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Critical Path executives leave, lawsuits pile up

Ten days after trading was halted by the Nasdaq, Critical Path still isn't on the road to recovery. Things looked even worse Monday with reports that CEO Doug Hickey has departed and the class-action lawsuits against the company are continuing to pile up.

Shares in the Internet messaging services provider were still frozen at $10.06, its 52-week low. The stock has been stalled there since Feb. 2, when the Nasdaq halted trading on the stock after the company said it might have fudged fourth-quarter results. Critical Path (Nasdaq: CPTH) issued a brief press saying its Board of Directors has formed a special committee to investigate revenue recognition practices after discovering a number of transactions that "put into question the company's financial results."

In another press release Friday, the company announced a slew of executive departures without explaining anything more about the accounting problems, a sign that things are worse than expected.

The company said Hickey has "decided to step down." David Hayden, the company's chairman and founder, will serve as executive chairman until a successor is found.

The company also announced the departures of President David A. Thatcher, and William Rinehart, vice president of worldwide sales, who were placed on administrative leave more than a week ago. It was unclear whether the two were fired or quit.

The release didn't clarify anything more about the company's fourth-quarter accounting fiasco. The only news in the release was that Chief Financial Officer Larry Reinhold was the one who had discovered irregularities.

"This wholesale firing of top management indicates Critical Path's problems are likely deep and severe, rather than isolated to a few incidents," said CIBC Oppenheimer analyst Steve Murphy in a research note. Murphy has suspended his rating while awaiting further information.

What is known at this point is what the company announced Feb. 2. Critical Path believes that results it stated Jan. 18--fourth-quarter revenue of $52 million and net loss, excluding special charges, of $11.5 million--"may be materially misstated."

For perspective, the fourth-quarter results were already a disappointment. Critical Path missed projections even though the company had reiterated its outlook in December. The December guidance was used to offset news that Critical Path would replace its chief financial officer, who resigned due to a family illness.

Not only were fourth-quarter results a disappointment, the company also lowered its 2001 projections, citing four reasons: the uncertain environment for Internet infrastructure spending, increases in bad debt reserves, foreign currency impacts and the impact of accounting rule changes on a $7 million software license sale.

The company had intended to give more details about its 2001 outlook in early February, but Wall Street wasn't expecting these problems.

A host of analysts downgraded the stock February 2 with Josephthal & Co. giving Critical Path a "sell" rating.

"The stock will clearly be under pressure following this news," said Goldman Sachs analyst Lilly Bahramipour, who reacted to the news by downgrading the stock to "market performer" from "market outperformer." Bahramipour had kept Critical Path on Goldman's "recommended list" until the company's fourth-quarter earnings in January.

SG Cowen analyst Raj Seth also downgraded the stock--to "neutral" from "buy." Seth had raised red flags about Critical Path's accounting recently. Critical Path's current problems come on the heels of a last-minute accounting change to the $7 million deal closed in the fourth quarter. The company had originally booked all the revenue from that deal in the fourth quarter, but after an audit review, Critical Path changed it to a 12-month deferral. That accounting change is the primary reason the company missed its fourth-quarter targets.

Analysts also had said Critical Path management on the fourth-quarter conference call denied that the $7 million contract was indicative of more widespread accounting irregularities or revenue-recognition problems.

"It now appears that Critical Path's internal financial controls have completely broken down, and that management assurances to the contrary were wrong," said Daniel J. Renouard, an analyst with Robert W. Baird, which kept a "market perform" rating pending more information. "We have no confidence in the company's recently issued financial results or forward guidance. With restatements likely, we believe our estimates for both 2001 and 2002 may be materially lower and that liquidity could ultimately become an issue."

The liquidity problems could surface even though Critical Path has a $216 million cash cushion; the company also has $300 million of convertible debt.

The string of lawsuits filed against the company in recent days are sure to add to the company's financial difficulties. The complaints include allegations that officials concealed a revenue shortfall amid slowing customer orders and accounting changes.

The lawsuits charge that the price of Critical Path stock was artificially inflated while the defendants, David Hayden, David Thatcher and Douglas Hickey were able to unload over $21 million worth of common stock. The class period for most lawsuits stretches back from Feb. 1, 2001 to April 2000.