CNT Drags Its Feet on Earnings

The pending acquisition by McData Corp. (Nasdaq: MCDTA) of Computer Network Technology Corp. (CNT) (Nasdaq: CMNT) for $235 million appeared to be on the fast track last month. Today, it hit a speed bump.

Just hours before the release of last quarter's figures, CNT delayed its earnings report and announced it will probably have to restate earnings for three quarters of 2004 (see McData Bags CNT for $235M and CNT Postpones Earnings Call).

Although the deal, announced in January, cleared two regulatory hurdles in February, CNT indicated it might not face smooth sailing. CNT postponed reporting earnings so it can reconcile its cost of finished goods between the general ledger and its material requirements planning (MRP) system. The adjustments would likely increase cost of goods sold by around $2 million for the nine months ended October 31, 2004, and widen CNTs loss per share of $3.58 by another $0.07 over that period.

CNT provided little detail behind the changes in its release today, and McData did not respond to inquiries by press time. Gail Greener, CNT’s marketing VP, says it would be “very difficult to comment at all,” until after the issues are resolved. She did say the differences were found during a routine audit by CNT and not by McData’s due diligence.

Last month, McData received Hart-Scott-Rodino antitrust and preliminary Securities and Exchange Commission (SEC) approval earlier than expected (see McData Clears Antitrust Hurdle and McData Wraps Rocky Year). During McData’s earnings call two weeks ago, CFO Ernie Sampias said he expected the deal to close by the end of July.That was before CNT said it might have to restate earnings. But financial analysts say today’s news is unlikely to impede the acquisition as long as the restatement is completed quickly and is no worse than CNT indicated.

“Although this speed bump causes us some concern and we want to see the amended 10-Qs, it appears McData’s acquisition is still on track,” Dan Renouard of Baird Equity Research wrote today in a research note. “We believe management must quickly resolve CNT accountings/earnings issues to expedite deal completion and integration efforts to produce cost synergies and reduce employee angst.”

An analyst who asked not to be identified says a $2 million difference is unlikely to be large enough to cause McData executives to change their minds about the transition. “It would probably have to be quite a bit more significant to affect the acquisition,” the analyst says.

Another analyst says it shouldn’t matter if CNT lost more than earlier reported for last year, because the acquisition is strategic on McData’s part. Its plan is to use the acquisition to diversify its revenue through SAN extension products and services. McData’s switch business has been in steady decline under competition from Brocade Communications Systems Inc. (Nasdaq: BRCD) and Cisco Systems Inc. (Nasdaq: CSCO). (See Cisco's Elbowing McData, Report Says) and Brocade Boasts Strong Quarter.)

“Nobody is looking at CNT's earnings for last year or the near future for the acquisition,” says Kaushik Roy of Susquehanna Financial Group. “The acquisition is a battle for survival of both CNT and McData. So, although cost of goods issues from the past should not be ignored, they may be less relevant at this time.”CNT’s financial struggles were well known before the acquisition. It hit bottom in the quarter that ended last July when it lost $5.5 million or $0.20 per share and laid off 220 (see CNT Takes a Hit). The following quarter it posted a net profit of $237,000 or $0.01 per share (see CNT Gets UMD Bounce).

The analyst who asked not to be named says it’s strange that CNT waited until hours before it would report earnings to make its announcement. “It is disappointing that it is coming out the day of the earnings release,” he says. “They certainly didn’t discover these issues last night.”

If it has to restate earnings, CNT would become the sixth storage company to do so in the past year. Brocade, BakBone Software Inc. (Toronto: BKB), Dot Hill Systems Corp. (Nasdaq: HILL), Maxtor Corp. (NYSE: MXO), and Veritas Software Corp. (Nasdaq: VRTS) previously restated earnings. (See BakBone Slips Again, Maxtor Marches On, Brocade to Restate , Dot Hill Restates 2004, and Veritas Searches for Truth.)

— Dave Raffo, Senior Editor, Byte and Switch