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Extreme Wipeout

Light Reading
News Analysis
Light Reading
12/18/2000

Talk about having a bad Monday.

Extreme Networks Inc. (Nasdaq: EXTR)), an Ethernet switch company, on Monday saw its stock price drop 24 percent, or $17.31, to close at $54.94 after a negative report from the Center for Financial Research and Analysis Inc. (CFRA) circulated among financial institutions.

The CFRA is an independent financial research organization that warns investors and creditors about companies experiencing operational problems.

Several investment firms came to Extreme’s defense as the stock went into free-fall. Mark Sue, a research analyst with Lehman Brothers, and Gina Sockolow of Brean Murray & Co. Inc. both issued notes defending Extreme and saying that CFRA had overstated several issues. They also reiterated “buy” ratings on the stock.

The report, which went out to subscribers consisting mostly of institutional investors, noted a surge in inventory levels, a plunge in operating cash flows, a reduction in allowance for doubtful accounts as percentage of receivables, and insider sales, according to the Lehman Brothers note.

Extreme officials declined to comment, citing quiet period restrictions.

Extreme doubled its inventory level from about $24 million in Q4 2000 to $59 million in Q1 2001, according to Lehman Brothers. But Sue said that this was normal for networking companies in this market.

“While this is a sharp increase in absolute dollar terms, we note that most networking companies have elected to increase inventory levels due to the industry-wide component tightness. This is not a concern unique to Extreme,” he wrote in the note.

The CFRA report also hammered Extreme for diminishing its allowance for doubtful accounts. But with only 35 percent of its revenue coming from service providers, the company’s risk from selling to shaky competitive local exchange carriers (CLECs) is minimal, said Sue and Sockolow in their notes.

This is ironic, considering that the company has aggressively marketed itself to that sector over the last year.

The CFRA report also referred to warrants that were given to customers. But Sue and Sockolow pointed out these warrants were not given to customers, but to 3Com Corp. (Nasdaq: COMS) and its employees.

“EXTR issued warrants to 3Com, in conjunction with the purchase of the CoreBuilder product line, and some of the sales force, not to a customer as stated in the report,” wrote Sockolow.

Sue looks for Extreme to meet and potentially beat the revenue target of $145.6 million when the company reports earnings on January 17, 2000. But with some uncertainty left with respect to the service provider market, he also noted that he expects the company to be more conservative about its outlook going forward.

Foundry Networks Inc. (Nasdaq: FDRY), which competes head to head with Extreme in the Layer 3 switch market, was also down today, closing at $33 a share, 14 percent lower than yesterday. Cisco Systems Inc. (Nasdaq: CSCO) also ended the day on a sour note, losing 10 percent to end at about $43 a share.

-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com

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