Finisar Falls

For the past several months, suppliers of storage area networkingproducts have been trying to burn off component inventories the way weightwatchers attempt to burn off fat. Meanwhile, down the food chain, partspurveyors, such as FinisarCorp. (Nasdaq: FNSR), which reported earnings yesterday (Tuesday), areonly hoping that such discipline is working and purchases will soon pick up.

Finisar, a maker of components for SANs and optical networking gear,reported a painful quarterly sequential revenue drop from $52 million in itsfourth fiscal quarter 2001 ending in May, to $34 million during its first quarter 2002 ending July 31. Compared with year-ago revenues of $27 million, however,sales were up 26 percent (see Finisar Reports on Q1).

CEO Jerry Rawls said he expects revenues for the second fiscal quarter tobe flat to up slightly” on a sequential basis. But he refused to forecastbeyond that due to “limited visibility” and the fact that his customers arerefusing to forecast their own prospects. Rawls said orders are already upin the Gigabit Ethernet and Fibre Channel SAN business. But he hedged on howquickly these orders will be booked as sales. He added he expects

“substantial revenues for 10-gigabit products” in the third fiscalquarter.

The sorest spot during the quarter was the bottom line, with an $8.3million pro forma loss, or a nickel a share. That compares with a pro formaprofit of $4.9 million, or three cents a share, for the corresponding quarter last year.The pro forma results exclude one-time charges for deferredcompensation, merger costs, and inventory write-downs.

The company’s actual loss (according to generally accepted accountingprinciples) was $69 million, or 40 cents a share. That compares with a $3.2million profit, or 2 cents a share, for the quarter last year.Cash on the company’s balance sheet dropped from $146 million to $120million over the last three months, while gross margins took a sequentialplunge from 38 percent to 24 percent. Company officials assigned part of theblame to the transition of their manufacturing to a new plant in Malaysia.Once the new operation ramps up, they expect margins to improvesignificantly.

Practitioners in the half-baked science of market research expect the SANmarket to sizzle over the long haul. For instance, Gartner/Dataquest expects revenues for the“fabric attached storage market,” which includes SANs and networked attachedstorage products, to grow at a 45 percent compound rate between2000 and 2005. Some financial analysts believe corporate earnings for thesevendors should exceed this amount, due to the increased operatingefficiencies of large-scale production. But with the near-term outlook incorporate IT spending still murky, the demand for SAN products is not likelyto leap from the freezer to the broiler pan.

With Rawls boasting of new customer wins and a pickup in orders, perhapsthe company is already in the midst of a rebound. “In the last two or threequarters, Fibre Channel hasn’t seen a lot of growth, but I think sales will pickup soon due to new software products in the storage space from companieslike

Legato Systems Inc. (Nasdaq: LGTO) and VeritasSoftware,” says analyst Matt Bryson of Avian Research LLC.

As an indicator of the company’s near-term prospects, investors shouldpay attention to the results of its biggest customers. Brocade Communications SystemsInc. (Nasdaq: BRCD), for instance, recently reported earnings that werein line with analysts’ expectations (not great, but not the negative newsthat everyone has come to expect nowadays -- see Brocade Hits Numbers). On the other hand, EMC Corp. (NYSE: EMC), another major customer, has been stung recently by negative news regardingits sales force (see EMC Hits New Lows ).

Analysts’ views on Finisar have soured recently due to the company’sannouncement in July of lowered expectations for the quarter just ended andthe company’s inability to forecast beyond the current quarter. The First Call

consensus of 10 analysts gives Finisar an average rating of 2.2, downsubstantially from the 1.7 rating at the time of its last earnings reportthree months ago. (A no. 1 rating is a Strong Buy, a no. 2 is a Buy, anda no. 3 is a Hold.)Last fall, when analysts were very bullish on the stock, Finisar began itsdecent from a 52-week high of $51. In Tuesday aftermarket trading on Island,the stock was around $11. Now that the financial community has become sobearish, some observers think it may be time to buy.

— Tom Davey, special to Byte and Switch, http://www.byteandswitch.com