How long will the optical communications correction last?

By Stephen Hardy -- By now you've may have heard that Finisar had good news and bad news to relate during its Q3 fiscal 2011 earnings call. The good news was record revenues in Q3 of $263 million, which exceeded the upper end of the guidance it provided during its Q2FY11 call by $1 million. The bad news sunk optical communications stocks across the board.

By Stephen Hardy -- By now you've may have heard that Finisar (NASDAQ: FNSR) had good news and bad news to relate during its Q3 fiscal 2011 earnings call. The good news was record revenues in Q3 of $263 million, which exceeded the upper end of the guidance it provided during its Q2FY11 call by $1 million. The bad news sunk optical communications stocks across the board.

Finisar forecasted a decrease in revenues for its fiscal fourth quarter, guiding $235 to $250 million. The fact that the company wasn't expecting to top its new record wasn't the problem; the issue was the rationale Finisar provided -- in particular, a slowing of business from China and what Finisar termed an "adjustment of inventory levels at some telecom customers, particularly for products which had previously been on allocation and long lead times, including WSS and ROADM line cards."

Never say "adjustment of inventory levels" to a financial community still smarting from a macroeconomic downturn and with long memories of the post-bubble era.

So what can we expect the future to bring? While Finisar forecasted only the upcoming quarter, company Chairman Jerry Rawls told Lightwave that he expects the correction to last one to three quarters -- and most likely two. He said that the excess inventory was created by capacity shortages earlier in the fiscal year that had caused customers to double book. Now that capacity had caught up with demand and those orders were being filled, a surplus was created in the stock rooms of some customers, Rawls explained.

Rawls said he is very optimistic about the second half of the year, and that the fundamental elements that had led to the company's previous status as Wall Street darling remain in place.

Alain Couder, president and CEO of Oclaro, said he agreed with Rawls's assessment of the situation, adding that a slowdown in deployment of 40-Gbps technology in China was one aspect of the reduction in activity there. He said he was happy that his current fiscal quarter doesn't end for another few weeks, which gives him more time than his competitor to adjust to the changing circumstances.

Assuming that Rawls and Couder are correct -- and given the recent forecasts for overall growth in the optical communications space from several market research firms, all of whom had factored a slowing in the Chinese market into their thinking -- it would appear that the industry isn't heading into another Ice Age and that revenues should rebound in the not too distant future.

Whether we can expect the stock prices of companies in the space to do the same is less certain.

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