Critical Path trading halts as earnings results questioned

Critical Path Inc. (Nasdaq: CPTH) is in a critical situation after the company said Friday officials may have fudged fourth quarter results.

Shares plunged more than 60 percent in pre-market trading, but the Nasdaq halted trading on the stock today at 9:09 a.m. EST to request additional information.

Shares in the Internet messaging services provider were frozen Friday at $10.06, a new 52-week low. They had traded as low as $4 in pre-market action. A host of analysts downgraded the stock Friday with Josephthal & Co. giving Critical Path a "sell" rating.

The company said 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."

The company now believes that results it stated January 18 -- fourth quarter revenue of $52 million and net loss, excluding special charges, of $11.5 million -- "may be materially misstated." The Board of Directors has placed on administrative leave David Thatcher, the company's president, and William Rinehart, the vice president of worldwide sales, effective immediately.

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

In its fourth quarter report, the company 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.

"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 its "recommended list" until the company's fourth quarter earnings last month.

SG Cowen analyst Raj Seth also downgraded the stock -- to "neutral" from "buy." "Things look bad here," Seth wrote in a research note.

Seth 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 revenues from that deal in the fourth quarter, but after an audit review changed it to a 12-month deferral. That accounting change is the primary reason Critical Path missed its fourth quarter targets.

Analysts said 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.

Critical Path becomes the latest company affiliated with CMGI (Nasdaq: CMGI) to face a meltdown. Being associated with Internet incubator CMGI was a badge of honor in 1999 and early 2000. Operating companies in CMGI's portfolio such as NaviSite (Nasdaq: NAVI) and Engage (Nasdaq: ENGA) have also struggled. CMGI's venture capital unit funded Critical Path.