Belcamp's SafeNet works on its `Street' credibility

Security firm faces SEC probe, accounting problems

May 31, 2006|By STACEY HIRSH | STACEY HIRSH,SUN REPORTER

SafeNet Inc. has seen its share of success.

From its start in a Timonium basement in the '80s by two engineers, the Belcamp network security firm has grown to 1,100 employees, 5,000 customers and a company that promotes itself as protecting more financial transactions and government secrets than any other in the world.

"The two things that the world cares about protecting are government secrets and money, and we protect more of [them] than anybody," said SafeNet's Chief Marketing Officer Ian Dix.

But the high-flying company hit snags recently that analysts say leave investors in a conundrum. SafeNet disappointed investors with its fourth-quarter profit in February and later restated earnings. Then the company outlined accounting problems in March. Last month, its chief financial officer left. And SafeNet could now be caught up in what may emerge as Wall Street's latest corporate scandal.

Just over a week ago, SafeNet said it received a federal subpoena for information about stock option awards as well as an informal inquiry from the Securities and Exchange Commission, which also is looking into the company's accounting problems. A day later, the stock price dropped more than 22 percent - it fell 40 cents yesterday to close at $15.83, and is down from its 52-week high of $38.33.

Analysts say the company has lost credibility on The Street and the inquiries could become a distraction. But many still believe in the long-term viability of SafeNet and its technology, leaving investors torn between the company's solid product portfolio and a federal probe that hangs over it. For its part, the company hopes to emerge from the turmoil by focusing on growing its business and restoring Wall Street's confidence by posting better financial results.

"From an investor perspective, the tough thing to swallow is when you keep thinking all the bad stuff is behind you, then all a sudden, this comes out," said Daniel Ives, a vice president and analyst for Friedman Billings Ramsey, who does not own shares of SafeNet. "And that's why a lot of investors have thrown in the white towel until this investigation comes to more of a resolution phase."

SafeNet makes a range of encryption technologies to protect communications and sensitive data for businesses and the government. The company sells information security hardware, software and chips, and secures information on a range of technologies from satellites to cell phones. SafeNet makes smartcards, for instance, that use both passwords and biometrics, such as fingerprints, to identify users.

SafeNet says its customers include Bank of America, Texas Instruments, the departments of Defense and Homeland Security, and the Internal Revenue Service.

Dix of SafeNet said the probe is "absolutely not a distraction." He would not comment on the inquiries because they are current legal matters. Dix said the company is cooperating with authorities.

"Of course, nobody wants to experience a 22 percent drop in a couple of days," Dix said. "But there isn't a company that's been public for five or six years for which that hasn't happened."

Despite its financial reporting problems, Dix said SafeNet has continued to generate cash. The company has $354 million in cash reserves. It generated nearly $14 million in cash last quarter, doubling from the corresponding quarter of 2005, he said.

"This is a good and healthy and profitable company that continues to sell and market its technology successfully," Dix said.

In an SEC filing in March, SafeNet said it had "identified one material weakness pertaining to insufficient staffing and technical expertise in the company's accounting and financial reporting functions." In April, SafeNet announced that Chief Financial Officer Ken Mueller had left the company, offering few details about his departure

Dix said the material weakness was a staffing and personnel issue, and that the company has hired two senior executives in revenue recognition and grown its accounting department.

Larry Crumbley, an accounting professor at Louisiana State University and editor of the Journal of Forensic Accounting, said a material weakness is a serious issue for any business and should be fixed. But he said it is not uncommon. More than 500 companies have been found to have material weaknesses as a result of the Sarbanes-Oxley law that makes companies more closely examine their internal controls.

If the weaknesses persist, however, it could give the indication that the company can't fix the trouble due to financial problems or incompetent executives, Crumbley said.

Accounting is just one piece of analysts' concern over SafeNet.

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