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Executives

Pete Currillo - IR

Giovanni Barbarossa - President and CEO

Mark Weinswig - VP of Finance and CFO

Analysts

Mark Harrell - Morgan Keegan

John Harmon - Needham & Company

Avanex Corp (AVNX) F2Q09 (Qtr End 12/31/08) Earnings Call February 5, 2009 4:30 PM ET

Operator

Good day, and welcome to the Avanex Second Fiscal Quarter Conference Call. As a reminder this call is being recorded. On today's call we have Giovanni Barbarossa, President and CEO and Mark Weinswig, Vice President of Finance and CFO. Now let me turn the call over to [Pete Currillo]

Pete Currillo

Thank you, everyone, for joining us today. Today's call contains forward-looking statements about our (inaudible) our expectations, future events, and the performance of the Company and statements about the proposed combination of Bookham and Avanex.

Forward-looking statements are subject to risks and uncertainties and actual results could differ materially from those projected or contemplated by the forward-looking statements. We encourage you to look at the company's most recent SEC filings, particularly, today's earnings release, 8-K and our most recent Forms10-K and 10-Q.

Avanex does not intend to update any forward-looking statements, including guidance, as a result of new developments or otherwise. Additionally, in order to comply with SEC regulations, because non-GAAP information is presented on today's call, please note that Avanex has provided a reconciliation table and other information attached in today's earnings release, which can be found in our website at www.avanex.com.

In connection with proposed combination of Bookham and Avanex, both parties intend to file documents with the SEC including the Registration Statement on Form S-4 containing a Joint Proxy Statement and Prospectus.

Investors and security holders are urged to read the carefully the Joint Proxy Statement/Prospectus when it is filed with the SEC and other documents filed by either company with the SEC relating to the proposed combination when they are filed, because they will contain important information.

I would now like to turn the call over to Giovanni.

Giovanni Barbarossa

Good afternoon and welcome to our 2009 fiscal second quarter earnings call. During today's call, we will be discussing the key events of the second quarter, which end in December 31, 2008 and the continuing impact of macroeconomic trends on our business as well as the proposed merger with Bookham announced Tuesday, January 27, 2009.

First, let me review the highlights from our announcement last week of our intention to merge with Bookham Incorporated. We have agreed to merge with Bookham, because we believe that the combined company can realize significant cost synergies and thereby create immediate value to shareholders of both companies.

We have for a few quarters now that we believe industry consolidation is necessary in order to prosper. With the merger announcement last week, we are demonstrating our continuous commitment to industry consolidation to improve the company's future opportunities and results. There are a number of benefits that we expect to realize from the proposed transaction. I would like to take moment to highlight a few of these.

First, the merger will mean the combined company a leader in the medical telecom optics market focusing on major long haul application with one the broadest product portfolios in the industry. The product offerings of the two companies are very complimentary, which expands the new company's hold as a strategic supplier to our customer base.

Second, as we've discussed last week, we believe that as a combined company, we will save $7 million per quarter beginning in, or full quarter after the merger is closed. The industry dynamics and the current outlook, demand as we implement cost savings initiatives to return to profitability.

We believe that the total cash position of the combined company will be higher towards 12 months from the close of the merger. And the two separate companies on a standalone basis. As of December 31, 2008 the two companies had a combined $80 million of cash and impairments and no debt outstanding. Finally, the combined company will increase its competitiveness in the marketplace and vertical integration of component technologies in module and subsystem products.

Please note that the deals we review, the proposed merger is available on our website. With this merger, Avanex shareholders will receive 5.426 Bookham shares for each Avanex share. The Avanex shareholders owning 46.75% of the combined company at full completion of the merger.

Alain Couder will be the CEO of the combined company, and I will be actively be involved in helping to ensure a smooth integration of the two organizations and to define a strategic direction of the combined company. In addition, I will be a board member of the combined company.

On today' call, we will not be able to add any additional details beyond what was in the press release on January 27. Now that we have talked about the manager, lets talk about Avanex's performance in our fiscal second quarter ending December 31, 2008.

There are three key accomplishments that I would like to highlight on the second quarter. First, we review our dispersion compensation business. Thanks to strong sales in both, tunable and fixed dispersion compensators.

Second, we made significant progress on introduction of a number of new subsystem platforms, including an Integrated ROADM subsystem incorporating, Avenex Wavelength Selective Switch and amplifier model technologies. And in Integrated 2R optical regenerator incorporating, our own tunable dispersion compensator in amplifier module technology.

Third Infinera became a 10% for the company. We have had a several design wins on this account on numerous product. Overall, we had a respectable quarter on the design win front, and I'm exited about our future prospects for offering highly integrated products at the module and subsystem level.

While the market is still uncertain, we continue to invest in our leading technologies and product portfolio. For example, in Asia, we continue to expand our relationships with top-tier customers.

Thanks to design wins so far our tunable dispersion compensator and gain block product line. Both wins are for submarine deployments that represents the market share gains due to our technology advantage. Now, I would discuss our revenue and design win progress by product application.

Revenue for our transmission products, which includes transponders and modulators, decline by 27% from the previous quarter to 31% of total revenues. One positive note, was that our modulator product line was relatively flat compared to last quarter, due to increase in market share. The modulator product line had three design wins including one for cable TV application and one for a tunable pluggable format, both at a leading a leading supplier (inaudible).

During the quarter, we also made strives in our product development activities. We continued to innovate new modulator product such as the single drive 40 gigabyte per second DQPSK modulator. We are very excited about new opportunities with our next-generation modulator product.

Revenue from our regeneration products which includes, both sophisticated control amplifiers, gain blocks, fixed and tunable dispersion compensation modules and integrated optical performance monitoring products, declined by approximately 10% from the previous quarter primarily from introduction of a single customer.

Regeneration representing 55% of total revenues. Sales of our fiber base dispersion compensator modules remained strong in the quarter. In addition, the tunable dispersion compensator product line, you have seen significant traction. The product has been design in, at more than 10 customers in BIOS configurations and we additional opportunities on the horizon.

Our etalon based technologies quickly becoming the industry standard for tunable dispersion compensation due to its high performance in competitive price. One update on our tunable dispersion compensation that recession we received our $1 million purchase order from a single customer.

The 2R optical regenerator i.e. our integrated amplifier tunable dispersion compensation subsystem, which is the first product of this kind it's also seen market attraction. We relieved that the first all those for this product from leading 40G system.

And I am happy to announce that shipped our first unit in January. The benefits of integrated both function in the single subsystems is our, speed, power and cost reduction. Our customers believe that this product key enabler for the 40G network system.

We feel strongly about the future of this operating as the diversifications in next generation terrestrial and submarine networks. Within amplification, we are happy to announce the major design of product line as a Tier-1 Asian customer.

These are second major design wins that was previously supplied internally at an OEM. After reviewing our technological differentiation and market leadership, the customer decided to start procuring their amplifier solutions from us.

We're currently seeing additional opportunities with respect to the make versus buy decisions of OEMs in the amplification product application and we believe that we are the best positioned supplier to win captive business due to our technology, scale and market leadership.

As a result, we expect to win more captive OEM amplified business in the future. One additional item to note during the second fiscal quarter was awarding of the Value Engineering Award by Bell Labs to Avanex. The owner was provided in recognition of Avanex contribution to cost reduction through innovation, specifically for our optic amplifier subsystems product.

As we have discussed previously, our latest platform allows significant cost reduction for our customers to its ability to seriously integrated digital controls with optical functionalities at a very competitive cost.

Products, which include both fixed and reconfigurable wavelength routing products we remained relatively flat in the second quarter and represented 40% of total revenues.

Customer interest in our interleaver technologies remained strong in the quarter, as we had new design wins for our industry-leading product. One product that we are very excited about is the raw material roll down into interest discount. Incorporating our proprietary (inaudible) switch, amplifiers and optical performance monitoring modules.

We have received our first orders for this integrated sub system and we are targeting production revenue in the June of this year.

I am excited to announce that we had a significant design win with our dynamics gain equalizer product, you will receive one complement. Which leverages Avanex proprietary liquid crystal technology platforms and reaffirms the technology leadership of the platform for our wavelength selective switch product.

Now let take here a few more minutes to discuss the talent, the recessionary model. We believe that our low fixed cost structure give us the ability to weather the storm better then most.

The key to winning during this challenging times is to move quickly to cut expenses while that same time [Audio Gap] and design win opportunities for the future.

To that effect is our long-term and EBITDA discretionary spending to further improve our cost structure. This cost improvement actions, will take a cost over time and expands all size but primarily approach in SG&A. In fact with the major showing these times, the continuously develop due to the promising market opportunities in front of us, for our new products. We will continue to closely monitor the company's cost and performance in the environment risk accordingly.

I look forward to further discussing our focus on these activities in future period.

Finally on these up 20% and Thomas Wiesel Partners Technology and Telecom Conference on Wednesday, February 11 2009 at 9 AM Pacific Time, the conference would be held at the Fairmount [Audio Gap].

The live webcast will be available via a link on the Investor Relations page of the Avanex web site at www.avanex.com. A replay of the webcast will be available for 30 days following the live presentation.

Now I would like to turn the call over to Mark Weinswig, who will discuss our financials. Mark?

Mark Weinswig

Thanks, Giovanni. Net revenue for the fiscal second quarter was $38 million, down 16% from $45.3 million last quarter and down 27% from $52 million in the same period last year.

The sequential decline was primarily driven by a significant reduction in the demand for telecommunication purchases due to macro economic issues.

We saw declines in most of our top customers on a comparative basis.

On a geographic basis North America was 33% of revenues, Europe was 41%, and Asia 26%. Greater than 10% customers in the quarter were Alcatel and Infinera.

Gross margin was $0.15 for the second fiscal quarter this includes the impact of roughly $3 million from excess and obsolete and losses on purchase commitment. Total operating expenses including $9.6 million of impairment charges for goodwill and intangible asset. For the second fiscal quarter were $22.5 million. This compares to $18 million in the first fiscal quarter and $16.9 million in the same period last year.

Without the one time impairment and restructuring charges operating expenses would have been $12.9 million or 34% of revenue compared to $15.7 million or 35% of revenue in the first fiscal quarter and $16.9 million or 32% of revenue for the same period last year. This represents a reduction of $3 million of operating expenses from the first fiscal quarter all coming from R&D and SG&A.

In addition, as Giovanni discussed we are implementing further initiatives to continue to reduce our cost structure.

Our net loss was $16.8 million or $1.08 per diluted share for the second quarter. This compares to net loss of $9.6 million or $0.63 per diluted share last quarter and a net income of $86,000 or $0.01 per diluted share for the same period last year. The loss for the second quarter of fiscal year 2009 includes the $9.6 million impairment or goodwill as discussed above.

Moving to the balance sheet, we ended the quarter with $37.3 million in cash and investments down $12.4 million from the prior quarter. The significant reduction in cash was due to our pay down of accounts payable in line with our terms and conditions with key suppliers and our operating loss in the quarter. We believe that our cash outflows will be significantly lower in the future periods.

As a result of our cost cutting activities total headcount at the end of the quarter was 486 down from 515 in the prior quarter. As Giovanni discussed the company has implemented a further headcount reduction of roughly 5% in the third fiscal quarter. The savings from our cost reduction activity implemented in our third fiscal quarter will result in $2.5 million in annual savings.

With that I will turn it back to Giovanni who'll discuss the outlook for the third fiscal quarter of 2009.

Giovanni Barbarossa

Thanks, Mark. In summary, we believe that Avanex is well positioned as we continue to improve our business through both strategic and tactical activities. We've scaled down our expenses. At the same time, we're maintaining our focus on the recession development activities that we feel will be growth engines for the future. We have announced our intention to merger with Bookham, a move that we feel picks up in the right strategic direction and would bring long term value to our shareholders.

Now, let me turn to guidance for the third quarter of fiscal year 2009. We expect revenue to be in the range of $24 million to $31 million. Given the current recessionary macro-economic environment, there is less visibility than typical and accordingly the companies guide on range is more than the normal.

We continue to monitor the market environment as it remains on segment. Thank you for your continued interest in Avanex we look forward to updating you on our progress, on our initiatives and on the proposed merger Bookham. As I mentioned in the beginning of today's we will not be disclosing any additional details concerning the Bookham merger beyond the last week.

Operator we are now ready for the question and answer part of our call.

Question-and-Answer Session

Operator

(Operator Instructions) And we will go first to Paul Bonenfant with Morgan Keegan.

Mark Harrell - Morgan Keegan

Hi this is [Mark Carrol] calling for Paul Bonenfant. First question is just on housekeeping, would you guys mind repeating the percent for each segment. My numbers weren't adding when I heard software transmission, regeneration wavelength?

Mark Weinswig

Yeah we can kind of give only basic figure. So basically, our transmission products were about 31% of revenues in the quarter.

Mark Harrell - Morgan Keegan

Okay

Mark Weinswig

Our wavelength management was 14% and then remaining 55% was for our generation products.

Mark Harrell - Morgan Keegan

Okay thanks. Next thing top customers sold knows that Infinera had joined list along Alcatel Lucent, are you willing to give us specific percentages on that move?

Mark Weinswig

We will be disclosing all those things in our upcoming 10-Q, but just so, we do which is pretty typical for us. But we are very happy about the fact that Infinera did join the greater than 10% customer list for us and as Giovanni mentioned on the call it was due to a couple of design wins.

Mark Harrell - Morgan Keegan

Okay and as well as last quarter Nortel came in around 15% of sales noticed that they were absent, this quarter can you talk about the reproductions and their bankruptcy and how that business looks going forward?

Giovanni Barbarossa

Yeah hi thank you this is Giovanni. So I think it’s very difficult to distinguish between impact on revenue from Nortel because of the macro economical environment which we are facing verge of the bankruptcy, but from a daily kind of interaction standpoint with Nortel there is really no change from our standpoint. There was a decline in revenue and the fall at the top from the 10% customer list that there is still a load of activity for new amplifier designs with Nortel. So we are counting on them to be again the 10% customers sometime in the future.

Mark Harrell - Morgan Keegan

Okay and did you differ any revenue from Nortel in the quarter?

Mark Weinswig

In the quarter we had about $600,000 that was in our accounts receivable balance as at the end of quarter. As a result of that what we wrote off $200,000 to bad debt. And then we reversed the revenue for $400,000. So it was a rather minimal impact for us in the quarter. And just as we stated on the last quarters conference call Nortel’s revenue did significantly increase last quarter which was a little bit surprising for us. So we were obviously we are happy about that last quarter. And they’ve gone back down to more normal levels for us.

Mark Harrell - Morgan Keegan

Okay. And just one more. In the past, you have talked about guidance from gross margin, and it was obviously down or below your prior guidance this quarter, do you have any feel for that going forward, at least for the next three months?

Giovanni Barbarossa

Well, you have seen that our revenue guidance range is broader than normal, because we are experiencing the non-normal, non-typical market environment. So, at this point we decided to wait and let us see how the revenue comes out in terms of product mix and so forth, because of the range of the guidance very difficult for us to give you an accurate range for the margin at this point.

Mark Weinswig

And one other quick thing is that in the quarter, we did have a significant increase in our E&O expense as a percentage of revenue. And our losses on purchase commitments this quarter, it increased from about 3.5% of revenue to 6% of revenue for Q2. So, that’s one of things that was little bit unexpected this quarter. Obviously, when you have more market uncertainty your excess and obsolete and losses on purchase commitment. Those charges can fluctuate rather significantly.

Mark Harrell - Morgan Keegan

Okay. I am sorry. Just one more, is there a pricing pressure, kind of built into that decline, I know you talked about macro does that include pricing pressure?

Giovanni Barbarossa

There is definitely pricing pressure, we have experienced pricing pressure for quite some time in this market. And there was a factor there for sure. It's difficult to see whether we have reached the bottom in sense of the market at this point. But the pricing pressure that we have experienced between, I would say 15% or 20% in the past quarter, over the past several quarters kind of constant I would say. We don’t see really that’s getting any worst than it was in the recent past.

Mark Harrell - Morgan Keegan

Okay. Thank you.

Mark Weinswig

Thank you.

Giovanni Barbarossa

Thank you.

Operator

(Operator Instructions). We will next go to John Harmon with Needham & Company.

John Harmon - Needham & Company

Hi. Good afternoon.

Mark Weinswig

Hi John.

Giovanni Barbarossa

Hi John.

John Harmon - Needham & Company

I was wondering looking at your guidance, if there is any variations, by product type, by geography, by customer, across the board, but whatever detail you can add would be helpful?

Mark Weinswig

Yeah. Giovanni start and I can kind of transition, Giovanni you can try talk a little bit from the new product developments that this point the ramp is still a little bit uncertain. In terms of our revenue by region, we do see Asia remaining relatively strong for us. Most of the weakness that we have them seeing is really over in the Americas, and also in Europe. So, just from a geographic standpoint, that’s kind of what we are seeing right now in the marketplace.

In addition, in terms of revenue by product category, within the product category, we are seeing some interesting areas of strength. This quarter for example, dispersion compensation increased significantly quarter-to-quarter. One of the reasons for that, obviously was the tunable product, Giovanni can describe a little bit more around that. And in addition, we also saw some strengthening in some of our fixed business. The DCM and DCF business has really been a positive for the company in the last quarter.

Giovanni Barbarossa

Whether depending on the new product that we have introduced over the past three to six months. The ramp up will really depend on how the buying pattern of our customers will develop over the next couple next couple of months. We have a number of new platforms that have not ramped up yet. A good example is the integrated tunable dispersion compensator with the amplifier on the subsystem cost which shift recently to the customer and we see more interest for other customers.

We just received, for example, and all of the just few hours ago from a customer for our wavelength selective switch platform. Never placed an order before for that platform, so we count on that product to ramp up nicely in next few months. There is also the more kind of integrated ROADM line card, which integrates our own wavelength selective switch and our own amplifier in the subsystems that’s also something which we see ramping up in revenue sometime during the summer. And so we will be seeing all those throughout between now and December for developing and qualifying that kind of product with some customers and so forth.

So, there is a number of new products that we have engaged the customer with and we have also has design wins that does not really ramped up in volume. So, depending on how the buying pattern of our customers developed. We will see one end or the other end of the revenue guidance that we have given.

John Harmon - Needham & Company

Okay, thank you. And just one for Mark, please? I was wondering if you have a cash flow number, inversely your cash decreased by $12.4 million, you said it was from payables and your operating loss your payables decreased by $9.3 million. So would that mean the remaining 3 million is from operations?

Mark Weinswig

In terms of our, I think the networking capital, the biggest piece of kind on the unfavourable side was really the pay down of our payables. In addition, in the quarter, John, we did have almost $2.5 million charge for excess and obsolete and obviously that runs though the income statement, but it really is the purchases of inventory. So, this quarter unfortunately, due to some of the market uncertainty, we have seen some higher losses and typical on our excess and absolute and losses on purchase commitments.

Just one last thing Jonathan, we have stayed on the call, is that we do we expect our cash outflow from operations and from the business in generally to be lower in future quarters. The payables issue was more of a kind of a catch up items it's basically something’s that have lingered after September 30th. So, we hope that that will kind of go down to kind more normal kind of levels in future periods.

John Harmon - Needham & Company

Okay. Thanks very much.

Mark Weinswig

Great, thank you, Jon.

Operator

(Operator Instructions). And we will take a follow-up question from Paul Bonenfant.

Mark Harrell - Morgan Keegan

Hi guys, its Mark again, just one follow-up, you had mentioned previously you talked about our breakeven run rate of around 46 million to 48 million in sales, any updates for that or is that are we still looking for that as a breakeven?

Giovanni Barbarossa

Just as we said during the call that we have taken further action to reduce our cost structure. Last quarter we did already moved very faster from that perspective. This week we have taken another action to further reduce our cost primarily in SG&A which reduce our CapEx and we have also done some additional cutting from the discretionary spending center point. So, we have taken enough actions at this point to improve our cost structure. And I will let Mark talk a little bit more about the breakeven point that we see moving forward.

Mark Weinswig

Yes Mark just quick, we have not made any changes or estimates based on either cost savings that we have right now. Just in general at this point the company is focusing really on kind of going forward this next step in terms of industry consolidation and some of the synergies and benefits that we see through to the proposed merger with Bookham. So that’s kind of where we are focusing most of our efforts right now in terms of kind of our return to kind of profitability.

Mark Harrell - Morgan Keegan

Okay. Thank you.

Mark Weinswig

Thank you.

Operator

And we have no additional question at this time. I would like to turn the call back over to management for any additional or closing remarks.

Giovanni Barbarossa

We thank you very much for your continued interest in Avanex. Have a good day. Thank you.

Operator

And again that does conclude today's call. We do appreciate everyone's participation. You may disconnect at this time.

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