The company should focus on cutting costs and reducing expenses.
Sifting through the wreckage littering the tech landscape can be great fun. Is there value out there, or I am looking at fool's gold? That many technology stocks rose to inflated heights early this year was pretty clear, but so many have collapsed that it's time to begin a treasure hunt. Still, there may be more pain as investors struggle with the implications of increasing interest rates.
Extreme Networks had been one of the high fliers of the networking-equipment world. The company went public in '99, and the stock rose from the mid-$20s to almost $129 a share before the tech bubble burst. The latest downturn had the stock at less than $6 per share last week.
Extreme's first products were Layer 3 Ethernet switches. The company has since expanded its product lineup to include offerings that span metropolitan area networks as well. Extreme was hit by the downturn in technology spending, though sales didn't evaporate entirely as they did for so many other companies. During Extreme's best quarter (ending December 2000), revenue amounted to $144 million, and annual revenue that fiscal year was $491.2 million. Since then, quarterly sales have dropped to $84 million from $90 million.
It's no secret that spending on networking equipment has declined over the past two years. However, there's another dynamic at play: Cisco Systems appears to be gaining market share at the expense of its smaller competitors. Extreme seems to have realized this and has teamed up with Avaya (a Lucent spin-off) to boost sales. Avaya will function as a reseller of Extreme products, giving Avaya an end-to-end offering that can handle voice over IP. Though the deal is nonexclusive, I believe it may generate a significant amount of revenue in 12 to 18 months.
But all is not well at Extreme. The head of worldwide sales recently resigned; sales have been stagnant for a while, which could have hastened the change. Also, the CFO position has been a revolving door. Six months ago, Extreme hired its third CFO in as many years.
Last quarter, sales, general, and marketing expenses as a percentage of revenue amounted to 35.3%, which is rather high. Add to that research and development expenses as a percentage of revenue of 16.9%, and you can begin to understand how very decent gross margins can lead to no profits. Product gross margins held up well at 54.7%, and service gross margins increased to 29.9%. The bottom line for Extreme was a disappointing loss of 1 cent per share.
In my opinion, the company should focus more on cost containment and how to reduce the current expense load permanently. I understand that it requires marketing and salespeople to compete in a very difficult environment, but Extreme should understand that it won't be a $2 billion company in the next couple of years. Is the stock cheap? Probably not. Profits are depressed, leading to a very high price/earnings multiple of 37.6 times next year's earnings. On a price-to-book basis, the stock is trading at three times book value; while not wildly inflated, it's not particularly cheap. Looks like I better keep looking for other nuggets out there.
William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. Reach him at email@example.com. This article is provided for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security. Bay Isle has no affiliation with, nor does it receive compensation from, any of the companies mentioned above. Bay Isle's current client portfolios may own publicly traded securities in one or more of these companies at any given time.
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