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Covad filing delays leave analysts suspicious

Covad Communications is struggling to get its act together after the digital subscriber line market's troubles, but Wall Street is losing patience.

Covad, a one-time highflier that provides wholesale high-speed DSL Internet connections, still hasn't filed its annual report from last year and faces the possibility of being delisted from the Nasdaq stock market exchange.

After delaying its required regulatory duty three times since February, the publicly traded company on Friday promised to finally unveil its long-awaited annual report sometime next week.

But on top of its inability to comply with Securities and Exchange Commission regulations, some analysts are questioning the viability of Covad's wholesale DSL delivery business while it continues to burn through cash and to rack up huge losses quarter after quarter.

Covad is not alone in facing financial troubles within the DSL industry. Dozens of high-speed Internet service providers, many of them Covad customers, have failed, filed for bankruptcy or sold their assets to others in recent months. For example, NorthPoint Communications, a Covad competitor, was acquired by AT&T in bankruptcy court. But despite the tough times across the sector, analysts say Covad's inability to meet its federal fiscal obligations is curious.

"There's no excuse for this," said Brent Bracelin, an analyst at Pacific Crest Securities. "It certainly raises a lot of questions about the company and its management that it's taken this long just to get out an annual report. There could be a number of reasons for this, but at this point they're all speculation."

Covad's current condition
Last Friday, Covad delayed its annual report for the third time, saying an ongoing internal investigation of its accounting and revenue was still "incomplete."

"We thought we would be done with (the accounting review) by now," Covad Chairman Chuck McMinn said in a release. "It is embarrassing for all of us, but it is important to clarify and resolve all year 2000 accounting matters, and we simply must take time to do that."

The company says it will finally unveil its annual report next week, expecting to file it before a May 24 Nasdaq hearing.

Some analysts have suggested that Covad may be delaying its annual report because it contains some damaging information relating to its operating results in the fiscal year. Other analysts said the company may be buying time in the hopes of being acquired in the interim, rendering the annual report moot.

A company representative said Covad had nothing else to add beyond the statement it released Friday.

The Nasdaq exchange has added an "E" to Covad's ticker symbol--Wall Street's equivalent of the scarlet letter, warning investors that the company has not complied with SEC filing requirements. Before the delisting proceedings Covad traded under the ticker symbol, "COVD."

Nasdaq spokesman Wayne Lee said the delisting process can take as much as six or seven months to complete, giving companies ample time to comply with SEC regulations.

"I can't comment on the specifics of the Covad situation," Lee said. "All I can tell you is that it has been delinquent in its filings, and we're in the process of gathering more information from the company."

Regardless of when or if it files its annual report, Covad still may eventually be delisted. If the stock falls below $1 a share for 30 consecutive trading days, the exchange will immediately delist the stock. After peaking at $30.56 a share in June, Covad is now trading around $1 a share.

If the stock is delisted, the company loses its ability to raise revenue through the public markets as well as the esteem associated with trading on a major exchange.

In the first four months of this year, 147 companies have been delisted from the Nasdaq exchange for a variety of reasons. That compares with a total of 240 delistings in all of 2000.

Fuzzy financials
In February, when the company was originally expected to report its fourth-quarter and fiscal 2000 results, Covad executives said they needed more time to review the company's "revenue-recognition procedures" and that this review could affect results in previous quarters.

The company's annual report, also known as a 10-K filing, was due March 31, three months after the close of its fiscal year.

Covad said it needed more time to examine contracts with Internet service providers, some of which had filed for bankruptcy, and to decide whether or not to write off the value of assets and goodwill related to its $217 million acquisition of BlueStar.net, an ISP serving rural markets, in June 2000.

Further complicating matters, the company said, is a new accounting standard that effects how companies recognize nonrecurring revenue from the installation of equipment.

Adam Giansiracusa, an analyst at Frost Securities Technology, points out that although this new accounting rule requires a thorough examination of operating results, hundreds of other companies have successfully adjusted their revenue totals to comply.

"Covad's message was sent out in an awkward way," Giansiracusa said. "They've known about this for several quarters. We'll just have to wait until they release their annual to see just how much of an impact the (accounting standard) had on their results."

Covad said its review could reduce 2000 revenue by about $52 million and increase losses before interest, depreciation, taxes and amortization (EBIDTA) by about $17 million. "Further analysis is required to confirm these estimates," the company added.

After this announcement, the Nasdaq temporarily halted trading of Covad shares until the company provided more information regarding its fiscal results.

Covad restated its third-quarter results after several ISP partners failed to pay their bills or filed for bankruptcy as the DSL market evaporated. Instead of losing $125.3 million on sales of $66.7 million as it previously reported, Covad actually lost $130.2 million on sales of $56.3 million in the third quarter.

After receiving an extension from the SEC, Covad for the second time delayed releasing its fourth-quarter and year-end results in mid-April, telling the SEC in a late-notice filing that it still had "complex accounting issues" stemming from fast growth and financial problems among customers and that it planned to file the annual report as soon as "practical" to do so.

It also blamed high turnover in its accounting department for further complicating the process.

Last Friday's release marked Covad's third request for delaying its annual report.

A question of debt
Although Covad hasn't been able to deliver its annual report or fourth-quarter results to Wall Street, it's had no trouble spending money in this same period.

In April, it won U.S. Bankruptcy Court approval to buy a list of 11,000 customers from privately held Zyan Communications for an undisclosed amount of cash, and in February it shelled out $3.5 million in cash and forgave some outstanding debts for another 24,500 customers from Flashcom.

These moves didn't go over well with convertible bondholders who asked the company to further restructure its operations and cut spending.

The bondholders told Covad in an April 30 letter that it's responsible for managing assets to increase their value to creditors, adding that the money-losing company has $1.3 billion in debt rated below investment grade. Some of Covad's convertible bonds were valued at just 10 cents on the dollar in late April.

Industry observers say the business plans of many communications start-ups require immense capital, but investment dollars have largely evaporated for these companies.

Covad has about $600 million of cash and cash equivalents on hand, said Kasowitz, Benson, Torres & Friedman, a law firm representing the bondholders.

Covad executives said the company has enough cash to sustain operations through the first quarter of fiscal 2002.

For now, analysts expect Covad to post a loss of $4.91 a share in fiscal 2001. Wall Street also anticipates a loss of $3.60 a share in fiscal 2002, suggesting that if the company is to survive, it's going to need a significant cash infusion from an investor--something as difficult to find these days as a copy of Covad's annual report.

Analysts: The right strategy?
"We did a fairly exhaustive evaluation of Covad's business model and showed the company that it had no chance of ever reaching profitability with its current model," said one analyst who maintains a "neutral" recommendation on the stock. "We asked them to tell us where we were wrong, and they couldn't answer those questions to our satisfaction. At this point, in our opinion, there's no way its wholesale model can create any equity value."

But Dan Sinsabaugh, an analyst at Punk Ziegel, remains one of the company's few proponents, maintaining a "buy aggressive" recommendation on the stock despite its losses and ongoing battles with the SEC and Nasdaq exchange.

"Covad is just being extremely conservative in preparing its results and annual report," he said. "Their accountants are double- and triple-checking all the sales in the past year to make sure they have it right."

Of the six analysts following Covad, Sinsabaugh is the only one who doesn't rate it either a "hold" or a "sell."

"This stock is super cheap," he said. "If the company does survive, it will be worth a hell of a lot more than it's trading at right now." >