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PDFLast month, CyberDefender disclosed plans to reverse a suspect accounting practice that – for a brief, but crucial, period – allowed the company to look like a profitable operation. Thanks to that accounting change, which improperly slashed CyberDefender’s advertising expenses, the company managed to report its first-ever pretax profit just months before securing a coveted listing on the Nasdaq exchange.
The stock remained strong, always commanding at least the $4 minimum bid required by Nasdaq, ahead of its mid-2010 move from the OTC Bulletin Board to the larger exchange. It fell below that $4 threshold less than three weeks later, however, and has largely traded below that price ever since. Down 2 cents on Wednesday, following a delisting threat from Nasdaq, the thinly traded stock currently fetches $3.29 a share.
The only analyst who covers CyberDefender, James Ragan of Crowell Weedon, still has a buy rating and an $8 price target on the company’s stock. His forecasts have so far proven wildly optimistic, however, and continue to bank on future profits – subject to massive dilution and dependant upon drastic improvements in the company’s shrinking margins and dismal renewal rates – that now seem hopelessly elusive to some. Far from objective, he also stands to benefit from his bullish call since he owns stock in the company himself.
In contrast, skeptics view CyberDefender as a dubious company that should have never escaped from the penny-stock arena at all. They portray CyberDefender’s computer-protection service as an outright scam, unable to compete with popular software sold by giant rivals McAfee (NYSE: MFE) and Symantec (Nasdaq: SYMC), and attribute the company’s eye-popping growth to sensational advertising – costing more than the revenue that it ultimately generates – rather than legitimate demand for its products.
Specifically, critics say, CyberDefender has achieved its rapid growth through high-pressure sales of computer-security services loudly criticized by many of its own customers. After overcharging consumers for those products, they say, CyberDefender has then further boosted its numbers with the help of a CFO – and the blessing of an audit committee and an outside auditing firm – tainted by lousy track records. (See details below.) Now under fire for its sensational TV advertisements and its aggressive accounting treatment for those high-priced ads, critics conclude, CyberDefender may never achieve profitability and in fact likely faces imminent disaster instead.
CyberDefender failed to answer questions for this story.
Far away from Wall Street, online critics – including professional computer repairmen – have raised serious questions about CyberDefender’s business model as well. After testing CyberDefender’s offerings themselves, outside computer technicians have regularly emerged with negative reviews of those products.
“It is not very effective, which is probably why it has never been submitted for certification,” one computer expert reported this May. “And it is certainly not a product that could remain on the market by word of mouth alone, with all the complaints. It is probably why they rely on sensational TV and radio ads to market their product …
“While CyberDefender is definitely not an outright fake security product,” he stated in a more generous conclusion than those reached by some, “I firmly have reason to believe it is surprisingly close to one.”
Early Glitches
Co-founded by current CEO Gary Guseinov, CyberDefender originally began operations as Network Dynamics seven years ago.
Less than a year after its launch, records show, Network Dynamics quickly came under fire by customers unhappy with its eBlocs and SpyBlocs software programs. By then, one consumer-watchdog website reported, the company had already generated negative feedback from two-thirds of the customers who posted online reviews of its products. In a nutshell, those customers claimed that they had been overcharged – with their credit cards billed multiple times – for software that failed to protect their computers and, in some cases, actually damaged their systems instead.
In 2005, the year after those complaints began to surface, Network Dynamics paid a meager $200,000 for its CyberDefender software – which became the core product for the company – and began operating under the CyberDefender name. The company went public on the OTC Bulletin Board a couple of years later, with its stock fetching around $1 a share, and aggressively set out to attract potential investors right after that.
Within six weeks of its August 2007 debut as a public company, corporate filings show, CyberDefender had already kicked things off by paying an obscure firm to begin “research coverage” of its business. By early 2008, records show, CyberDefender had followed up by hiring two investor relations firms – the first of many – to further publicize the company’s stock. Despite those efforts, however, CyberDefender’s stock largely remained stuck between $1 and $1.50 a share throughout that period.
Meanwhile, online critics had once again begun to generate their own – unwanted – publicity about the company. Those complaints, dating back to at least September of 2008, continued to surface as recently as last month.
“I own a computer service company in California, and I can attest that this software is definitely a SCAM!” one critic reported earlier this year. “We see dozens of computers on a weekly basis, and 100% of the PCs with CyberDefender installed need it removed.
“This virus installs approximately 11-18 different viruses and always reports finding at least 200-plus viruses,” he continued. “If you are using CyberDefender (and don’t work for them), spend some time on Google researching what others are saying.
“If out of 1,000 negative posts and a handful of positives, you don’t learn,” he concluded, “then as they say: ‘You get what you deserve.’”
Heavy Traffic
Thanks to its aggressive advertising campaign, corporate filings show, CyberDefender has managed to attract thousands of new customers – fueling a huge jump in sales – over the course of the past two years.
CyberDefender has paid a high price for that growth, however. For example, records show, CyberDefender saw its annual revenue climb by 120% to almost $5 million in 2008. However, those records reveal, the company also saw its advertising expenses skyrocket by more than 1,000% to $7.11 million – eclipsing the sum generated by actual sales – during that same period.
CyberDefender placed an even bigger bet on advertising the following year. In March of 2009, CyberDefender inked a deal with GR Match (GRM) – a division of direct marketing powerhouse Guthy Renker – to cover a massive TV advertising campaign financed by warrants for millions of shares of cheap company stock. That move, which later triggered CyberDefender’s ill-advised decision to “capitalize” most of its advertising expenses, marked a significant turning point for the company.
Since then, critics say, CyberDefender has successfully directed huge crowds of TV viewers to websites (such as DoubleMySpeed.com and MyCleanPC.com) that the company secretly controls. Once there, they say, customers are invited to run “free” scans of their computers that invariably identify hundreds of problems. Customers are then forced to pay for any so-called “repairs,” they say, and often wind up connected to call centers staffed with high-pressure sales agents that convince them to sign up for expensive “Live Tech” support services – a lower-margin business that now accounts for most of the company’s revenue – as well. Those customers will later see their credit cards automatically billed for renewed subscriptions, they add, even though many of them don’t want the service and report headaches when they try to secure refunds.
The Internet is crowded with horror stories – some involving tests of CyberDefender software on brand-new computers – that help back up those claims.
Unlike those customers, however, CyberDefender investors belong to a relatively quiet crowd that rarely posts messages in stock chat rooms and seems downright oblivious to risks associated with the company. When CyberDefender disclosed plans for a massive restatement last month, for example, the company’s stock barely reacted – actually rising a couple of cents on consistently weak volume – despite the obvious magnitude of that news. With the stock already down 30% since its well-timed move to the Nasdaq, critics insist, those investors better take a closer look at the company – particularly those in charge of its numbers -- before it’s too late.
Short Circuit
In early 2009, shortly before the launch of its aggressive advertising campaign, CyberDefender hired Kevin R. Harris – a recent executive at a struggling penny-stock company – as its CFO and soon placed him on its board as well. When announcing the appointment, CyberDefender portrayed Harris as an accomplished finance veteran who promised to be a good catch for the company.
“We found a CFO who can handle the growth that we have seen within these latest two years,” CyberDefender’s CEO stated at the time. “With Kevin on board, we are quickly becoming the company that I envisioned.”
Harris arrived at CyberDefender with a tarnished record, however. He had spent the past eight years working for Statmon Technologies (OTC: STCA.PK), corporate filings show, serving the last four as the company’s chief operating officer. When Harris officially took over as Statmon’s COO in April of 2004, records show, the company’s stock had just hit a record high of $1.45 a share. While the stock would match that peak a few years later, touching $1.46 in the spring of 2007, it lost serious ground after that time.
By the time that Harris resigned from Statmon on the first day of 2009, records show, the company’s stock had fallen to 34 cents a share. Statmon now fetches just 12 cents a share and, delisted by the OTC Bulletin Board after Harris’s departure, currently trades on the lowly Pink Sheets with a crowd of suspicious penny stocks.
CyberDefender hired Harris just one month after he left Statmon and, with no real audit committee, essentially gave him full control over the company’s finances. Only after the U.S. Securities and Exchange Commission began challenging its numbers earlier this year, in fact, did CyberDefender actually install an audit committee charged with governing the company’s accounting practices.
Boardroom Scan
Even then, however, CyberDefender failed to attract the sort of finance experts that normally install confidence. Take Howard Bain, for example, the chairman of CyberDefender’s audit committee. After leaving Arthur Andersen, the giant accounting firm destroyed by its approval of Enron’s fraudulent financial reports, Bain went on to serve as CFO of two different companies hit with class-action lawsuits for allegedly fleecing their investors.
Bain became the finance chief of Vicinity in January of 2000, helped take the company public the following month and then promptly resigned near the end of that year. When Portal Software hired Bain as its own CFO nine months later, the company credited him with “successfully managing (Vicinity’s) initial public offering.” Within days of that announcement, records show, Vicinity faced a class-action lawsuit for allegedly defrauding investors who participated in that IPO and continued to purchase the stock through a period that almost mirrored Bain’s brief 10-month tenure at the company.
At Portal, Bain would actually wind up as a named defendant in another class-action lawsuit. With Bain in charge of its finances, that lawsuit noted, Portal managed to post impressive results that allowed the company and its insiders to score millions by selling stock to the public in the fall of 2003. Two months later, records show, Portal stunned the market with news of a big quarterly loss that cut the stock in half and triggered a shareholder lawsuit against the company and its top executives. Bain departed from Portal the following year, records show, and has largely focused on boardroom appointments – serving as a director for multiple companies – since that time.
Bain officially joined CyberDefender’s board along with several other independent directors just two weeks before the company’s move to the Nasdaq in the middle of this year. CyberDefender celebrated the arrival of Bain and fellow audit committee member Tom Connerty, a direct-marketing veteran with no apparent accounting experience, by touting their “stellar track records of creating value for shareholders” in the past. Curiously, the company never even mentioned the third member of its newly formed audit committee – Liquidmetal (OTC: LQMT.OB) Executive Vice President Ricardo Salas – when publicly announcing the fresh additions to its board.
At that time, TheStreetSweeper noted in a previous story, LiquidMetal was just another cash-strapped microcap company – trading on the Pink Sheets for around 20 cents a share – that was struggling to survive. Liquidmetal’s chairman had quietly resigned after being convicted of fraud for his activities at another company a few months earlier, TheStreetSweeper observed, while Salas himself had attracted some government scrutiny as well.
About two months after Salas joined CyberDefender’s board, however, Liquidmetal suddenly rocketed on news of a mysterious deal with Apple (Nasdaq: AAPL) that triggered big payoffs for company insiders. Liquidmetal’s stock quickly soared from 30 cents to $1.70 in less than a week, records show, but has since fallen back to just 50 cents a share.
Going forward, critics predict, CyberDefender could soon face a significant plunge – fueled by massive dilution and major restatements -- as well.
Math Problems
The month after installing Harris as its new CFO, CyberDefender inked a financing deal with GRM that would allow the marketing firm to purchase 10 million shares of stock – more than one-fourth of the entire company – at $1.25 to $2 a share in exchange for a big advertising campaign. Based on figures supplied in corporate filings, critics say, CyberDefender effectively pays GRM an annual interest rate of 22% for financing those ads as well. Meanwhile, they add, GRM has already earned all of its CyberDefender warrants and is now free to start selling its cheap shares.
At this point, critics estimate, CyberDefender has spent more on advertising (counting warrant costs, interest and previously capitalized expenses) than it has generated in actual sales. According to the company’s own financial reports, they estimate, CyberDefender has been spending $1.03 on advertising for every $1 in revenue it has booked.
By changing its accounting practices, however, CyberDefender managed to temporarily report much lower advertising costs – resulting in its first-ever pre-tax profits – during the crucial period leading up to its move to the Nasdaq and its first six months on that exchange. As CFO, Harris himself touted CyberDefender’s new accounting treatment for advertising costs as a helpful one that also made good sense.
“Our migration to direct marketing through television and radio during the fourth quarter now allows us to capitalize a substantial portion of our customer acquisition costs and amortize concurrently with revenue over the life of the related subscription,” Harris stated when explaining the sudden improvement to CyberDefender’s financial results this spring. “We believe the migration to off-line direct marketing will not only increase profitability but will provide a more accurate view of our operational performance.”
The SEC apparently disagreed. Within months of that change, the SEC began questioning CyberDefender about its new accounting policy and several other issues – including its renewal rate and its lack of reserves for refunds – as well.
Future Crash?
Based on its comments to the SEC, CyberDefender suffers from a dismal renewal rate of 40% or less. (In contrast, research indicates, industry leaders McAfee and Symantec boast renewals rates approaching 80% instead.) Despite weak customer loyalty, however, CyberDefender automatically bills customer credit cards for renewals whenever subscriptions expire. CyberDefender must then record any credit card “chargebacks” or company refunds that occur when customers demand their money back.
For example, records show, CyberDefender recorded $3.7 million worth of chargebacks and refunds last quarter that eclipsed the $2.2 million that it generated in actual renewal revenue. Nevertheless, records indicate, the company has never established any reserves to cover those payouts or even acknowledged a reason for doing so.
This fall, however, CyberDefender hired a new auditing firm that has clearly begun to question the company’s accounting practices. Up to that point, CyberDefender could rely on KMJ Corbin – the target of a particularly negative review by the Public Company Accounting Oversight Board – to sign off on its financial statements. A few weeks after the SEC sanctioned KMJ for alleged violations this September, however, CyberDefender finally dismissed the firm and hired Grant Thornton as its independent auditor instead.
Six weeks later, CyberDefender suddenly revealed plans for a looming restatement that could prove even worse than it now seems. The company already expects its loss for 2009 and the first half of 2010 to skyrocket from $20.48 million to $40.37 million due to the accounting treatment for its hefty advertising expenses alone. If Grant Thornton identifies additional issues (as new auditors often do), critics say, CyberDefender could wind up posting restated financial results that bear even less resemblance to the healthy numbers that made the company look so promising earlier this year.
Back then, at least, CyberDefender appeared to be headed in the right direction. Even at that time, however, CyberDefender’s CEO acknowledged that the company faced clear challenges when delivering a hopeful message that – given the firm’s current condition – now sounds almost haunting instead.
“We’re still struggling,” Guseinov confessed to the Los Angeles Business Journal in mid-July. “It’s going to take a lot more energy and capital to get to the point where customers ask, ‘McAfee, Symantec or CyberDefender?’
“Creating brand loyalty is going to take us a while,” he concluded. “Credibility is only built over time.”
* Note: No member of TheStreetSweeper’s staff or advisory board has ever taken a financial position in CyberDefender (CYDE) or received any compensation from others who have positions in the stock. As editor of the site, Melissa Davis will never take a position in any of the stocks that she covers. To contact Ms. Davis, the author of this story, please send an email to editor@thestreetsweeper.org.
