UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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 March 31, 2004

OR

[   ] 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

40919 Encyclopedia Circle
Fremont, California 94538

(510) 897-4188

     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 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES [X] NO [    ]

     There were 143,265,517 shares of the Company’s Common Stock, par value $.001 per share, outstanding on May 7, 2004.

AVANEX CORPORATION

FORM 10-Q

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AVANEX CORPORATION

See accompanying notes.

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AVANEX CORPORATION

See accompanying notes.

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AVANEX CORPORATION

See accompanying notes.

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AVANEX CORPORATION

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of March 31, 2004, and for the three and nine months ended March 31, 2004 and 2003 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission, and include the accounts of Avanex Corporation and its wholly-owned subsidiaries (collectively “Avanex” or the “Company”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States 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 March 31, 2004, the consolidated operating results for the three and nine months ended March 31, 2004 and 2003, and the consolidated cash flows for the nine months ended March 31, 2004 and 2003. The consolidated results of operations for the three and nine months ended March 31, 2004 are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2004.

The condensed consolidated balance sheet at June 30, 2003 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes for the year ended June 30, 2003 contained in its annual report on Form 10-K filed with the Commission on September 26, 2003.

     Fiscal Year and Fiscal Quarter

The Company’s fiscal year ends on June 30, with fiscal quarters ending on the last calendar day of the quarter. Prior to April 1, 2003, the Company’s fiscal quarters ended on the Friday closest to the end of the period, resulting in thirteen-week periods.

     Foreign Currency Translation

Functional currency of our foreign subsidiaries is the local currency. Assets and liabilities denominated in foreign currencies are translated using the exchange rate on the balance sheet dates. Revenues and expenses are translated using average exchange rates prevailing during the period. Any translation adjustments resulting from this process are included as a component of accumulated other comprehensive income. Foreign currency transaction gains and losses are included in the determination of net loss.

     Discontinued Operations

The operating results of the Company’s silica planar lightwave circuit (PLC) product line manufactured in Livingston, Scotland, are reflected as discontinued operations in the accompanying consolidated statement of operations for the three and nine months ended March 31, 2004. Results of all prior periods have been reclassified to conform to this presentation.

2. Acquisitions

On July 31, 2003, the Company acquired Alcatel Optronics France SA, a subsidiary of Alcatel that operated the optical components business of Alcatel to augment its optical technologies and intelligent photonic solutions product line with dense wave division multiplexing (DWDM) lasers, photodetectors, optical amplifiers, high–speed interface modules and key passive devices such as arrayed waveguide multiplexers and Fiber Bragg Grating (FBG) filters. Alcatel also assigned and licensed certain intellectual property rights to the Company. In addition, the Company acquired certain assets of the optical components business of Corning to augment its optical technologies and intelligent photonic solutions product line with

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optical amplifiers and lithium-niobate modulators. Corning also assigned and licensed certain intellectual property rights to the Company. In consideration for the above, the Company issued shares of its common stock to Alcatel and to Corning, representing 28% (35.4 million shares) and 17% (21.5 million shares) at the date of acquisition, respectively, of the outstanding shares of the Company’s common stock on a post-transaction basis. The transactions were accounted for under the purchase method of accounting.

On August 28, 2003, the Company acquired certain assets of Vitesse Semiconductor Corporation’s Optical Systems Division to enhance its presence in transponders and expand its product offerings in subsystem products. The Company acquired substantially all of the assets of Vitesse’s Optical Systems Division in exchange for 1.4 million shares of Avanex common stock. The transaction was accounted for under the purchase method of accounting.

The purchase price for these acquisitions is as follows (in thousands):

Under the purchase method of accounting, the total purchase price as shown in the table above is allocated to the net tangible and intangible assets based on their estimated fair values as of the date of the completion of the transaction. The purchase price allocation, which has been revised, and may continue to be revised, based upon receipt of final valuations for certain items such as inventory and pension liabilities, and revision to the estimate of accrued restructuring costs assumed on acquisition is as follows (in thousands):

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The Company acquired developed technology from Alcatel, which is comprised of products that are technologically feasible, primarily including DWDM lasers, photodetectors, optical amplifiers, high-speed interface modules and passive optical devices. Core technology and patents represent a combination of Alcatel’s Optronics division processes, patents and trade secrets. The Company amortizes the developed technology on a straight-line basis over an estimated life of 3-4 years.

The Company acquired developed technology from Corning, which is comprised of products that are technologically feasible, primarily including optical amplifiers, dispersion compensation modules and lithium-niobate modulators. Core technology and patents represent a combination of the optical components business of Corning processes, patents and trade secrets. The Company amortizes the developed technology on a straight-line basis over an estimated life of 3-4 years.

The Company acquired developed technology from Vitesse, which is comprised of products that are technologically feasible, primarily including transponders. Core technology and patents represent a combination of the optical components business of Vitesse processes, patents and trade secrets. The Company amortizes the developed technology on a straight-line basis over an estimated life of 3-4 years.

The Company allocated the purchase price of the acquired companies and assets to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The Company engaged an independent third-party appraisal firm to assist it in determining the fair values of the assets acquired and the liabilities assumed. Such valuations require management to make significant estimations and assumptions, especially with respect to intangible assets.

Critical estimates in valuing certain intangible assets include, but are not limited to: future expected cash flows from customer contracts, customer lists, supply agreements, and acquired developed technologies and patents. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable.

The following unaudited pro forma information presents a summary of our consolidated results of operations as if the Alcatel, Corning and Vitesse acquisitions had taken place at the beginning of each period presented (in thousands, except per share amounts):

The pro forma consolidated results of operations include adjustments to record the difference between the depreciation on the preliminary estimate of fair value of property and equipment and the historical amounts, to eliminate pre-acquisition amortization of intangibles and/or impairment charge and to reflect amortization of the preliminary estimate of fair value of inventory and the core development technology assets.

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Significant Developments

During the second quarter of fiscal 2004, the Company announced the discontinuance and closing of its Livingston, Scotland facility and reassessed the related exit costs and workforce reductions, resulting in an additional restructuring charge of approximately $9.8 million with an offset of approximately $6.1 million to certain long-lived assets and intangible assets acquired at the acquisition date. The remainder of approximately $3.7 million was recorded as an increase in goodwill. On February 17, 2004, the Company sold its silica planar lightwave circuit (“PLC”) product line to Gemfire Corporation (“Gemfire”) at which time the Company adjusted the purchase price allocation of the optical components business of Alcatel to decrease the accrual for restructuring costs by $6.3 million, decrease certain long-lived assets and intangible assets by $2.6 million and decrease goodwill by $3.7 million.

Concurrently with this transaction, the Company acquired a minority interest of approximately 16.6% in GC Holdings, the parent company to Gemfire, for $4.4 million, which is accounted for under the cost method and included in “Other Assets”.

3. Pro Forma Disclosure of the Effect of Stock-Based Compensation

The Company accounts for its stock-based compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards Board No. 123, “Accounting for Stock-Based Compensation” to stock-based employee compensation (in thousands, except per share amounts).

4. Inventories

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Inventories consisted of the following (in thousands):

In the first nine months of fiscal 2004 and 2003, the Company recorded charges to cost of revenue for excess and obsolete inventory of $0.9 million and $4.1 million, respectively. In the first nine months of fiscal 2004, the provision was due to decreased demand for certain products. In the first nine months of fiscal 2003, the provision was due to $2.6 million of inventory that became obsolete due to a change in a customer’s product specification, and $1.5 million was due to excess inventory as a result of decreased demand for the Company’s products. Management did not believe it could sell or use this inventory in the future based on the then current forecasts of demand. Actual results may differ from such forecasts, which has been the experience in the past several quarters.

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The Company sold inventory previously written-off with original cost totaling $1.0 million and $3.0 million in the first nine months fiscal 2004 and 2003, 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 the Company’s estimates.

The total cost of inventory written-off since inception is approximately $49.4 million, including receipts under previously accrued non-cancelable purchase obligations. Of this amount, items representing $10.7 million have been sold, items representing $1.7 million have been consumed in research and development activities, items representing $19.2 million have been discarded, and items representing $17.8 million are on hand. The ultimate disposition of the inventory items on hand will occur as the Company integrates its new acquisitions and transitions its manufacturing to third-party manufacturers in Asia.

5. Goodwill and Other Intangible Assets

The following table reflects other intangible assets subject to amortization as of March 31, 2004 (in thousands):

     The estimated future amortization expense as of March 31, 2004 is as follows (in thousands):

In accordance with the adoption of Statement of Financial Accounting Standard (“SFAS”) No. 142 “Goodwill and Other Intangible Assets” (SFAS 142), the Company performed the required two-step impairment tests of goodwill and indefinite-lived intangible assets as of July 1, 2002. In the first step of the analysis, the Company’s assets and liabilities, including existing goodwill and other intangible assets, were assigned to its identified reporting units to determine their carrying value. The Company believes it operates as one reporting unit. After comparing the carrying value of the reporting unit to its fair value, it was determined that the goodwill recorded was impaired. After the second step of comparing the implied fair value of the goodwill to its carrying value, the Company recognized a transitional impairment loss of $37.5 million in the first quarter of fiscal 2003. This loss was recognized as the cumulative effect of an accounting change.

The fair value of the reporting unit was determined using the income approach. The income approach focuses on the income-producing capability of an asset, measuring the current value of the asset by calculating the present value of its future economic benefits such as cash earnings, cost savings, tax deductions, and proceeds from disposition. Value indications are developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment.

As required by SFAS 142, intangible assets that did not meet the criteria for recognition apart from goodwill were reclassified to goodwill. The Company reclassified $0.3 million of net assembled workforce to goodwill as of July 1, 2002.

The following table reflects the changes in the carrying amount of goodwill (including assembled workforce) (in thousands):

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6. Warranties

The Company accrues for the estimated cost to provide warranty services at the time revenue is recognized. The Company’s estimate of costs to service its warranty obligations is based on 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.

Changes in the Company’s product warranty accrual for the nine months ended March 31, 2004 and the year ended June 30, 2003 are as follows (in thousands):

7. Financing Arrangements

     Securities Purchase Agreements

In November 2003, the Company entered into a securities purchase agreement pursuant to which the investors named therein purchased, in the aggregate, 6,815,555 shares of our Common Stock at a price of $4.63 per share for aggregate gross proceeds of approximately $31.5 million. Net proceeds from this transaction amounted to approximately $29.6 million after payment of fees to financial and legal advisors and other direct costs. In connection with the issuance of the shares of Common Stock, the investors were issued rights, which were exercisable for up to an additional 1,363,116 shares of our Common Stock at $4.63 per share. During the third quarter of fiscal 2004, shares of Common Stock of 193,584 were issued upon the exercise of certain of such rights. The remainder of the rights expired on March 16, 2004.

In February 2004, the Company entered into a securities purchase agreement pursuant to which the investors purchased, in the aggregate, 7,319,761 shares of Common Stock of the Company at a price of $5.49 per share for aggregate gross proceeds of approximately $40.2 million. Net proceeds from this transaction amounted to approximately $38.7 million after payment of fees to financial and legal advisors and other direct costs. In connection with the issuance of the shares of Common Stock, the investors were issued rights which are exercisable for up to an additional 1,463,954 shares of the Company’s Common Stock at $5.49 per share, representing approximately $8.0 million in proceeds if the rights are exercised in full for cash. These rights are scheduled to expire on June 9, 2004.

     Short-Term Borrowings

The Company renewed a revolving line of credit from a financial institution, effective December 31, 2003, which allows

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maximum borrowings up to $20.0 million and terminates on December 31, 2004. This line of credit requires the Company to comply with specified covenants. At March 31, 2004 and June 30, 2003 the Company had borrowings of $0.5 million and $3.1 million, respectively, against this line. Additionally, the line of credit secures four letters of credit totaling approximately $4.8 million in the aggregate relating to certain facility leases and software related financing which expire in March through January of 2005. The line bears interest at prime plus 1.25% and, at March 31, 2004 the effective interest rate was 5.25%. The Company has pledged all of its assets as collateral for this line; more specifically, the line of credit is collateralized by $21.0 million in short-term investments at March 31, 2004.

     Other Long-term Obligations

In connection with the acquisition of the optical components business of Alcatel, the Company assumed additional long-term obligations, which were comprised of accrued pensions and retirement obligations totaling $3.7 million and capital lease obligations totaling $7.1 million as of March 31, 2004 at interest rates ranging from 3.1% to 7.7% with varying maturity dates through fiscal 2009. In connection with the acquisition of the optical components business of Corning, the Company assumed $1.6 million of accrued pensions and retirement obligations. The remaining portion of other long-term obligations of $4.7 million relates to other capital lease obligations of $3.6 million existing prior to the acquisitions and software financing and equipment financing arrangements of $1.1 million, with interest rates ranging from 5.2% to 14.4% with varying maturity dates through November 2006.

8. Restructuring

A summary of the Company’s restructuring accrual is as follows (in thousands):

     Acquisition-Related Restructuring

In the first quarter of fiscal 2004, the Company acquired the optical components businesses of Alcatel and Corning. As part of the acquisitions, the Company assumed restructuring liabilities at July 31, 2003 totaling $72.2 million relating to future workforce reductions and the costs of exiting duplicate facilities, which were included in the purchase price of the optical components businesses of Alcatel and Corning. During the second quarter of fiscal 2004, the Company announced the closing of its Livingston, Scotland facility and reassessed the related exit costs and workforce reductions, resulting in an additional restructuring charge of approximately $9.8 million. During the third quarter of fiscal 2004, the Company sold its planar lightwave circuit (“PLC”) unit in Livingston, Scotland, and adjusted the purchase price allocation of the optical components business of Alcatel to decrease the accrual for restructuring costs by $6.3 million.

A summary of the accrued restructuring charges relating to these acquisitions is as follows (in thousands):

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     Other Restructuring

     Workforce Reduction

During the third quarter of fiscal 2004, the Company announced and implemented several additional restructuring programs throughout the Company, resulting in net restructuring charges of $9.1 million. During fiscal 2003, the Company reduced its workforce primarily in its manufacturing operations, and recorded charges of $3.0 million for employee separations, including termination benefits and related expenses.

     Abandonment of Excess Equipment

The Company abandoned excess equipment and leasehold improvements and recorded charges of $3.5 million during fiscal 2003. The equipment was abandoned because it was no longer required to support expected operating levels and, given the downturn in its industry, the Company concluded it could not be sold. During the nine months ended March 31, 2004, the Company sold $0.6 million of these and other previously abandoned assets.

     Abandonment of Excess Leased Facilities

During fiscal 2001, the Company announced a restructuring program to realign resources in response to the changes in its industry and customer demand. As a result of the restructuring program, the Company recorded a restructuring charge of $22.6 million in the fourth quarter of fiscal 2001. During the third quarter of fiscal 2002, the Company reassessed its initial estimate of probable costs and the sublease timeline associated with abandoning excess leased facilities in Newark, California and Richardson, Texas. As a result, the Company recorded an additional charge of $17.2 million relating to these facilities in the third quarter of fiscal 2002.

During the first quarter of fiscal 2003, the Company announced the closing of its facility in Richardson, Texas and the integration of the functions in Richardson into its facility in Fremont, California. The Company also consolidated its facilities in Fremont. During the second quarter of fiscal 2003, the Company reassessed its initial estimate of probable costs and the sublease timeline associated with abandoning each of its excess leased facilities. The reassessment was prompted by a further decline in the real estate market in the cities where those facilities are located. After considering information provided to the Company by its real estate advisors, the Company concluded it was probable these facilities could not be subleased at rates originally contemplated nor could they be subleased in the timeframe originally planned. During the third quarter of fiscal 2003, the Company continued to restructure and downsize its workforce, primarily in its manufacturing operations and further consolidated its facilities in Fremont.

During the second quarter of fiscal 2004, the Company reassessed its estimate of probable costs associated with abandoning each of its excess leased facilities. After considering information provided to the Company by its real estate advisors, the Company concluded it was probable these facilities could not be subleased at the rental rates previously estimated. In January 2004, the Company restructured its leased facilities in Newark, California and reduced the related lease obligation, including by issuing warrants amounting to $0.4 million (valued using the Black-Scholes method). The reduction in the lease obligation offset the reduction in estimated sublease income and there was no impact on the restructuring reserve or operating results for the second and third quarters of fiscal 2004.

The following table summarizes changes in the restructuring accrual for the nine months ended March 31, 2004, excluding accruals related to the acquisitions noted above (in thousands):

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Amounts related to the abandonment of excess leased facilities will be paid as the payments are due through the remainder of the lease term through 2010. Capital lease payments are due over the term of the leases through the third quarter of fiscal 2005.

9. Net Loss per Common Share

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

10. Related Party Transactions

On July 31, 2003, Alcatel was issued 28% of the Company’s common stock and Corning was issued 17% of the Company’s common stock on a post-transaction basis. The Company sells products and purchases raw materials and components from Alcatel and Corning in the regular course of business. Additionally, Alcatel and Corning provide administrative and other transitional services to the Company. Sales of products to Alcatel and Corning were $21.8 million and $0.4 million, respectively, during the period August 1, 2003 through March 31, 2004. Purchases of raw materials and components from Alcatel and Corning were $2.6 million and $21.2 million, respectively, during the period August 1, 2003 through March 31, 2004. As of March 31, 2004, the Company had paid $3.1 million and $2.0 million to Alcatel and Corning, respectively, for administrative and other transitional services. Amounts due from Alcatel and Corning were $16.5 million and $2.6 million, respectively, at March 31, 2004, which includes $10.3 million and $2.6 million, respectively, relating to receivables arising in the acquisition. Amounts due to Alcatel and Corning were $1.4 million and $1.7 million, respectively, at March 31, 2004.

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11. Disclosures about Segments of an Enterprise

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS No. 131), 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 operates in one business segment, which focuses on the development and commercialization of fiber optic-based products. The Company has adopted a matrix management organizational structure whereby management of worldwide activities is on a functional basis.

Revenue by geographical area (in thousands):

Long-lived assets by geographical area (in thousands):

Revenue by component (in thousands):

For the three months ended March 31, 2004, three customers accounted for 30%, 22%, and 15%, respectively, of net revenues, compared with one customer, which accounted for 73%, of net revenues for the same period in the prior fiscal year. For the nine months ended March 31, 2004, two customers accounted for 29% and 22%, respectively, compared with two customers which accounted for 51% and 14%, respectively, of net revenues for the same period in the prior fiscal year. No other customers accounted for more than 10% of net revenues for the three and nine months ended March 31, 2004.

12. Comprehensive Income and (Loss)

Foreign currency translation adjustments for the three and nine months ended March 31, 2004 were a loss of approximately $1.8 million and a gain of $4.4 million, respectively, resulting in a comprehensive net loss of $42.8 million and $94.8 million, respectively. In prior periods, the Company did not have other comprehensive income and loss.

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13. 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. A proposal has been made for the settlement and release of claims against the issuer defendants, including Avanex, which has been approved (subject to the conditions noted below) by a special committee of our Board of Directors. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. If the 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 flows.

     High Hopes Enterprises and Hon Hai Precision Industry Co. Litigation

On May 31, 2002, High Hopes Enterprises Ltd. and Hon Hai Precision Industry Co., Ltd., filed an action in the Superior Court of California, County of Alameda, against us alleging breach of an oral contract, breach of the covenant of good faith and fair dealing, breach of implied contract, promissory estoppel, deceit by fraud and deceit by negligent misrepresentation. This action was settled in October 2003 with the mutual consent of both parties under terms of a confidentiality agreement. The settlement did not have a material impact on the Company’s consolidated financial statements.

14. Recent Accounting Pronouncements

In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on EITF 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. EITF 00-21 sets out criteria for when revenue on a deliverable can be recognized separately from other deliverables in a multiple deliverable arrangement. The Company adopted the provisions of EITF 00-21 effective July 1, 2003 and such adoption did not have a material impact on its consolidated financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46) “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” In December 2003, FIN 46 was revised to clarify certain provisions and change the effective date. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Application of FIN 46 (as revised) is required for all variable interest entities or potential variable interest entities effective December 31, 2003. Application of FIN 46 for all other entities is required effective March 31, 2004. The Company adopted the provisions of FIN 46 effective July 1, 2003 and such adoption did not have a material impact on its consolidated financial statements.

In April 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No.

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149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for contracts and hedging relationships entered into or modified after June 30, 2003. The Company adopted the provisions of SFAS 149 effective July 1, 2003 and such adoption did not have a material impact on its consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for classification and measurement in the statement of financial position of certain financial instruments with characteristics of both liabilities and equity. The Company adopted the provisions of SFAS 150 effective July 1, 2003 and such adoption did not have a material impact on its consolidated financial statements.

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 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 for the reasons, among others, detailed in “Factors That May Affect Future Results”. The forward-looking statements 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 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, 2003, included in our Form 10-K filed with the SEC.

Acquisitions

In May 2003, we entered into a Share Acquisition and Asset Purchase Agreement with Alcatel and Corning Incorporated. Pursuant to the purchase agreement, in July 2003, we acquired all of the outstanding equity of Alcatel Optronics France SA, a subsidiary of Alcatel that operated the optical components business of Alcatel, and Alcatel assigned and licensed certain intellectual property rights to us. We also entered into a supply agreement with Alcatel whereby Alcatel agreed to purchase seventy percent (70%) of its requirements for certain qualified products from us for a period of three years, subject to certain requirements. In addition, we acquired certain assets of the optical components business of Corning, and Corning assigned and licensed certain intellectual property rights to us. As a result of these acquisitions we acquired approximately 1,117 employees and manufacturing operations located in Nozay, France; San Donato, Italy; Livingston, UK; and Erwin Park, New York. Pursuant to the purchase agreement, 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. The transactions were accounted for under the purchase method of accounting.

In August 2003, we entered into an Amended and Restated Asset Purchase Agreement with Vitesse Semiconductor Corporation. Pursuant to the purchase agreement, in August 2003 we acquired substantially all of the assets of Vitesse Semiconductor Corporation’s Optical Systems Division located in San Jose, California, in exchange for 1.4 million shares of our common stock. The transaction was accounted for under the purchase method of accounting.

As a result of these acquisitions, we offer a substantially broader range of photonic processing solutions and technologies, including passive and active optical components, optoelectronics integration and software and interface controls, demonstrating our continuing commitment to become the leading supplier of intelligent photonic solutions to telecommunications system integrators and carriers worldwide.

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Subsequent to the acquisitions, we have been performing ongoing evaluations of our cost and operating structure and we are continuing to eliminate redundancies and reduce costs to improve our future financial performance. For example, in February 2004 we entered into a share acquisition agreement with Gemfire Corporation (“Gemfire”) pursuant to which Gemfire acquired our silica planar lightwave circuit (“PLC”) product line manufactured in Livingston, Scotland. The operating results of the PLC business are reflected as discontinued operations in the accompanying consolidated statements of operations. Our continuing operations include the results of our Fiber Bragg Grating (“FBG”) product line, not included in the transaction, which were transferred to our Nozay, France location.

Overview

We design, manufacture and market fiber optic-based products, which include a full range of solutions and technologies, including passive and active optical components, optoelectronics integration and software and interface controls. We sell our products to communication service providers and optical system manufacturers. We were founded in October 1997, and began making volume shipments of our products during the quarter ended September 30, 1999.

We, like many of our peers in the communications equipment industry, have been adversely affected by the general economic downturn, and particularly by the significant reduction in telecommunications equipment spending. Our operating results may fluctuate significantly from quarter to quarter due to several factors. Our expense levels are based in part on our management’s expectations of future revenues. Although management has taken and will continue to take measures to reduce expense levels, if revenue in a particular period is less than anticipated, operating results will be affected adversely.

As a result of our acquisitions, our costs and operating expenses have significantly increased and will continue to be significantly higher in fiscal 2004 as compared to the prior fiscal year. As a result, our combined operations have substantially increased the rate at which Avanex utilizes its cash resources. We also anticipate that our revenue in fiscal 2004 will be significantly greater than our revenue in previous fiscal years due to these acquisitions.

Revenues. The market for intelligent photonic solutions is new and evolving 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, and the practice of customers in the communications industry to sporadically place orders with short lead times, may cause our revenues, gross margins, operating results and the identity of our largest customers to vary significantly and unexpectedly from quarter to quarter.

Our revenues in the first nine months of fiscal 2004 were principally derived from the sales of our product portfolio, which was significantly enhanced by the acquisitions of the optical component businesses of Alcatel and Corning, including our multiplexing, transmission and amplification products, which together accounted for 79% of net revenue for the nine months ended March 31, 2004. Our revenues for the first nine months of fiscal 2003 were principally derived from sales of PowerFilter, PowerMux and PowerExchanger, which together accounted for 88% of net revenue for the nine months ended March 31, 2003.

We have substantially diversified our customer base, although a significant proportion of our sales continue to be concentrated with a limited number of customers. We anticipate that our operating results for any given period will continue to depend on a small number of customers.

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 subassemblies.

Research and Development Expenses. Research and development expenses consist primarily of salaries and related personnel costs, fees paid to consultants and outside service providers, allocated facilities, non-recurring engineering charges and

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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 marketing, sales, customer service and application engineering support, allocated facilities, as well as costs associated with promotional and other marketing expenses.

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

Stock Compensation. In connection with the grant of stock options to employees, we recorded deferred stock compensation representing the difference between the deemed value of our common stock for accounting purposes and the exercise price of these options at the date of grant. Moreover, in connection with the assumption of stock options previously granted to employees of companies we acquired, we recorded deferred compensation representing the difference between the fair market value of our common stock on the date of closing of each acquisition and the exercise price of unvested options granted by those companies which we assumed. Deferred stock compensation is presented as a reduction of stockholders’ equity, with accelerated amortization recorded over the vesting period, which is typically three to five years. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited prior to vesting.

Amortization of Intangibles. A portion of the purchase price in a business combination is allocated to goodwill and intangibles. Goodwill and intangible assets with indefinite lives are not amortized but rather are subject to an annual impairment test. Intangible assets with definite lives are amortized over their estimated useful lives.

Reduction in Long-Lived Assets. Reduction of long-lived assets generally includes charges related to long-lived assets such as fixed assets and intangibles when the carrying value of those assets is not recoverable from estimated future cash flows.

Restructuring Charges. Restructuring charges generally include termination costs for employees and excess manufacturing equipment and facilities associated with formal restructuring plans.

Merger Costs. Merger costs generally includes costs incurred in connection with transactions that were not completed.

Interest and Other Income (Expense), Net. Interest and other income, net consists primarily of interest on our cash investments offset by interest expense associated with borrowings under our line of credit, capital lease obligations and equipment loans.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, 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 follows SEC Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements” and Emerging Issues Task Force Abstract 00-21, “Revenue Arrangements with Multiple Deliverables”. Specifically, we recognize product revenue when persuasive evidence of an arrangement exists, the product has been shipped, title has 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 in the same period as the related revenues are recorded which is netted against revenue. These estimates are based on historical sales returns,

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other known factors and our return policy. If future sales returns differ from the historical data we use to calculate these estimates, changes to the provision may be required.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. 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. For all other customers, we record an allowance for doubtful accounts based on the length of time the receivables are past due. 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. This may be magnified due to the concentration of our sales to a limited number of customers.

Excess and Obsolete Inventory. We make inventory commitment and purchase decisions based upon sales forecasts. To mitigate component supply constraints that have existed in the past and to fill orders with non-standard configurations, we build inventory levels for certain items with long lead times and enter into short-term commitments for certain items. We write off 100% of the cost of inventory that we specifically identify and consider obsolete or excessive to fulfill future sales estimates. If we subsequently sell previously written-off inventory, we will recognize revenue with no related cost of sales. We define obsolete inventory as 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 our best estimate of future demand at the time, based upon information then available to us.

In estimating obsolete and excess inventory, we currently use a six-month to twelve-month demand forecast depending upon visibility of demand from our customers. Prior to the first quarter of fiscal 2004, we used a three-month demand forecast, as visibility to our customers’ demand was limited. We also consider: (1) parts and subassemblies that can be used in alternative finished products, (2) parts and subassemblies that are unlikely to be engineered out of our products, and (3) known design changes which would reduce our ability to use the inventory as planned. If either our demand forecast or estimate of future uses of inventory is inaccurate, we may need to make additional write-offs of inventory in future periods.

Impairment of Long-Lived Assets including Goodwill and Other Intangible Assets. We review long-lived assets other than goodwill and indefinite lived intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable, such as a significant industry downturn, significant decline in our market value or significant reductions in projected future cash flows. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is assessed using discounted cash flows. In assessing the recoverability of long-lived assets other than goodwill and indefinite lived intangible assets we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If circumstances arise that cause these estimates or their related assumptions to change in the future we may be required to record additional impairment charges for these assets.

Goodwill is reviewed for impairment annually and as impairment indicators arise. Goodwill is tested for impairment at the reporting unit level utilizing a two-step methodology. The initial step requires us to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such unit. We believe we operate as one reporting unit. If the fair value of the reporting unit exceeds the carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit exceeds its fair value, the goodwill of this unit may be impaired. The amount, if any, of the impairment would then be measured in the second step.

The fair value of the reporting unit is determined using the income approach. The income approach focuses on the income-producing capability of an asset, measuring the current value of the asset by calculating the present value of its future economic benefits such as cash earnings, cost savings, tax deductions, and proceeds from disposition. Value indications are developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation, and risks associated with the particular investment. In response to changes in industry and market conditions, we may be required to strategically realign our resources and consider restructuring, disposing, or otherwise exiting businesses, which could result in an impairment of goodwill.

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Warranties. We accrue for the estimated cost to provide warranty services at the time revenue is recognized. 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.

Restructuring. We have recorded significant accruals in connection with our restructuring programs. These accruals include estimates pertaining to employee separation costs and related abandonment of excess equipment and facilities. Actual costs may differ from these estimates or our estimates may change.

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 respective fair values. The recorded values of assets and liabilities are based on third-party and internal estimates and valuations. 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.

Contingencies. We are subject to proceedings, lawsuits and other claims related to our initial public offering and other matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of accrual required, if any, for these contingencies is made after careful analysis of each individual issue and consultation with legal counsel. The required accrual may change in the future due to new developments in each matter or changes in approach such as a change in settlement strategy in dealing with these matters, resulting in higher net loss.

Results of Operations

The results for the nine months ended March 31, 2004 include eight months of operating results from the business activities and assets acquired from Alcatel and Corning on July 31, 2003 and seven months of operating results from the business activities and assets acquired from Vitesse on August 28, 2003.

Net Revenue

Net revenue for the quarter ended March 31, 2004 was $30.1 million, compared to $5.4 million for the quarter ended March 31, 2003, an increase of $24.7 million, of which $22.1 million is attributable to additional net revenue resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse. The remaining increase of $2.6 million is primarily as a result of an increased customer base and increased sales to existing customers. In the quarter ended March 31, 2004, three customers each accounted for greater than 10% of net revenue and combined accounted for 67% of net revenue. This compares to one customer that accounted for greater than 10% of net revenue in the quarter ended March 31, 2003 and accounted for 73% of net revenue.

Net revenue for the nine months ended March 31, 2004 was $75.1 million, compared to $16.0 million for the nine months ended March 31, 2003, an increase of $59.1 million, of which $55.1 million is attributable to additional net revenue resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse. The remaining increase of $4.0 million is primarily as a result of an increased customer base and increased sales to existing customers. For the nine months ended March 31, 2004, two customers each accounted for greater than 10% of net revenue and combined accounted for 51% of net revenue. This compares to two customers that each accounted for greater than 10% of net revenue in the nine months ended March 31, 2003 and combined accounted for 65% of net revenue.

Cost of Revenue

Cost of revenue for the three months ended March 31, 2004 was $36.3 million, compared to $6.7 million for the three months ended March 31, 2003, an increase of $29.6 million, of which $25.8 million is attributable to additional cost of revenue resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse. The remaining increase of $3.8 million is primarily due to a corresponding increase in revenues. A provision of $0.6 million for excess and obsolete inventory was recorded in the three months ended March 31, 2004, as compared to a provision of $0.3 million for the same period in the prior fiscal year. In the three months ended March 31, 2004, we sold inventory previously written-off with an

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original cost totaling $0.2 million due to unforeseen demand for such inventory, compared to $1.1 million for the same period in the prior fiscal year. Cost of revenue associated with the sale of this inventory was zero. The selling price of the finished goods that include these components was similar to the selling price of products that did not include components that were written-off.

Cost of revenue for the nine months ended March 31, 2004 was $96.2 million, compared to $24.0 million for the nine months ended March 31, 2003, an increase of $72.2 million, of which $70.3 million is attributable to additional cost of revenue resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse. The remaining increase of $1.9 million is primarily due to an increase in revenues. A provision for excess and obsolete inventory of $0.9 million was recorded in the nine-month period ended March 31, 2004. In the nine-month period ended March 31, 2003, we recorded a provision for excess and obsolete inventory of $4.1 million which was due to $2.6 million of inventory that became obsolete due to a change in a customer’s product specification and the remaining $1.5 million was due to excess inventory as a result of decreased demand for our products. In each of the nine-month periods ended March 31, 2004 and 2003, we sold inventory previously written-off with an original cost totaling $1.0 and $3.0 million, respectively due to unforeseen demand for such inventory.

Our gross margin percentage improved to negative 21% for the quarter ended March 31, 2004 from negative 24% for the quarter ended March 31, 2003. The improvement is primarily due to a favorable product mix attributable to an increase in sales volume of our long haul product line, which includes certain inventory items with low product costs. Our gross margin percentage improved to negative 28% for the nine-month period ended March 31, 2004 from negative 49% for the nine-month period ended March 31, 2003. The overall improvement in gross margin percentage for the nine-month period ended March 31, 2004 was primarily due to the reduction in the provision for excess and obsolete inventory noted above, as well as the favorable product mix described above. Our gross margin percentage on net revenue resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse for the three and nine months ended March 31, 2004 was negative 17% and 28%, respectively. Our gross margins are and will be primarily affected by changes in mix of products sold including inventory items with low product costs, manufacturing volume, and changes in market prices. We expect cost of revenue, as a percentage of net revenue, to fluctuate from period to period. In addition, we expect continued pressure on our gross margin percentage as a result of underutilized manufacturing capacity and price competition.

Research and Development

Research and development expenses increased to $10.7 million for the quarter ended March 31, 2004 from $3.0 million for the quarter ended March 31, 2003 and increased to $31.2 million for the nine month period ended March 31, 2004 from $13.1 million for the nine month period ended March 31, 2003. The increase was primarily attributable to $21.1 million of costs associated with increased headcount and facilities-related expenses due to the acquisitions of the optical components business of Alcatel, Corning and Vitesse. As a percentage of revenue, research and development expenses decreased to 36% in the quarter ended March 31, 2004 from 56% for the quarter ended March 31, 2003, and decreased to 42% in the nine months ended March 31, 2004 from 82% for the nine months ended March 31, 2003 as a result of a combination of increased sales volume and efforts to reduce research and development expenses.

Sales and Marketing

Sales and marketing expenses increased to $5.1 million for the quarter ended March 31, 2004 from $1.9 million for the quarter ended March 31, 2003, an increase of $3.2 million, and increased to $14.5 million for the nine months ended March 31, 2004 from $4.7 million for the nine months ended March 31, 2003, an increase of $9.8 million. The increase in sales and marketing expenses resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse was $2.4 million and $6.9 million for the three and nine months ended March 31, 2004, respectively. Increased tradeshow, marketing, headcount and facilities related expenses due to the acquisitions and a settlement with a distributor also contributed to the increase in sales and marketing expenses. As a percentage of revenue, sales and marketing expenses decreased to 17% in the quarter ended March 31, 2004 from 34% for the quarter ended March 31, 2003, and decreased to 19% in the nine months ended March 31, 2004 from 29% for the nine months ended March 31, 2003.

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General and Administrative

General and administrative expenses increased to $7.8 million for the quarter ended March 31, 2004 from $2.4 million for the quarter ended March 31, 2003, an increase of $5.4 million, and increased to $19.3 million for the nine month period ended March 31, 2004 from $7.2 million for the nine month period ended March 31, 2003, an increase of $12.1 million. The increase in general and administrative expenses resulting from our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse was $3.1 million and $7.6 million for the three and nine months ended March 31, 2004, respectively. Costs associated with increased headcount and facilities related costs due to the acquisitions and payments related to settlement of claims contributed to the increase in general and administrative expenses. As a percentage of revenue, general and administrative expenses decreased to 26% in the quarter ended March 31, 2004 from 45% for the quarter ended March 31, 2003, and decreased to 26% in the nine months ended March 31, 2004 from 45% for the nine months ended March 31, 2003.

Stock Compensation/(Benefit)

Stock compensation expense increased to $0.1 million for the quarter ended March 31, 2004 from a benefit of $2.3 million for the quarter ended March 31, 2003 and increased to $0.7 million for the nine-month period ended March 31, 2004 from a benefit of $0.7 million for the nine month period ended March 31, 2003. From inception through March 31, 2004, we have expensed a total of $102.5 million of stock compensation, leaving an unamortized balance of $0.7 million on our March 31, 2004 unaudited condensed consolidated balance sheet. The increase in stock compensation expense for the three and nine-month period ended March 31, 2004 was primarily attributable to the absence of reversed amortized stock-based compensation expense relating to former executive officers that left the Company during the quarter ended March 31, 2003.

Amortization of Intangibles

Amortization of intangibles for the quarter ended March 31, 2004 increased to $1.3 million compared to zero for the quarter ended March 31, 2003 and increased to $3.3 million for the nine month period ended March 31, 2004 compared to $0.2 million for the nine month period ended March 31, 2003. The increase was due to the amortization of the intangibles assumed due to the acquisitions in fiscal 2004. The intangible balance on our condensed consolidated balance sheet as of March 31, 2004 was $16.1 million.

Restructuring Charges

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.

During fiscal 2003, we announced the closing of our facility in Richardson, Texas and the integration of the functions in Richardson into our facility in Fremont, California. We also continued to downsize our workforce, primarily in our manufacturing operations and further consolidated our facilities in Fremont, resulting in net restructuring charges of $4.8 million and $22.5 million for the three and nine months ended March 31, 2003.

During the third quarter of fiscal 2004, we announced and implemented several additional restructuring programs throughout the organization, resulting in net restructuring charges of $9.1 million. Restructuring charges for the nine months ended March 31, 2004 were $8.6 million, which include the charges noted above, offset by $0.5 million relating to sales of previously abandoned equipment.

Merger Costs

On March 18, 2002, we entered into an Agreement and Plan of Reorganization with Oplink Communications pursuant to which we intended to acquire all of the outstanding capital stock of Oplink. The merger was subject to the approval of our stockholders and the stockholders of Oplink. While our stockholders approved the issuance of our common stock in connection with the merger, the stockholders of Oplink failed to approve the merger on August 15, 2002. We expensed $4.1 million in related merger costs in the first quarter of fiscal 2003.

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Interest and Other Income (Expense), Net

Interest and other income (expense), net was $0.6 million for each of the quarters ended March 31, 2004 and 2003 and $2.3 million for the nine month period ended March 31, 2004 and $1.9 million for the nine month period ended March 31, 2003. The increase in interest and other income, net was primarily due to an increase in our cash and cash equivalents and investment balances due to the cash acquired in acquisitions.

Discontinued Operations

In February 2004, we entered into a share acquisition agreement with Gemfire Corporation (“Gemfire”) pursuant to which Gemfire acquired our silica planar lightwave circuit (“PLC”) product line manufactured in Livingston, Scotland, which was acquired in our acquisition of Alcatel Optronics in the first quarter of fiscal 2004. For the three and nine months ended March 31, 2004, we have recorded a net loss from discontinued operations of $1.3 million and $6.1 million, respectively.

Cumulative Effect of an Accounting Change to Adopt SFAS 142

In accordance with the adoption of SFAS 142, “Goodwill and Other Intangible Assets”, we performed the required two-step transitional impairment tests of goodwill and indefinite-lived intangible assets as of July 1, 2002. In the first step of the analysis, our assets and liabilities, including existing goodwill and other intangible assets, were assigned to our identified reporting units to determine their carrying value. We believe we operate as one reporting unit. After comparing the carrying value of the reporting unit to its fair value, it was determined that the goodwill recorded was impaired. After the second step of comparing the implied fair value of the goodwill to its carrying value, we recognized a transitional impairment loss of $37.5 million in the first quarter of fiscal 2003. This loss was recognized as the cumulative effect of an accounting change. The impairment loss had no income tax effect.

As required by SFAS 142, intangible assets that did not meet the criteria for recognition apart from goodwill were reclassified to goodwill. We reclassified $0.3 million of net assembled workforce to goodwill as of July 1, 2002.

Liquidity and Capital Resources

Prior to our initial public offering, we financed our operations primarily through private sales of approximately $30.4 million of convertible preferred stock. We have also financed our operations through bank borrowings as well as through equipment lease financing. In February 2000, we received net proceeds of approximately $238 million from the initial public offering of our common stock and a concurrent sale of stock to corporate investors.

In connection with the acquisitions of the optical components business of Alcatel and Corning on July 31, 2003, Corning and Alcatel contributed cash, cash equivalents and short-term investments of $128.6 million and we assumed liabilities of $132.1 million.

In November 2003, we entered into a securities purchase agreement pursuant to which the investors named therein purchased, in the aggregate, 6,815,555 shares of our Common Stock at a price of $4.63 per share for aggregate gross proceeds of approximately $31.5 million. Net proceeds from this transaction amounted to approximately $29.6 million after payment of fees to financial and legal advisors and other direct costs. In connection with the issuance of the shares of Common Stock, the investors were issued rights which were exercisable for up to an additional 1,363,116 shares of our Common Stock at $4.63 per share. During the third quarter of fiscal 2004, shares of Common Stock of 193,584 were issued upon the exercise of certain of such rights. The remainder of these rights expired on March 16, 2004.

In February 2004, we entered into a securities purchase agreement pursuant to which the purchasers named therein purchased, in the aggregate, 7,319,761 shares of our Common Stock at a price of $5.49 per share for aggregate gross proceeds of approximately $40.2 million. Net proceeds from this transaction will amount to approximately $38.7 million after payment of fees to financial and legal advisors and other direct costs. In connection with the issuance of the shares of Common Stock, the investors were issued rights which are exercisable for up to an additional 1,463,954 shares of our Common Stock at $5.49 per share, representing approximately $8.0 million in proceeds if the rights are exercised in full for cash. These rights are scheduled to expire on June 9, 2004.

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As of March 31, 2004, we had cash and cash equivalents and short-term investments of $107.4 million and long-term investment holdings of $73.5 million.

Net cash used in operating activities was $139.1 million for the nine months ended March 31, 2004, primarily reflecting a net loss, payments of restructuring costs and warranty repair costs, purchases of inventories, and additional trade receivables related to increased sales volume. Our use of cash was primarily offset by non-cash charges related to depreciation, amortization of intangibles, and the provision for doubtful accounts, and an increase in accounts payable primarily related to inventory purchases and other operating expenses in connection with the increased business from our acquisitions. Net cash used in operating activities was $26.4 million for the comparable period of fiscal 2003, primarily reflecting a loss from operations, a decrease in accrued expenses, deferred revenue and warranty and an increase in inventory offset by a decrease in accounts receivable and an increase in accounts payable and accrued restructuring. Our use of cash was primarily offset by non-cash charges related to the provision for excess inventory, depreciation and amortization, stock compensation expense, non-cash restructuring charges, merger expenses and cumulative effect of an accounting change.

Cash provided by investing activities was $101.5 million for the nine months ended March 31, 2004. Cash provided by investing activities was primarily the result of the cash acquired due to the acquisitions of the optical components businesses of Alcatel and Corning offset by net purchases of investment securities, our $4.4 million investment in Gemfire, and purchases of property and equipment. Cash provided by investing activities was $32.9 million for the comparable period of fiscal 2003, primarily the result of maturities of investment securities, net of purchases of held-to-maturities securities, offset by costs incurred related to the proposed merger with Oplink.

Cash provided by financing activities was $65.0 million for the nine months ended March 31, 2004, primarily due to proceeds from our two recent private placements of Common Stock and the exercise of investment rights issued in the private placements (see Note 7) and borrowings under financing arrangements offset by payments on short term borrowings, long term-debt and capital lease obligations. Cash used in financing activities was $5.6 million for the comparable period of fiscal 2003, primarily as a result of payments on long-term debt and capital lease obligations and payments on short-term borrowings, offset by proceeds from short-term borrowings, cash payments received from stockholders’ notes receivable and the proceeds from issuance of common stock.

Our principal source of liquidity as of March 31, 2004 consisted of $180.9 million in cash, cash equivalents, short-term and long-term investments. Additionally, we renewed a revolving line of credit from a financial institution, which allows maximum borrowings up to $20.0 million through December 31, 2004, of which $0.5 million was drawn down and $4.8 million was pledged to secure letters of credit at March 31, 2004. The line of credit requires us to comply with specified financial and non-financial covenants. We were in compliance with all the covenants at March 31, 2004. The renewed line bears interest at the prime rate plus 1.25%. At March 31, 2004 the effective interest rate was 5.25%. We have pledged all of our assets as collateral for this line. We believe that if we are unable to renew the line of credit subsequent to December 31, 2004, it will not have a significant impact on our liquidity.

From time to time, we may also consider the acquisition of, or evaluate investments in, products and businesses complementary to our business. Any acquisition or investment may require additional capital. Although we believe that our current cash and cash equivalents, short-term and long-term investment balance will be sufficient to fund our operations for at least 12 months, we cannot assure that we will not seek additional funds through public or private equity or debt financing or from other sources within this time frame or that additional funding, if needed, will be available on terms acceptable to us, or at all.

Our contractual obligations and commitments have been summarized in the tables below (in thousands):

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We have unconditional purchase obligations to certain of our suppliers that support our ability to manufacture our products. As of March 31, 2004, we had approximately $5.1 million of purchase obligations, none of which is included on our balance sheet in accounts payable.

Under operating and capital leases described in the table above, we have included total future minimum rent expense under non-cancelable leases for both current and abandoned facilities and equipment leases. We have included in the balance sheet $13.9 million and $20.6 million in current and long-term restructuring accruals, respectively, for the abandoned facilities and capital leases relating to excess equipment as of March 31, 2004.

Recently Issued Accounting Pronouncements

In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on EITF 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. EITF 00-21 sets out criteria for when revenue on a deliverable can be recognized separately from other deliverables in a multiple deliverable arrangement. We adopted the provisions of EITF 00-21 effective July 1, 2003 and such adoption did not have a material impact on our consolidated financial statements.

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46) “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” In December 2003 FIN 46 was revised to clarify certain provisions and change the effective date. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Application of FIN 46 (as revised) is required for all variable interest entities or potential variable interest entities effective December 31, 2003. Application of FIN 46 for all other entities is required effective March 31, 2004. We adopted the provisions of FIN 46 effective July 1, 2003, and such adoption did not have a material impact on our consolidated financial statements.

In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for contracts and hedging relationships entered into or modified after June 30, 2003. We adopted the provisions of SFAS 149 effective July 1, 2003 and such adoption did not have a material impact on our consolidated financial statements.

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In May 2003, the FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for classification and measurement in the statement of financial position of certain financial instruments with characteristics of both liabilities and equity. We adopted the provisions of SFAS 150 effective July 1, 2003 and such adoption did not have a material impact on our consolidated financial statements.

FACTORS THAT MAY AFFECT FUTURE RESULTS

In addition to the other information contained in this Form 10-Q, we have identified the following risks and uncertainties that may have a material adverse effect 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 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.

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 for use in infrastructure projects. In the past few years, there has been a significant reduction in spending for infrastructure projects in the telecommunications industry. Certain large telecommunications companies who were customers or potential customers of ours have suffered severe business setbacks and face uncertain futures. There is currently a perception that an oversupply of communications bandwidth exists. This perceived oversupply, coupled with the current economic environment, may lead to the continuation of lower telecommunications infrastructure spending, and our customers may continue to cancel, defer or significantly reduce their orders for our products. Reduced infrastructure spending 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 infrastructure spending, or if the prices we charge continue to decline, our revenues may be adversely affected

We have a history of losses, and such losses are likely to continue if we are unable to increase our revenues and further reduce our costs.

We have never been profitable. We have experienced operating losses in each quarterly and annual period since our inception in 1997, and we may continue to incur operating losses for the foreseeable future. As of March 31, 2004, we had an accumulated deficit of $489 million. Also, for the quarter ended March 31, 2004 and several previous quarters, we had negative operating cash flow, and we expect to continue to incur negative operating cash flow in future periods.

Due to insufficient cash generated from operations, we have funded our operations primarily through the sale of equity securities, bank borrowings, equipment lease financings, and other strategic transactions. Although we implemented cost reduction programs in fiscal 2003 and fiscal 2004, we continue to have significant fixed expenses, and we expect to continue to incur considerable manufacturing, sales and marketing, product development and administrative expenses. In addition, we completed our acquisitions of the optical components businesses of Alcatel and Corning in July 2003 and Vitesse in August 2003. The costs and operating expenses of the combined company are significantly greater than the costs and operating expenses of Avanex as a stand-alone company. As a result, the combined operations of Avanex and the optical components businesses of Alcatel, Corning and Vitesse have substantially increased the rate at which Avanex utilizes its cash resources. If we fail to generate higher revenues and increase our gross margins while containing our costs and operating expenses, our financial position will be harmed significantly. Our revenues may not grow in the future, and we may never generate sufficient revenues to achieve profitability.

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Difficulties in integrating our acquisitions of the optical components businesses of Alcatel, Corning and Vitesse could adversely impact our business.

We completed the acquisitions of the optical components businesses of Alcatel, Corning and Vitesse in 2003. These acquisitions are the largest acquisitions we have completed, and the complex process of integrating these businesses has required, and will continue to require, significant resources. Integrating the businesses acquired from Alcatel, Corning and Vitesse has been and will continue to be time consuming and expensive. Failure to achieve the anticipated benefits of these acquisitions or to successfully integrate the operations of the acquired businesses could harm our business, results of operations and cash flows. We may not realize the benefits we anticipate from these acquisitions because of the following significant challenges:

•

expected synergistic benefits from the acquisitions, such as lower costs, may not be realized or may be realized more slowly than anticipated, particularly with regard to costs associated with a reduction in headcount and facilities;

•

potentially incompatible cultural differences between the businesses;

•

incorporating technology and products acquired from Alcatel, Corning and Vitesse into our current and future product lines;

•

generating market demand for an expanded product line;

•

integrating products acquired from Alcatel, Corning and Vitesse with our business;

•		geographic dispersion of operations;
•		integrating technical teams acquired from Alcatel, Corning and Vitesse with our engineering organization;

•

some of Alcatel’s, Corning’s and Vitesse’s suppliers, distributors, customers and licensors are our competitors or work with our competitors, and as a result may terminate their business relationships with us; and

•

our inability to retain previous customers or employees of Alcatel, Corning and Vitesse.

We currently employ approximately 1,000 employees, primarily located in California, New York, France and Italy. Prior to the acquisitions of the optical components businesses of Alcatel, Corning and Vitesse, most of our employees had been based at or near our headquarters in Fremont, California. As a result, we face challenges inherent in efficiently managing a large number of employees over large geographic distances, including the need to implement appropriate systems, policies, benefits and compliance programs. The inability to successfully manage the substantially larger and geographically diverse organization, or any significant delay in achieving successful management, could have a material adverse effect on us and, as a result, on the market price of our common stock.

We have incurred and expect to continue to incur significant costs and commit significant management time integrating the operations, technology, development programs, products, information systems, customers and personnel of the businesses acquired from Alcatel, Corning and Vitesse. These costs have been and will likely continue to be substantial and include costs for:

•

converting, integrating and upgrading information systems, including the extremely complex and time-consuming integration of data from Alcatel and Corning’s incompatible enterprise resource planning systems with our system;

•

integrating and reorganizing operations, including combining teams, facilities and processes in various functional areas;

•

identifying duplicative or redundant resources and facilities, developing plans for resource consolidation and implementing those plans;

•

professionals and consultants involved in completing the integration process;

•

vacating, subleasing and closing facilities;

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•

employee relocation, redeployment or severance costs;

•

integrating technology and products; and

•

our financial advisor, legal, accounting and financial printing fees.

In addition to the significant costs associated with converting and integrating Alcatel’s and Corning’s information systems, there are other significant risks associated with this process. For example, while migrating Alcatel or Corning data to our information system, we could lose such data or such data may be inaccessible to us during the lengthy integration process. In addition, we are in the process of upgrading our information systems, which will be costly and will further divert management’s attention.

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 mix of our products sold, including inventory items with low product costs;

•

our ability to control expenses

•

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, and particularly to limit excess capacity commensurate with the volatile demand levels for our products;

•

our ability to successfully complete a transition to an outsourced manufacturing model;

•

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 companies in the telecommunications industry of sporadically placing large orders with short lead times;

•

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 processor 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;

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•

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 or later quarter;

•

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

•

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

A high percentage of our expenses, including those related to manufacturing, engineering, sales and marketing, research and development, and general and administrative functions, is 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 seriously 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.

We rely on a limited number of customers for a substantial portion of our revenue, and 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 operating results.

To date we have depended upon a small number of customers for a substantial portion of our revenue. Two customers accounted for an aggregate of 51% of our net revenue in the nine months ended March 31, 2004. 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 these 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 revenues and results of operations. 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 operating results.

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

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.

Our customers are under no obligation to buy significant quantities of our products, and may cancel or delay purchases with minimal 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 penalty 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, particularly if they are not anticipated.

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We may face risks related to a concentration of research and development efforts on a limited number of key industry standards and technologies.

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.

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.

We currently offer products in seven solution categories: Multiplexing, Transmission, Amplification, Dispersion Management, Switching and Routing, Monitoring, and Network Managed Subsystems. 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:

•

changing product specifications and customer requirements;

•

difficulties in hiring and retaining necessary technical personnel;

•		difficulties in reallocating engineering resources and overcoming resource limitations;
•		changing market or competitive product requirements; and

•

unanticipated engineering complexities.

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 operating results 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.

The vigorous competition in the optical components industry has led to the continued erosion of sales prices, and the failure to develop new products that are less susceptible to price competition may adversely affect our business.

Competition in the optical systems and components industry has contributed to substantial price-driven competition. As a result, sales prices for specific products have tended to decrease 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 have increased pricing pressures in fiscal 2003 and the first three quarters of fiscal 2004. Pricing pressures are expected to continue for the foreseeable future, which may continue to adversely affect our operating results.

We expect competition in our industry to increase, and if we are unable to compete successfully our revenues could decline further and harm our operating results.

We believe that our principal competitors in the optical systems and components industry include Bookham Technology, DiCon Fiberoptics, Finisar, Fujitsu, Hitachi Cable, Opnext, Inc., JDS Uniphase, NEC, Oplink Communications, and Triquint

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Semiconductor. We may also face competition from companies that choose to 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 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. For example, three of our historical competitors, JDS Uniphase, SDL, and E-Tek Dynamics have merged over the past several years to become a single, more formidable competitor. This merged company has announced its intention to offer more integrated products that could make our products less competitive.

Some existing customers and potential customers are also our competitors. These customers may develop or acquire additional competitive products or technologies in the future, which may cause them to reduce or cease their purchases from us. 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. 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. Delays, disruptions or quality control problems in manufacturing could result in delays in shipments of products to customers and 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. Furthermore, even if we are able to timely deliver products to our customers, we may be unable to recognize revenue because of our 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. Because the majority of our manufacturing costs are relatively fixed, manufacturing yields are critical to our results of operations. Lower than expected manufacturing yields could delay product shipments and further impair our gross margins. We may need to develop new manufacturing processes and techniques that will involve higher levels of automation 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.

If we are unable to accurately forecast component and material requirements, our results of operations will be adversely affected.

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, the inventory write-offs taken in the years ended June 30, 2003, and June 30, 2002 were primarily the result of our inability to anticipate the sudden decrease in demand for our products. Cumulatively, we have recorded $49.4 million of inventory write-offs since our inception. 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 inventory write-offs. 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 results of operations.

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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 facility, and we have passed subsequent reviews as well. 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.

All of the sites acquired as a result of the acquisitions of the optical components businesses of Alcatel and Corning are currently certified to ISO 9001.

We may lose orders and customers if we are unable to commit to deliver sufficient quantities of our products to satisfy customers’ needs.

Communications service providers and optical systems manufacturers 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. If we cannot deliver sufficient quantities of our products, we may lose business, which could adversely impact our business, financial condition, and results of operations.

Our dependence on independent manufacturers may result in product delivery delays and may harm our operations.

We rely on a small number of outsourced manufacturers to manufacture a portion of our subassemblies. We intend to develop further our relationships with these manufacturers so that they will eventually manufacture many of our high volume key components and subassemblies, and possibly a substantial portion of our finished products, in the future. The qualification of these independent manufacturers under quality assurance standards is an expensive and time-consuming process. Our independent manufacturers have a limited history of manufacturing optical subcomponents, and have no history of manufacturing our products on a turnkey basis. 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. As a result, we may lose existing or potential customers. We have limited experience in working with outsourced manufacturers, and do not have contracts in place with many of these manufacturers. As a result, we may not be able to effectively manage our relationships with these manufacturers. If we cannot effectively manage our manufacturing relationships, or if these manufacturers 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 the ultimate disposition of our manufacturing capacity in the future, may result in impairment charges relating to our long-lived assets in future periods, which would have an adverse impact on our business, financial condition and results of operations.

If we do not improve our gross margin our financial condition and results of operations will be adversely impacted.

Our ability to achieve profitability depends on our ability to control costs and expenses in relation to sales and to increase our gross margin. During the fiscal quarter ended March 31, 2004, our gross margin percentage was negative 21%. Because the majority of our manufacturing costs are relatively fixed, our inability to maintain appropriate manufacturing capacity in relation to our sales negatively impacts our gross margin. In addition, over our limited operating history, the average selling prices of our products have decreased, and we expect this trend to continue. 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

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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 revenues. If our average selling prices decline more rapidly than our costs of production, our gross margin will decline, which could adversely impact our business, financial condition and results of operations. If we are unable to generate positive gross margin in the future, our cash flows from operations will be negatively impacted and we would be unable to achieve profitability.

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:

•

loss of customers or customer orders;

•

loss of or delay in revenues;

•

loss of market share;

•		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;

•

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. 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, financial condition or results of operations. However, we cannot be certain that product defects will not have a material negative effect on our business, financial condition or results of operations in the future.

We depend on key personnel to manage our business effectively, and if we are unable to hire and retain 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. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel, or delays in hiring required personnel, particularly engineering, sales or marketing personnel, may seriously harm our business, financial condition and results of operations. 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. For example, four of our executive officers left Avanex in the second quarter of fiscal 2003, and two of our executive officers left Avanex in the second quarter of fiscal 2004. 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.

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While we have expanded our international operations as a result of the acquisitions of the optical components businesses of Alcatel and Corning, we face risks that could prevent us from successfully manufacturing, marketing and distributing our products internationally.

As a result of the acquisitions of the optical components businesses of Alcatel and Corning, 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. This expansion has required and will continue to require significant management attention and financial resources to successfully develop direct and indirect international sales and support channels. We may not be able to maintain international market demand for our products. We currently have little experience in manufacturing, marketing and distributing our products internationally. In addition, international operations are subject to inherent risks, including, without limitation, the following:

•

greater difficulty in accounts receivable collection and longer collection periods;

•

difficulties inherent in managing remote foreign operations;

•

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

•

import or export licensing and product certification requirements;

•		tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers imposed by foreign countries;
•		potential adverse tax consequences;

•

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

•

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

•

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

•

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

•

political and economic instability, terrorism and war.

Historically our international revenues and expenses have been denominated predominantly in U.S. dollars; however, as a result of the acquisitions of the optical components businesses of Alcatel and Corning, a portion of our international revenues and expenses are now denominated in foreign currencies. 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, financial condition and results of operations.

Our business and future operating results may be adversely affected by events 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.

We may incur costs and experience disruptions complying with environmental regulations and other regulations.

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

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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.

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 achieving profitability.

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, and sometimes 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. 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 or write off excess inventory. Even if we receive an order, if we are required to add additional manufacturing capacity in order to service the customer’s requirements, such manufacturing capacity may be underutilized in a subsequent quarter, especially if an order is delayed or cancelled. Either situation could cause our results of operations to be below the expectations of investors and public market analysts, which could, in turn, cause the price of our common stock to decline.

We will lose significant sales and may not be successful if our customers do not qualify our products to be designed into their products and systems.

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. If we fail to achieve design-in wins in potential customer’s qualification process, we may lose the opportunity for significant sales to such customers for a lengthy period of time.

If carriers for new telecommunications systems deployments do not select our systems-level customers, our shipments and revenues will be reduced.

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.

If the Internet does not continue to expand as a widespread communication and commerce media, demand for our products may decline further.

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

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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.

If the communications industry does not achieve a widespread transition to optical networks, our business may not succeed.

The market for our products is relatively new and evolving. Future demand for our products is uncertain 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.

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. 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; and

•

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

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. As long as we continue to depend on a limited customer base and a limited number of products, there is substantial risk that our quarterly results will fluctuate. Furthermore, if our stockholders sell substantial amounts of our common stock in the public market during a short period of time, our stock price may decline significantly.

Subject to certain restrictions on transfer which apply for a period of two years following the completion of our acquisitions of the optical components businesses of Alcatel and Corning, Alcatel or Corning may sell substantial amounts of our common stock in the public market which 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 particular, during the quarter ending December 31, 2004, Alcatel will be permitted to sell a greater number of shares of our common stock than it will be permitted to sell during other quarters during this two-year period.

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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, financial condition, results of operations and cash flows.

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, software, 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. We cannot assure 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. Our intellectual property also consists of trade secrets, which require 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 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.

If necessary licenses of third-party technology become unavailable or very expensive, we may be unable to develop new products and product enhancements, which could prevent us from operating our current business.

From time to time we may be required to license technology from third parties to develop new products or product enhancements. We cannot assure 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 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. For example, Alcatel currently holds patent cross licenses with various third parties that may be applicable to the optical components business we acquired from Alcatel. We cannot guarantee that we will be able to obtain these patent licenses from these third parties, or that we will be able to obtain these licenses on favorable terms. If we are not able to obtain licenses from these third parties, then we may be subject to litigation to defend against infringement claims from these third parties. In addition, we license certain proprietary technology from Fujitsu related to its proprietary virtually imaged phased array technology, which is critical to our PowerShaper VIPA product. The license agreement expires, unless earlier terminated, when the latest issued patent covered by the agreement expires. Currently, the latest expiring United States patent covered by the agreement will expire on June 18, 2018. The license agreement is also subject to termination upon the acquisition of more than a 50% interest in us by certain major communications system suppliers. Thus, if we are acquired by any of these specified companies, we will lose this license. The existence of this license termination provision may have an anti-takeover effect in that it would discourage those specified companies from acquiring us.

We may become subject to litigation 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 lawsuit, 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;

•

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;

•

redesign the products that use the technology; or

•

indemnify certain customers against intellectual property claims asserted against them.

If we are forced to take any of these actions, our business may be seriously harmed. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. 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. These claims could result in costly litigation and the diversion of our technical and management personnel.

Acquisitions and investments may adversely affect our business.

We regularly review acquisition and investment prospects that would complement our existing product offerings, augment our market coverage, secure supplies of critical materials or enhance our technological capabilities. For example, in July 2003, we acquired the optical components businesses of Alcatel and Corning, and in August 2003 we acquired certain assets of the optical systems division of Vitesse. Acquisitions or investments 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;

•

amortization expenses related to intangible assets; and

•

large one-time write-offs.

For example, as a result of our acquisitions of Holographix and LambdaFlex, we recorded in the first quarter of fiscal 2003 a transitional goodwill impairment charge for all of our goodwill of $37.5 million, in accordance with Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets.” Further, as a result of our disposal of certain property, equipment and intellectual property rights, we recorded in the second quarter of fiscal 2003 a reduction in long-lived assets of $1.5 million, in accordance with Statement of Financial Accounting Standard No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”.

Also, in March 2002, we entered into an Agreement and Plan of Reorganization with Oplink Communications, pursuant to which we intended to acquire all of the outstanding capital stock of Oplink. The merger was subject to the approval of our stockholders and the stockholders of Oplink. While our stockholders approved the issuance of Avanex common stock in connection with the merger, the stockholders of Oplink failed to approve the merger in August 2002. We expensed $4.1 million in related merger expenses during the first quarter of fiscal 2003.

Furthermore, acquisitions involve numerous operational risks, including:

•

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

•

diversion of management’s attention from other business concerns;

•

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

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•

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.

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.

In addition, Alcatel and Corning own shares of Avanex common stock representing 24.7% and 15.0%, respectively, of the outstanding shares of Avanex common stock as of May 7, 2004. Pursuant to the stockholders’ agreement entered into by Avanex, Alcatel and Corning, Alcatel and Corning are generally required to vote on all matters as recommended by the board of directors of Avanex, except, in the case of Alcatel, for proposals relating to certain acquisition transactions between Avanex and certain competitors of Alcatel. The concentration of ownership of our shares of common stock, combined with the voting requirements contained in the stockholders’ agreement, could have the effect of delaying or preventing a change of control or otherwise discourage a potential acquirer from attempting to obtain control of us, unless the transaction is approved by our board of directors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. Currently, we do not utilize derivative financial instruments to hedge such risks.

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 with maturities ranging 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 investment have significant exposure to interest rate risk.

We have one equipment loan with a fixed rate of interest of 9.4% with remaining principal and interest payments of $0.3 million from March 31, 2004, and a software financing arrangement with a fixed rate of interest of 5.2% with remaining principal and interest payments of $0.9 million from March 31, 2004.

The following table summarizes the expected maturity, average interest rate and fair market value of the short-term and long-term securities held by us (in thousands):

As of March 31, 2004:

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As of June 30, 2003:

Exchange Rate Risk

We have operations in the United States, 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. 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.

We attempt to minimize our currency exposure risk through working capital management and by maintaining a euro-denominated, highly liquid investment account to fund operations in France and Italy. At March 31, 2004, the balance in our euro-denominated investment account was $36.4 million. 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.

Our management evaluated, with the participation of our Chief Executive Officer, our Chief Financial Officer and our Chief Governance Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our Chief Executive Officer, our Chief Financial Officer and our Chief Governance Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal controls over financial reporting.

There was no change in our internal control over financial reporting that occurred during the period covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

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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. A proposal has been made for the settlement and release of claims against the issuer defendants, including Avanex, which has been approved (subject to the conditions noted below) by a special committee of our Board of Directors. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. If the 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 flows.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On January 16, 2004, we issued a warrant to purchase up to 60,000 shares of our Common Stock at an exercise price of $7.39 per share in connection with the renegotiation of a lease for certain facilities in Newark, California that we no longer use. The issuance of the warrant was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

On February 13, 2004, we issued 7,319,761 shares or our Common Stock in connection with a securities purchase agreement at a price of $5.49 per share for aggregate gross proceeds of approximately $40.2 million. Net proceeds from this transaction amounted to approximately $38.7 million after payment of fees to financial and legal advisors and other direct costs. In addition, the purchasers were issued rights, which are exercisable for up to an additional 1,463,954 shares our Common Stock at a price of $5.49 per share, and which are scheduled to expire on June 9, 2004. The issuance of the Common Stock and rights was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     Not applicable.

ITEM 5. OTHER INFORMATION

     Not applicable.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

     (a) List of Exhibits:

10.1		Securities Purchase Agreement, dated as of February 11, 2004, between Avanex Corporation and the purchasers named therein (which is incorporated by reference to Exhibit 99.1 of the Registrant’s Current Report on Form 8-K filed on February 13, 2004).
10.2		Form of Additional Investment Right (which is incorporated by reference to Exhibit 99.2 of the Registrant’s Current Report on Form 8-K filed on February 13, 2004).

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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.

(b) Reports on Form 8-K:

     (i) On February 2, 2004, the Registrant filed a current report on Form 8-K furnishing pursuant to Item 12 its press release regarding its financial results for the second quarter ended December 31, 2003.

     (ii) On February 13, 2004, the Registrant filed a current report on Form 8-K reporting pursuant to Items 5 and 7 that it had entered into a securities purchase agreement with certain purchasers.

     (iii) On March 1, 2004 the Registrant filed a current report on Form 8-K pursuant to Items 2 and 7 regarding the acquisition of all of the outstanding equity of Alcatel Optronics France SA and its purchase of certain assets of the photonic technologies business of Corning Incorporated. The following financial statements were filed as exhibits to this current report:

99.1

Unaudited Pro Forma Condensed Combined Financial Information of Avanex Corporation, the Optronics Division of Alcatel and the Optical Components Business of Corning for the six months ended December 31, 2003 and for the year ended June 30, 2003.

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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/ LINDA REDDICK
	Linda Reddick Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) Date: May 17, 2004

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EXHIBIT INDEX

10.1		Securities Purchase Agreement, dated as of February 11, 2004, between Avanex Corporation and the purchasers named therein (which is incorporated by reference to Exhibit 99.1 of the Registrant’s Current Report on Form 8-K filed on February 13, 2004).
10.2		Form of Additional Investment Right (which is incorporated by reference to Exhibit 99.2 of the Registrant’s Current Report on Form 8-K filed on February 13, 2004).
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.