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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

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 135,220,459 shares of the Company’s Common Stock, par value $.001 per share, outstanding on February 6, 2004.

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AVANEX CORPORATION
FORM 10-Q
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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AVANEX CORPORATION
Condensed Consolidated Balance Sheets
(In thousands)

See accompanying notes.

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AVANEX CORPORATION
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)

See accompanying notes.

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AVANEX CORPORATION
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

See accompanying notes.

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AVANEX CORPORATION
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1.     Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements as of December 31, 2003, and for the three and six months ended December 31, 2003 and 2002 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 December 31, 2003, the consolidated operating results for the three and six months ended December 31, 2003 and 2002, and the consolidated cash flows for the six months ended December 31, 2003 and 2002. Certain reclassifications have been made to a prior period’s presentation to conform to the current period’s presentation. The reclassifications have no effect on the statements of operations as previously reported. The consolidated results of operations for the three and six months ended December 31, 2003 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

     An additional accounting policy has been adopted as a result of the acquisitions of the optical components business of Alcatel and Corning:

     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.

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 optical amplifiers and lithium-niobate modulators. Corning also assigned and licensed certain intellectual property rights to

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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), 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 and revision to the estimate of accrued restructuring costs assumed on acquisition is as follows (in thousands):

     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. 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 (see Note 8) with an offset of approximately $6.1 million to certain long-lived assets and intangible assets

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acquired to their appraised values at the acquisition date. The remainder of approximately $3.7 million was recorded as an increase in goodwill.

     The Company acquired developed technology from Corning, which is comprised of products that are technologically feasible, primarily including amplifiers, dispersion compensation modules and 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 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 allocated the purchase price of 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.

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 Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” to stock-based employee compensation (in thousands, except per share amounts).

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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 six months of fiscal 2004 and 2003, the Company recorded charges to cost of revenue for excess and obsolete inventory of $0.3 million and $3.9 million, respectively. In the first six months of fiscal 2004, the provision was due to decreased demand for certain products. In the first six 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 $1.3 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.

     The Company sold inventory previously written-off with original cost totaling $1.9 million in the first six months of both fiscal 2004 and 2003 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 $47.6 million, including receipts under previously accrued non-cancelable purchase obligations. Of this amount, items representing $10.5 million have been sold, items representing $2.8 million have been consumed in research and development activities, items representing $16.6 million have been discarded, and items representing $17.7 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

     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

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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):

     The following table reflects other intangible assets subject to amortization as of December 31, 2003 (in thousands):

     The estimated future amortization expense as of December 31, 2003 is as follows (in thousands):

     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 six months ended December 31, 2003 and the year ended June 30, 2003 are as follows (in thousands):

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7.

Financing Arrangements

     Securities Purchase Agreement

     In November 2003, the Company entered into a securities purchase agreement pursuant to which the investors purchased, in the aggregate, 6,815,555 shares of Common Stock of the Company 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 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 1,363,116 shares of the Company’s Common Stock at $4.63 per share, representing approximately $6.3 million in proceeds if the rights are exercised in full for cash. These additional investment rights are scheduled to expire on March 16, 2004.

     Short-Term Borrowing

     The Company renewed a revolving line of credit from a financial institution, effective December 31, 2003, which allows 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 December 31, 2003 and June 30, 2003 the Company had borrowings of $1.6 million and $3.1 million, respectively, against this line. Additionally, the line of credit secures three letters of credit totaling approximately $4.0 million in the aggregate relating to certain facility leases which expire in March through September of 2004. The renewed line bears interest at prime plus 1.25% and, at December 31, 2003 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 $20.0 million in short-term investments at December 31, 2003.

     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 $3.6 million and capital lease obligations totaling $6.9 million as of December 31, 2003 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 long-term obligations of $0.3 million relates to other capital lease obligations existing prior to the acquisitions, with interest rates ranging from 8.5% to 14.4% with varying maturity dates through May 2005.

8.

Restructuring Charge

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

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     Fiscal 2004 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 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 (see Note 2).

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

     Prior Years’ Restructuring

     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.

     In the first quarter of fiscal 2003, the Company announced a restructuring program to downsize its workforce, primarily in its manufacturing operations. In addition, 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. However, in January 2004, the Company restructured its leased facilities in Newark, California and reduced the related lease obligation (see Note 14). The reduction in the lease obligation offset the reduction in estimated sublease income

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and there was no impact on the restructuring reserve or operating results for the second quarter of fiscal 2004.

     Workforce Reduction

     The Company reduced its workforce by a total of 202 employees during fiscal 2003, primarily in its manufacturing operations. The Company recorded charges of $3.0 million for employee separations, which included 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.

     The following table summarizes changes in the restructuring accrual for the six months ended December 31, 2003, excluding accruals related to the acquisitions noted above (in thousands):