Avanex falls on warning, downgrades

Avanex shed 19 percent Wednesday after warning that sales and earnings would miss estimates for its third quarter. Analysts said the company's largest customer, WorldCom, was to blame, and cut their ratings on the optical parts maker.

Avanex (Nasdaq: AVNX) designs photonic processors that give communications service providers and optical systems manufacturers greater levels of performance and miniaturization, and reduced complexity and increased cost- effectiveness. Shares were off $4.47 to $19.47.

The company said in a statement Tuesday that it expects sales in the third quarter of fiscal 2001 to be about $41 million, an improvement over the $10.5 million in 2000's third quarter. It also sees pro forma diluted earnings per share of between 2 cents and 3 cents a share, well below 2000's third-quarter loss of 4 cents a share, and less than half of First Call's consensus estimate of 6 cents a share.

The company also said revenue for fiscal year 2001 is now expected to be about $169 million, compared to $41 million in fiscal year 2000. For the year, pro forma diluted earnings are expected to be 15 cents to 16 cents a share.

The company said it had improved the mix of new products, with next-generation PowerMux and PowerExchanger products making up over 70 percent of revenue in its third quarter, compared to about 45 percent in the second quarter. It also said international sales grew to over 50 percent of revenue as compared to about 20 percent in the second quarter. That's good news, according to analysts, who saw it as one of the few short-term positives for the stock, along with Avanex's new 10 percent customer, Alcatel (NYSE: ALA).

Avanex's main problem in its third quarter, and a cause for ongoing worry is its dependence on WorldCom (Nasdaq: WCOM), the main customer of its PowerFilter product.

UBS Warburg analyst Joseph Wolf said it was WorldCom that was mostly to blame for the company's weak sales. WorldCom--Avanex's largest customer, accounting for over 50 percent of sales--had a seasonal inventory buildup in the December quarter that caused this slowdown in orders. Even now that it has been reduced to around 30 percent of revenue, WorldCom remains "one of the biggest risks to the stock," Wolf added.

Wolf lowered his rating to "hold" from "buy" and chopped his target price to $18 from $100. Despite the steep drop in his expectations, Wolf said he still believes that Avanex "offers a unique play into next generation optical modules."

Lehman Brothers analyst Steven Levy also lowered his rating to "market perform" from "strong buy."

Levy noted that unlike some of the other telecommunications equipment companies that have reduced expectations--such as JDS Uniphase (Nasdaq: JDSU)--Avanex's disappointment was due entirely to a single customer: WorldCom.

Though this makes it more probable that the company's foreseeable future should be easier to forecast, Levy said he was lowering his rating nevertheless, as "investors are not going to reinstate a premium valuation on a company like Avanex until the overall uncertainty in the space is removed."

Levy said the company's revised revenue figure of $41 million for its first quarter is way off his estimate of $52 million.

Robertson Stephens analyst Paul Johnson maintained a "buy" rating but lowered revenue and earnings estimates for fiscal 2001 and 2002.

"Despite strong growth in the company's next-generation product lines and international presence, we believe that a softening telecommunications spending environment at least in the short-term in conjunction with WorldCom's significantly reduced appetite for legacy products will precede this growth on the near- to intermediate-term basis," Johnson wrote.