What's Up With Enterasys?

Networking equipment maker Enterasys Networks Inc. (NYSE: ETS) announced two seemingly unrelated events on Friday afternoon that sent analysts scurrying to downgrade the stock and generally panicked investors on Monday.

Here's what happened:

Enterasys said it will delay announcing its fourth quarter and 2001 year-end financial results so it can review some sales and revenue recognition practices in its Asia/Pacific business.

As the story goes, Enterasys's CFO was reviewing the Asia/Pacific region's results when he saw a $4 million sales contract that should not have been counted as recognized revenues, according to CEO Henry Fiallo. The company called its auditor, KPMG, and found that it had been presented with a different version of the same sales contract that did qualify as recognizable revenues. So Enterasys hired a law firm to look into the problem and find out what's going on.

In the meantime, three employees in the Asia/Pacific region have been put on leave. Fiallo says Enterasys was already concerned with the leadership there, which led the recent appointment of Gary Jackson as the region's president (see Enterasys Nabs Cisco Exec).

The Asia/Pacific region has historically represented 13 percent -- about $25 million to $30 million a quarter -- of Enterasys's revenues. Fiallo says he doesn't know what impact the mess will have on the company's fourth quarter or prior quarters.

Enterasys also said that the Securities and Exchange Commission has ordered an investigation relating to it and its affiliated companies. Fiallo says the company doesn't know much about the SEC's investigation but does know that some part of it will focus on the planned spinoff of its Aprisma Management Technologies subsidiary.

Some background: Cabletron Systems Inc. (NYSE: CS) was restructured in early 2000 and split into four companies -- Riverstone Networks Inc. (Nasdaq: RSTN), Enterasys, Aprisma, and GlobalNetwork Technology Services (GNTS) (see Cabletron, R.I.P. ). Riverstone became a public company in February 2001, and the Riverstone shares owned by Enterasys were distributed to investors last August. Enterasys was established as a public company in March 2000 by merging into Cabletron. Aprisma was a subsidiary of Cabletron at the time of the merger, and it remains a subsidiary of Enterasys. In July 2001, it was announced that Enterasys, Aprisma, and a third party would each acquire parts of GNTS.

On Feb. 5, Enterasys was supposed to distribute shares of Aprisma, which was to start trading under the ticker symbol "APRM" on the Nasdaq on Feb. 13. On Monday, however, Enterasys announced that it had cancelled the share distribution.

Meanwhile, Riverstone, which isn't part of Enterasys, took care to issue a press release letting everyone know that the SEC had not contacted it in relation to the Enterasys investigation.

CIBC World Markets dropped its coverage of Enterasys. J.P. Morgan & Co., Salomon Smith Barney, Credit Suisse First Boston, Wit Soundview, Wachovia Securities, A.G. Edwards, and Goldman Sachs & Co. downgraded the stock. Merrill Lynch & Co. Inc. says its investment opinion of Enterasys is under review pending further information.

On Monday, Enterasys shares dropped $6.60 (61%) to $4.20, and Riverstone Networks dropped $1.73 (11%) to $13.99 in a generally drab day on the stock market.

— Phil Harvey, Senior Editor, Light Reading
http://www.lightreading.com