A quarterly report released last night has put Nortel Networks Corp. (NYSE/Toronto: NT) in the Wall Street dog house, with its optical networking division experiencing negative quarter-to-quarter (sequential) growth. The results sent Nortel’s stock price down 26 percent today.

After the market closed yesterday, Nortel reported that its Q3 2000 net earnings were 18 cents per share, beating analyst expectations by one cent, and its optical networking business grew 90 percent from the corresponding quarter last year. Revenues were up 42 percent year over year to $7.3 billion. Sounds great, right?

Wrong. Under the fluffed-up annual numbers were some disturbing surprises on the quarter. The most damaging was negative sequential growth in optical, which was down five percent from the last quarter. Most analysts had expected it to be up 15 percent. The yearly growth was a disappointment, as well, for analysts, who were expecting to see 120 to 125 percent growth in this area. Revenues were also on the low end of expectations.

The company blamed the slowdown on customers who had been double booking orders in anticipation of a shortage in products.

"Customers don’t want to be short of any parts,” said John Roth, CEO of Nortel. "They buy more than they need, and when lead times are restored to their normal level they have no need for a large inventory."

Nortel also attributed the dip in growth to a shortage of field engineers. As a result, Roth said, the vendor wasn’t able to install and turn on new equipment.

The news completely surprised most analysts on Wall Street. "It’s very bizarre,” says Max Schuetz, optical networking analyst at Thomas Weisel Partners. “There isn't a person out there on the Street that had a clue this was happening.”

And it even had some questioning Nortel’s rationale for the downturn. "It's strange that people could build inventory in a space that was supply constrained,” adds Schuetz. "It's one more worry for an already paranoid investor base."

Nortel claims that the problems experienced this quarter are already being worked out. Executives indicated on the conference call that bookings are already up for the fourth quarter and they expect 40 to 50 percent growth in optical for the next quarter.

Analysts have mixed feelings on this reassurance. The surprises of this quarter have shaken their faith in the Nortel leadership. Lehman Brothers and Chase H&Q have already downgraded the stock this morning. Others like UBS Warburg hold to their Buy rating but have indicated some skeptism in Nortel’s positive outlook for the future.

“Credibility of management, which was dampened given this quarter’s performance, is likely on the line with such an aggressive target for Q4,” writes analyst Nikos Theodospoulos in this morning’s report. Consequently, he has lowered the revenue expectations from $11.5 billion to $10.2 billion.

But not everyone is panicking. Some analysts are optimistic.“It’s not as bad as it seems. Nortel management indicated overall demand for its optical networking products has not slowed and that Q3 was simply a ‘bubble’,” according to the CIBC World Markets report.

Nortel’s poor performance coupled with Lucent Technologies Inc.'s (NYSE: LU) problems has sent many stocks in the sector down. Sycamore Networks Inc. (Nasdaq: SCMR) and Ciena Corp. (Nasdaq: CIEN) are down 15 percent and 12 percent, respectively. Among component vendors, JDS Uniphase Inc. (Nasdaq: JDSU) lost 15 percent, and Corning Inc. (NYSE: GLW) 17 percent.-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com