwards of
     approximately  $938,000  and  $980,000  at  December  31,  1997  and  1996,
     respectively, which expire from 2009 to 2012.


6.   Stock Option Plans

         The Company  currently  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
     5,950,000  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, 1997, 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. Shares issued
     upon  exercise of options may be subject to certain  restrictions  on their
     transferability.  The Company has the right to repurchase such shares, at a
     price  equal to the fair  market  value,  when the  optionee  is no  longer
     associated with the Company.  As of December 31, 1997, there were no shares
     subject to  repurchase.  Shares  repurchased  increase the number of shares
     available for grant under the Plans.

         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 Algorithmic  Research 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.

                                       34
<PAGE>

         The following table  summarizes the Company's stock option activity and
     related  weighted  average  exercise price within each category for each of
     the three years in the period ended December 31, 1997:

                                                                       Weighted
                                       Shares                          Average
                                      Available      Options           Exercise
                                      for grant     Outstanding         Price
                                    -----------     -----------     ------------

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

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

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

         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
     previously granted to employees, and reissued all such options at $11.00 to
     $11.63, the fair market value of the stock on the date of cancellation. The
     reissued  options  have a  ten-year  term and vest over five years from the
     date of reissuance.
<TABLE>
         Significant option groups outstanding at December 31, 1997, 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 $ 2.00   1,206,408           7.5          $   1.27         933,085            $  1.07
$ 4.80 to $ 8.88   1,060,983           9.5              8.30          90,009               7.05
$ 9.00 to $11.00   1,450,834           9.0             10.75         259,827              10.71
$11.06 to $23.50   1,546,995           8.9             12.23         159,647              12.98
                   ---------                                       ---------
                   5,265,220           8.7          $   8.52       1,442,568            $  4.50
                   =========                                       =========
</TABLE>
                                       35
<PAGE>

         The weighted  average  estimated  grant date fair value,  as defined by
     SFAS 123, for options  granted during 1995 at market price and below market
     price on the dates of grant was $1.04 and $1.47, respectively. The weighted
     average estimated grant date fair value for options granted at market price
     during 1997 and 1996 was $4.70 and $6.03, respectively. The estimated grant
     date  fair  value  disclosed  by  the  Company  is  calculated   using  the
     Black-Scholes  model. The  Black-Scholes  model, as well as other currently
     accepted option valuation models,  was developed to estimate the fair value
     of  freely   tradeable,   fully   transferable   options   without  vesting
     restrictions,  which  significantly  differ from the Company's stock option
     awards. These models also require highly subjective assumptions,  including
     future stock price  volatility  and  expected  time until  exercise,  which
     greatly affect the calculated grant date fair value.

         The estimated  grant date fair value for options granted 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.

         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:


                                        1997        1996        1995
                                       -----       -----       -----

          Expected life (years)         3.10        3.04        3.04
          Risk-free interest rate       5.98%       5.93%       6.22%
          Volatility                   64.16%      69.46%      54.89%
          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
     it's 1994 Plan,  the  Company's net income (loss) and net income (loss) per
     share would have been reduced to the pro forma  amounts below for the years
     ended December 31, 1997, 1996 and 1995 (in thousands,  except for per share
     amounts):

                                             1997         1996       1995
                                           --------    ---------    -------

Net income (loss)             As reported  $(58,777)   $   1,197    $(1,079)
                              Pro forma     (62,275)        (325)    (1,354)

Net income (loss) per share   As reported  $  (2.20)   $    0.05    $ (0.06)
                              Pro forma       (2.33)       (0.01)     (0.08)


         The pro forma  effect on net income  (loss)  and net income  (loss) per
     share for 1997, 1996 and 1995 is not representative of the pro forma effect
     on net income in future years  because it does not take into  consideration
     pro forma compensation expense related to grants made prior to 1995.

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

7.   Notes Receivable From Employees

         Pursuant to their employment  agreements and related  promissory notes,
     during  the first  quarter of 1997 the  Company  loaned  certain  employees
     $3,473,000  towards the  purchase of their  principal  residences.  Of this
     amount,  $2,843,000 is receivable  from officers of the Company.  The notes
     are  interest  free and are due five  years  from the dates of the  related
     notes,  at which time the notes must be repaid or convert into,  and become
     subject to, the terms of a standard,  interest-bearing commercial loan. The
     notes are  secured by deeds of trust on the  related  residences.  The loan
     agreements  provide for accelerated  payment in the event of termination of
     employment  under certain  conditions  and, in one instance,  under certain
     circumstances  will be forgiven to the extent of any  decrease in the value
     of the related residence.

                                       36
<PAGE>

8.   Research and Development Contracts

         During the years ended  December 31, 1997,  1996 and 1995,  the Company
     performed   research  and  development  under  several   government  funded
     arrangements    aggregating   $1,201,000,    $3,777,000,    and   $526,000,
     respectively. These contracts provide funding (irrespective of the results)
     for research and development of certain  cryptographic  technologies  which
     will be jointly owned by the Company and these government agencies. Amounts
     received under these contracts are offset against  research and development
     expenses.

         The Company  performed  research and  development  under  several other
     research and  development  contracts  which provide for the development and
     transfer of technology  in exchange for  development  funding.  The Company
     recorded as a reduction  of research  and  development  expenses  $225,000,
     $2,363,000 and $604,000 under such arrangements in the years ended December
     31, 1997, 1996 and 1995, respectively.

9.   Joint Venture and Contingencies

         On  September  6, 1995,  the  Company  obtained  an  arbitration  award
     dissolving  a former  partnership,  known as Public Key  Partners  ("PKP"),
     between the Company's wholly-owned subsidiary,  Caro-Kann Corporation,  and
     RSA DSI.  Although  various  claims  between  the  Company and RSA DSI were
     settled on December  31, 1996,  a third party  continues to pursue  various
     claims  against PKP and RSA DSI for wrongful  business  practices in action
     C-94-20512  SW before the United  States  District  Court for the  Northern
     District of California. A summary judgement favorable to PKP was entered on
     August 29, 1997,  and the matter has been  appealed by the plaintiff to the
     United  States Court of Appeals for the Federal  Circuit.  In the event the
     judgement of the  district  court is reversed,  an  unfavorable  outcome at
     trial might affect the  residual  value of the  Company's  interest in PKP.
     Management  believes  that the ultimate  resolution of this matter will not
     have a material adverse effect on the Company's financial position, results
     of operations or cash flows.

         On March 7, 1997,  ten former  employees  of the Company  filed suit in
     action No.  CV764647 in the Superior Court of  California,  County of Santa
     Clara, against the Company,  each of its Directors and its General Counsel,
     asserting  claims for wrongful  termination,  fraud,  libel,  slander,  age
     discrimination,  invasion of privacy,  and  violation  of the federal  RICO
     statute.  On July 11, 1997, an eleventh  employee  filed suit in action No.
     CV767448  in the  Superior  Court of  California,  County  of Santa  Clara,
     alleging  similar  claims  against  the  Company  and its  Chief  Executive
     Officer. The Company removed CV764647 to the Federal District Court for the
     Northern  District of California  and, after the Company  obtained an order
     dismissing certain of the plaintiffs' claims, including the claims of libel
     and RICO  violations,  the Court  remanded  the action  back to Santa Clara
     Superior  Court.  Following the remand,  the Company then obtained an order
     consolidating  CV764647  with CV767448 for purposes of discovery and trial.
     Both matters are currently in the discovery phase, with trial scheduled for
     December  1998.  Although  the Company has placed its insurers on notice of
     these claims,  all of its insurers have reserved  their rights and defenses
     under their policies, and the extent of the insurers' liability under their
     respective policies is undetermined.  The Company believes the terminations
     were lawful, in the best interests of the Company and intends to defend the
     matter vigorously.  The defense of this matter may divert a material amount
     of management's  attention and require the expenditure of significant legal
     fees  and  costs.  An  unfavorable  outcome  which  exceeds  the  Company's
     insurance coverage, if any, may also result in a material adverse effect on
     the Company's financial  condition.  However,  management believes that the
     ultimate  resolution of this matter will not have a material adverse effect
     on the Company's financial position, results of operations or cash flows.

                                       37
<PAGE>
10.  Geographic Information

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

                                                  Year ended December 31,
                                            -----------------------------------
                                             1997           1996          1995
                                            -------       -------       -------
                                                       (in thousands)

Revenue:
   Sales to unaffiliated customers:
      United States:
         Customers in United States
            and Canada                      $26,970       $13,744       $13,096
         Customers in Central and
            South America                     2,340           911         1,044
         Customers in Europe                  7,996         5,694         2,072
         Customers in Asia                    2,326         1,592         1,852
      Europe                                  5,113         3,852         3,470
      Israel:
         Customers in Europe                    674             -             -
         Customers in Asia                    3,410             -             -
         Other                                  504             -             -
                                            -------       -------       -------
                                            $49,333       $25,793       $21,534
                                            =======       =======       =======

Intercompany sales among geographic
   entities eliminated in consolidation     $ 2,266       $ 2,233       $ 1,782
                                            =======       =======       =======
Income (loss) from operations:
   United States                            $(3,723)      $(8,127)      $(4,490)
   Europe                                        76           (81)          357
   Israel                                   (62,679)            -             -
                                            -------       -------       -------
                                           $(66,326)      $(8,208)      $(4,133)
                                            =======       =======       =======

                                                               December 31,
                                                            ----------------
                                                            1997        1996
                                                            ----        ----
                                                              (in thousands)

Identifiable assets:
   United States                                          $42,878       $26,026
   Europe                                                   2,124         2,213
   Israel                                                  14,614             -
                                                          -------       -------
                                                           59,616        28,239

General corporate assets consisting of cash
   and cash equivalents                                    22,977        78,849
                                                          -------       -------
                                                          $82,593      $107,088
                                                          =======       =======

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

         At December 31, 1997 and 1996,  total  foreign  liabilities  (excluding
     intercompany balances) were $2,747,000 and $660,000, respectively.

                                       38
<PAGE>
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  June 2001 and  certain of the leases are
     renewable  for an additional  five years.  In addition to the minimum lease
     payments,  the Company is responsible  for  insurance,  repairs and certain
     other  operating  costs  under the terms of the leases.  The  Company  also
     leases  certain   equipment  under  long-term  lease  agreements  that  are
     classified as capital leases. These capital leases, which consist primarily
     of computer  equipment,  terminate at various  dates  through  2000.  Total
     equipment  acquired  under  these  capitalized  leases,  which  secure such
     borrowings,  was  $621,000  at cost and  $294,000  at net book  value as of
     December 31, 1997.

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

                                             Operating      Capital
Year ending December 31,                       Leases        Leases
                                             ---------      -------

1998                                         $   1,175      $   191
1999                                               721           86
2000                                               393            8
2001                                               197          --
                                             ---------      -------
Total minimum payments                       $   2,486          285
                                             =========
Less:  amount representing interest                             (40)
                                                            -------
Present value of capital lease obligations                      245
Less:  current portion                                         (165)
                                                            -------
Lease obligations, long-term                                $    80
                                                            =======

         Rent expense under operating leases totaled $1,720,000,  $1,207,000 and
     $909,000  during  the  years  ended  December  31,  1997,  1996  and  1995,
     respectively.

12.  Subsequent Event

         On March 13, 1998, the Company sold its Wireless  Communications  Group
     ("Wireless") to P-Com, Inc. for  approximately  $46.0 million in cash and a
     $14.5 million unsecured note receivable due 100 days after closing, subject
     to final  closing  adjustments.  The results of operations of Wireless have
     been classified as discontinued operations in the accompanying consolidated
     statements  of  operations.  Wireless  revenues were $31.3  million,  $26.2
     million and $13.4 million for the years ended  December 31, 1997,  1996 and
     1995, respectively. The components of Wireless assets at December 31, 1997,
     were as follows:

                        Accounts receivable, net       $ 10,688
                        Inventories                       4,298
                        Property and equipment              696
                        Other assets                         12
                        Accounts payable                 (1,874)
                        Accrued liabilites                 (602)
                                                       --------
                                                       $ 13,218
                                                       ========

                                       39
<PAGE>

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

         Not applicable.


                                    PART III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The  information  required  by this Item  with  respect  to  directors,
appearing  under the  caption  "Election  of  Directors"  including  subcaptions
thereof,  in the  Company's  Proxy  Statement  for the 1998  annual  meeting  of
shareholders  to be held on or about May 22,  1998 (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  1997,  is
incorporated  herein  by  reference.  The  information  required  by  this  Item
concerning the Company's  executive officers is set forth in Part I hereof under
the caption "Executive Officers of the Registrant."


ITEM 11.  EXECUTIVE COMPENSATION

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


ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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


ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

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


                                     PART IV

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

(a)    1.          Financial  Statements -- See index to Consolidated  Financial
                   Statements  and  Financial  Statement  Schedule at page 24 of
                   this Form 10-K.

       2.          Financial  Statement  Schedule  -- See Index to  Consolidated
                   Financial Statements and Financial Statement Schedule at page
                   24 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)

            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)

            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.

                                       40
<PAGE>

            4.2      Specimen certificate for Common Stock.  (1)

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

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

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

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

           10.5      Employment  Agreement  between  the  Company and Fernand B.
                     Sarrat, dated as of November 6, 1996. (2) (3)

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

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

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

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

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

           21.1      Subsidiaries of the Company.

           23.1      Consent of Price Waterhouse 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.

(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.

                                       41
<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, 1998             By:      /s/  FERNAND B. SARRAT
                                  ----------------------------------------------
                                           Fernand B. Sarrat
                                           President and Chief Executive Officer

         KNOW ALL PERSONS BY THESE  PRESENTS,  that each person whose  signature
appears below  constitutes and appoints John H. Daws and Robert B. Fougner,  and
each of them, acting  individually,  as his or her  attorney-in-fact,  each with
full power of substitution  and  resubstitution,  for him and in his name, place
and stead,  in any and all  capacities,  to sign any and all  amendments to this
Report on Form 10-K, and to file the same, with all exhibits thereto,  and other
documents in connection therewith,  with the Securities and Exchange Commission,
granting unto said  attorneys-in-fact  and agents,  and each of them, full power
and  authority  to do and  perform  each and every act and thing  requisite  and
necessary to be done in connection therewith and about the premises, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said  attorneys-in-fact and agents, or any of them, or their
or his substitute or substitutes,  may lawfully do or cause to be done by virtue
hereof.
<TABLE>
         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities and on the dates indicated.

<CAPTION>
Signature                                            Title                                            Date
---------                                            -----                                            ----
<S>                                         <C>                                                  <C>
/s/  FERNAND B. SARRAT                      President and Chief Executive Officer                March 30, 1998
     -----------------                      (Principal Executive Officer) and Director
     Fernand B. Sarra

/s/  JOHN H. DAWS                           Vice President of Finance and Administration         March 30, 1998
     ------------                           and Chief Financial Officer
     John H. Daws                           (Principal Financial and Accounting Officer)

/s/  LEO A. GUTHART                         Chairman of the Board                                March 30, 1998
     --------------
     Leo A. Guthart

/s/  ELWYN BERLEKAMP                        Director                                             March 30, 1998
     ---------------
     Elwyn Berlekamp

/s/  WILLIAM W. HARRIS                      Director                                             March 30, 1998
     -----------------
     William W. Harris

/s/  HOWARD L. MORGAN                       Director                                             March 30, 1998
     ----------------
     Howard L. Morgan

</TABLE>

                                       42
<PAGE>

SCHEDULE II

                               CYLINK CORPORATION
<TABLE>
                        VALUATION AND QUALIFYING ACCOUNTS
                  Years ended December 31, 1995, 1996 and 1997
                                 (in thousands)
<CAPTION>

                                                        Additions
                                        Balance at      Charged to        Deductions       Balance
                                        Beginning       Statement of         from          at end
                                        of Period       Operations         Reserves        of  Period
                                        ----------      ------------      -----------      ---------
<S>                                      <C>               <C>             <C>               <C>
Allowance for doubtful accounts
Year ended December 31, 1995             $279              $210            $ (6)             $483

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

Year ended December 31, 1997             $644             $(211)           $  -              $433
</TABLE>


                                       43