Ex-Enterasys CEO admits revenue ‘concerns’

Former Enterasys Networks CEO Enrique “Henry” Fiallo told Wall Street that his company would meet expected revenue goals in the first quarter after it spun off from Cabletron Systems in 2001, even though he didn’t think such a target was “really attainable.”

Fiallo made his admission Wednesday in his first day of testimony in the securities fraud trial of five other Enterasys executives in U.S. District Court in Concord.

Fiallo, who had earlier pleaded guilty to a count of securities fraud, testified that he was so worried about the revenue goals that he warned employees they could lose their jobs and urged them to “stay paranoid” become “manically focused” and to “not assume anything is sacred” to meet them.

Fiallo, who had worked at Cabletron since 1998, also was concerned about his own position. Not meeting that 30 percent growth rate — set to “grab the attention” of Wall Street — “would be a disaster” and he would personally be held accountable. But meeting the goals would increase the value of his stock options, lifting his compensation package to well over $1 million.

It was in this context, prosecutors contend, that Fiallo, along with the five other defendants, turned to dubious methods of recognizing revenue, including investments in shaky companies for the sole reason of inflating sales.

The goal was to get $20 million more in revenue that quarter, in hopes of filling the shortfall of the company’s revenue target of $238 million to $242 million, contend prosecutors.

“My concerns were that we were buying revenue,” Fiallo said.

The company had been investing in fledgling companies that would agree to buy Enterasys products that quarter, even though “they didn’t have the ability to take this product and sell it,” said Fiallo.

Fiallo wasn’t the only one who was worried, according to his testimony. He said that his new chief financial officer — defendant Robert Gagalis — allegedly told him that he wanted to route the deals through a third-party distributor so they wouldn’t be reported as a related transaction, thereby preventing Enterasys from counting them as revenue.

Gagalis, who wanted to sign off on deals larger than $2 million because of their “sensitive nature,” compared the investment deals to “cocaine” because they were so “addicting,” Fiallo testified.

Also allegedly part of the “investment team” was Robert Baker, a consultant who Cabletron assigned to work on such deals while Enterasys was still a subsidiary and Enterasys’ chief operating officer – defendant Jerry Shanahan – whose job was “to deliver the revenue.”

Shanahan allegedly warned Fiallo that Enterasys was “significantly behind” its goals, which made Fiallo “extremely nervous” before taking part in a July 10 conference call with Gagalis and Cabletron CEO Piyush Patel to update investors on upcoming spin-off.

The prosecution broke for the day before going into the details of that conference call, with plans to finish today before defense attorneys start their cross examination.

Meanwhile, prosecutors are still facing repercussions from a gaffe made when questioning their first witness, Gary Workman – president of Enterasys’ Asia Pacific division — about the “extreme pressure” he was under from Shanahan.

Workman testified last week that Shanahan urged him to do “whatever it takes” to meet the division’s $31 million goal for the quarter after the Cabletron spinoff. The goal was an arbitrary number that was 25 percent higher than the $25 million achieved in the previous quarter, he said.

On Monday, defense lawyers confronted Workman with documents showing that the previous quarter revenue was actually $31 million, not $25 million. At the time Assistant U.S. Attorney William Morse told the judge that he had just learned of the discrepancy over the weekend. But on Tuesday afternoon, Workman said that the prosecution had reviewed the document with him several times and had previously discussed this discrepancy with Morse. Workman said that the $25 million figure was in his own mind because he had lied about the previous quarter’s revenue in order to be paid a bonus.

Workman, in follow-up questioning by Morse, said that he never said that Shanahan had been told about the $25 million figure.

Shanahan’s attorney, Andrew Good, asked the judge (while the jury was out of the courtroom) to be allowed to accuse the prosecutor of willful misconduct in his closing arguments

Judge Paul Barbadoro said he thought Morse’s gaffe was “too stupid” to be willful misconduct, but chastised the prosecutor for not carefully going through the documents before questioning Workman.

“You had a year to prepare, and you have not done a good job,” he said. “I’m very disappointed.” – BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW

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