Enterasys Hits New Low
Stock in Enterasys Networks Inc. (NYSE: ETS), an enterprise Ethernet switch maker, dropped nearly 65 percent today after the company announced a spate of bad news.
Enterasys will be missing its quarterly revenues by roughly $40 million (see Enterasys Forecasts, Names CEO). It's acknowledged that three of its top executives will be leaving the company. It's announced the widening of an internal investigation of revenue-recognition policies. And to top things off, it doesn't expect to file its annual report with the SEC by the April 15th deadline.
As a result of all this, several investment firms have downgraded the stock. Salomon Smith Barney dropped its rating to Outperfom from Neutral; Robertson Stephens to Under Review from Strong Buy; Frost Securities Inc. to Sell from Hold; and A.G. Edwards to Sell from Hold.
Shares in the company dropped $2.66 (64.25%) to $1.48 in midday trading.
"Given the controversy surrounding accounting recognition issues, regulatory investigations, and late SEC filings, it’s difficult to argue that extreme changes needed to be made," writes Salomon Smith Barney's Alex Henderson in his research note. "On the other hand, the company seems to be in a state of turmoil. They missed their numbers badly, are burning cash furiously, and must be distracted from servicing their customers... We feel we have no recourse but to lower our rating and price target and increase the risk rating."
Enterasys's present woes began two months ago, when the company first announced that it would delay reporting its fourth quarter to review a $4 million sales contract booked in the Asia/Pacific region. On the same day, the SEC said it was investigating an "apparently unrelated" matter (see What's Up With Enterasys?). Enterasys's stock took a 60 percent drop on these announcements from which it has been struggling since to recover.
And now this: Late last night, the company issued a press release stating that CEO Enrique P. Fiallo had resigned, effective immediately. In addition, J.E. Riddle, vice chairman and executive VP of worldwide marketing, and Jerry Shanahan, COO, also have quit their posts.
The board has hired William O'Brien, formerly a managing partner at PricewaterhouseCoopers as interim CEO and director. Yuda Doron, a sales executive from Computer Associates International (NYSE: CA), has stepped in as president.
Interestingly, Robert J. Gagalis, the company's CFO, who joined the company last summer, remains on staff.
"It wouldn't surprise me if Gagalis was the one blowing the whistle on some of this accounting business," says one equities analyst who didn't want to be named. "You don't usually see the CEO and COO getting booted while the CFO keeps his job, especially when there are questions about accounting."
In last night's release, the company dropped another bombshell: Revenues for the fourth quarter are now expected to be between $145 million and $155 million, significantly below consensus estimates between $190 million and $193 million. The company attributed the downward revision to the previously disclosed revenue recognition issues in the Asia/Pacific region and to poor sales execution in other areas.
The company also revised its first-quarter revenue estimates to between $110 million and $120 million, down from estimates of $195 million. Management blamed the sequential decline on a lengthening sales cycle, poor sales execution, and the impending SEC investigation.
Enterasys is not the only company in its segment struggling to meet its numbers this quarter. Other players selling Ethernet switches to enterprise customers, including Extreme Networks Inc. (Nasdaq: EXTR) and Foundry Networks Inc. (Nasdaq: FDRY), also appear to be having a hard time.
"This quarter has been a tough sales environment," says Stephen Kamman, an analyst with CIBC World Markets. "The trend is brutally clear that IT budgets in the enterprise are flat and will continue to be flat into 2003. The second half might pick up a little bit, but 2003 isn't expected to be a bell-ringer year either."
Enterasys also is delving deeper into the revenue recognition "issues" that surfaced in Asia. The internal investigation is now being opened up to reviews in North America, Europe, and Latin America as well. Rumors are floating around the Street that the SEC, which was investigating the company on "unrelated" matters, is now looking into the accounting irregularities as well.
- Marguerite Reardon, Senior Editor, Light Reading