SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549


                                    FORM 10-Q


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

                For the quarterly period ended September 27, 1998

                           Commission File No. 0-27742


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




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


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


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



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

As of January 11, 1999, there were 29,104,567 shares of the Registrant's  Common
Stock outstanding.

<PAGE>



PART I.  FINANCIAL INFORMATION
Item 1.    Financial Statements
<TABLE>

CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data; unaudited)
<CAPTION>
                                                                   September 27,      December 31,
                                                                      1998               1997
                                                                    ---------          --------- 
                                   Assets                                           (restated -Note 1)
<S>                                                                 <C>                <C>       
Current assets:
   Cash and cash equivalents                                        $  49,241          $  22,977 
   Accounts receivable, net of allowances of $457 and $278             13,483             13,914
   Note receivable                                                      3,545               --
   Inventories                                                          9,826              6,224
   Net assets of discontinued operations                                 --               11,299
   Deferred income taxes                                                1,629              1,533
   Other current assets                                                 2,432              2,190
                                                                    ---------          --------- 
            Total current assets                                       80,156             58,137
                                                                                     
Property and equipment, net                                             5,884              6,003
Acquired technology, goodwill and other intangibles, net                5,979              8,017
Notes receivable from employees                                         5,762              3,473
Other assets                                                              211                925
                                                                    ---------          --------- 
                                                                    $  97,992          $  76,555
                                                                    =========          =========
                    Liabilities and Shareholders' Equity                             
Current liabilities:                                                                 
   Current portion of lease obligations and long-term debt          $     156          $     210
   Accounts payable                                                     3,163              2,238
   Accrued liabilities                                                  8,984              6,194
   Accrued liabilities related to discontinued operations               3,634               --
   Income taxes payable                                                  --                1,304
   Deferred revenue                                                     1,378                206
                                                                    ---------          --------- 
            Total current liabilities                                  17,315             10,152
                                                                    ---------          --------- 
                                                                                     
Capital lease obligations and long-term debt                              164                256
                                                                    ---------          --------- 

Deferred income taxes                                                      13                 13
                                                                    ---------          --------- 
Shareholders' equity:                                                                
   Preferred stock, $0.01 par value; 5,000,000 shares authorized;                    
      none issued and outstanding                                        --                 --
   Common stock, $0.01 par value; 40,000,000 shares authorized;                      
      29,090,000 and 28,695,000 shares issued and outstanding             291                287
   Additional paid-in capital                                         122,564            120,092
   Deferred compensation related to stock options                        (188)              (250)
   Cumulative translation adjustment                                      (27)               (63)
   Accumulated deficit                                                (42,140)           (53,932)
                                                                    ---------          --------- 
            Total shareholders' equity                                 80,500             66,134
                                                                    ---------          --------- 
                                                                    $  97,992          $  76,555
                                                                    =========          =========
<FN>

           See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
                                       1

<PAGE>
<TABLE>

CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<CAPTION>
                                                                   Three Months Ended             Nine Months Ended
                                                               ----------------------------  --------------------------  
                                                               September 27,  September 26,  September 27, September 26, 
                                                                   1998           1997            1998        1997       
                                                               ------------   -------------  ------------- ------------- 
<S>                                                             <C>             <C>             <C>         <C>          
Revenue                                                         $ 12,130        $ 13,129        $ 32,555    $ 34,065     
Cost of revenue                                                    5,924           3,826          12,545      10,021     
                                                                --------        --------        --------    --------     
Gross profit                                                       6,206           9,303          20,010      24,044     
                                                                --------        --------        --------    --------     
Operating expenses:                                                                                                      
   Research and development, net                                   6,222           3,394          12,037       9,365     
   Selling and marketing                                           6,170           4,006          17,950      10,720     
   General and administrative                                      2,452           2,268           5,782       6,291     
   Amortization of purchased intangibles                             679             133           2,038         133     
   Purchased in-process technology                                  --            63,920            --        63,920     
                                                                --------        --------        --------    --------     
            Total operating expenses                              15,523          73,721          37,807      90,429     
                                                                --------        --------        --------    --------     
                                                                                                                         
Loss from operations                                              (9,317)        (64,418)        (17,797)    (66,385)    
                                                                                                                         
Other income:                                                                                                            
   Interest income, net                                              542             663           1,381       2,479     
   Royalty and other income (expense), net                            32              76             (83)        402     
                                                                --------        --------        --------    --------     
                                                                                                                         
Loss from continuing operations before income taxes               (8,743)        (63,679)        (16,499)    (63,504)    
Benefit for income taxes                                           3,060            --             5,774        --       
                                                                --------        --------        --------    --------     
Loss from continuing operations                                   (5,683)        (63,679)        (10,725)    (63,504)    
Income (loss) from discontinued operations, net of                                                                       
   income tax expense (benefit) of $335, $(139) and $1,333,
   as restated (Note 1)                                             --               796            (259)      2,951     
Gain on disposal of discontinued operations,                                                                             
   net of income tax expense of $12,358, as restated (Note 1)       --              --            22,776        --       
                                                                --------        --------        --------    --------     
Net income (loss)                                               $ (5,683)       $(62,883)       $ 11,792    $(60,553)    
                                                                ========        ========        ========    ========     
                                                                                                                         
Earnings (loss) per share - basic:                                                                                       
   Continuing operations                                        $  (0.20)       $  (2.40)       $  (0.37)   $  (2.44)    
   Discontinued operations, as restated (Note 1)                    --              0.03            0.78        0.12     
                                                                --------        --------        --------    --------     
   Net income (loss)                                            $  (0.20)       $  (2.37)       $   0.41    $  (2.32)    
                                                                ========        ========        ========    ========     
                                                                                                                         
Earnings (loss) per share - diluted:                                                                                     
   Continuing operations                                        $  (0.20)       $  (2.40)       $  (0.37)   $  (2.44)    
   Discontinued operations, as restated (Note 1)                    --              0.03            0.78        0.12     
                                                                --------        --------        --------    --------     
   Net income (loss)                                            $  (0.20)       $  (2.37)       $   0.41    $  (2.32)    
                                                                ========        ========        ========    ========     
                                                                                                                         
Shares used in per share calculation - basic                      29,082          26,514          28,971      26,046     
                                                                ========        ========        ========    ========     
                                                                                                                         
Shares used in per share calculation - diluted                    29,082          26,514          28,971      26,046     
                                                                ========        ========        ========    ========     
                                                                                                                         
<FN>

                       See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
                                       2
<PAGE>
<TABLE>

CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<CAPTION>

                                                                                           Nine Months Ended
                                                                                   -------------------------------
                                                                                   September 27,     September 26,
                                                                                       1998               1997
                                                                                   -------------     -------------  
<S>                                                                                  <C>                <C>       
Cash flows from operating activities:
   Loss from continuing operations                                                   $(10,725)          $(63,504) 
   Adjustments to reconcile loss to net                                                                 
      cash used in continuing operations:                                                               
         Write-off of investment in unaffiliated company                                3,000           
         Purchased in-process technology                                                 --               63,920
         Depreciation and amortization                                                  3,695              1,513
         Deferred compensation related to stock options                                    62                 62
         Deferred income taxes                                                            (96)              --
         Changes in assets and liabilities:                                                             
            Accounts receivable                                                           431             (4,412)
            Inventories                                                                (3,602)              (287)
            Other assets                                                                  472               (921)
            Accounts payable                                                              925             (1,165)
            Accrued liabilities                                                       (10,971)             1,611
            Deferred revenue                                                            1,172                 (8)
                                                                                     --------           --------  
            Net cash used in continuing operations                                    (15,637)            (3,191)
            Net cash used in discontinued operations                                   (7,173)              (762)
                                                                                     --------           --------  
               Net cash used in operating activities                                  (22,810)            (3,953)
                                                                                     --------           --------  
                                                                                                        
Cash flows from investing activities:                                                                   
   Acquisition of property and equipment                                               (2,157)            (2,803)
   Loans to employees in exchange for notes receivable                                 (2,289)            (3,473)
   Purchase of Algorithmic Research, net of cash acquired                                --              (44,350)
   Proceeds from sale of discontinued operations                                       54,879               --
   Acquisition of preferred stock of unaffiliated company                              (3,000)              --
                                                                                     --------           --------  
               Net cash provided by (used in) investing activities                     47,433            (50,626)
                                                                                     --------           --------  
                                                                                                        
Cash flows from financing activities:                                                                   
   Proceeds from issuance of common stock, net                                          1,751                731
   Payment of notes receivable from shareholders                                         --                  301
   Repayment of capital lease obligations and long-term debt                             (146)              (109)
                                                                                     --------           --------  
               Net cash provided by financing activities                                1,605                923
                                                                                     --------           --------  
Effect of exchange rate changes on cash and cash equivalents                               36               (104)
                                                                                     --------           --------  
Net increase (decrease) in cash and cash equivalents                                   26,264            (53,760)
Cash and cash equivalents at beginning of period                                       22,977             78,849
                                                                                     --------           --------  
Cash and cash equivalents at end of period                                           $ 49,241           $ 25,089
                                                                                     ========           ========
                                                                                                        
Supplemental disclosures:                                                                               
   Cash paid for income taxes                                                        $  8,215           $     31
   Cash paid for interest                                                                  55                 78
   Equity issued and liabilities incurred for                                                           
     purchase of Algorithmic Research                                                    --               30,056
   Note Receivable from disposition of Wireless Group, as restated (Note 1)            12,424               --
                                                                                                        
<FN>

                       See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
                                       3
<PAGE>


CYLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


1.   Basis of Presentation

         The unaudited  condensed  consolidated  financial  statements  included
     herein  contain  all  adjustments,  consisting  only  of  normal  recurring
     adjustments  which,  in the opinion of management,  are necessary to fairly
     state the consolidated  financial position,  results of operations and cash
     flows of Cylink  Corporation  ("Cylink" or the  "Company")  for the periods
     presented.  These financial  statements  should be read in conjunction with
     the Company's audited financial statements included in the Company's Annual
     Report on Form 10-K for the year ended December 31, 1997.  Interim  results
     of operations are not necessarily  indicative of the results to be expected
     for the full year.

         Beginning  in 1998,  the  Company's  interim  quarters  end on the last
     Sunday  preceding  the calendar  quarter  end.  Previously,  the  Company's
     interim  quarters ended on the last Friday  preceding the calendar  quarter
     end.

         On November 5, 1998,  the Company  publicly  announced  that it and its
     independent  accountants  had  initiated  a review of  revenue  recognition
     practices  which would result in a restatement  of previously  issued first
     and second  quarter 1998  results and that all three  quarters of 1998 were
     expected to show substantial operating losses.  During the review,  certain
     facts became known  indicating  errors had been made in the  application of
     revenue  recognition  policies  which also  impacted the fourth  quarter of
     1997, and as a result, 1997 full-year results have been restated along with
     first  and  second  quarter  1998  results.  These  restated  results  were
     announced in a press release dated December 16, 1998. The Company will file
     an amended  Form 10-K for 1997,  and  amended  Forms 10-Q for the first and
     second quarters 1998.

2.   Discontinued Operations

         On March 28, 1998, the Company sold its Wireless  Communications  Group
     ("Wireless") to P-Com, Inc. for an originally reported $60.5 million ($46.0
     million  in cash and an  unsecured  promissory  note in the amount of $14.5
     million due 100 days after closing,  subject to closing adjustments).  As a
     result,  the  operations of Wireless have been  classified as  discontinued
     operations in the accompanying  Condensed Consolidated Financial Statements
     and related Notes.  Accrued  expenses in the amount of  approximately  $6.8
     million, primarily for professional services, anticipated excess facilities
     expenses,  and certain other  transaction  related accruals were charged to
     discontinued  operations and reduced the gain on disposal.  Pursuant to the
     restatement  referred to in Note 1, certain revenues of Wireless previously
     recognized in the fourth quarter of 1997 and the first quarter of 1998 were
     adjusted.  Based on the net assets of Wireless as of March 28, 1998,  after
     restatement, the sales proceeds would have been approximately $58.4 million
     resulting in a note receivable of approximately  $12.4 million. On July 14,
     1998,  P-Com made a partial  payment of $9.7 million on its promissory note
     and is  disputing  the  remaining  balance  of the note and  certain  other
     amounts the Company believes are receivable from P-Com. See Part II, Item 1
     "Legal Proceedings."  Wireless revenues were $7.4 million and $20.9 million
     in the third quarter and first nine months of 1997, respectively,  and were
     $4.0 million in 1998 through the date of disposal.

3.   Notes Receivable From Employees

         Pursuant to their employment  agreements and related  promissory notes,
     through  September 27, 1998, the Company had loaned certain  employees $5.8
     million towards the purchase of their principal residences. Of this amount,
     $5.2  million  was  receivable  from  officers  or former  officers  of the
     Company.  The notes are generally interest free and 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.  Subsequent to September 27, 1998,  certain loan agreements were
     amended  and the  Company  applied  certain  accrued  compensation  amounts
     against $1.6 million of the  outstanding  loan balance.  Maturity dates for

                                       4
<PAGE>

     the remaining notes receivable, all of which are due from current or former
     officers of the Company, are as follows: $1.0 million in 1999, $1.0 million
     in 2002, $1.4 million in 2003, and $0.8 million thereafter.

4.   Inventories
                                                 September 27,   December 31,  
                                                    1998            1997       
                                                  -------         -------
                                                       (in thousands)          
         Raw materials                            $ 3,115         $ 2,191
         Work in process and subassemblies          2,213           1,858      
         Finished goods                             4,498           2,175      
                                                  -------         -------      
                                                  $ 9,826         $ 6,224      
                                                  =======         =======      
 

<TABLE>

5.   Earnings Per Share
<CAPTION>
                                                            Three Months Ended             Nine Months Ended
                                                        ---------------------------   ---------------------------
                                                        September 27, September 26,   September 27, September 26,    
                                                            1998           1997           1998           1997        
                                                        ------------- -------------   ------------- -------------
                                                                             (in thousands)
<S>                                                       <C>            <C>            <C>            <C>   
Shares used to compute basic earnings per share
  (weighted average number of common shares
  outstanding during the period)                          29,082         26,514         28,971         26,046
Incremental common shares attributable to assumed
  exercise of dilutive stock options                         -              -              -              -
                                                          ------         ------         ------         ------
Shares used to compute diluted earnings per share         29,082         26,514         28,971         26,046
                                                          ======         ======         ======         ======

Antidilutive stock options                                 5,735          5,325          4,321          4,077
                                                          ======         ======         ======         ======
</TABLE>

         All  options  to  purchase  common  stock have been  excluded  from the
     computation of diluted  earnings per share as their effect is  antidilutive
     on the loss from continuing operations.

         On December 11 and 14, 1998, the Company  canceled  options to purchase
     2.6 million shares of common stock with exercise  prices ranging from $4.19
     to $23.50 previously granted to employees and certain current officers, and
     reissued all such  options at $4.25 to $4.63,  the fair market value of the
     stock on the dates of reissuance. The reissued options have a six-year term
     and vest over three years from the date of issuance.

6.   Recent Accounting Pronouncements
<TABLE>

         Effective  January 1, 1998, the Company adopted  Statement of Financial
     Accounting  Standards  No.  130,  "Reporting  Comprehensive  Income."  This
     Statement establishes standards for reporting  comprehensive income and its
     components in an annual 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.
     Annual  financial  statements  for prior periods will be  reclassified,  as
     required. The Company's total comprehensive income was as follows:

<CAPTION>
                                              Three Months Ended            Nine Months Ended
                                        ----------------------------  ----------------------------
                                        September 27,  September 26,  September 27,  September 26,
                                           1998           1997           1998           1997
                                        -------------  -------------  -------------  -------------
                                                             (in thousands)
<S>                                      <C>            <C>             <C>           <C>       
   Net income (loss)                     $ (5,683)      $ (62,883)      $ 11,792      $ (60,553)
   Other comprehensive income (loss)           35             (58)            36           (104)
                                         --------       ---------       --------      --------- 
   Total comprehensive income (loss)     $ (5,648)      $ (62,941)      $ 11,828      $ (60,657)
                                         ========       =========       ========      ========= 
</TABLE>
                                       5
<PAGE>


         In June  1997,  the  FASB  issued  Statement  of  Financial  Accounting
     Standards No. 131, "Disclosures about Segments of an Enterprise and Related
     Information" ("FAS 131"). 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 FAS 131 are  effective  for  1998,  and are not
     required   for  interim   periods.   The  Company   does  not  expect  this
     pronouncement to have a material impact on its financial statements.






                                       6

<PAGE>


Item 2.  Management's Discussion and Analysis of Financial Condition and
         Results of Operations


         The  statements  contained  in this  Report  on Form  10-Q 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,  and  include  statements  regarding  Cylink's  expectations,   hopes,
intentions,   beliefs  or  strategies  regarding  the  future.   Forward-looking
statements  include:  the Company's  statements in Part I, Item 2  "Management's
Discussion  and  Analysis of  Financial  Condition  and  Results of  Operations"
regarding  the  sufficiency  of the  Company's  existing  liquidity  and capital
resources,  the  Company's  expectation  that it will  introduce a number of new
products  in 1998 and 1999 and  continue  to make a  significant  investment  in
engineering, research and development, its intention to expand its foreign sales
channels and enter additional international markets, and the Company's intention
to  protect  itself  from  liability  arising  out of "year  2000  errors."  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-Q,  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 "Risk  Factors  That May Affect  Future
Results" and other sections of this Report on Form 10-Q. You should also consult
the risk factors listed from time to time in the Company's Reports on Form 10-Q,
8-K, 10-K and Annual Reports to the Shareholders.

RECENT EVENTS

         As  publicly  announced  on  November  5,  1998,  the  Company  and its
independent  accountants,  together with legal counsel, on that date initiated a
review of the  Company's  revenue  recognition  practices.  During  the  review,
certain facts became known indicating errors had been made in the application of
revenue  recognition  policies  in  various  prior  periods.  The  Company  also
announced  that all three  quarters of 1998 were  expected  to show  substantial
losses from continuing  operations.  On December 16, 1998, the Company  released
restated  financial  results for the fourth  quarter and year ended December 31,
1997 and first  and  second  quarters  of 1998  which  resulted  in the  Company
recognizing  substantial losses from continuing  operations in the 1998 periods.
Additionally,  a substantial loss from continuing operations is expected for the
fourth quarter of 1998 and the year ended December 31, 1998.

DISCONTINUED OPERATIONS

         Pursuant  to an asset  purchase  agreement  dated March 27,  1998,  the
Company sold its Wireless business for approximately $46.0 million in cash and a
$12.4 million  unsecured note receivable due 100 days after closing,  subject to
closing  adjustments.  The sale  resulted in an after tax gain of  approximately
$22.8  million.  See  Note  2  of  Notes  to  Condensed  Consolidated  Financial
Statements  and Part II, Item 1 "Legal  Proceedings."  Except where  noted,  the
following comments are associated with the continuing network security business.

BUSINESS ACQUISITION

         On September 8, 1997, the Company acquired Algorithmic  Research,  Ltd.
("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.  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  amounting to approximately $.7 million
per quarter  subsequent  to the third  quarter of 1997 and the charge  resulting
from  in-process  technology  are not  deductible  for income 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.

                                       7

<PAGE>

RESULTS OF OPERATIONS

         Revenue.  The Company's  revenue is derived primarily from sales of its
family of commercial network security products. Fees for maintenance and support
services are charged  separately.  Revenue from product sales is recognized upon
shipment to the customer.  Concurrently, a provision is made for estimated costs
to repair or replace products under warranty arrangements. Revenue from sales to
distributors  is  recognized  upon  shipment  when no right of  return  or price
protection  is given.  A provision  is recorded for any  estimated  reduction in
gross profit due to limited  stock  rotation  privileges.  Revenue from sales to
value added resellers is recognized  upon shipment and  concurrently a provision
for  estimated  returns is recorded.  In connection  with the  Company's  recent
restatement of financial results,  the Company undertook a review of its revenue
recognition  practices to ensure that they are in  accordance  with the policies
described above. See "Recent Events" above.

         The Company's  revenue decreased by 8% from $13.1 million for the three
months  ended  September  26, 1997 to $12.1  million for the three  months ended
September  27, 1998,  and decreased by 4% from $34.1 million for the nine months
ended  September 26, 1997 to $32.6  million for the nine months ended  September
27, 1998. The decrease is  attributable to decreases in both the average selling
prices and unit shipments of existing products.

         Gross Profit.  Gross profit  decreased by 33% from $9.3 million for the
three months ended September 26, 1997 to $6.2 million for the three months ended
September 27, 1998,  and decreased by 17% from $24.0 million for the nine months
ended  September 26, 1997 to $20.0  million for the nine months ended  September
27, 1998. As a percentage of revenue, gross profit was 71% and 51% for the third
quarter  of 1997 and  1998,  respectively,  and 71% and 61% for the  first  nine
months of 1997 and 1998,  respectively.  The  decrease  in gross  margin for the
third  quarter and first nine  months of 1998  compared  with the  corresponding
periods in 1997 was  primarily  due to an increased  percentage of revenues from
lower margin  products,  particularly  those  products  that are provided by OEM
suppliers,  and to an  overall  decrease  in  average  selling  prices for other
product lines. Additionally,  in the third quarter of 1998, the Company recorded
a charge to cost of revenue of approximately  $1.1 million  primarily related to
excess and obsolete inventory and to the write off of certain prepaid royalties.

         Research and  Development.  Research and development  expenses  consist
primarily of salaries and other  personnel  related  expenses,  depreciation  of
development  equipment,   facilities  and  supplies.  Research  and  development
expenses  for the third  quarter  of 1998  included  a  one-time  charge of $3.0
million  related to the write off of an investment in an  unaffiliated  company.
Excluding  this  one-time  charge,   gross  research  and  development  expenses
increased 12% from $3.4 million for the three months ended September 26, 1997 to
$3.8 million for the three months ended  September  27, 1998,  and  decreased 4%
from $10.5 million for the nine months ended September 26, 1997 to $10.0 million
for the nine months ended  September 27, 1998.  Excluding  the one-time  charge,
gross research and development  expenses as a percentage of revenue were 26% and
31% for the third quarter of 1997 and 1998,  respectively,  and were 31% for the
first  nine  months  of both 1997 and 1998  respectively.  From time to time the
Company  receives  engineering  funding for  development of projects to apply or
enhance the Company's  technology to a particular  customer's  need. The amounts
recognized  under these  research and  development  contracts are offset against
research and development  expenses.  The amounts recognized under  non-recurring
engineering  contracts  totaled $0.6 million for the third quarter of 1998,  and
$1.1  million  and $1.0  million  for the  first  nine  months of 1997 and 1998,
respectively.  No engineering funding was recognized during the third quarter of
1997.

         Selling and Marketing. Selling and marketing expenses consist primarily
of  personnel   expenses,   including  sales   commissions,   and  expenses  for
advertising,  public relations,  seminars and trade shows. Selling and marketing
expenses  increased  54% from $4.0 million for the three months ended  September
26, 1997 to $6.2  million for the three  months ended  September  27, 1998,  and
increased 67% from $10.7 million for the nine months ended September 26, 1997 to
$18.0  million  for the nine  months  ended  September  27,  1998.  Selling  and
marketing  expenses as a  percentage  of revenue  were 31% and 51% for the third
quarter  of 1997 and  1998,  respectively,  and 31% and 55% for the  first  nine
months of 1997 and 1998, respectively.  Selling and marketing expenses increased
from the third  quarter and first nine months of 1997  primarily  to support the
launch of new or enhanced products, as well as due to continued expansion of the
Company's  direct  field   operations,   product  line   management,   marketing
development  and  international  operations.  Additionally,  sales and marketing
expenses increased due to integration expenses resulting from the acquisition of
ARL in September 1997.

         General and Administrative. General and administrative expenses consist
primarily of personnel  and related  costs,  recruitment  expenses,  information
systems costs, and audit, legal and other professional service fees. General and
administrative  expenses  increased  8% from $2.3  million for the three  months
ended  September  26, 1997 to $2.5 million for the three months ended  September
27, 1998, and decreased 8% from $6.3 million for the nine months ended September
26, 1997

                                       8
<PAGE>

to $5.8  million for the nine  months  ended  September  27,  1998.  General and
administrative  expenses  as a  percentage  of revenue  were 17% and 20% for the
third  quarter of 1997 and 1998,  respectively,  and were 18% for the first nine
months of both 1997 and 1998, respectively.

         As a result of the  aforementioned  restatement  of financial  results,
during the fourth quarter of 1998 the Company has incurred  substantial fees for
professional   services.   Additionally,   the  Company  has  reached  severance
agreements  with several  former  officers.  Total fourth quarter pretax charges
related to these matters may approach $4 million.

         Other  Income.  Other income  consists  primarily  of interest  income.
Interest income,  net, decreased from $0.7 million for the third quarter of 1997
to $0.5 million for the third quarter of 1998,  and decreased  from $2.5 million
for the first nine months of 1997 to $1.4 million for the  comparable  period in
1998. The decrease was  principally due to the decrease in average cash and cash
equivalents  resulting  from cash used in investing  activities  and for working
capital requirements.

LIQUIDITY AND CAPITAL RESOURCES

         At September  27, 1998,  the Company had cash and cash  equivalents  of
$49.2  million,   working  capital  of  $62.8  million  and  minimal   long-term
obligations.  For the nine months ended September 27, 1998, the Company recorded
net income of $11.8  million,  largely due to the $22.8  million net gain on the
sale of Wireless.  Net cash used in continuing operating activities for the nine
months of 1998 of $15.6 million  resulted  primarily from losses from continuing
operations,  increased  inventories and estimated income tax payments related to
the gain on sale of Wireless.

         Cash  provided  by  investing  activities  for the  nine  months  ended
September 27, 1998 was $47.4 million, of which $54.9 million was attributable to
the sale of Wireless. The funds attributable to the Wireless sale were partially
offset by  expenditures  for property and equipment of $2.2  million,  long-term
loans  to  employees  of $2.3  million,  and a $3.0  million  investment  in the
preferred stock in an unaffiliated company.

         See Part II, Item 1 "Legal  Proceedings."  The Company  believes it has
meritorious  defenses to these actions and intends to defend itself  vigorously.
However,  it is not feasible to predict or determine  the final outcome of these
proceedings,  and if the outcome were to be unfavorable, the Company's business,
financial  condition  and results of operations  could be  materially  adversely
affected.

         See comments regarding year 2000 readiness under "Risk Factors That May
Affect Future Results."

         The Company  believes that  existing  cash balances and cash  generated
from  operations,  if any,  will be sufficient  to fund  necessary  purchases of
capital  equipment and to provide  working capital  through 1999.  However,  the
Company may require additional funds to support its working capital requirements
or for other purposes and may seek to raise such additional funds through public
or private  equity  financing or from other  sources.  No assurance can be given
that  additional  financing will be available or that, if available,  will be on
terms favorable to the Company or its shareholders.


RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

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

         The Company incurred  substantial losses from continuing  operations in
1994,  1995,  1996,  1997 and the first  nine  months  of 1998.  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 have been and continue to be affected by
a number  of  factors,  many of which  are  outside  of the  Company's  control,
including:  the timing of the  introduction  of new or enhanced  products by the
Company or its  competitors;  market  acceptance of new products of the Company,
its customers and its competitors; the timing, cancellation or delay of customer
orders,   including  cancellation  or  delay  in  anticipation  of  new  product
introduction   or  enhancement  or  resulting   from   uncertainty   related  to

                                       9
<PAGE>

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 introduced a number
of new  products  in 1998 and expects to  introduce a number of new  products in
1999. 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

         The Company's  business,  results of operations and financial condition
could  be  adversely  impacted  by any of a  number  of  pending  or  threatened
litigation matters. See Part II, Item 1. "Legal Proceedings."

Dependence on Key Personnel

         On  November 4, 1998,  the  Company  accepted  the  resignation  of Mr.
Fernand B. Sarrat as a Director,  President and Chief Executive  Officer,  along
with the  resignation of Mr. John Daws,  Chief  Financial  Officer,  and Mr. Tom
Butler, Vice President of Sales. On November 4, Mr. William C. Crowell, formerly
Vice  President  of  Product  Strategy,  was  promoted  to  President  and Chief
Executive Officer,  and on November 16, Mr. Roger A. Barnes became the Company's
Chief  Financial  Officer.  The  Company's  future  success  will  depend on the
abilities of Mr. Crowell and the contributions by its other executive  officers,
key management and technical personnel.  The loss of the services of one or more
of the  Company's  executive  officers or key  personnel,  or the  inability  to
continue  to  attract  and  retain  qualified  personnel,  could  delay  product
development  cycles or otherwise have a material adverse effect on the Company's
business and  operating  results.  Retention and  attraction  of such  qualified
personnel may become even more difficult for the Company following the Company's
recent restatement of its financial statements and recently determined losses.

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 are highly unpredictable and can fluctuate substantially. If revenue falls
significantly  below  anticipated  levels,  as it has in times in the past,  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, as they did during the first nine months of 1998. As a result,
on September  14, 1998,  the Company  announced  that its earnings for the third
quarter of 1998 would be below consensus  estimates.  It is possible that in the
future the Company's  operating  results will again be below the expectations of
securities  analysts  and  investors.  In such an event,  or in the  event  that
adverse conditions prevail or are perceived to prevail generally or with respect
to the Company's business,  the price of the Company's Common Stock would likely
be materially adversely affected.

Dependence on Recently Introduced and New Information Security Products

         The Company's  future results of operations will be highly dependent on
the successful completion of the design,  development,  introduction,  marketing
and manufacture of the PrivateWire  and PrivaCy  Manager  products,  portions of
which  are  under  development,   and  Link  Encryptors  NRZ,   SecureFrame  and
PrivateWire 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

                                       10
<PAGE>

acceptance.  If such new and  recently  introduced  products  have  performance,
reliability,  quality or other  shortcomings,  then such products  could fail to
achieve market acceptance. The failure by the Company's new or existing products
to achieve or enjoy market acceptance, whether for these or other reasons, could
cause the Company to experience  reduced  orders,  higher  manufacturing  costs,
delays in collecting  accounts  receivable and  additional  warranty and service
expenses,  which in each  case  could  have a  material  adverse  effect  on the
Company's business, 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,  name  recognition  and
perception of Company  stability and long term viability.  Many of these factors
are beyond  the  Company's  control.  In  addition,  some  factors,  such as the
perception of the Company's  stability and viability over the long term may have
been adversely affected by the recent  restatement of the Company's  financials,
which could materially adversely impact the Company's ability to compete.

         The  Company's   competitors  in  the  information   security  markets,
including  companies that offer products  similar to or as an alternative to the
Company's  products,  include  Axent  Technologies,  Inc.,  Checkpoint  Software
Technologies,  Ltd.,  Network  Associates,  Inc.,  SecureComputing  Corporation,
Security  Dynamics  Technologies,  Inc.,  Racal-Guardata,  Inc., and Information
Resource Engineering, Inc. In addition, Northern Telecom Limited, AT&T, Motorola
Corporation,  and Sun  Microsystems,  Inc.  offer certain  information  security
products as part of their overall networking solutions.  A number of significant
vendors,  including Microsoft Corporation,  Netscape Communications  Corporation
and Cisco Systems,  Inc., have embedded security solutions in their software. To
the extent that these embedded or optional security  capabilities provide all or
a portion of the functionality provided by 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 from (and incompatible with)
the method of implementing public key cryptography currently used by the Company
in most of its products.  Although Cylink has a license to use all of the public
key methods promoted by Certicom and RSA DSI, to the extent significant segments
of the network  security market adopt technical  standards  different from 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 result in price  reductions,  loss of market share or otherwise  have a
material  adverse  effect on 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, financial condition and results of operations.

         In addition,  a  well-publicized  actual or perceived  security  breach
could adversely affect the market's  perception of security products in general,
or 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 business, financial condition and results of operations.

                                       11
<PAGE>

Year 2000

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

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

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

         The Company has defined  "Year 2000  Compliant"  as the ability to: (i)
correctly handle date information needed for the December 31, 1999 to January 1,
2000 date change; (ii) function according to the product documentation  provided
for this date change,  without changes in operation resulting from the advent of
a new century, assuming correct configuration;  (iii) where appropriate, respond
to two-digit  date input in a way that resolves the ambiguity as to century in a
disclosed,  defined,  and  predetermined  manner,  such as in certificate  based
products, or in accordance with the Company's Year 2000 Compliant test plan; and
(iv) recognize year 2000 as a leap year. The Company has not tested its products
on all platforms or all versions of operating systems that it currently supports
and has  advised its  customers  to verify that their  platforms  and  operating
systems support the transition to the year 2000.

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

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

         Some commentators have predicted significant  litigation regarding Year
2000 compliance issues.  Because of the unprecedented nature of such litigation,
it is uncertain whether or to what extent the Company may be affected by it.

         The Company has initiated a review of its material internal information
systems  (including  the  third-party  software for its  management  information
systems, networks and desktop applications,  and its hardware telecommunications
technology).  The Company  expects to complete  that review by mid 1999.  To the
extent  that  the  Company  is not  able  to test  the  technology  provided  by
third-party  vendors, the Company is purchasing upgrades for versions which have
been  certified  by their  vendors as  compliant.  Although  the  Company is not
currently  aware of any material  operational  issues or costs  associated  with
preparing its internal  information  systems for the Year 2000,  the Company may
experience material unanticipated problems and costs caused by undetected errors
or defects in the technology used in its information systems.

                                       12
<PAGE>

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

         The Company has funded its Year 2000 plan from  operating  cash.  While
the Company  does not expect such costs to be  material,  the Company will incur
additional amounts related to the Year 2000 plan for administrative personnel to
manage  the  Company's  readiness  plans,  technical  support  for  its  product
engineering  and  customer  satisfaction.  The Company may  experience  material
problems and costs with Year 2000  compliance  that could  adversely  affect the
Company's business, results of operations, and financial condition.

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

Management of Growth And Reduction In Employees

         The Company has  recently and may  continue to  experience  substantial
fluctuations  in the number of employees and the scope of its  operations in the
network  security  business,   resulting  in  increased   responsibilities   for
management.  To  manage  its  business  effectively,  the  Company  will need to
continue  to improve  its  operational,  financial  and  management  information
systems and to hire,  train,  motivate and manage its employees.  Competition is
intense  for   qualified   technical,   marketing  and   management   personnel,
particularly highly skilled engineers.  In particular,  the current availability
of qualified  engineers  is quite  limited,  and  competition  among  companies,
academic  institutions,  government entities and other organizations for skilled
and  experienced   engineering  personnel  is  very  intense.  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,   especially   given  the  recent
announcement  regarding the restatement of its financial  results and associated
issues.  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  business,  the Company has experienced a
significant  reduction  in  employees,  including  the  Company's  former  Chief
Technical Officer, Dr. Jim Omura. The sale of Wireless,  the uncertainty created
by the Company's recently announced  restatements of its financial results,  the
initiation of highly publicized class actions securities  litigation against the
Company,  and the 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.

         In September  1997, the Company  acquired  Algorithmic  Research,  Ltd.
("ARL") and assumed responsibility for management of its worldwide operations of
approximately sixty 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  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
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.  To date, the Company's  efforts to market ARL's products  through the
Company's  direct sales channel have not met the Company's  expectations  due to
differences  between the sales  expertise  required for selling the ARL products
and that required for the Company's  other products.  Consequently,  the Company
has  recently   reorganized   the   management  of  ARL  to   strengthen   ARL's

                                       13
<PAGE>

responsibility  for  marketing  and sales of its  products.  In addition,  ARL's
improvements  and  development  of new products  have been delayed by inadequate
coordination  between engineering  departments located in Sunnyvale,  CA and Tel
Aviv,  Israel.  This  inadequate  coordination  to  date  is  due  to  differing
engineering  practices concerning  development planning and restrictions imposed
by U.S. export control laws governing the transfer of  cryptographic  expertise.
The  Company  and  ARL's  successful   working   relationship  may  be  hindered
significantly  by  differences  between the two  organizations  created by time,
distance,  language and  culture.  ARL operates  from its  principal  offices in
Israel,  a country which is vulnerable to disruption due to the sudden  outbreak
of hostilities with its neighbors and various indigenous factions. Many of ARL's
employees have extensive  commitments  to the country's  military  organizations
which may require a loss of their  services on the Company's  behalf in times of
political instability.

Intellectual Property and Other Proprietary Rights

         The Company  relies on patents,  trademarks,  copyrights,  licenses and
trade secret law to establish and preserve its intellectual property rights. The
Company owns a number of U.S.  patents  covering  certain aspects of its network
security product designs,  and has additional U.S. patent applications  pending.
There can be no assurance that any patent, trademark, copyright or license owned
or held by 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; Market Acceptance Risks

         The  market  for  the  Company's  network  security  products  is  only
beginning  to  emerge.   This  market  is   characterized  by  rapidly  changing
technology,  emerging industry standards,  new product introductions and changes
in customer  requirements  and  preferences.  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. The
Company faces continuing  challenges to educate customers as to the value of its
security  products.  The Company  believes that many potential  customers do not
appreciate the need for high-end  security  products  unless and until they have
faced a major security breach. If the Company is unable to successfully  educate
potential  customers  as to the  value  of,  and  thereby  obtain  broad  market
acceptance for, its products,  it will continue to rely primarily on selling new
and  existing   products  to  its  base  of  existing   customers,   which  will
significantly  limit any  opportunity for growth.  In addition,  any significant

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<PAGE>

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 business, financial condition and results of operations.
See  "Competition."  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  continue  to  be
developed, or that, once developed, these networks will become viable commercial
marketplaces.

Rapid Technological Change

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

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,  export control laws, tariffs and other trade barriers,  political
and economic  instability  in foreign  markets,  difficulties  in the  staffing,
management and integration of foreign operations, longer payment cycles, greater
difficulty  in  collecting  accounts  receivable,   currency   fluctuations  and
potentially adverse tax consequences.  Since most of the Company's foreign sales
are  denominated  in U.S.  dollars,  the  Company's  products  become less price
competitive in countries in which local currencies  decline in value relative to
the U.S. dollar. The uncertainty of monetary exchange values has caused, and may
in the future cause, some foreign customers to delay new orders or delay payment
for existing  orders.  The long-term impact of such  devaluation,  including any
possible effect on the business outlook in other developing countries, cannot be
predicted.

         The Company's  ability to compete  successfully in foreign countries is
dependent  in part on the  Company's  ability to obtain and retain  reliable and
experienced  in-country  distributors and other strategic partners.  The Company
does not have long-term  relationships with any of its value added resellers and
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 and software,  including certain of the Company's network
security  products,  the Company is often 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 deliver its  products in a timely  manner 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.

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<PAGE>

PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings

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

         After  asserting  certain  deductions  arising under the contract dated
March 27, 1998, for the purchase of the Company's Wireless division,  P-Com made
a  partial  payment  on July 14,  1998,  in the  amount of $9.7  million  on its
promissory  note dated April 1, 1998.  The Company is presently  evaluating  the
merits of the balance of P-Com's deductions and, failing an amicable  resolution
of P-Com's  contentions,  the matter will proceed to  litigation.  See Note 2 of
Notes to Condensed Consolidated Financial Statements.

         On  September  3, 1998,  P-Com put the Company on notice  that  certain
shipments  in the fourth  quarter  of 1997 and the first  quarter of 1998 by the
Company's former Wireless  division and having an invoice value of approximately
$3.7 million had been seized by an agency of the United States Department of the
Treasury  and  that  P-Com  intends  to hold  the  Company  responsible  for the
consequences  of this event.  P-Com is currently  petitioning for release of the
goods. Based on the Company's investigation to date, the Company believes either
that  the  grounds  for the  seizure  are  unfounded  or that  P-Com  itself  is
responsible  for this action.  The Company has no reason at this time to believe
that it is the subject of any  official  investigation  and the Company has been
informed  that  P-Com is  presently  petitioning  for the  release of the seized
goods.  A failure by P-com to obtain  release of the shipment due to a violation
of law by the Company might adversely  affect the amount collected from P-Com on
its outstanding  obligations under the promissory note, including payment of any
relevant fines or penalties.

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

                                       16
<PAGE>

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

Item 5.   Other Information

         Any shareholder  proposal  submitted with respect to the Company's 1999
Annual  Meeting  of  Shareholders,  which  proposal  is  submitted  outside  the
requirements  of Rule 14a-8 under the Securities  Exchange Act of 1934,  will be
considered  untimely for  purposes of Rule 14a-4 and 14a-5 if notice  thereof is
received by the Company after March 9, 1999.

Item 6.   Exhibits and Reports on Form 8-K

(a)   Exhibits Index:

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

       27.1      Financial Data Schedule


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<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.


Date:  January 14, 1999                       CYLINK CORPORATION

                                              By:   /s/  ROGER A. BARNES   
                                                    -------------------------
                                                    Roger A. Barnes
                                                    Vice President of Finance
                                                    and Administration and
                                                    Chief Financial Officer
                                                    (Duly Authorized Officer and
                                                    Principal Financial  and
                                                    Accounting Officer)



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