CNT, McData Mull Product Conundrum

In a rescheduled earnings conference call yesterday, execs at Computer Network Technology Corp. (CNT) (Nasdaq: CMNT) said accounting problems pose no immediate threat to its pending acquisition by McData Corp. (Nasdaq: MCDTA). But any delays in closing the deal keep potential customers in the dark regarding the switch vendors combined roadmap.

CNT CEO Hudson admits the accounting problems that delayed CNT’s earnings report will kill any chance of the McData deal closing early (see CNT Drags Its Feet on Earnings). Although they never publicly moved up the expected closing date, McData executives were hoping for a quick close after receiving early Hart-Scott-Rodino antitrust and preliminary Securities and Exchange Commission (SEC) approval earlier than expected (see McData Bags CNT for $235M and McData Wraps Rocky Year).

“They have been consistent on trying to close this by the end of May,” Hudson said Tuesday night on CNT’s conference call. “I think we’ve probably blown any of the early timeframe to do it much earlier than that.”

McData wants to close quickly so it can clear up any confusion about the overlap in products. McData CEO John Kelley would like to unveil the combined companies’ product roadmap as soon as possible, and CNT’s earnings raise an interesting question about competing directors. Indeed, ever since McData announced it would spend $235 million on CNT in January, there has been speculation over how it would handle product overlap between its new Intrepid 10000 (i10K) and CNT’s UltraNet Multi-service Director (UMD).

Both products were developed at a high price. McData spent $102 million on Sanera for the i10K, and CNT paid $190 million for Inrange Technologies to obtain the UMD (see McData Completes Sanera Acquisition and CNT Walks Off With Inrange). Considering McData needed more than a year to launch the i10K after acquiring Sanera and has been hyping the director for at least seven months, industry insiders expect McData to keep it (see McData Stays Out of the Red and McData Goes on Offensive).However, CNT reports that it shipped around 300 UMDs last quarter, and recent reseller deals with Hitachi Data Systems (HDS) and IBM Corp. (NYSE: IBM) could further pump sales (see HDS Resells CNT's UMD and IBM Brands CNT's UMD).

The i10K is just starting to ramp and has delivered little revenue so far (see McData's Ready for Rollout). Might it make sense for McData to swallow its pride and keep the UMD instead of the i10K? So far, the jury is out. Hudson, who is expected to hold a senior management position at McData, says he doesn’t have any answers yet.

“We are seeing caution by customers to try and understand from John Kelley and I what the product plan would be,” he said. “We can’t give them that just now because we are not working as one team just yet. But we will get that information and our product roadmap out as quickly as possible after the merger is complete.”

CNT reported revenue of $104 million last quarter, with net income of $1.3 million or $0.04 per share. According to Thomson First Call, analysts expected CNT to report $93 million in income and earnings per share of $0.06. Revenue and income fell from $110 million and $3.7 million for the same quarter a year ago. For the year, CNT lost $6.3 million or $0.23 per share in 2004 after a net profit of $6.4 million or $0.23 in 2003.

Last week CNT announced it discovered accounting errors that led it to overstate inventories and understate the cost of goods sold by about $2 million over the first three quarters of 2004. CNT expects to refile its financial statement for 2004 next month. The error appears similar to those that have forced other companies to restate earnings as they move to comply with Sarbanes-Oxley, but in this case it could interfere with the acquisition if it goes unresolved too long (see Brocade Switches CEOs, Restates , BakBone Slip Called Temporary, Veritas Searches for Truth, and Dot Hill Restates 2004).In a research note today, Baird Equity Research analyst Dan Renouard writes that he believes the McData acquisition remains on track but he would like to see the accounting problems cleared up as soon as possible.

“We believe management must quickly resolve CNT accounting issues to expedite deal completion,” he writes.

— Dave Raffo, Senior Editor, Byte and Switch