Cylink Sets Sights on Growth After Stumbling in 1998

Cylink Sets Sights on Growth After Stumbling in 1998

William Crowell, Cylink Corp.

By Richard McCaffery, Staff Writer

It's hard to fall much farther than Cylink Corp. did in 1998.

The Sunnyvale, Calif., maker of computer security products dropped a bomb on investors Dec. 16. Executives restated financial results for the first two quarters of 1998 as well as year-end results from 1997 because of errors in the way the company reported revenue.

"The company fell on hard times due to its own internal management flaws," said Roy Lobo, a research analyst at Moors & Cabot Dakin, a San Francisco division of Moors & Cabot Inc.

Over the past year Cylink's stock price has plunged from $17.50 to less than $5 a share. The stock hit a low of $2.93 last fall and is still hovering near bottom. It closed Dec. 31 at $3.62 a share.

The company now faces numerous shareholder lawsuits from parties alleging the company violated federal securities laws. Cylink first notified investors Nov. 5 that it was reviewing its revenue recognition practices. About $12 million in sales shouldn't have been reported as such, company officials said.

Lobo and other analysts said the company was stuffing the channel to inflate sales.

"Obviously, it's not a pleasant time for anybody to go through," William Crowell, Cylink's new president and chief executive officer, told Washington Technology. "The advantage we have is we're a strong company." Crowell is a former Cylink vice president who was named president and chief executive officer Nov. 4.

Crowell, who served as deputy director of the National Security Agency before joining Cylink, said the company has $50 million in cash and virtually no debt. "It's the bright side of what I inherited," said Crowell.

The financial problems stemmed from inadequate internal controls, said Crowell. "Clearly, it's an event any company in this alley wants to be sure it avoids," he said, adding that Cylink meticulously combed its books to ensure it was "absolutely correct in its restatement."

Roger Barnes, Cylink's new chief financial officer, stressed the $12 million that had to be wiped off the books does not represent cash, and thus does not affect the company's cash position. Most of the revenue that was recorded improperly was on the company's books in the form of accounts receivable ? money owed to the company, Barnes said.

Founded in 1983, Cylink specializes in encryption hardware and software. Encryption products, used to secure transmissions over networks such as the Internet, are an increasingly important niche within the fast-growing computer security market, analysts said. The Yankee Group, a market research firm in Boston, expects the worldwide security market to grow from $2.4 billion in 1998 to $6.7 billion in 2001.

Cylink always has had a strong focus on the federal government. About 30 percent of its revenue comes from federal customers, said Crowell, who expects government revenue to continue to grow as more agencies recognize the importance of security.

The government is an important customer, because many agencies tend to be early adopters of technology and, as a result, set the standards for product acceptance, said Crowell, whose company has a staff of 10 in Fairfax, Va.

Its customers include the Federal Reserve Board, Justice Department, the U.S. Postal Service, Defense Department, AT&T Corp., Boeing Co., Motorola Inc. and Caterpillar Inc.

Cylink competes with Check Point Software Technologies Ltd., Ramat Gan, Israel; Secure Computing Corp., San Jose, Calif.; and Security Dynamics Technologies Inc., Bedford, Mass.

In 1997, Cylink had revenue of $49.3 million and reported a net loss of $61.7 million, or $2.31 a share. Most of the losses were related to one-time charges for the purchase of Algorithmic Research Ltd., a privately held Israeli company Cylink paid $83 million for in 1997.

Overall, Cylink has had profitable quarters but not a profitable year since 1993, three years before it went public. Its revenue has creaked along, from $21 million in 1993 to $49 million in 1997.

"It's never been a barn burner in terms of growth rates," said Larry Dietz, director of Current Analysis Inc., an IT analysis firm in Sterling, Va. "It's a typical engineering-driven company." Dietz and other analysts said Cylink must develop some marketing savvy.

On the bright side, analysts said Cylink's products and customer base are so strong, the company is likely to muddle through.

"Cylink's technology and where they sit in the market are too important for them not to survive," said Matthew Kovar, senior analyst at the Yankee Group.

"Their products are good, and the company has always been sound," said Dietz.

Lobo, a financial analyst, was less optimistic. The burden is on management to right the ship, said Lobo, who has a hold rating on the stock.

"They continue to gain contracts and are moving forward. We certainly think they have good things going ... Now, the question is, can they come out with timely products and a good marketing strategy?"

In the last three months, Cylink has cleaned house. It has replaced much of its senior management team and has constructed a new set of checks and balances to prevent another financial nightmare. Crowell has traveled more than 25,000 miles in the last six weeks to speak with the company's 300 employees. He's met one on one with about one-third of his work force.

For the future, Crowell's strategy will be to focus the company on its core business and expand its number of encryption products. In March 1998, Cylink divested its wireless products group.

Analysts didn't downplay Cylink's financial straits, but said many of its customers don't care about the company's management difficulties so long as they support their products.

"I believe I could say their customer base is pretty conservative," Dietz said. "Their customer base isn't going to make any dramatic left or right turns."

Crowell declined to comment on Cylink's 1998 revenue or net income, citing a quarterly quiet period required by the Securities and Exchange Commission. He did say he is focused on growing the company.

"What we believe we're going to do in the near term is take all the actions we need to take to build a strong, growing business. We do not expect to turn a quick profit," he said. "We're building for the future."

Since September, Cylink has hired a new president and chief executive officer and a new chief financial officer, and the company is looking for a new vice president of marketing. The company recently split its sales and marketing division into separate units to promote its brand name.

"[Marketing] is an area we're really going to excel in," Crowell said. "I have very concrete plans for the company's marketing strategy."

In addition, the company has implemented safeguards to prevent a repeat of its financial debacle. New checks and balances include:

  • Double checking the customer's desired date of purchase to make sure orders aren't shipped in advance.

  • Having Cylink's financial division ensure that revenue isn't recognized in advance.

  • Making sure all recognized revenue has no sales condition attached to it, such as a right of return.

  • Requiring executives to make sure shipments include an end user's address.

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