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Consumer Diversification Aids Finisar's March To Profitability

Fiber-optic component manufacturers Finisar and Avanex believe their financial and technological strategies will bear fruit next year in the form of profitability.

As the situation appears to be looking up in the photonic components business, the big question now is this: when will the improving conditions translate into profitability for optoelectronic chip manufacturers?

Two of the major suppliers - Avanex and Finisar - have indicated in recent presentations to the investment community that they expect this to happen in 2006.

Both believe that they will post an operating profit next year as revenues steadily increase and the results of cost-cutting actions coincide on what Finisar CEO Jerry Rawls calls "the march to profitability".

Finisar certainly seems to be making some decent headway in that direction. As revenue from the Infineon business it acquired early this year kicked in, Finisar s top line of $81.7 million in its most recent quarter represented the highest yet recorded in company history. What s more, its cash balance figures over the past year indicate a near-negligible rate of cash burn (see graph, below). Finisar s cash reserves have also been boosted by $12 million resulting from the sale of Sensors Unlimited, in which it held a minority stake, to aerospace giant Goodrich.

An even more promising sign is that Finisar s operational improvement was largely due to sales from its optics business unit rather than its network tools division. In the three months that ended July 31, optics revenue was up 35% on the same period last year. The acquired Infineon product lines contributed around 40% to this increase, indicating a pretty healthy "organic" yearly growth rate of 20%.

One important factor in Finisar s favor is that it does not rely too heavily on any single customer, with Cisco the only one to represent more than 10% of sales. Rawls now estimates that Finisar is the number-one optical module supplier in the storage area network (SAN) sector and is level with Agilent Technologies in local area networks (LANs). And with Agilent in the hands of a private equity group, there is perhaps an opportunity for Finisar to capitalize.

Away from the telecoms arena, Finisar is set to compete with Agilent in the consumer-led world of computer peripherals for the first time. That s because VCSEL technology acquired by Finisar when it bought Honeywell s laser diode business is now being exploited in a mouse designed by leading peripherals supplier Logitech - a company that uses Agilent optics in its existing laser-based mouse products.

Mass-production of these new optical mice, featuring VCSELs and an integrated monitor photodiode made by Finisar s Advanced Optical Components (AOC) division, is scheduled to begin in the final quarter of this calendar year. That should give Finisar penetration into a high-volume consumer market to augment the cyclical telecoms business. The Sunnyvale, CA, company is also hoping to penetrate the automotive datacom market in a further sign of diversification.

Rawls says that the VCSEL structures, which are manufactured at the company s wafer fab in Texas, could even find volume application in identification devices, printers and mobile phones.

After factoring all of that, as well as a fast-dropping revenue break-even point, into his financial predictions, Rawls estimates that Finisar will be able to post an operating profit in the third quarter of fiscal 2006, which ends in January next year. If he s right, Finisar will be generating cash flow at that point, with more cost reductions set to follow as chips manufactured at Finisar s Fremont fab are incorporated into modules that previously featured lasers supplied externally.

"It has been four years since the Internet boom collapsed, forever changing the competitive dynamics of our industry," remarked the CEO in a recent conference call. "We have reached a point where our highest priority is our march to profitability."

As Finisar jostles with JDSU and Agilent for the leading positions in the fiber-optic components market, another local rival in the form of Avanex is also sounding the profitability horn.

Recent downsizing, including a workforce reduction of 60% at its fab in Nozay, France, as well as the completion of a plan to consolidate module manufacturing operations into its Thailand facility, should be almost completed by the end of this year. Excluding costs resulting from that restructuring process, Avanex now says that it will be generating cash by June 2006.

Whether that will convince any would-be investors is not certain, bearing in mind that Avanex is facing the prospect of being de-listed from the Nasdaq exchange after its stock price bumped along at less than $1 for 30 consecutive days recently. Further worries may result from an audit by Deloitte and Touche, which indicated accounting problems and a need for Avanex to raise more cash to survive. Finisar s stock had been looking set to face a similar fate until a sharp uptick in late August (see graph, left).

Another of Finisar s competitors, Bookham, has been rapidly burning cash for years, but it has made a series of recent moves towards boosting its liquidity. A tax break worth nearly $12 million and the sale of land in the south of England for $15 million have had an immediate positive effect, while the company plans to add cash to the balance-sheet through another public offering of stock that could potentially realize a further $35 million.

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