After the close of trading yesterday, Sonus Networks (NASDAQ:SONS) announced that it had found revenue recognition problems and had fired several "non-executive employees" as a result. The high-flying provider of telecommunications infrastructure equipment saw its shares get sliced by 11% yesterday, on 10 times the average trading volume, and it's off another 20%-plus today in heavy trading.
The company has surged in the last year on the back of capital spending increases at big telecom firms such as Verizon (NYSE:VZ) and AT&T (NYSE:T), as well as the speculative mania over Voice over Internet Protocol (VOIP). But since it announced on Jan. 20 that it would be delaying release of its fourth-quarter financial statements due to an audit, it has shed 46% of its market capitalization, or $1.2 billion dollars.
There are a number of problems with this story. First and foremost, the news of the findings came out after yesterday's close, and yet the stock began tanking with huge volume at around 11 a.m. -- several hours before any official comments by the company. That smells an awful lot like the news was leaked before it was released to the public. Certainly, stocks that have attracted momentum investors can drop on very little provocation. But Sonus investors suddenly turned over nearly 20% of its float on absolutely no news at all? That's difficult to swallow.
I'm not assuming that the company's officers have done anything wrong, but I don't think it's far-fetched to suggest that someone let the cat out of the bag in advance -- the trading pattern certainly suggests it. And this isn't some "reaffirming guidance" kind of communiqué -- it was a bombshell.
Second, the whole "non-executive" firing thing sounds a heck of a lot like scapegoating. The company claims the problem is with revenue recognition for certain accounts. It says the equipment in question has been bought and already deployed. That's certainly better than some of the alternatives, like someone was throwing equipment off the back of the truck and declaring it sold. But given the company's business model, it's still extremely troubling.
According to its (now suspect) mid-year 2003 filing, Sonus generates 70% of its revenue from equipment sales, and about 30% from back-end services. It sells either directly to end customers, or to a distribution network. Its services are accounted for on an "as-provided" basis, which is conservative accounting. So, since the equipment in question has already been delivered to the end customer, as stated by the company, it would mean that Sonus was booking revenues for services that it never provided to customers. Worse, management noted that these improper revenues occurred 2003, and possibly went back to previous years.
That's a disaster, because companies are either providing services, or they are not. For management to have missed such activity for an extended period of time is inexcusable. So while it may be great that it has identified and eliminated wrongdoers, this sounds like a much deeper problem.
Bill Mann has no interest in any security mentioned in this article.
