Avanex 10Q 2008 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________to _________

Commission file number 000-29175

AVANEX CORPORATION

(Exact name of Registrant as Specified in its Charter)

Delaware

94-3285348

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer
Identification Number)

40919 Encyclopedia Circle

Fremont, California 94538

(Address of Principal Executive Offices including Zip Code)

(510) 897-4188

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

There were 228,223,801 shares of the Company’s Common Stock, par value $.001 per share, outstanding on October 25, 2007.

AVANEX CORPORATION

FORM 10-Q

TABLE OF CONTENTS


		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited):	3
	Condensed Consolidated Balance Sheets as of September 30, 2007 and June 30, 2007	3
	Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2007 and 2006	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2007 and 2006	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22
Item 4.	Controls and Procedures	22

PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	23
Item 1A	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Submission of Matters to a Vote of Security Holders	37
Item 5.	Other Information	38
Item 6.	Exhibits	38

Signatures

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PART I — FINANCIAL INFORMATION

ITEM 1.

Financial Statements

AVANEX CORPORATION

Condensed Consolidated Balance Sheets

(In thousands, except share and par value data)

(Unaudited)


	September 30, 2007			June 30, 2007
Assets
Current assets:
Cash and cash equivalents	$	12,999		$	14,837
Restricted cash and investments		6,445			3,620
Short-term investments		27,010			28,942
Accounts receivable, net of allowance for doubtful accounts of $172 and $0 at September 30, 2007 and June 30, 2007, respectively		33,424			33,764
Inventories		15,504			15,188
Due from related party		15,657			14,381
Other current assets		6,952			5,716

Total current assets		117,991			116,448
Property and equipment, net		7,224			5,900
Intangibles, net		597			559
Goodwill		9,408			9,408
Deposits and other assets		2,932			2,685

Total assets	$	138,152		$	135,000

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	35,374		$	32,549
Accrued compensation		4,175			6,091
Accrued warranty		842			873
Due to related party		2,144			2,144
Other accrued expenses and deferred revenue		8,128			8,796
Current portion of long-term obligations		7			9
Current portion of accrued restructuring		2,769			2,837

Total current liabilities		53,439			53,299
Long-term liabilities:
Accrued restructuring		7,284			8,269
Other long-term obligations		1,413			1,350

Total liabilities		62,136			62,918

Stockholders’ equity:
Common stock, $0.001 par value, 450,000,000 shares authorized; 227,991,142 and 226,184,325 shares outstanding, net of 157,656 treasury shares, at September 30, 2007 and June 30, 2007, respectively		227			226
Additional paid-in capital		779,700			775,901
Accumulated other comprehensive income		1,153			1,064
Accumulated deficit		(705,064	)		(705,109	)

Total stockholders’ equity		76,016			72,082

Total liabilities and stockholders’ equity	$	138,152		$	135,000

See accompanying notes.

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AVANEX CORPORATION

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)


	Three Months Ended September 30,
	2007			2006
Net revenue:
Third parties	$	41,395		$	37,354
Related parties		13,314			13,537

Total net revenue		54,709			50,891
Cost of revenue:
Cost of revenue except for purchases from related parties		39,516			45,574
Purchases from related parties		1			5

Total cost of revenue		39,517			45,579

Gross profit		15,192			5,312
Operating expenses:
Research and development		6,774			5,625
Sales and marketing		3,915			3,548
General and administrative:
Third parties		4,475			5,662
Related parties		—			(11	)
Amortization of intangibles		559			852
Restructuring		(335	)		(63	)
Gain on disposal of property and equipment		—			(20	)

Total operating expenses		15,388			15,593

Loss from operations		(196	)		(10,281	)
Interest and other income		526			839
Interest and other expense		(11	)		(272	)

Income (loss) before income taxes		319			(9,714	)
Provision for income taxes		(274	)		—

Net income (loss)	$	45		$	(9,714	)

Basic net income (loss) per common share	$	0.00		$	(0.05	)

Diluted net income (loss) per common share	$	0.00		$	(0.05	)

Weighted-average number of shares used in computing basic net income (loss) per common share		226,749			205,389

Weighted-average number of shares used in computing diluted net income (loss) per common share		230,827			205,389

See accompanying notes.

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AVANEX CORPORATION

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Three Months Ended September 30,
	2007			2006
Operating Activities:
Net income (loss)	$	45		$	(9,714	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Gain on disposal of property and equipment		—			(20	)
Depreciation and amortization		683			639
Amortization of intangibles		559			914
Stock-based compensation		3,407			1,888
Provision for (recovery from) doubtful accounts and sales returns		738			210
Non-cash interest expense		—			161
Write-off of excess and obsolete inventory		1,355			3,476
Changes in operating assets and liabilities:
Accounts receivable		(2,652	)		(4,742	)
Inventories		(1,217	)		(1,947	)
Other current assets		97			3,456
Other assets		(246	)		(5	)
Due to/from related party		(159	)		(8,308	)
Accounts payable		2,630			2,181
Accrued compensation		(1,681	)		168
Accrued restructuring		(1,053	)		(1,420	)
Accrued warranty		(31	)		(65	)
Other accrued expenses and deferred revenue		(999	)		1,303

Total adjustments		1,431			(2,111	)

Net cash provided by (used in) operating activities		1,476			(11,825	)

Investing Activities:
Purchases of investments		(49,433	)		(139,689	)
Maturities of investments		51,373			139,612
Increase in restricted cash		(2,825	)		(39	)
Purchases of property and equipment		(765	)		(1,082	)
Net cash used in asset purchase		(2,211	)
Proceeds from sale of property and equipment		—			20

Net cash used in investing activities		(3,861	)		(1,178	)

Financing Activities:
Payments on capital lease obligations		(2	)		(298	)
Proceeds from issuance of common stock, net of repurchases		393			707

Net cash provided by financing activities		391			409

Effect of exchange rate changes on cash		156			(11	)
Net decrease in cash and cash equivalents		(1,838	)		(12,605	)
Cash and cash equivalents at beginning of period		14,837			28,963

Cash and cash equivalents at end of period	$	12,999		$	16,358

Supplemental Information:
Cash paid during the period for:
Interest expense	$	—		$	16

Non-cash investing and financing activities:
Conversion of senior convertible notes into common stock, net of discount of $96	$	—		$	449

Amortization of actuarial gain recognized in accumulated other comprehensive income	$	(8	)	$	—

See accompanying notes.

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AVANEX CORPORATION

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

Avanex Corporation and its wholly owned subsidiaries (“the Company”, “we”, “us” and “our”) design, manufacture and market fiber optic-based products, known as photonic processors, which are designed to increase the performance of optical networks. The Company sells products to telecommunications system integrators and their network carrier customers. The Company was incorporated in October 1997 in California and reincorporated in Delaware in January 2000.

The accompanying unaudited condensed consolidated financial statements as of September 30, 2007, and for the three months ended September 30, 2007 and 2006 have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission, and include the accounts of Avanex. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position at September 30, 2007, the consolidated operating results for the three months ended September 30, 2007 and 2006, and the consolidated cash flows for the three months ended September 30, 2007 and 2006. The consolidated results of operations for the three months ended September 30, 2007 and 2006 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2008.

The condensed consolidated balance sheet at June 30, 2007 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying unaudited condensed financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes for the year ended June 30, 2007, contained in its Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 7, 2007.

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes— an interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” It prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. This Interpretation was effective for our fiscal year beginning July 1, 2007. The adoption of FIN 48 did not have a material impact on our consolidated balance sheet and statement of operations.

2. Stock-Based Compensation

Determining Fair Value

Valuation and amortization method—The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula and a single-option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

Expected Term—The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and is determined based on the SEC Staff Accounting Bulletin 107 simplified method.

Expected Volatility—The Company’s volatility factor is estimated using the Company’s stock price history.

Expected Dividend—The Black-Scholes valuation model calls for a single expected dividend yield as an input. The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends in the future.

Risk-Free Interest Rate—The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Company’s stock-based awards does not correspond with the term for which interest rates are quoted, the Company performs a straight-line interpolation to determine the rate from the available term maturities.

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Fair Value—Fair value of the Company’s stock options granted to employees for the three months ended September 30, 2007 and 2006 was estimated using the following weighted-average assumptions:


	Three Months Ended September 30,
	2007			2006
Option Plan Shares:
Expected term (in years)		6.25			6.25
Volatility		75	%		81.0	%
Expected dividend		0	%		0	%
Risk-free interest rate		4.32	%		4.60	%
Weighted-average fair value	$	1.89		$	1.24

ESPP Shares:
Expected term (in years)		1.00			1.00
Volatility		76.0	%		81.0	%
Expected dividend		0	%		0	%
Risk-free interest rate		4.15	%		4.86	%
Weighted-average fair value	$	0.77		$	0.69

Stock-Based Compensation Expense

Under the provisions of Statement of Financial Accounting Standards No. 123(R) (“SFAS 123(R)”) “Share-Based Payment,” effective July 1, 2005, we recorded $3.4 million and $1.9 million of stock compensation expense in our consolidated statements of operations for the three months ended September 30, 2007 and 2006, respectively. Of the $3.4 million recorded, $1.6 million relates to the Company’s fiscal 2007 bonus, which was paid out as restricted stock in the first quarter of fiscal 2008 and was previously accrued for as bonus expense in the June 30, 2007 financial statements.

At September 30, 2007, the total stock-based compensation expense related to unvested stock options granted to employees under the Company’s stock option plans but not yet recognized was approximately $9.2 million, net of estimated forfeitures of $3.5 million. This expense will be amortized on a straight-line basis over a weighted-average period of approximately 2.9 years and will be adjusted for subsequent changes in estimated forfeitures.

The amortization of stock-based compensation expense under SFAS 123(R) for the three months ended September 30, 2007 and 2006 is based on the single-option approach.

Stock Option Activity

The Company issues new shares of common stock upon exercise of stock options. Stock option activity for the three months ended September 30, 2007 is summarized below:


	Number of Shares		Weighted- average Exercise Price		Weighted- average Remaining Contractual Term in Years	Aggregate Intrinsic Value, in thousands
Outstanding at July 1, 2007	13,312,450		$	4.20	6.6	$	1,889
Granted	451,900		$	1.89
Exercised	(219,359	)	$	0.97
Canceled	(882,098	)	$	3.65

Outstanding at September 30, 2007	12,662,893		$	4.22	6.9	$	1,077

Vested and expected to vest at September 30, 2007	11,262,350		$	4.53	6.7	$	921

Exercisable at September 30, 2007	7,716,816		$	5.81	5.7	$	626

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Aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for the 2.1 million options that were in-the-money at September 30, 2007 and for the 2.9 million options that were in-the-money at September 30, 2006. During the three months ended September 30, 2007 and 2006, the aggregate intrinsic value of options exercised under the Company’s stock option plans was $201,000 and $12,000, respectively. Intrinsic value was determined as of the date of option exercise.

Restricted Stock Unit Activity

The Company issues new shares of common stock upon the vesting of restricted stock units. Restricted stock unit activity for the three months ended September 30, 2007 is summarized below:


	Number of Shares		Weighted- average Exercise Price		Weighted- average Remaining Contractual Term in Years	Aggregate Intrinsic Value, in thousands
Outstanding at July 1, 2007	4,206,895		$	0.001	1.3	$	7,575
Awarded	996,074		$	0.001
Released	(1,365,266	)	$	0.001
Forfeited	(208,626	)	$	0.001

Outstanding at September 30, 2007	3,629,077		$	0.001	1.2	$	5,948

Vested and expected to vest at September 30, 2007	2,638,168		$	0.001	1.0	$	4,324

Aggregate intrinsic value is calculated as the difference between the exercise price of the shares and the quoted price of the Company’s common stock for the 3.6 million of outstanding restricted stock units at September 30, 2007, all of which were in-the-money. During the three months ended September 30, 2007 and 2006, the aggregate intrinsic value of restricted stock units vesting was $2.3 million and $3.3 million, respectively. Intrinsic value was determined as of the date the restricted stock unit vested.

Employee Stock Purchase Plan (“ESPP”) Activity

During the three months ended September 30, 2007 and 2006, 222,192 and 202,552 shares were issued at weighted-average purchase prices of $0.95 and $0.84, respectively, in connection with the ESPP. During the three months ended September 30, 2007 and 2006, the aggregate intrinsic value of options exercised under the Company’s ESPP was $152,000 and $94,000, respectively.

3. Inventories

Inventories consist of raw materials, work-in-process and finished goods and are stated at the lower of cost or market. Cost is computed on a standard basis, which approximates actual costs on a first-in, first-out basis. Inventories consisted of the following (in thousands):


	September 30, 2007		June 30, 2007
Raw materials	$	6,742	$	4,781
Work-in-process		562		591
Finished goods		8,200		9,816
	$	15,504	$	15,188

In the three months ended September 30, 2007 and 2006, the Company recorded charges to cost of revenue for the write-off of excess and obsolete inventory of $1.4 million and $3.5 million, respectively.

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4. Restructuring

A summary of the Company’s accrued restructuring expense and accrued restructuring liability is as follows (in thousands):


	Expense for Three Months Ended September 30, 2007			Balance June 30, 2007			Accrued		Paid			Recovered			Balance September 30, 2007
Workforce reduction, fiscal 2004	$	—		$	—		$	—	$	—		$	—		$	—
Workforce reduction, fiscal 2005		—			11			—		(11	)		—			—
Workforce reduction, fiscal 2006		—			—	��		—		—			—			—
Abandonment of excess leased facilities		(335	)		11,095			16		(707	)		(351	)		10,053

Total restructuring	$	(335	)	$	11,106		$	16	$	(718	)	$	(351	)	$	10,053

The portions of accrued restructuring liability that are expected to be paid by September 30, 2008 are $2.8 million. The liability related to abandoned facilities will be paid out through fiscal 2011.

5. Acquisition of Essex

On July 2, 2007, the Company purchased certain assets from Essex Corporation (“Essex”), a subsidiary of Northrop Grumman Space and Mission Systems Corporation, for $2.2 million in cash, including $0.2 million of direct transaction costs incurred in connection with the acquisition. The Company acquired the assets relating to the MSA 300-pin transponder and XFP transceiver businesses of the Commercial Communication Products Division of Essex.

The transaction was accounted for as a purchase of assets in accordance with Statement of Financial Accounting Standards No. 141, “Business Combination” (“SFAS 141”); therefore, the tangible assets acquired were recorded at fair value on the acquisition date.

In allocating the purchase price based on estimated fair values, we recorded approximately $1.6 million and $0.6 million of tangible and intangible assets acquired, respectively. The tangible assets consist of $1.1 million of fixed assets, $0.3 million of inventory, and $0.2 million of prepaid rent, while the intangible assets consist of $0.3 million for technology and $0.3 million for a non-compete agreement. The allocation of the purchase price was based upon assessments by management of the fair value of the assets acquired.

6. Warranties

In general, the Company provides a product warranty for one year from the date of shipment. The Company accrues for the estimated costs of product warranties during the period in which revenue is recognized. The Company estimates the costs of its warranty obligations based on its historical experience and expectation of future conditions. To the extent the Company experiences increased warranty claim activity or increased costs associated with servicing those claims, the Company’s warranty costs will increase resulting in decreases to gross profit. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

Changes in the Company’s accrued product warranty liability are as follows (in thousands):

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	Three Months Ended September 30,
	2007			2006
Balance at beginning of period	$	873		$	1,799
Accrual for sales during the period		161			136
Cost of warranty repair		(192	)		(134	)
Adjustment to prior sales (including expirations and changes in estimates)		—			(56	)

Balance at end of period	$	842		$	1,745

7. Income Taxes

The Company recorded an income tax provision of $274,000 for the three months ended September 30, 2007. For the three months ended September 30, 2006 the Company recorded no provision for income taxes. The higher income tax provision for the three months ended September 30, 2007 as compared to the same period in 2006 primarily reflects higher foreign income during the period in 2007 as compared to 2006.

As of September 30, 2007, our deferred tax assets are fully offset by a valuation allowance. The Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes,” provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes Avanex’s historical operating performance and reported cumulative net losses since inception the Company provided a full valuation allowance against its net deferred tax assets. We reassess the need for our valuation allowance on a quarterly basis. If it is later determined that a portion of the valuation allowance should be reversed it will be a benefit to the income tax provision.

Effective July 1, 2007, the Company adopted Financial Accounting Standards Interpretation, No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement guidance for the financial statement reporting of uncertain tax positions taken or expected to be taken in a company’s income tax return. FIN 48 also provides guidance related to derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition matters related to uncertain tax positions. FIN 48 utilizes a two-step approach for evaluating uncertain tax positions accounted for in accordance with SFAS 109. Step one, Recognition, requires a company to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. Step two, Measurement, is based on the largest amount of benefit, which is more likely than not to be realized on ultimate settlement. The cumulative effect of adopting FIN 48, if any, is recorded as an adjustment to the opening balance of retained earnings as of the adoption date.

As a result of the implementation of FIN 48, the Company recognized no change in the liability for unrecognized tax benefits related to tax positions taken in prior periods.

Upon adoption of FIN 48, the Company’s policy to include interest and penalties related to unrecognized tax benefits within the Company’s provision for (benefit from) income taxes did not change. At September 30, 2007, the Company had nothing accrued for payment of interest and penalties related to unrecognized tax benefits.

As of adoption, the Company’s total unrecognized tax benefits were $6,325,000, none of which, if recognized, would affect its effective tax rate. Tax years 2004 through 2006 and 2003 through 2006 for domestic and foreign taxes, respectively, remain open to examination.

8. Net Income (Loss) per Share and Comprehensive Income (Loss)

The following table presents the calculation of basic and diluted net income (loss) per share, and comprehensive income (loss) (in thousands, except per share data):


	Three Months Ended September 30,
	2007			2006
Net income (loss)	$	45		$	(9,714	)

Shares used to compute basic net income (loss) per share		226,749			205,389
Potentially dilutive shares used to compute net income per share on a diluted basis		4,078			—

Shares used to compute diluted net income (loss) per share		230,827			205,389

Net income (loss) per share:
Basic	$	0.00		$	(0.05	)

Diluted	$	0.00		$	(0.05	)

Net income (loss)	$	45		$	(9,714	)
Unrealized gain on investments		8			25
Amortization of actuarial gain recognized in accumulated other comprehensive income		(8	)		—
Cumulative translation adjustment		86			(121	)

Comprehensive income (loss)	$	131		$	(9,810	)

During the periods presented, the Company had securities outstanding that could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per share, as their effect would have been anti-dilutive. The anti-dilutive securities are as follows:


	Balance at September 30,
	2007	2006
Employee stock options	12,165,131	11,971,744
Employee restricted stock units	2,802,098	3,284,982
8% convertible notes	—	5,555,556
Warrants attached to 8% convertible notes	5,184,948	8,237,689
Warrants granted to landlord	60,000	60,000
Warrants attached to March 2006 equity securities offering	7,339,727	7,222,500
Warrants attached to March 2007 equity securities offering	2,698,764	—

	30,250,668	36,332,471

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9. Related Party Transactions

On July 31, 2003, Alcatel (now known as Alcatel-Lucent) was issued 28% of the Company’s common stock in connection with the acquisitions of certain businesses of Alcatel. As of September 30, 2007 and June 30, 2007, Alcatel-Lucent owned 12% and 13%, respectively, of the outstanding shares of Avanex common stock. The Company sells products to and purchases raw materials and components from Alcatel-Lucent in the regular course of business. Additionally, Alcatel-Lucent provides certain administrative and other transitional services to the Company.

Amounts sold to and purchased from related parties were as follows (in thousands):


	Three Months Ended September 30,
	2007*		2006
Related party transactions
Sales to related parties	$	13,314	$	13,537
Purchases from related parties in cost of revenue		1		5
Administrative and transitional services purchased from related parties		—		(11	)

*	On November 30, 2006, the merger of Alcatel and Lucent was completed and the combined company was named “Alcatel-Lucent.” As a result, we have included both Alcatel and Lucent transactions in the related party disclosure beginning December 1, 2006.

Amounts due from and due to related parties (in thousands):


	September 30, 2007*		June 30, 2007*
Due from related parties	$	15,657	$	14,381
Due to related parties		2,144		2,144

*	On November 30, 2006, the merger of Alcatel and Lucent was completed and the combined company was named ”Alcatel-Lucent.” As a result, we have included both Alcatel and Lucent transactions in the related party disclosure for September 30, 2007 and June 30, 2007.

On October 29, 2007, the Pirelli Group announced that it had agreed to acquire all the shares of the Company's common stock held by Alcatel-Lucent.

10. Disclosures about Segments of an Enterprise

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for the way public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers.

The Company’s chief operating decision maker is considered to be the Company’s Chief Executive Officer (“CEO”). The CEO reviews the Company’s financial information presented on a consolidated basis substantially similar to the accompanying consolidated financial statements. Therefore, the Company has concluded that it operates in one segment, to manufacture and market photonic processors, and accordingly has provided only the required enterprise-wide disclosures. The Company has adopted a matrix management organizational structure whereby management of worldwide activities is on a functional basis.

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Customers who represented 10% or more of our net revenue or accounts receivable were as follows:


	Percentage of Net Revenue				Percent of Accounts Receivable at
	September 30,				Sept. 30,		June 30,
	2007		2006		2007		2007
Company A	24	%	27	%	25	%	24	%
Company B	17	%	10	%	15	%	10	%
Company C	*		12	%	*		*
	41	%	49	%	40	%	34	%

*	less than 10%

Revenues by geographical area were as follows (in thousands):


	Three Months ended September 30,
	2007		2006
Americas	$	24,108	$	23,904
Europe		16,787		19,975
Asia-Pacific		13,814		7,012

Total	$	54,709	$	50,891

11. Disposition

On February 28, 2007, the Company entered into a share purchase agreement with Global Research Company, a société à responsibilité limitée incorporated under the laws of France (“GRC”), and Mr. Didier Sauvage, an individual and former employee of the Company (together with GRC, the “Purchasers”), pursuant to which the Company sold ninety percent (90%) of the share capital and voting rights of its wholly owned subsidiary, Avanex France, a société anonyme incorporated under the laws of France, which owned the Company’s semiconductor fabs and associated product lines located in Nozay, France, to the Purchasers for the nominal amount of €1.00. The sale closed on April 16, 2007. The Purchasers changed the name of Avanex France to “3S Photonics” following the closing.

The sale involved the divestiture of the Company’s laser, terrestrial and submarine pumps and Fiber Bragg Grating product lines. The Company will continue to operate its optical interfaces (OIF) business and optical fiber amplifiers and raman amplifiers business, which have been transferred to a new wholly owned subsidiary of the Company in France prior to the closing.

The sale resulted in a loss to the Company of approximately $3.2 million primarily as a result of the approximately $24.9 million cash paid, transaction expenses incurred of approximately $1.0 million, and transfer of approximately $4.3 million of assets, partially offset by approximately $15.9 million of liabilities written-off, the assumption of approximately $6.7 million of liabilities by 3S Photonics, the write-off of cumulative translation gain related to Nozay of approximately $3.3 million, and a reduction of the pension obligation of approximately $1.1 million related to the sale.

In July 2007, the Company and 3S Photonics entered into a Settlement Agreement that finalized the cash payments between the two parties under the share purchase agreement. As part of this agreement, the Company placed in an escrow account the amount of 2 million Euros to provide for payment of certain vendor liabilities discovered by 3S Photonics. In the event that the liabilities presented for payment by 3S Photonics do not exceed the 2 million Euros prior to the expiration of the escrow agreement in January 2008, then such unused funds will be returned to the Company. The cash placed in escrow has been classified as restricted cash as of September 30, 2007. As of September 30, 2007, no amounts have been disbursed from the escrow funds.

In July 2007, the Company and 3S Photonics entered into an amended distribution agreement that provided 3S Photonics with the right in April 2008 to terminate the Company’s global distributor agreement with 3S Photonics, except for one customer, Alcatel-Lucent, for which 3S Photonics has the right to extend the term of the global distributor agreement for an additional year provided it notifies the Company in writing of such intent. The amended distribution agreement also provides 3S Photonics with the opportunity to terminate the entire global distributor agreement early in exchange for a cash payment by 3S Photonics to Avanex, calculated on the timing of the termination. Beginning with the quarter ended September 30, 2007 and continuing for six quarters in total, 3S Photonics will provide Avanex with free product under the global distributor agreement in the amount of 415,806 Euros per quarter in exchange for Avanex continuing to provide sales and distribution services under the global distributor agreement. In the three months ended September 30, 2007, the Company reduced cost of goods sold for this product credit by approximately $593,000.

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12. Litigation

IPO Class Action Lawsuit

On August 6, 2001, Avanex, certain of its officers and directors, and various underwriters in its initial public offering (“IPO”) were named as defendants in a class action filed in the United States District Court for the Southern District of New York, captioned Beveridge v. Avanex Corporation et al., Civil Action No. 01-CV-7256. This action and other subsequently filed substantially similar class actions have been consolidated into In re Avanex Corp. Initial Public Offering Securities Litigation, Civil Action No. 01 Civ. 6890. The consolidated amended complaint in the action generally alleges that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in Avanex’s IPO. Plaintiffs have brought claims for violation of several provisions of the federal securities laws against those underwriters, and also against Avanex and certain of its directors and officers, seeking unspecified damages on behalf of a purported class of purchasers of Avanex’s common stock between February 3, 2000 and December 6, 2000. Various plaintiffs have filed similar actions asserting virtually identical allegations against more than 40 investment banks and 250 other companies. All of these “IPO allocation” securities class actions currently pending in the Southern District of New York have been assigned to Judge Shira A. Scheindlin for coordinated pretrial proceedings as In re Initial Public Offering Securities Litigation, 21 MC 92. On October 9, 2002, the claims against Avanex’s directors and officers were dismissed without prejudice pursuant to a tolling agreement. The issuer defendants filed a coordinated motion to dismiss all common pleading issues, which the Court granted in part and denied in part in an order dated February 19, 2003. The Court’s order did not dismiss the Section 10(b) or Section 11 claims against Avanex.

In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including Avanex, was submitted to the Court for approval. On August 31, 2005, the Court preliminarily approved the settlement. In December 2006, the appellate court overturned the certification of classes in the six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. Because class certification was a condition of the settlement, it was unlikely that the settlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints in the six focus cases. It is uncertain whether there will be any revised or future settlement. If a settlement does not occur, and litigation against Avanex continues, Avanex believes it has meritorious defenses and intends to defend the action vigorously. Nevertheless, an unfavorable result in litigation may result in substantial costs and may divert management’s attention and resources, which could seriously harm our business, financial condition, results of operations or cash flow in a particular period.

Section 16(b) Demand

On October 3, 2007, a purported Avanex shareholder filed a complaint for violation of Section 16(b) of the Securities Exchange Act of 1934, which prohibits short-swing trading, against the Company's IPO underwriters. The complaint, Vanessa Simmonds v. Morgan Stanley, et al., Case No. C07-01568, filed in District Court for the Western District of Washington, seeks the recovery of short-swing profits. The Company is named as a nominal defendant. No recovery is sought from the Company.

13. Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“Statement 157”). Statement 157 defines fair value, establishes a framework for measuring fair value and expands fair value measurement disclosures. Statement 157 is effective for our fiscal year beginning July 1, 2008. We are currently evaluating the impact of the adoption of Statement 157 on our consolidated balance sheet and statement of operations.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“Statement 159”), which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to fair value will be recognized in earnings. Statement 159 also establishes additional disclosure requirements. Statement 159 is effective for our fiscal year beginning July 1, 2008, with early adoption permitted provided that the entity also adopts Statement 157. We are currently evaluating the impact of the adoption of Statement 159 on our consolidated balance sheet and statement of operations.

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14. Subsequent Event

On October 29, 2007, Pirelli Group announced that it had agreed to acquire all the shares of the Company's common stock held by Alcatel-Lucent amounting to approximately 12.4% of the outstanding shares of Avanex common stock.

Further on October 29, 2007, the Company announced that it had entered into a new three-year supply agreement with Alcatel-Lucent from the date the Pirelli Group acquires the shares of common stock held by Alcatel-Lucent. Such agreement governs terms of purchases by Alcatel-Lucent from the Company and includes minimum purchase commitments.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements contained in this Quarterly Report on Form 10-Q that are not purely historical are “forward-looking statements” within the meaning of the federal securities laws, including, without limitation, statements regarding our anticipated cost of revenue, operating expenses, gross margins, anticipated savings from our restructuring and cost reduction plans, and statements regarding our expectations, beliefs, anticipations, commitments, intentions and strategies regarding the future. In some cases forward-looking statements can be identified by terms such as “may,” “could,” “would,” “might,” “will,” “should,” “expect,” “plan,” “intend,” “ forecast,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or the negative of these terms or other comparable terminology. Actual results could differ from those projected in any forward-looking statements, which are made as of the date of this Form 10-Q, and we assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements.

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and our audited consolidated financial statements and notes for the year ended June 30, 2007, included in our Annual Report on Form 10-K filed with the SEC on September 7, 2007.

Overview

We design, manufacture and market fiber optic-based products, known as photonic processors, which are designed to increase the performance of optical networks. We sell our products to telecommunications system integrators and their network carrier customers. We were incorporated in October 1997 in California and reincorporated in Delaware in January 2000. We began making volume shipments of our products during the quarter ended September 30, 1999.

In fiscal 2004, we assumed restructuring liabilities with fair values of $64.1 million at the date of acquisition of the optical components businesses of Alcatel-Lucent and Corning, which were included in the purchase price. Subsequent to these acquisitions, we have continued to restructure our organization, primarily through the downsizing of our workforce and the abandonment of excess facilities. As of September 30, 2007, our accrued restructuring liability balance was $10.1 million, consisting of excess facilities costs payable through fiscal 2011.

The restructurings have resulted in, among other things, a significant reduction in the size of our workforce, consolidation of our facilities, and increased reliance on outsourced, third-party manufacturing. In March 2005, we announced that we had opened an operations center in Thailand to centralize global manufacturing and operational overhead functions in a lower-cost region. In July 2005, we announced the opening of a development and marketing office in Shanghai, China. In March 2007, we announced the sale of ninety percent (90%) of the share capital and voting rights of our wholly owned subsidiary, Avanex France, which operated our semiconductor fabs and associated product lines located in Nozay, France. This transaction closed on April 16, 2007.

Although we have relocated most of our manufacturing operations to reduce our production costs, we expect to continuously take actions to further reduce costs and improve our gross margins. However, there can be no assurance that our cost structure will not increase in the future or that we will be able to align our cost structure with our expectations.

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Net Revenue. The market for optical equipment continues to evolve and the volume and timing of orders is difficult to predict. A customer’s decision to purchase our products typically involves a commitment of its resources and a lengthy evaluation and product qualification process. This initial evaluation and product qualification process typically takes several months and includes technical evaluation, integration, testing, planning and implementation into the equipment design. Implementation cycles for our products can be lengthy, and the practice of customers in the communications industry to sporadically place orders with short lead times may cause our net revenue, gross margin, operating results and the identity of our largest customers to vary significantly and unexpectedly from quarter to quarter.

To date, a substantial proportion of our sales have been concentrated with a limited number of customers. Two customers accounted for 24% and 17% of our net revenue, respectively, for the three months ended September 30, 2007. Three customers accounted for 27%, 12% and 10% of our net revenue, respectively, for the three months ended September 30, 2006. We expect that a substantial portion of our sales will remain concentrated with a limited number of customers, as evidenced by the increase in customer concentration.

Cost of Revenue. Our cost of revenue consists of costs of components and raw materials, direct labor, warranty, manufacturing overhead, payments to our contract manufacturers and inventory write-offs for obsolete and excess inventory. We rely on a single or limited number of suppliers to manufacture some key components and raw materials used in our products, and we rely on the outsourcing of some turnkey solutions.

We write off the cost of inventory that we specifically identify and consider obsolete or in excess of future sales estimates. We define obsolete inventory as products that we no longer market, for which there is no demand, or inventory that will no longer be used in the manufacturing process. Excess inventory is generally defined as inventory in excess of projected usage, and is determined using management’s best estimate of future demand at the time, based upon information then available to us. We wrote off excess and obsolete inventory of $1.4 million and $3.5 million in the three months ended September 30, 2007 and 2006, respectively.

Gross Margin.Gross margin represents revenue less cost of revenue. During the three months ended September 30, 2007, gross margin increased to 28% of revenue, which was an increase in gross margin of 18 percentage points over our gross margin of 10% in the three months ended September 30, 2006. The increase was due to a more profitable mix of products sold to our customers, decreased vendor costs, improved yields, and cost reductions resulting from having our design and operations teams working with our contract manufacturers to lower production costs.

Research and Development Expenses. Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers, costs of allocated facilities, non-recurring engineering charges, and prototype costs related to the design, development, testing, pre-manufacturing, and significant improvement of our products. We expense our research and development costs as they are incurred. We believe that research and development is critical to our strategic product development objectives. We further believe that, in order to meet the changing requirements of our customers, we must continue to fund investments in several development projects in parallel.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, commissions, and related personnel costs of employees in sales, marketing, customer service, and application engineering functions, costs of allocated facilities, and promotional and other marketing expenses.

General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related personnel costs for executive, finance, accounting, legal, and human resources personnel, costs of allocated facilities, recruiting expenses, professional fees, and other corporate expenses.

Amortization of Intangible Assets. A portion of the purchase price in a business combination is allocated to goodwill and intangibles. Goodwill is not amortized, but rather is assessed for impairment at least annually. Intangible assets with definite lives continue to be amortized over their estimated useful lives.

Restructuring. Restructuring expense generally includes employee severance costs and the costs of excess facilities associated with formal restructuring plans.

Gain on Disposal of Property and Equipment. Gain on disposals includes gains incurred as a result of disposal of property, plant, or equipment for an amount greater than the net book value.

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Interest and Other Income. Interest and other income consist primarily of interest earned from the investment of our cash and cash equivalents, short-term investments, and long-term investments.

Interest and Other Expense. Interest and other expense consists primarily of interest expense associated with borrowings under our line of credit, senior secured convertible notes, capital lease obligations, equipment loans, and foreign currency exchange rate loss.

Income Taxes. In accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”), we recognize income taxes using an asset and liability approach. This approach requires the recognition of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. The measurement of current and deferred taxes is based on provisions of the enacted tax law and the effects of future changes in tax laws or rates are not anticipated.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, net revenues and expenses, and related disclosures. We believe our estimates and assumptions are reasonable; however, actual results and the timing of the recognition of such amounts could differ from these estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. Our revenue recognition policy complies with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition.” We recognize product revenue when persuasive evidence of an arrangement exists, the product has been shipped, risk of loss has been transferred, collectibility is reasonably assured, fees are fixed or determinable and there are no uncertainties with respect to customer acceptance. We record a provision for estimated sales returns and price adjustments in the same period as when the related revenues are recorded. These estimates are based on historical sales returns and adjustments, other known factors, and our return policy. If future sales returns or price adjustment levels differ from the historical data we use to calculate these estimates, changes to the provision may be required. We generally do not accept product returns from customers; however, we do sell our products under warranty. The specific terms and conditions of our warranties vary by customer and region in which we do business; the warranty period is generally one year.

Allowance for Doubtful Accounts. In the last three years, our uncollectible accounts experience has been almost zero. When we become aware, subsequent to delivery, of a customer’s potential inability to meet its obligations, we record a specific allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Such an allowance may be magnified due to the concentration of our sales to a limited number of customers. At September 30, 2007, we determined that an allowance of $172,000 was required due to the uncertainty of collections from one customer.

Excess and Obsolete Inventory. We write off the cost of inventory that we specifically identify and consider obsolete or excessive to fulfill future sales estimates. We define obsolete inventory as products that we no longer market or for which there is no demand, or inventory that will no longer be used in the manufacturing process. Excess inventory is generally defined as inventory in excess of projected usage, and is determined using management’s best estimate of future demand at the time, based upon information then available to us.

In estimating excess inventory, we use a range of six-month to twelve-month demand forecast. We assess inventory on a quarterly basis and write-down those inventories which are obsolete or in excess of our forecasted usage to their estimated realizable value. Our estimates of realizable value are based upon our analysis including, but not limited to forecasted sales levels by product, expected product life cycle, product development plans, and future demand requirements. Our marketing department plays a key role in our excess review process by providing updated sales forecasts, managing product rollovers, and working with sub-contract manufacturing to maximize recovery of excess inventory. If actual market conditions are less favorable than our forecasts or actual demand from our customers is lower than our estimates, we may be required to record additional inventory write downs. If actual market conditions are more favorable than anticipated, inventory previously written down may be sold, resulting in lower cost of sales and higher income from operations than expected in that period.

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Stock-based Compensation Expense. We account for employee stock-based compensation costs in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) and Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). We utilize the Black-Scholes option pricing model to estimate the fair value of employee stock-based compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical volatility was used in estimating the fair value of our stock-based awards, and the expected life was estimated to be 6.25 years using the simplified method permitted under SAB 107. Further, as required under SFAS 123(R), we now estimate forfeitures for options granted that are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. The estimated fair value is charged to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. Accordingly, our estimate of fair value may not represent the value assigned by a third-party in an arms-length transaction. While our estimate of fair value and the associated charge to earnings materially impacts our results of operations, it has no impact on our cash position.

Goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recorded in net income (loss). We operate in one segment, which we consider our sole operating unit. Measurement of the fair value of the reporting unit in our annual test for impairment in June is determined using the market capitalization approach. The capitalization approach focuses on the fair value of the enterprise, which is determined based on our current market capitalization.

Impairment of Long-lived Assets. We evaluate the recoverability of long-lived assets in accordance with SFAS No.144, “Accounting for the Impairment or Disposal of Long-lived Assets.” When events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, we recognize such impairment in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets.

Warranties. In general, we provide a product warranty for one year from the date of shipment. We accrue for the estimated cost to provide warranty services at the time revenue is recognized. The specific terms and conditions of our warranties vary by customer and region in which we do business. Our estimate of costs to service our warranty obligations is based on historical experience and expectation of future conditions. To the extent we experience increased warranty claim activity or increased costs associated with servicing those claims, our warranty costs will increase resulting in decreases to gross profit. Conversely, to the extent we experience decreased warranty claim activity, or decreased costs associated with servicing those claims, our warranty costs will decrease resulting in increases to gross profit. We periodically assess the adequacy of our recorded warranty liabilities and adjust the amounts as necessary.

Restructuring. During the past few years we have recorded significant accruals in connection with restructuring programs. Given the significance and complexity of restructuring activities, and the timing of the execution of such activities, the restructuring accrual process involves periodic reassessments of estimates made at the time the original decisions were made, including evaluating real estate market conditions for expected vacancy periods and sub-lease rents. Although we believe that these estimates accurately reflect the costs of the restructuring programs, actual results may differ, thereby requiring us to record additional provisions or reverse a portion of such provisions.

Purchase Accounting. We account for business combinations under the purchase method of accounting and accordingly, the assets acquired and liabilities assumed are recorded at their fair values. The recorded values of assets and liabilities are based on management estimates making use of third-party valuations, or if market price information is not available, based on the best information available. The values are based on our judgments and estimates, and accordingly, our financial position or results of operations may be affected by changes in these estimates and judgments. Specifically, our valuation of intangible assets is based on a discounted cash flow valuation methodology that incorporates estimates of future revenue, revenue growth, expenses, estimated useful lives, balance sheet assumptions and weighted average cost of capital.

Contingencies. We are or have been subject to proceedings, lawsuits and other claims related to our initial public offering and other matters. We evaluate contingent liabilities including threatened or pending litigation in accordance with SFAS No. 5, “Accounting for Contingencies”. If the potential loss from any claim or legal proceedings is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based upon management’s judgment and the best information available to management at the time. As additional information becomes available, we reassess the potential liability related to its pending claims and litigation and may revise its estimates.

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In addition to product warranties, we, from time to time, in the normal course of business, indemnify certain customers with whom we enter into contractual relationships. We have agreed to hold the other party harmless against third party claims that our products, when used for their intended purpose, infringe the intellectual property rights of such third party or other claims made against certain parties. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to the limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in each particular claim. The estimated fair value of these indemnification provisions is minimal. To date, we have not incurred any costs related to claims under these provisions, and no amounts have been accrued in the accompanying financial statements.

Income Taxes. We account for income taxes under the liability method, which recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax bases of assets and liabilities and their financial statement reported amounts, and for net operating loss and tax credit carryforwards. We record a valuation allowance against deferred tax assets when it is more likely than not that such assets will not be realized.

Results of Operations

The following table sets forth, for the periods indicated, our Condensed Consolidated Statements of Operations, expressed as amounts in thousands and as percentages of net revenue. Our historical operating results are not necessarily indicative of our results for any future period.


	Three Months Ended September 30,
	2007			% of revenue		2006			% of revenue
Net revenue	$	54,709		100	%	$	50,891		100	%
Cost of revenue		39,517		72	%		45,579		90	%

Gross profit		15,192		28	%		5,312		10	%
Operating expenses:
Research and development		6,774		13	%		5,625		11	%
Sales and marketing		3,915		7	%		3,548		7	%
General and administrative		4,475		8	%		5,651		11	%
Amortization of intangibles		559		1	%		852		2	%
Restructuring		(335	)	-1	%		(63	)	0	%
Gain on disposal of property and equipment		—		—			(20	)	0	%

Total operating expenses		15,388		28	%		15,593		31	%

Loss from operations		(196	)	0	%		(10,281	)	-20	%
Interest and other income		526		1	%		839		2	%
Interest and other expense		(11	)	0	%		(272	)	-1	%

Income (loss) before income taxes		319		1	%		(9,714	)	-19	%
Provision for income taxes		(274	)	-1	%		—		0	%

Net income (loss)	$	45		0	%	$	(9,714	)	-19	%

Net Revenue

Net revenue for the three months ended September 30, 2007 was $54.7 million, which represents an increase of $3.8 million, or 8%, from net revenue of $50.9 million for the three months ended September 30, 2006. The increase in net revenue was attributable to an overall increase in demand for our current and new products from existing customers.

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To date, a substantial portion of our sales has been concentrated with a limited number of customers. For the three months ended September 30, 2007 and 2006, sales to customers that each comprised 10% or more of net revenue were as follows:


	Three Months Ended September 30,
	2007		2006
Company A	24	%	27	%
Company B	17	%	10	%
Company C	—		12	%

	41	%	49	%

While we have substantially diversified our customer base, we expect that a substantial portion of our sales will remain concentrated with a limited number of customers. Sales to our major customers vary significantly from period to period, and we do not have the ability to predict future sales to these customers.

Net revenue from customers outside the United States accounted for $38.2 million and $33.7 million of total net revenue, or 70% and 66%, for the three months ended September 30, 2007 and 2006, respectively.

Cost of Revenue and Gross Margin

Cost of revenue for the three months ended September 30, 2007 was $39.5 million, compared to $45.6 million for the three months ended September 30, 2006, a decrease of $6.1 million. The decrease was primarily due to improvements from supply-chain, product portfolio, new product introductions, capacity and yield improvement programs and focus on operational manufacturing processes.

We wrote off excess and obsolete inventory of $1.4 million and $3.5 million for the three months ended September 30, 2007 and 2006, respectively. This write-off was primarily due to lower demand for certain products and lower expected usage of previously purchased inventory. The reduction in the write-off of excess and obsolete inventory was primarily due to improved accuracy in predicting the demand for our products, the product mix ordered by our customers, and increased efforts to recover and use this inventory. For the three months ended September 30, 2007 and 2006, we sold inventory previously written-off with original costs totaling $167,000 and $201,000, respectively, due to unforeseen demand for such inventory. As a result, cost of revenue associated with the sale of this inventory was zero. The selling price of the finished goods that included these components was similar to the selling price of products that did not include components that were written-off. These items were subsequently used and sold because customers ordered products that included these components in excess of our estimates.

Cost of revenue as a percentage of net revenue improved from the three months ended September 30, 2006 to the three months ended September 30, 2007 due to a number of factors. Manufacturing overhead as a percentage of net revenue decreased as we completed the outsourcing of our manufacturing to contract manufacturers in lower-cost regions. Also, direct manufacturing costs as a percentage of net revenue decreased due to the lower cost of direct labor in these lower cost regions and improvement in our supply chain management. These favorable factors were assisted by lower write-offs of excess and obsolete inventory. Consequently, our gross margin percentage improved from 10% for the three months ended September 30, 2006 to 28% for the three months ended September 30, 2007. In addition, the improvement in gross margin percentage was driven by a shift to products with higher volume and higher gross margins.

Our gross margins are and will be primarily affected by changes in mix of products sold, manufacturing volume, changes in sales prices, product demand, inventory write-downs, sales of previously written-off inventory, warranty costs, and product yields. We expect cost of revenue, as a percentage of net revenue, to fluctuate from period to period.

Research and Development

Research and development expenses increased $1.2 million to $6.8 million for the three months ended September 30, 2007 from $5.6 million for the three months ended September 30, 2006. The increase was primarily due to an increase in headcount, primarily due to our acquisition of Essex and at our development center in Shanghai. As a percentage of net revenue, research and development expenses increased to 13% for the three months ended September 30, 2007 from 11% for the three months ended September 30, 2006. We expect our research and development expenses to remain level as a percentage of net revenue in the current fiscal year. Despite our continued efforts to reduce expenses, there can be no assurance that our research and development expenses will not increase in the future.

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Sales and Marketing

For the three months ended September 30, 2007, sales and marketing expenses increased $0.4 million to $3.9 million from $3.5 million for the three months ended September 30, 2006. The increase in sales and marketing expense was primarily due to increased headcount in Shanghai. As a percentage of net revenue, sales and marketing expenses remained level at 7% for the three months ended September 30, 2007 and 2006. We expect our sales and marketing expenses as a percentage of net revenue to remain level or decline in the current fiscal year. Despite our continued efforts to reduce expenses, there can be no assurance that our sales and marketing expenses will not increase in the future.

General and Administrative

General and administrative expenses were $4.5 million for the three months ended September 30, 2007, a decrease of $1.2 million from expenses of $5.7 million for the three months ended September 30, 2006. As a percentage of net revenue, general and administrative expenses decreased to 8% in the three months ended September 30, 2007 from 11% in the three months ended September 30, 2006. The decrease in general and administrative expenses was primarily driven by decreased audit and consulting expenses. We expect our general and administrative expenses to decline as a percentage of revenue in the current fiscal year. Despite our continued efforts to reduce expenses, there can be no assurance that our general and administrative expenses will not increase in the future.

Amortization of Intangible Assets

Amortization of intangible assets decreased by $0.3 million to $0.6 million for the three months ended September 30, 2007, from $0.9 million for three months ended September 30, 2006. This decrease was primarily attributable to the fact that certain intangible assets were fully amortized. These intangible assets were purchased in the acquisitions of the optical businesses of Alcatel-Lucent, Corning and Vitesse in fiscal 2004.

Restructuring

Over the past several years, we have implemented various restructuring programs to realign resources in response to the changes in our industry and customer demand, and we continue to assess our current and future operating requirements accordingly.

For the three-month periods ended September 30, 2007 and 2006, restructuring recovery was $0.3 million and $0.1 million, respectively. The recovery in restructuring expense was due to our ability to sublease excess facilities at our Fremont site.

Interest and Other Income

Interest and other income decreased by $0.3 million to $0.5 million in the three months ended September 30, 2007 from $0.8 million in the three months ended September 30, 2006. This decrease was primarily due to lower investment income driven by lower cash balances, combined with lower foreign exchange gains.

Interest and Other Expense

Interest and other expense decreased by $0.3 million to $11,000 in the three months ended September 30, 2007 from $0.3 million in the three months ended September 30, 2006. This decrease was primarily due to the reduction in interest expense associated with the reduction in senior convertible notes balance at September 30, 2006.

Provision for Income Taxes

The provisions for income taxes of $0.3 million and $0 were recorded for estimated taxes due on income generated in certain state and foreign tax jurisdictions for the three months ended September 30, 2007 and 2006, respectively. The income tax provision for the three months ended September 30, 2007 reflects an effective tax rate of 10%, which differs from the statutory tax rate due to the tax impact of income from foreign operations and unbenefited losses in the U.S. taxes due to the full valuation allowance on our net deferred tax assets in accordance with SFAS 109.

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Liquidity and Capital Resources

Subsequent to our initial public offering in February 2000, we have financed our operations through the sale of equity securities, issuance of convertible notes and warrants, bank borrowings, equipment lease financing and acquisitions. Financing activities for prior fiscal years are summarized in the annual report on Form 10-K as filed with the SEC on September 7, 2007.

As of September 30, 2007, Avanex had cash and cash equivalents of $13.0 million and short-term investments of $27.0 million for an aggregate of $40.0 million, excluding restricted cash of $6.4 million.

Net cash provided by operating activities of $1.5 million for the three months ended September 30, 2007 was due primarily to an increase of $2.6 million in accounts payable and non-cash charges including stock-based compensation of $3.4 million, provision for doubtful accounts and sales returns of $0.7 million, inventory write-offs of $1.4 million, and other changes to working capital, partially offset by an increase of $2.7 million in accounts receivable, an increase of $1.2 million in inventories, a decrease in accrued compensation of $1.7 million, a decrease of $1.1 million in accrued restructuring and a decrease of $1.0 million in other accrued expenses and deferred revenue.

Net cash used in investing activities during the three months ended September 30, 2007 was $3.9 million, which was primarily due to $2.2 million for the purchase of assets from Essex, an increase in restricted cash of $2.9 million and capital expenditures of $0.8 million, partially offset by net maturities of short-term investments of $1.9 million.

Net cash provided by financing activities was $0.4 million during the three months ended September 30, 2007, which was the result of proceeds generated through the sale of common stock of $0.4 million from the exercise of stock options and the sale of common stock through the Employee Stock Purchase Plan.

Our contractual obligations and commercial commitments have not materially changed from those reported in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K filed with the SEC on September 7, 2007. As of September 30, 2007, the Company does not have any off-balance sheet arrangements.

Recent Accounting Pronouncements

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The objectives of our investment activities are preservation and safety of principal; maintenance of adequate liquidity to meet cash flow requirements; attainment of a competitive market rate of return on investments; minimization of risk on all investments; and avoidance of inappropriate concentrations of investments.

We place our investments with high quality credit issuers in short-term and long-term securities and maturities can range from overnight to 36 months. The average maturity of the portfolio will not exceed 18 months. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. We do not have any derivative financial instruments. Accordingly, we do not believe that our investments have significant exposure to interest rate risk.

The following table summarizes average interest rate and fair market value of the short-term securities and restricted cash and investments held by Avanex (in thousands), which were classified as available-for-sale at September 30, 2007 and June 30, 2007:


	September 30, 2007			June 30, 2007
Amortized cost	$	39,107		$	32,575
Fair market value	$	39,102		$	32,562
Average interest rate		5.28	%		5.09	%

Exchange Rate Risk

Our international business is subject to normal international business risks including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors.

We have operations in the United States, China, Thailand, France, and Italy. Accordingly, we have sales and expenses that are denominated in currencies other than the U.S. dollar. As a result, currency fluctuations between the U.S. dollar and the currencies in which we do business could cause foreign currency translation gains or losses that we would recognize in the period incurred. A 10% fluctuation in the dollar at September 30, 2007 would have led to an additional profit of approximately $1.1 million (dollar strengthening), or an additional loss of approximately $1.1 million (dollar weakening) on our net dollar position in outstanding assets and liabilities. We cannot predict the effect of exchange rate fluctuations on our future operating results because of the variability of currency exposure and the potential volatility of currency exchange rates. It has not been our recent practice to engage in the hedging of foreign currency transactions to mitigate for foreign currency risk, and currently, we do not hedge our exposure to translation gains and losses related to foreign currency net asset exposures.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

Management, including our principal executive officer and principal financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of September 30, 2007. Based upon that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were not effective as of September 30, 2007 because of the material weakness discussed below.

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As discussed in more detail in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 7, 2007, as of June 30, 2007, our management concluded that controls over judgmental and complex processes and transactions were inadequate resulting in insufficient control over financial reporting. During the three month period ended September 30, 2007, we began remediating the material weakness described in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 7, 2007. However, as of September 30, 2007, we have not completed the remediation of the material weakness.

Changes in internal controls over financial reporting

Our management is treating the outstanding material weakness, as well as the control environment, seriously and has implemented the following actions to remediate them:

•

Evaluated and revised where necessary calculations used in the preparation of accounts receivable, warranty, and excess and obsolete inventory reserves; and

•

Increased supervision and review of judgmental and complex processes and transactions

During the fiscal quarter ended September 30, 2007, there were no changes in our internal control over financial reporting that have materially affected, or are likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

From time to time, we are subject to various legal proceedings that arise from the normal course of business activities. In addition, from time to time, third parties assert patent or trademark infringement claims against us in the form of letters and other forms of communication. We do not believe that any of these legal proceedings or claims is likely to have a material adverse effect on our consolidated results of operations, financial condition, or cash flows. However, it is possible that an unfavorable resolution of one or more such proceedings could in the future materially affect our future results of operations, cash flows, or financial position in a particular period.

IPO Class Action Lawsuit

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Section 16(b) Demand

ITEM 1A.

RISK FACTORS

In addition to the other information contained in this Quarterly Report on Form 10-Q, we have identified the following risks and uncertainties that may have a material adverse affect on our business, financial condition or results of operations. Investors should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks and investors may lose all or part of their investment. This section should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this Form 10-Q.

I. Financial and Revenue Risks.

We have a history of negative cash flow and losses, which may continue for an indeterminate period of time, if we are unable to increase our revenues and/or further reduce our costs.

We have never been profitable until the current quarter, in which we reported nominal net income of $45,000. Except for the current quarter, we have experienced operating losses in each quarterly and annual period since our inception in 1997, and we may again incur operating losses for an indeterminate period of time. As of September 30, 2007, we had an accumulated deficit of $705.1 million. Also, for three months ended September 30, 2007, the fiscal year ended June 30, 2007 and for each of our prior fiscal years, we had negative operating cash flow, and we may incur negative operating cash flow in future periods. There can be no assurance that our business will be profitable in the future or that additional losses and negative cash flows from operations will not be incurred, which could have a material adverse affect on our financial condition.

Due to insufficient cash generated from operations, we have funded our operations primarily through the sale of equity securities, debt securities, bank borrowings, equipment lease financings, acquisitions and other capital raising transactions. Although we implemented cost reduction programs during the past several years, we continue to have significant fixed expenses, and we expect to continue to incur considerable manufacturing, sales and marketing, product development and administrative expenses.

If we do not increase our revenues and/or reduce costs, and improve our gross margins, our financial condition and results of operations will be adversely impacted.

Our ability to be profitable depends on our ability to increase our revenues and/or control costs and expenses in relation to revenues and to increase our gross margin. During the three months ended September 30, 2007, our gross margin percentage was 28%. During the fiscal years ended June 30, 2007 and 2006, our gross margin percentage was 18% and 5%, respectively. Despite our continued efforts to improve our gross margins, there can be no assurance that our gross margins will improve in the future.

We have reduced fixed costs through the extensive reliance on third party contract manufacturing and the relocation of most of our manufacturing operations into a central facility in Bangkok, Thailand. We may further reduce fixed costs by relocating certain transactional activities to lower cost regions. We have faced and may face execution issues working with our contract manufacturers, including difficulties managing our supply chain and deliveries to our customers. From a financial viewpoint, should these difficulties continue to occur, we could see negative impacts to revenue, gross margin and inventory levels.

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In addition, over our limited operating history, the average selling prices of our existing products have decreased and this trend may continue. However, our overall product mix has shifted toward products with higher levels of integration, typically selling at higher unit prices. Future price decreases may be due to a number of factors, including competitive pricing pressures, rapid technological change and sales discounts. Therefore, to improve our gross margin, we must develop and introduce new products and product enhancements on a timely basis and reduce our costs of production. Moreover, as our average selling prices decline, we must increase our unit sales volume, or introduce new products, to maintain or increase our total revenues. If our average selling prices decline more rapidly than our costs of production, our gross margin will decline, which would adversely impact our business, financial condition and results of operations. If we are unable to continue to generate positive gross margins, our cash flows from operations would be negatively impacted, and we would be unable to be profitable.

We may not continue to realize the anticipated benefits from our restructuring efforts.

As part of our cost reduction efforts, over the past several years we have implemented various restructuring programs to realign our resources in response to changes in the industry and customer demand. These efforts have included transferring most of our manufacturing operations to lower-cost contract manufacturers and selling our semiconductor fabs and related product lines in France. Our past restructuring programs may have a material effect on our financial position in the future as we pay severance to employees and rent for excess facilities. We may initiate future restructuring actions, which are likely to result in additional expenses that could affect our results of operations or financial position. There can be no assurance that we will realize the benefits we anticipate from our current or future restructuring programs or that such programs will reduce our operating expenses and improve our cost structure.

Our future revenues and operating results are inherently unpredictable, and as a result, we may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline.

Our revenues and operating results have fluctuated significantly from quarter-to-quarter in the past, and may continue to fluctuate significantly in the future. Factors that are likely to cause these fluctuations, some of which are outside of our control, include, without limitation, the following:

•

the current economic environment and other developments in the telecommunications industry, including the severe business setbacks of customers or potential customers and the current perceived oversupply of communications bandwidth;

•

the average margin of the mix of products we sell;

•

fluctuations in demand for and sales of our products, which will depend upon the speed and magnitude of the transition to an all-optical network, the acceptance of our products in the marketplace, and the general level of spending on infrastructure projects in the telecommunications industry;

•

cancellations of orders and shipment rescheduling;

•

changes in product specifications required by customers for existing and future products;

•

satisfaction of contractual customer acceptance criteria and related revenue recognition issues;

•

our ability to maintain appropriate manufacturing capacity through our contract manufacturers and materials suppliers, from whom we have no long-term commitments;

•

the ability of our outsourced manufacturers to timely produce and deliver subcomponents, and possibly complete products in the quantity and of the quality we require;

•

the current practice of our customers in the telecommunications industry of sporadically placing large orders with short lead times;

•

our ability to comply with new rules and regulations;

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•

competitive factors, including the introduction of new products and product enhancements by competitors and potential competitors, pricing pressures, and the competitive environment in the markets into which we sell our photonic processing solutions and products, including competitors with substantially greater resources than we have;

•

our ability to effectively develop, introduce, manufacture, and ship new and enhanced products in a timely manner without defects;

•

the availability and cost of components for our products;

•

new product introductions that may result in increased research and development expenses and sales and marketing expenses that are incurred in one quarter, with revenues, if any, that are not recognized until a subsequent quarter;

•

the unpredictability of customer demand and difficulties in meeting such demand;

•

revisions to our estimated reserves and allowances, as well as other accounting provisions or charges;

•

costs associated with, and the outcome of, any litigation to which we are, or may become, a party; and

•

customer perception of our financial condition and resulting effects on our orders and revenue.

A high percentage of our expenses, including those related to manufacturing, engineering, sales and marketing, research and development, and general and administrative functions, are fixed in the short term. As a result, if we experience delays in generating and recognizing revenue, our quarterly operating results are likely to be harmed.

Due to these and other factors, we believe that quarter-to-quarter comparisons of our operating results may not be meaningful. Our results for one quarter should not be relied upon as any indication of our future performance. It is possible that in future quarters our operating results may be below the expectations of public market analysts or investors. If this occurs, the price of our common stock would likely decrease.

A lack of effective internal control over financial reporting could result in an inability to accurately report our financial results, which could lead to a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Effective internal controls are necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports or prevent fraud, our business and operating results could be harmed. We have in the past discovered, and may in the future discover, deficiencies in our internal controls. For example, as more fully described in Item 4 of this Quarterly Report on Form 10-Q, our management concluded that as of September 30, 2007 we did not maintain effective internal controls over the following:

Controls over judgmental and complex processes and transactions were inadequate resulting in insufficient control over financial reporting.

Our management determined that this control deficiency was considered a material weakness that could result in a material misstatement to annual or interim financial statements that would not be prevented or detected. As a result, our management concluded that our internal control over financial reporting was not effective as of June 30, 2007 using the criteria set forth in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). We expect the remediation of this material weakness to occur during fiscal year 2008.

A failure to implement and maintain effective internal control over financial reporting, including a failure to implement corrective actions to address the control deficiencies identified above, could result in a material misstatement of our financial statements or otherwise cause us to fail to meet our financial reporting obligations. This, in turn, could result in a loss of investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our business, financial condition, operating results and our stock price, and we could be subject to stockholder litigation.

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We incur increased costs as a result of being a public company.

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002, as well as, rules subsequently implemented by the Securities and Exchange Commission and Nasdaq, has required changes in corporate governance practices of public companies. These rules and regulations have increased our legal and financial compliance costs and made some activities more time consuming and costly. In addition, we incur additional costs associated with our public company reporting requirements.

Our stock price is highly volatile.

The trading price of our common stock has fluctuated significantly since our initial public offering in February 2000, and is likely to remain volatile in the future. For example, since the beginning of fiscal 2006, our common stock has closed as low as $0.62 and as high as $3.29 per share. The trading price of our common stock could be subject to wide fluctuations in response to many events or factors, including the following:

•

quarterly variations in our operating results;

•

significant developments in the businesses of telecommunications companies;

•

changes in financial estimates by securities analysts;

•

changes in market valuations or financial results of telecommunications-related companies;

•

announcements by us or our competitors of technology innovations, new products, or significant acquisitions, strategic partnerships or joint ventures;

•

any deviation from projected growth rates in revenues;

•

any loss of a major customer or a major customer order;

•

additions or departures of key management or engineering personnel;

•

any deviations in our net revenue or in losses from levels expected by securities analysts;

•

activities of short sellers and risk arbitrageurs;

•

future sales of our common stock or the availability of additional financing;

•

volume fluctuations, which are particularly common among highly volatile securities of telecommunications-related companies; and

•

material weaknesses in internal controls.

In addition, the stock market has experienced volatility that has particularly affected the market prices of equity securities of many high technology companies, which often has been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. There is substantial risk that our quarterly results will fluctuate.

Sales of securities by our stockholders or warrantholders could affect the market price of our common stock or have a dilutive effect upon our stockholders.

As of October 25, 2007, Alcatel-Lucent owned shares of our common stock representing 12% of the outstanding shares of our common stock. On October 29, 2007, the Pirelli Group announced that it had agreed to acquire all the shares of our common stock held by Alcatel-Lucent. If the Pirelli Group or our other stockholders sell substantial amounts of our common stock in the public market, it could cause the market price of our common stock to fall, and could make it more difficult for us to raise capital through public offerings or other sales of our capital stock.

In addition, we have issued warrants to purchase initially up to an aggregate of 17,919,288 million shares of common stock to certain institutional investors that are exercisable through 2008, 2009 and 2011 at exercise prices ranging from $1.13 to $2.68 per share, subject to broad-based anti-dilution provisions, including weighted average price-based anti-

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dilution provisions. If these institutional investors exercise the warrants, we will issue shares of our common stock and such issuances may be dilutive to our stockholders. Because the exercise price of the warrants may be adjusted from time to time in accordance with the provisions of the warrants, the number of shares that could actually be issued may be greater than the amount described above. For example, in connection with our March 1, 2007 financing, the holders of the warrants we issued on March 9, 2006 received an antidilution adjustment pursuant to the terms of such warrants resulting in up to 117,221 additional shares being issued upon the exercise of such warrants and the reduction of the exercise price of the warrants from $2.73 per share to $2.69 per share.

We may have difficulty obtaining additional capital.

Our balance of cash, cash equivalents, and unrestricted short-term investments decreased from $43.8 million at June 30, 2007 to $40.0 million at September 30, 2007. Except for the current quarter, we have not been profitable, and there can be no assurance that our business will be profitable in the future. If these trends continue in the future, it could have an adverse affect on our financial condition. It may be difficult for us to raise additional capital. If adequate capital is not available to us as required, or is not available on favorable terms, our business, operating results and financial condition would be adversely affected.

II. Market and Competitive Risks.

Market conditions in the telecommunications industry may significantly harm our financial position.

We sell our products primarily to a few large customers in the telecommunications industry. Two customers accounted for 24% and 17% of our net revenue, respectively, for the three months ended September 30, 2007. Two customers accounted for an aggregate of 29% and 17% of our net revenue, respectively, for the fiscal year ended June 30, 2007. We expect that the majority of our revenues will continue to depend on sales of our products to a small number of customers. If current customers do not continue to place significant orders, or if they cancel or delay current orders, we may not be able to replace those orders. In addition, any negative developments in the business of existing customers could result in significantly decreased sales to these customers, which could seriously harm our business, operating results and financial condition. We have experienced, and in the future we may experience, losses as a result of the inability to collect accounts receivable, as well as the loss of ongoing business from customers experiencing financial difficulties. If our customers fail to meet their payment obligations, we could experience reduced cash flows and losses in excess of amounts reserved. Because of our reliance on a limited number of customers, any decrease in revenues from, or loss of, one or more of these customers without a corresponding increase in revenues from other customers would harm our business, operating results and financial condition.

Few of our customers are under obligation to buy significant quantities of our products, and may cancel or delay purchases with little or no advance notice to us.

Our customers typically purchase our products pursuant to individual purchase orders. While we have executed long-term contracts with some of our customers, and may enter into additional long-term contracts with other customers in the future, these contracts do not obligate our customers to buy significant quantities of our products. Our customers may cancel, defer or decrease purchases without significant consequence to them and with little or no advance notice. Further, certain of our customers have a tendency to purchase our products near the end of a fiscal quarter. Cancellation or delays of such orders may cause us to fail to achieve that quarter’s financial and operating goals. Decreases in purchases, cancellations of purchase orders, or deferrals of purchases may significantly harm our business, operating results and financial condition, particularly if we are not able to anticipate these events.

We experience intense competition with respect to our products.

We believe that our principal competitors in the optical systems and components industry include Bookham Inc., JDS Uniphase Corporation, Oplink Communications, Inc., Opnext Inc. and Optium Corporation. We may also face competition from companies that expand into our industry in the future.

Some of our competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, some of these competitors are able to devote greater resources to the development, promotion, sale, and support of their products. In addition, our competitors that have larger market capitalization or cash reserves are better positioned than we are to acquire other companies in order to gain new

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technologies or products that may displace our product lines. Consolidation in the optical systems and components industry could intensify the competitive pressures that we face because these consolidated competitors may have longer operating histories and significantly greater financial, technical, marketing and other resources than we have.

Some existing customers and potential customers, as well as, suppliers and potential suppliers, are also our competitors. These customers and suppliers may develop or acquire additional competitive products or technologies in the future, which may cause them to reduce or cease their purchases from us or their supply to us, as the case may be. Further, these customers may reduce or discontinue purchasing our products if they perceive us as a serious competitive threat with regard to sales of products to their customers. Additionally, suppliers may reduce or discontinue selling materials to us if they perceive us as a serious competitive threat with regard to sales of products to their customers. As a result of these factors, we expect that competitive pressures will intensify and may result in price reductions, reduced margins, and loss of market share.

Competition in the optical systems and components industry has contributed to substantial price-driven competition. As a result, sales prices for specific products have decreased over time at varying rates, in some instances significantly. Price pressure is exacerbated by the rapid emergence of new technologies and the evolution of technical standards, which can greatly diminish the value of products relying on older technologies and standards. In addition, the current economic and industry environment in the telecommunications sector has resulted in pressure to reduce prices for our products, and we expect pricing pressure to continue for the foreseeable future, which may continue to adversely affect our operating results. Reduced spending by our customers has caused and may continue to cause increased price competition, resulting in a decline in the prices we charge for our products. If our customers and potential customers continue to constrain their spending, or if the prices we charge continue to decline, our revenues and margins may be adversely affected.

We will lose market share and may not be successful if our customers do not qualify our products to be designed into their products and systems or if our customers significantly delay purchasing our products.

In the telecommunications industry, service providers and optical systems manufacturers often undertake extensive qualification processes prior to placing orders for large quantities of products such as ours, because these products must function as part of a larger system or network. Once they decide to use a particular supplier’s product or component, these potential customers design the product into their system, which is known as a “design-in” win. Suppliers whose products or components are not designed in are unlikely to make sales to that company until the adoption of a future redesigned system at the earliest, which could occur several years after the last design-in win. If we fail to achieve design-in wins in potential customers’ qualification processes, we may lose the opportunity for significant sales to such customers for a significant period of time.

The long sales cycles for sales of our products to customers may cause operating results to vary from quarter to quarter, which could continue to cause volatility in our stock price, and may prevent us from being profitable.

The period of time between our initial contact with certain of our customers and the receipt of an actual purchase order from such customers often spans a time period of six to nine months, or longer. During this time, customers may perform, or require us to perform, extensive and lengthy evaluation and testing of our products and our manufacturing processes before purchasing our products. While our customers are evaluating our products before they place an order with us, we may incur substantial sales and marketing and research and development expenses, expend significant management efforts, increase manufacturing capacity and order long-lead-time supplies. For example, one of our largest customers required us to perform extensive and lengthy evaluation and testing of a proposed product. After such extensive work, we failed to be designed-in for that product. If we increase capacity and order supplies in anticipation of an order that does not materialize, our gross margins will decline, and we will have to carry and write off excess inventory. Even if we receive an order, if we are required to add additional internal manufacturing capacity in order to service the customer’s requirements, such manufacturing capacity may be underutilized in subsequent periods, especially if orders are delayed or cancelled. Either situation could cause our business, results of operations, and financial condition to be below the expectations of public market analysts or investors, which could, in turn, cause the price of our common stock to decline.

If the communications industry does not continue to evolve and grow steadily, our business may not succeed.

Future demand for our products is uncertain and unpredictable, and will depend to a great degree on the speed of the widespread adoption of optical networks. If the transition occurs too slowly or ceases altogether, the market for our products and the growth of our business will be significantly limited.

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Our future success depends on the continued growth and success of the telecommunications industry, including the continued growth of the Internet as a widely used medium for commerce and communication and the continuing demand for increased bandwidth over communications networks. If the Internet does not continue to expand as a widespread communication medium and commercial marketplace, the need for significantly increased bandwidth across networks and the market for optical transmission products may not develop. As a result, it would be unlikely that our products would achieve commercial success.

The rate at which telecommunications service providers and other optical network users have built new optical networks or installed new systems in their existing optical networks has fluctuated in the past, and these fluctuations may continue in the future. Sales of our components depend on sales of fiber optic telecommunications systems by our systems-level customers, which are shipped in quantity when telecommunications service providers add capacity. Systems manufacturers compete for sales in each capacity deployment. If systems manufacturers that use our products in their systems do not win a contract, their demand for our products will decline, reducing our future revenues. Similarly, a telecommunications service provider’s delay in selecting systems manufacturers for a deployment could delay our shipments and revenues.

III. Acquisition and Divestiture Risks.

Acquisitions, divestitures and other significant transactions may adversely affect our business.

We regularly review acquisition, divestiture and other strategic opportunities that would further our business objectives, complement our existing product offerings, augment our market coverage, secure supplies of critical materials or enhance our technological capabilities. The anticipated benefits of our acquisitions, divestitures and other strategic transactions may not be realized or may be realized more slowly than we expected. Acquisitions, divestitures and other strategic opportunities have resulted in, and in the future could result in, a number of financial consequences, including without limitation:

•

potentially dilutive issuances of equity securities;

•

reduced cash balances and related interest income;

•

higher fixed expenses, which require a higher level of revenues to maintain gross margins;

•

the incurrence of debt and contingent liabilities, including indemnification obligations;

•

restructuring actions, which could result in charges that have a material effect on our results of operations and our financial position;

•

loss of customers, suppliers, distributors, licensors or employees of the acquired company;

•

legal, accounting and advisory fees;

•

amortization expenses related to intangible assets; and

•

one-time write-offs of large amounts.

For example, in connection with our acquisition of the optical components businesses of Alcatel and Corning, we issued shares of our common stock to Alcatel and to Corning representing 28% and 17%, respectively, of the outstanding shares of our common stock on a post-transaction basis. In connection with such acquisitions, we recorded restructuring liabilities at July 31, 2003 with a fair value of $64.1 million relating to workforce reductions, which were included in the purchase price of such acquisitions. Following these acquisitions, we recorded additional significant restructuring liabilities that involved the acquired businesses and resulted in, among other things, a significant reduction in the size of our workforce, consolidation of our facilities and increased reliance on outsourced, third-party manufacturing.

In addition, as discussed above, we sold ninety percent (90%) of the shares of Avanex France, the operator of our semiconductor fabs and associated product lines located in Nozay, France. Pursuant to the provisions of French bankruptcy law, in the event that Avanex France, now “3S Photonics,” declares bankruptcy after such sale, we may be held liable, as

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“manager de facto” of 3S Photonics for the payment of all or part of the liabilities of 3S Photonics, should it appear that we committed mismanagement which would have solely or partially led to the bankruptcy of 3S Photonics, and these liabilities could be significant. Such liability, if incurred, could have a material adverse effect on our business, results of operations and financial condition. In addition, we agreed to indemnify the buyers of Avanex France generally for a period of up to two years in an amount generally not exceeding €5 million for breaches of certain representations, warranties and covenants relating to the condition of the business prior to and at the time of sale, and approximately €2 million for other liabilities. Should any such liabilities or expenses be of a material amount, our finances could be materially and adversely affected. Finally, we may be dependent on 3S Photonics to supply us with certain products and components that we sell to our customers. Any interruption in the operations of 3S Photonics, or any deficiency in the quality or quantity of the components or products built for us by 3S Photonics, could impede our ability to meet our scheduled product deliveries to our customers. As a result, we may experience a shortfall in revenue, lose existing or potential customers or otherwise experience material adverse effects upon our business, results of operation and financial condition.

Additionally, if any potential acquisitions are not completed, we are required to expense the frequently significant legal, accounting, consulting and other costs of pursuing these transactions in the period in which the activity ceases, which could adversely affect our operating results and may not be anticipated. In the quarter ended December 31, 2006, we expensed approximately $2.1 million in legal, accounting and consulting due diligence fees related to a potential acquisition in which Avanex decided not to proceed further.

Furthermore, our past acquisition and disposition activity has involved, and our future acquisition, disposition and other significant transactions may involve, numerous operational risks, including:

•

difficulties integrating or divesting operations, personnel, technologies, products and the information systems of the acquired or divested companies;

•

diversion of management’s attention from other business concerns;

•

diversion of resources from our existing businesses, products or technologies;

•

risks of entering geographic and business markets in which we have no or limited prior experience; and

•

potential loss of key employees of acquired organizations.

IV. Operations and Research and Development Risks.

We have a limited operating history, which makes it difficult to evaluate our prospects and our operations.

We are in the optical systems and components industry. We were first incorporated in October 1997. Because of our limited operating history, we have limited insight into trends that may emerge in our industry and affect our business. The revenue and income potential of the optical systems and components industry, and our business in particular, are unproven. As a result of our limited operating history, we have limited financial data that can be used to evaluate our business. Our prospects must be considered in light of the risks, expenses and challenges we might encounter because we are in a new and rapidly evolving industry.

We face various risks related to our manufacturing operations that may adversely affect our business.

We may experience delays, disruptions or quality control problems in our manufacturing operations or the manufacturing operations of our third party manufacturers, and, as a result, product shipments to our customers could be delayed beyond the shipment schedules requested by our customers, which would negatively affect our business, results of operations, and financial condition. Furthermore, even if we are able to timely deliver products to our customers, we may be unable to recognize revenue because of applicable revenue recognition policies. In the past, we have experienced disruptions in the manufacture of some of our products due to changes in our manufacturing processes, which resulted in reduced manufacturing yields, delays in the shipment of our products and deferral of revenue recognition. Any disruptions in the future could adversely affect our revenues, gross margins, and results of operations. Changes in our manufacturing processes or those of our third party manufacturers, or the inadvertent use of defective materials by our third party manufacturers or us, could significantly reduce our manufacturing yields and product reliability. Lower than expected manufacturing yields could delay product shipments and further impair our gross margins. These operational issues have included capacity constraints at our contract manufacturers, raw materials shortages, logistics issues, and manufacturing yield issues for some of our new products.

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We may need to develop new manufacturing processes and techniques that will involve higher levels of automation, or may need to further relocate certain manufacturing operations to lower cost regions, to improve our gross margins and achieve the targeted cost levels of our customers. If we fail to effectively manage this process, or if we experience delays, disruptions or quality control problems in our manufacturing operations, our shipments of products to our customers could be delayed.

We face risks related to our concentration of research and development efforts on a limited number of key industry standards and technologies, and our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers in a timely manner.

In the past, we have concentrated our research and development efforts on a limited number of technologies that we believed had the best growth prospects. If we are unable to develop commercially viable products using these technologies, or these technologies do not become generally accepted, our business will likely suffer.

The markets for our products are characterized by rapid technological change, frequent new product introduction, changes in customer requirements, and evolving industry standards. Our future performance will depend upon the successful development, introduction and market acceptance of new and enhanced products that address these changes. We may not be able to develop the underlying core technologies necessary to create new or enhanced products, or to license or otherwise acquire these technologies from third parties. Product development delays may result from numerous factors, including:

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changing product specifications and customer requirements;

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difficulties in hiring and retaining necessary technical personnel;

•

difficulties in reallocating engineering resources and overcoming resource limitations;

•

changing market or competitive product requirements;

•

unanticipated engineering complexities, and

•

failure to compete with new product releases by our competitors.

Our industry has increased its focus on products that transmit voice, video and data traffic over shorter distances and are offered at lower cost than the products that we offer to our telecommunications customers for transmission of information over longer distances. If we are unable to develop products that meet the requirements of potential customers of these products, our business, results of operations, and financial condition could suffer.

The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as, the accurate anticipation of technological and market trends. We cannot assure that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, or on a timely basis. In addition, the introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. To the extent customers defer or cancel orders for existing products due to the expectation of a new product release, or if there is any delay in development or introduction of our new products or enhancements of our products, our business, results of operations, and financial condition would suffer. Further, we cannot assure that our new products will gain market acceptance or that we will be able to respond effectively to competitive products, technological changes or emerging industry standards. Any failure to respond to technological change would significantly harm our business, results of operations and financial condition.

If we are unable to forecast component and material requirements accurately or if we are unable to commit to deliver sufficient quantities of our products to satisfy customers’ needs, our results of operations will be adversely affected.

Our customers typically require us to commit to delivering certain quantities of our products to them (in guaranteed safety stock, guaranteed capacity or otherwise) without committing themselves to purchase such products, or any quantity of such products. Therefore, wide variations between estimates of our customers’ needs and their actual purchases may result in:

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•

a surplus and potential obsolescence of inventory, materials and capacity, if estimates of our customers’ requirements are greater than our customers’ actual need; or

•

a lack of sufficient products to satisfy our customers’ needs, if estimates of our customers’ requirements are less than our customers’ actual needs.

We use a rolling six-month to twelve-month demand forecast based on anticipated and historical product orders to determine our component and material requirements. It is very important that we accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials. It is very difficult to develop accurate forecasts of product demand, especially given the current uncertain conditions in the telecommunications industry. Order cancellations and lower order volumes by our customers have in the past created excess inventories. For example, inventory write-offs are primarily the result of our inability to anticipate decreases in demand for certain of our products and variations in product mix ordered by our customers. For the three months ended September 30, 2007 and 2006, we recorded write-offs of $1.4 million and $3.5 million, respectively, for excess and obsolete inventory. For the fiscal years ended June 30, 2007 and June 30, 2006, we recorded write-offs of $12.9 million and $12.8 million, respectively, for excess and obsolete inventory. If we fail to accurately predict both the demand for our products and the lead times required to obtain the necessary components and materials in the future, we could incur additional excess and obsolete inventory write-downs. If we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively affect our business, results of operations, and financial condition.

Network carriers and telecommunication system integrators historically have required that suppliers commit to provide specified quantities of products over a given period of time. If we are unable to commit to deliver sufficient quantities of our products to satisfy a customer’s anticipated needs, we may lose the opportunity to make significant sales to that customer over a lengthy period of time. In addition, we may be unable to pursue large orders if we do not have sufficient manufacturing capacity to enable us to provide customers with specified quantities of products. We rely heavily upon the capacity and willingness of third party contract manufacturers and materials suppliers to enable us to fulfill our commitments to our customers, but we generally do not have the benefit of long term or other supply or services contracts with our third party contract manufacturers and materials suppliers, who are not generally obligated to adhere to our production schedule. If we cannot deliver sufficient quantities of our products, we may lose business, which could adversely impact our business, results of operations and financial condition.

If our customers do not qualify our manufacturing processes they may not purchase our products, and our operating results could suffer.

Certain of our customers will not purchase our products prior to qualification of our manufacturing processes and approval of our quality assurance system. The qualification process determines whether the manufacturing line meets the quality, performance, and reliability standards of our customers. These customers may also require that we, and any manufacturer that we may use, be registered under international quality standards, such as ISO 9001. In August 2000, we successfully passed the ISO 9001 registration audit and received formal registration of our quality assurance system at our Fremont California facility, and we have passed subsequent reviews as well. Our United States, Europe and Asia sites are currently TL-9000 certified. Delays in obtaining customer qualification of our manufacturing processes or approval of our quality assurance system may cause a product to be removed from a long-term supply program and result in significant lost revenue opportunity over the term of that program.

We depend upon a limited number of contract manufacturers and materials suppliers to manufacture and provide a majority of our products, and our dependence on these manufacturers and suppliers may result in product delivery delays, may harm our operations or have an adverse effect upon our business.

We rely on a limited number of outsourced manufacturers and suppliers to manufacture and provide a substantial majority of our components, subassemblies, and finished products. In particular, one contract manufacturer, Fabrinet, currently manufactures products for sale, which constitutes a significant majority of our net revenue. We intend to develop further our relationships with this and other manufacturers so that they will eventually manufacture many of our high volume key components and subassemblies in the future. The qualification of these independent manufacturers and materials suppliers under quality assurance standards is an expensive and time-consuming process. Our independent

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manufacturers have a limited history of manufacturing optical subcomponents. Any interruption in the operations of these manufacturers, or any deficiency in the quality or quantity of the subcomponents or products built for us by these manufacturers, could impede our ability to meet our scheduled product deliveries to our customers. Operational issues could result, such as, capacity constraints at our contract manufacturers, raw materials shortages, logistics issues, and manufacturing yield issues for some of our new products. As a result, we may lose existing or potential customers.

We have limited experience in working with outsourced manufacturers and suppliers. As a result, we may not be able to effectively manage our relationships with them. If we cannot effectively manage our manufacturing and supplier relationships, or if these manufacturers and suppliers fail to deliver components in a timely manner, we could experience significant delays in product deliveries, which may have an adverse effect on our business and results of operations. Increased reliance on outsourced manufacturing and suppliers, and the ultimate disposition of our manufacturing capacity in the future, may result in impairment expense relating to our long-lived assets in future periods, which would have an adverse impact on our business, financial condition, and results of operations.

Our products may have defects that are not detected until full deployment of a customer’s network, which could result in a loss of customers and revenue and damage to our reputation.

Our products are designed to be deployed in large and complex optical networks and must be compatible with existing and future components of such networks. Our products can only be fully tested for reliability when deployed in networks for long periods of time. Our products may not operate as expected, and our customers may discover errors, defects, or incompatibilities in our products only after they have been fully deployed and are operating under peak stress conditions. If we are unable to fix errors or other problems, we could experience:

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loss of customers or customer orders;

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loss of or delay in revenues;

•

loss of market share;

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loss or damage to our brand and reputation;

•

inability to attract new customers or achieve market acceptance;

•

diversion of development resources;

•

increased service and warranty costs;

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legal actions by our customers; and

•

increased insurance costs.

We may be required to indemnify our customers against certain liabilities arising from defects in our products, which liabilities may also include the following costs and expenses:

•

costs and expenses incurred by our customers or their customers to fix the problems; or

•

costs and expenses incurred by our customers or their customers to replace our products, or their products which incorporate our products, with other product solutions.

While we carry insurance policies covering this type of liability, these policies may not provide sufficient protection should a claim be asserted. To date, product defects have not had a material negative effect on our business, results of operations, or financial condition; however, we cannot be certain that they will not have a material negative effect on us in the future.

We depend on key personnel to manage our business effectively, and if we are unable to hire, retain, or motivate qualified personnel, our ability to sell our products could be harmed.

Our future success depends, in part, on certain key employees and on our ability to attract and retain highly skilled personnel. In addition, we have made changes in our executive management teams, and there can be no assurance that these changes will be successful. The loss of the services of any of our key personnel, the inability to attract or retain qualified

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personnel, or delays in hiring required personnel, particularly engineering, sales or marketing personnel, may seriously harm our business, results of operations, and financial condition. None of our officers or key employees has an employment agreement for a specific term, and these employees may terminate their employment at any time. We do not have key person life insurance policies covering any of our employees. Our ability to continue to attract and retain highly skilled personnel will be a critical factor in determining whether we will be successful in the future. Competition for highly skilled personnel is frequently intense, especially in the San Francisco Bay Area. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs.

In addition, we implemented restructuring programs designed to attempt to improve our financial performance. Among other things, we moved substantially all of our manufacturing operations to lower cost locations. As a result, our headcount in the United States and Europe has been substantially reduced and may be reduced further in the future. To date, such actions have not resulted in substantial work stoppages. Decreases in labor productivity, however, whether formalized by a work stoppage, or strike, or decreased productivity due to morale issues could have an adverse effect on our business and operating results.

We face various risks that could prevent us from successfully manufacturing, marketing and distributing our products internationally.

As a result of the opening of our operations center in Thailand and our research and development office in Shanghai, we expanded our international operations, including expansion of overseas product manufacturing, and we may continue to expand internationally in the future. Further, we have increased international sales and intend to further increase our international sales and the number of our international customers. We have also initiated significant restructuring programs overseas, and may initiate additional restructuring programs overseas in the future. Our international operations have required and will continue to require significant management attention and financial resources. For instance, we have incurred, and may continue to incur, startup costs to open our operations center in Thailand and our research and development office in Shanghai, and may incur costs in transferring operations to Thailand. We may not be able to maintain international demand for our products. We currently have limited experience in manufacturing, marketing and distributing our products internationally, particularly from our new operations center in Thailand. In addition, international operations are subject to inherent risks, including, without limitation, the following:

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greater difficulty in accounts receivable collection and longer collection periods;

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difficulties inherent in managing operations and employees in remote foreign operations;

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difficulties and costs of staffing and managing foreign operations with personnel who have expertise in optics;

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import or export licensing and product certification requirements;

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tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers imposed by foreign countries;

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potential adverse tax consequences;

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seasonal reductions in business activity in some parts of the world;

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burdens of complying with a wide variety of foreign laws and regulations, particularly with respect to taxes, intellectual property, license requirements, employment matters and environmental requirements;

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the impact of recessions in economies outside of the United States;

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unexpected changes in regulatory or certification requirements for optical systems or networks; and

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political and economic instability, terrorism and war.

A portion of our international revenues and expenses are now denominated in foreign currencies. It has not been our recent practice to engage in the hedging of foreign currency transactions to mitigate for foreign currency risk. Therefore, fluctuations in the value of foreign currencies could have a negative impact on the profitability of our global operations, which would seriously harm our business, results of operations, and financial condition.

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V. Intellectual Property and Litigation Risks.

Current and future litigation against us could be costly and time consuming to defend.

We are regularly subject to legal proceedings and claims that arise in the ordinary course of business. Litigation may result in substantial costs and may divert management’s attention and resources, which may seriously harm our business, results of operations, financial condition and liquidity.

We may be unable to protect our proprietary technology, which could significantly impair our ability to compete.

We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality agreements and other contractual restrictions on disclosure to protect our intellectual property rights. We also rely on confidentiality agreements with our employees, consultants and corporate partners, and controlled access to and distribution of our technology, documentation and other confidential information. We have numerous patents issued or applied for in the United States and abroad, of which some may be jointly filed or owned with other parties. Further, we license certain intellectual property from third parties, including Alcatel-Lucent and Corning, that is critical to our business, and we also license intellectual property to other parties. We cannot assure you that any patent applications or issued patents will protect our proprietary technology, or that any patent applications or patents issued will not be challenged by third parties. Further, we cannot assure you that parties from whom we license intellectual property will not violate their agreements with us; that they will not license their intellectual property to third parties; that their patent applications, patents and other intellectual property will protect our technology, products and business; or that their patent applications, patents, and other intellectual property will not be challenged by third parties. For example, Alcatel-Lucent has cross licenses with various third parties, which, when combined with their own intellectual property, may permit these third parties to compete with us. Our intellectual property also consists of trade secrets, requiring more monitoring and control mechanisms to protect. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we take will prevent misappropriation or unauthorized use of our technology. Further, other parties may independently develop similar or competing technology or design around any patents that may be issued or licensed to us.

We use various methods to attempt to protect our intellectual property rights. However, we cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property. In particular, the laws in foreign countries may not protect our proprietary rights as fully as the laws in the United States.

We face risks with regard to third-party intellectual property licenses.

From time to time we may be required to license technology or intellectual property from third parties for our product offerings or to develop new products or product enhancements. We cannot assure you that third-party licenses will be available to us on commercially reasonable terms, if at all. The inability to obtain a necessary third-party license required for our product offerings or to develop new products and product enhancements could require us to substitute technology of lower quality or performance standards, or of greater cost, either of which could prevent us from operating our business. If we are not able to obtain licenses from third parties, if necessary, then we may also be subject to litigation to defend against infringement claims from these third parties.

We may become subject to litigation or claims from or against third parties regarding intellectual property rights, which could divert resources, cause us to incur significant costs, and restrict our ability to utilize certain technology.

We may become a party to litigation in the future to protect our intellectual property or we may be subject to litigation to defend against infringement claims of others. These claims and any resulting lawsuits, if successful, could subject us to significant liability for damages and invalidation of our proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation also could force us to do one or more of the following:

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stop selling, incorporating, or using our products that use the challenged intellectual property;

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obtain from the owner of the infringed intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all;

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redesign the products that use the technology; or

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•

indemnify certain customers and others against intellectual property claims asserted against them.

If we are forced to take any of these actions, our business may be seriously harmed. We may in the future initiate claims or litigation against third parties for infringement of our proprietary rights in order to determine the scope and validity of our proprietary rights or the proprietary rights of competitors, or we may be required to grant certain third parties permission to enforce our intellectual property on our behalf. These claims could result in us being joined as a party to a lawsuit, counterclaims against us or our customers, invalidation or narrow interpretation of our proprietary rights, costly litigation, and the diversion of our technical and management personnel. Although we carry general liability insurance, our insurance may not cover potential claims of the above types or may not be adequate to indemnify us for all liability that may be imposed.

VI. Other Risks.

Our business and future operating results may be adversely affected by events that are outside of our control.

Our business and operating results are vulnerable to interruption by events outside of our control, such as earthquakes, fire, power loss, telecommunications failures and uncertainties arising out of terrorist attacks throughout the world, including the continuation or potential worsening of the current global economic environment, the economic consequences of additional military action and associated political instability, and the effect of heightened security concerns on domestic and international travel and commerce. We cannot be certain that the insurance we maintain against fires, floods and general business interruptions will be adequate to cover our losses for such events in any particular case.

In addition, we handle hazardous materials as part of our manufacturing activities and are subject to a variety of governmental laws and regulations related to the use, storage, recycling, labeling, reporting, treatment, transportation, handling, discharge and disposal of such hazardous materials. Although we believe that our operations conform to presently applicable environmental laws and regulations, we may incur costs in order to comply with current or future environmental laws and regulations, including costs associated with permitting, investigation and remediation of hazardous materials, and installation of capital equipment relating to pollution abatement, production modification and/or hazardous materials management. In addition, we currently sell products that incorporate firmware and electronic components. The additional level of complexity created by combining firmware and electronic components with our optical components requires that we comply with additional regulations, both domestically and abroad, related to power consumption, electrical emissions and homologation. Any failure to successfully obtain the necessary permits or comply with the necessary laws and regulations could have a material adverse effect on our operations.

Certain provisions of our certificate of incorporation and bylaws and Delaware law could delay or prevent a change of control of us.

Certain provisions of our certificate of incorporation and bylaws and Delaware law may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions allow us to issue preferred stock with rights senior to those of our common stock and impose various procedural and other requirements that could make it more difficult for our stockholders to effect certain corporate actions.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

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ITEM 5.

OTHER INFORMATION

Not applicable.

ITEM 6.

EXHIBITS


Exhibit No.		Description

2.1		Asset Purchase and Sale Agreement by and between the Registrant and Essex Corporation, dated July 2, 2007 (which is incorporated herein by reference to Exhibit 2.2 to the Registrant’s Current Report on Form 10-K filed on September 7, 2007).

10.1		Description of Fiscal 2008 Bonus Plan (which is incorporated herein by reference to Item 5.02 of the Registrant’s Current Report on Form 8-K filed on September 12, 2007).

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


AVANEX CORPORATION (Registrant)

By:		/s/ MARLA SANCHEZ
		Marla Sanchez
		Senior Vice President and Chief Financial Officer
		(Duly Authorized Officer and Principal Financial Officer)
Date:		November 2, 2007

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Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Good

Avanex (AVNX) Inactive 10-Q2008 Q1 Quarterly report

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