One of the more interesting recent litigation phenomena is that even though we are now well into the fifth year since the initial COVID outbreak in the U.S., COVID-related securities lawsuits continue to be filed. Indeed, in its recent survey of first half 2024 securities lawsuit filings, NERA noted COVID-related filings as one of the factors contributing to the volume of securities suit filing in the year’s first half, and indeed noted that COVID-related suit filings YTD were on pace to exceed the number COVID-related suit filings during the full year 2023. In the latest example of these securities suit filing trends, earlier this week, a plaintiff shareholder filed a COVID-related suit against cloud computing products company Extreme Networks, based on allegations that the company had misrepresented the long-term effects of COVID-related supply chain disruption on the company’s sales backlog. A copy of the August 13, 2024, complaint can be found here.

Background

Extreme Networks provides cloud-based computer networking equipment and services. One of the company’s key financial metrics is “backlog,” which the company defines as confirmed orders for products that are to be fulfilled and billed to customers. Actual shipment of products depends on the company’s manufacturing capabilities and supply chain.

The onset of COVID-19 pandemic disrupted Extreme Networks’ supply chain, causing component shortages, increased component and freight costs and higher order backlog. Its backlog rose from about $31 million in June 2020 to as much as $555 million by the end of September 2022.

In July 2022, the company reported an improvement in its supply chain environment. Investors began to question how soon the Company would work though its backlog and what impact the process would have on the Company’s revenue and growth. The securities complaint alleges that in order to “assure investors that the fulfillment of the Company’s backlog would add to – and not be at the expense of – the Company’s organic revenue,” the Company emphasized its “unprecedented” and “unabated market demand,” and stated that its backlog would continue to increase over subsequent quarters.

However, “unbeknownst to investors,” the company was “suffering from adverse client demand trends as its clients had ordered more product from Extreme than needed in the wake of the COVID-19 pandemic to avoid supply shortages and because of lack of alternative sourcing options,” thereby “cannibalizing their Class Period purchasing needs.”

The company, the complaint alleges, continued to try to reassure investors about continuing client demands. The complaint alleges further that by early 2024, the company was lowering its fiscal year and long-term revenue outlooks, noting “industry headwinds of channel digestion and elongated sales cycles,” as multiple deals were pushed out into future quarters.” The company also reported disappointing financial results for its second fiscal quarter 2024, including a 37% year-over-year revenue decline. The company reported similarly disappointing news in May 2024, noting that its customers were still “working through their prior purchases.”

The August 13, 2024, Complaint

On August 13, 2024, a plaintiff shareholder filed a securities class action lawsuit in the Northern District of California against Extreme Networks and certain of its executives. The complaint purports to be filed on behalf of investors who purchased the company’s securities between July 27, 2022, and January 30, 2024.

The complaint alleges that during the class period, the defendants failed to disclose: “(a) that Extreme was suffering from adverse client demand trends as its clients had ordered more product from Extreme than needed in the wake of the COVID-19 pandemic to avoid supply shortages and because of the lack of alternative sourcing options and thereby had cannibalized their Class Period purchasing needs; (b) that Extreme was offsetting these adverse organic demand trends with the fulfillment of backlog orders in a manner that materially exceeded the proportion represented to investors; (c) that as a result of (a)-(b), Extreme was drawing down its backlog at a much faster rate than represented to investors; (d) that as a result of (a)-(c), Extreme’s backlog was already decreasing and at a much quick pace than defendants’ statements to investors [suggested] … (e) that as a result of (a)-(d) Extreme’s backlog was not on track to continue increasing … (f) that as a result of (a)-(e) above, defendants had materially misrepresented Extreme’s organic demand, revenue growth, and market share gains as the fulfillment of Extreme’s backlog masked a decline in organic demand and attendant revenues.”

The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the class.

Discussion

This lawsuit falls in the sub-category of COVID-related securities suits involving companies that prospered initially during the pandemic, but whose fortunes later flagged as conditions changed and as the pandemic progressed. Here, the plaintiffs allege, the company prospered as customers over bought to avoid further supply disruption of the company’s products and services, building up a substantial backlog, but as the company worked off the backlog, new sales failed to materialize.

The striking thing to me about the allegations in this case, and in other cases like this one, is how disruptive the effects of the pandemic have turned out to be. I think in some ways I may have underappreciated just how disruptive the pandemic has proven to be for many companies. Even multiple financial reporting periods after government shutdown orders ceased, companies like this one are continuing to see their operations and financial results disturbed by the pandemic’s continuing reverberations.

So, even though we are now years beyond the period of the government shutdown, company’s results continue to be affected in ways that continue to generate securities class action lawsuits. The likelihood is that we will continue to see new COVID- related securities suits filed in the months ahead.

In any event, by my tally, this lawsuit is the 80^th COVID-related securities suit to be filed since the initial outbreak of the coronavirus in the U.S. in March 2020. This lawsuit is also the 9^th COVID-related securities suit to be filed so far in 2024.