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Sourcefire's Teething Troubles

A month after the company's IPO and on the first trading day since it warned, shares plummeted 29%.

Right out of the gate, network security company



stumbled badly.

The company, which made its debut on Wall Street

just about a month ago, disappointed investors with its preliminary first-quarter results late Friday. Shares plunged nearly 30% Monday.

Revenue for the quarter ended March 31 will be in the range of $10.1 million to $10.5 million. That compares with revenue of $8.5 million a year ago, but sales are down from $15.9 million in the last quarter.

Net loss for the first quarter of 2007 is likely to be between $2.2 million and $2.6 million, wider than the $1.9 million loss in the year-ago quarter. Excluding items, the company expects a profit of $7.8 million to $8.2 million, an increase from $6.5 million last year.

Sourcefire attributed the numbers to a "smaller-than-expected initial order from a substantial and strategic new account and an unusual number of transactions delayed or deferred very late in the quarter."

The Columbia, Md.-based company offers services based on an open-source technology called Snort that detects and prevents intrusions on networks.

Shares of Sourcefire dropped $5.07, or 29.2%, to $12.28. The stock is now down 35% since its high of $18.83 on March. 15.

Investors' faith in Sourcefire may be shaken, but the company's problems, if it can recognize and fix them, could be temporary.

"The earnings were reflective of them working out their open-source model to the expectations of the market," says Alex Fletcher, lead industry analyst at Entiva Group, an industry group that specializes in open-source software technologies.

"In the long term, as long as the technology continues to have a vibrant community around it, we will see the company's performance reflect strong figures," says Fletcher.

Sourcefire itself has said that the slow quarter is due to a number of delays the company is facing in the processing of awarded procurement transactions, especially in the federal sector of its business.

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That could be an indication that the company's fundamentals are right, but an inability to manage expectations and understand the investor mindset might have let it down.

The company, which released its first-quarter results on a day that the stock markets were closed, offered no details.

That served as a warning to investors who dislike companies trying to sneak bad news in, say experts.

"They weren't trying to be upfront and candid about what happened," says Mike Rothman, an analyst with independent consulting firm Security Incite. "And if a company doesn't offer details, investors are forced to draw their own conclusions."

Sourcefire declined requests from

to elaborate on the results earlier Monday and finally released a brief statement after market close.

It also failed to manage expectations. Sourcefire offered no guidance, and its numbers were off the mark from those of the lone analyst on Wall Street who covers the company.

Add to that Sourcefire's open-source business model, which could potentially confuse some investors, and it's not surprising that Sourcefire hit the ground hard.

Unlike traditional proprietary companies, Sourcefire cannot offer big licensing deals as proof of its success on its balance sheet -- at least in its early days, says Fletcher.

"In the short term, the business model involves them trading a lot of the upfront revenue for a larger user base by basically providing the software or making parts of it available for free," he explains.

A better indicator of the company's health could be the state of the open-source technology it is dependant on for its revenue.

To get a sense of this, investors should look at the community activity around the Snort project, the feedback about it, its release schedule and its flaws -- all of which are easily available, says Fletcher.

"Because of the open and transparent nature of open source, if someone wants to see this, they can easily look it up," he says.

In the short term, though, continued volatility around the stock shouldn't come as a surprise to investors. "On the one hand, a shift from 40% to 30% growth outlook is not exactly a blunder, but on a relatively smaller revenue base and an expensive stock it translates into volatility that gives Wall Street heartburn, particularly when they are already reevaluating their security investing," says Charlie Rice, principal with boutique investment banking firm East Peak Advisors, who does not have a banking relationship with Sourcefire.

Sourcefire expects to report its full first-quarter 2007 results in early May.