SafeNet profits will be revised

September 19, 2006|By Stacey Hirsh | Stacey Hirsh,Sun reporter

SafeNet Inc., the Harford County technology company facing federal probes into its stock option grants, will have to restate up to six years of earnings because it understated expenses related to the grants, the company disclosed yesterday in filings with the Securities and Exchange Commission.

The company will have to revise financial statements from 2000 through March 31, 2006, because "certain option grants made between 2000 and 2005, including grants to directors, officers and employees, were or likely were accounted for using incorrect measurement dates under applicable accounting rules in effect at the time," according to an SEC filing.

The company would not say which quarters would have to be restated or how much the restatements would affect previously reported profits, noting its continuing internal investigation.

But the company's investigation could cost SafeNet $12 million this year, $7 million more than it had originally anticipated, the company disclosed in its filings. About $6 million of that cost will come in the third quarter, $3.5 million more than it had estimated.

SafeNet's third-quarter revenue guidance remains at $70 million to $74 million, and the company said the restatements would not affect its cash position or previously reported revenues.

"I think that's an indication that, just like the last quarter, we're staying focused on our business despite a lot of potential distractions," said Ian Dix, SafeNet's chief marketing officer.

SafeNet is one of dozens of publicly traded companies that have come under federal investigation for possibly backdating option awards.

Sharper Image said yesterday that an internal review of its stock option practices found it must restate financial results for one quarter each in 2005 and 2006 and for the three years that ended Jan. 31, 2006.

Backdating is the term for making option awards effective at a time that coincides with a dip in the stock price, not the actual award date when the share price is likely to be higher. The effect is to make the option potentially more valuable. Backdating by itself is not illegal, but not disclosing it may be, and backdating also could lead to a company overstating its profits.

In SafeNet's case, SEC documents show that on several occasions Chief Executive Officer Anthony A. Caputo was issued immediately exercisable grants of stock options at or near the bottom of short-term dips in the stock price or at yearly lows.

In October 2002, for instance, SafeNet granted Caputo 100,000 options when the stock was trading at $13.75. Within two months it was $29. On Feb. 27, 2003, Caputo received 100,000 options when the stock was $16.47, according to SEC documents. That was the lowest price of any trading day that year. By October, the stock had reached almost $43.

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

In May, SafeNet announced that it had been subpoenaed by the U.S. attorney's office for the Southern District of New York for information about stock option awards and received an informal inquiry from the SEC.

The company formed a special board committee to investigate, and the committee retained counsel and forensic accountants to help. In June, SafeNet named former SEC Commissioner J. Carter Beese Jr. to its board and appointed him to the committee.

In July, the company said that it had found improprieties that would force it to restate earnings for at least one quarter. Then, last month SafeNet disclosed that it received a letter from Nasdaq saying it could be delisted for failing to file a timely financial report for the quarter that ended June 30.

Dix said the company is hoping to wrap up its internal investigation next month. He said the accelerated pace of the investigation drove up its cost, and the price could be less than $12 million if some expenses are reimbursed by insurance. SafeNet reported total earnings of $12.4 million for 2003, 2004 and 2005 combined.

Shares of SafeNet closed yesterday at $18.39, down 40 cents or 2.13 percent, after trading higher much of the day.

While investors could see SafeNet's stock option probes as a risk, they are more focused on the company's fundamentals in the coming quarters, said Daniel Ives, a vice president and analyst for Friedman Billings Ramsey, who does not own shares of SafeNet.

"They've already come out and said, `look, there were incorrect dates.' I think to some extent a lot of investors have looked past these issues," Ives said. "Right now what investors are focused on with SafeNet is the fundamentals."

The stock price might have come through trading relatively unscathed because the news shows that SafeNet is progressing toward meeting an October deadline for filing its second-quarter financial report, said Sean Jackson, an analyst with Avondale Partners in Nashville, who doesn't own SafeNet shares.

Todd C. Weller, an analyst for Stifel Nicolaus in Baltimore who does not own shares of SafeNet, believes the October deadline helps explain why SafeNet is being more aggressive than some other companies in its investigation and restatements.

The latest developments, while somewhat expected, likely add to investors' frustration with SafeNet management, said Jackson, the Avondale Partners analyst.

But for SafeNet and others involved in stock option grant investigations, management's fate will likely come down to how much of the improper accounting is fraudulent and how much of it is sloppy administrative procedures, said Weller, the Stifel Nicolaus analyst.

stacey.hirsh@baltsun.com

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