Ex-Enterasys CEO tells of revenue ‘red flag’

Enterasys Networks’ former CEO, Enrique “Henry” Fiallo, said he received a “pretty scary revelation” on July 21, 2001 — the day before he and his former CFO, Bob Gagalis, were about to go on a road show to talk up the subsidiary’s spinoff from Cabletron Systems.

Fiallo, testifying Thursday against Gagalis and four other former Enterasys executives in the ongoing securities fraud trial in U.S. District Court in Concord, said defendant Jerry Shanahan – chief operating officer at the time – had just told Fiallo that midway through the quarter the company had met less than 6 percent of its target of $240 million in revenue.

“It was a pretty red flag to me,” Fiallo, in his second day of testimony, said.

Yet Fiallo and Gagalis left on the road show anyway, giving some 50 or 60 slide show presentations, accompanied by a chart showing continual revenue growth.

“We killed them,” said Fiallo said in an e-mail after the first presentation. “They loved our story. The stock will be worth a lot of money if we keep up the momentum.”

The road show went on until just a few days before the spinoff on Aug. 6, 2001.

The U.S. government is charging that defendants conspired to defraud investors by artificially inflating revenue in the quarter when Enterasys was spun off from Cabletron, which was once New Hampshire’s largest employer.

Eventually, Gagalis also worried about the numbers, Fiallo testified. At one point, they both went down the hall to meet with Cabletron CEO Piyush Patel, to tell him that there was too much of a backup in the sales pipeline in order to meet the numbers. Prosecutors did not ask what Patel had to say, but Fiallo said that after the meeting, “it was business as usual.”

Fiallo, in what he called “the crowning moment” of his career, then went on to ring the bell to open the Aug. 6 session of the stock exchange, the first day that Enterasys began trading as a public company.

On Sept. 26, Enterasys announced that it met or exceeded sales goals, growing some 26 percent, despite a high-tech meltdown and despite counting on some shaky transactions as sales – transactions of which Fiallo “didn’t want to know the details. I just wanted the results,” he testified.

Those details came to light in February 2002, resulting in a Securities and Exchange Commission investigation that caused the new company to be engulfed in an accounting scandal that led to the current criminal prosecution.

That’s the government’s side of the story elicited by assistant U.S. Attorney Colleen Ann Conry.

But Cathy Green, Gagalis’ attorney, however, drew out another side of the story from the same witness, as she began her cross-examination Thursday afternoon.

Green painted Fiallo as a greedy and deceptive CEO who used Gagalis to put a reassuring corporate face on a company that was already struggling to make its numbers, and was now motivated to throw the blame on his CFO in order to escape a lengthy prison term.

Green pointed to e-mails in which Fiallo wrote that he wanted to be “f…ing rich” and be called the “f…ing Enterasys emperor” and who was “quite pissed” when Patel was reluctant to increase his base salary beyond $300,000.

She noted how Fiallo – though Enterasys internal correspondence — refused much of the financial information Gagalis was asking for before he was hired away from Fisher Scientific on June 26. She showed an agreement that Gagalis would only be working there one day or two days a week before the July 10 conference call before he “reiterated” the $240 million quarterly goal.

Fiallo had previously testified on Wednesday that he was “extremely nervous” about whether Enterasys would be able to meet those numbers before the conference call.

“You didn’t share that with Bob,” Green said

Fiallo said he didn’t.

“You were deceiving him, right?”

“I didn’t tell him a lot of things,” Fiallo replied.

“He was putting his credibility on the line, and you let him do it, right?”

“I wouldn’t characterize it that way,” Fiallo said.

The cross-examination of Fiallo is expected to continue today. – BOB SANDERS/NEW HAMPSHIRE BUSINESS REVIEW

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