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Avanex Corporation (AVNX)

F1Q07 Earnings Call

November 02, 2006 4:30 pm ET

Executives

Maria Riley - Director of Corporate Communications

Jo Major - Chairman of the Board, President and Chief Executive Officer

Marla Sanchez - Senior Vice President and Chief Financial Officer

Analysts

John Harmon - Needham and Company

Todd Koffman - Raymond James

Dave Kang - Roth Capital

Hamed Khorsand - BWS Financial

Jeff Osborne - CIBC World Markets

Michael [Klenk] - Primarius Capital

Operator

Welcome to the Avanex Corporation's fiscal 2007 first quarter financial results conference call. At the request of Avanex Corporation, this conference call is being recorded for replay purposes. Please note that all lines will be on listen-only mode until the question-and-answer portion of today's call.

With us on today's call are Jo Major, Chairman, President and CEO, and Marla Sanchez, Senior Vice President and CFO. I would now like to turn the call over to Maria Riley. Ms. Riley, you may begin.

Maria Riley

Good afternoon and thank you for joining us today.

I'd like to remind you that this call contains forward-looking statements including statements regarding second fiscal quarter of 2007 revenue, gross margin, accounts receivable and operating performance projections, cost reduction measures and trends, improvements in direct margin, market trend for the road on long haul metro and submarine markets, financial and operating goals and initiatives, our product development and manufacturing strategy, and changes in the markets for our products. Actual results could differ materially from those projected and/or contemplated by the forward-looking statements.

Factors that could cause actual results to differ include general economic conditions; the pace of spending and timing of economic recovery in the telecommunications industry and, in particular, the optical networks industry; the Company's inability to sufficiently anticipate market needs and develop products and product enhancements that achieve market acceptance; problems or delays in our restructuring activities or in reducing the cost structure of the Company; the Company's inability to achieve the anticipated benefit of acquired businesses or to successfully transfer manufacturing operations to lower cost regions; any slowdown or deferral of new order for products higher than anticipated expenses the Company may incur in future quarters; or the inability to identify expenses, which can be eliminated.

Please refer to the risk factors contained in the Company's SEC filings, including the annual report on Form 10-K filed with the SEC on September 28th 2006 and subsequent filings with the SEC. Avanex assumes no obligation and does not intend to update any forward-looking statements whether as a result of new information, future events, or otherwise.

In addition, because non-GAAP information is being presented on today's call and in order to comply with SEC regulations, please note that Avanex has provided a reconciliation table attached in today's press release which can be found on the Company's website, at www.avanex.com.

Avanex believes that this non-GAAP information provides investors with greater transparency to information used by management in its financial and operational decision-making. It helps investors better understand the Company's operating results and provides historical comparability.

Non-GAAP information should not, however, be considered superior to or a substitute for financial information prepared in accordance with GAAP. Investors should review the reconciliation of the non-GAAP financial information to the most directly comparable GAAP financial information as provided in the tables accompanying today's press release.

I'd like to take this opportunity to remind you that the Company will present at the AeA Classic Financial Conference on November 6th and 7th in Monterey, California, and at the CIBC 1-on-1 Optical Conference in New York on November 16th. We hope to see you there.

With that, I will turn the call over to Jo Major, Chairman, President and CEO. Jo?

Jo Major

Thanks, Maria. Good afternoon, everyone. Before we get started with our first quarter of fiscal 2007 discussion, I'd first like to welcome Marla Sanchez to the Avanex team.

I've known Marla for about seven years and initially brought her into Avanex about two months ago to help us with our yearend and SAP implementation program. Marla brings over 20 years of experience in international finance, cost accounting, controllership and strategic planning. I'm already impressed with her strong leadership and am very excited to have her on board.

I'd also like to take this opportunity to welcome Maria Riley to the Avanex team as Director of Communications. Many of you already know Maria as she has managed our Investor Relations program with an external communications firm over the past year. In Maria's new role within the Company, she will manage all communications functions, including both marketing communications and investor relations.

Now, let's move on to our performance in the first quarter of fiscal 2007. I'll first provide you with a brief review of our financial and operational highlights, and then Marla will give you a detailed look into our financial performance. In this review, we will focus on margin performance and areas of margin improvement. We'll then discuss our outlook for the second quarter of 2007 and take your questions.

I'm very pleased to say that in the first fiscal quarter of 2007, revenue grew to a record $50.9 million, up 12% from $45.5 million in the prior quarter, and up 23% from the first quarter of the prior fiscal year. This marks our third straight quarter of double-digit growth post restructuring. We saw strong growth from the new products we announced in the quarter led by our integrated amplifier developed for next generation network deployments.

In the quarter, gross margin grew to 9%. As Marla will discuss, our gross margin improved due to improvements in direct margin and a reduction in net reserve charges. Although we were pleased with this improvement in gross margin, we are more excited about the possibilities we now see and where we expect our gross margin to be over the next two quarters. We still have plenty of room to improve, and margin expansion will remain the key initiative for the Company throughout fiscal 2007.

GAAP net loss in the quarter was $9.8 million or $0.05 per share compared with a net loss of $9.1 million or $0.04 per share in the previous quarter, and a net loss of $17 million or $0.12 per share in the first quarter of the prior fiscal year. On a non-GAAP basis, net loss in the quarter decreased to $7.2 million or $0.03 per share, a $1.9 million improvement over the prior quarter's non-GAAP net loss.

Our 10% or greater customers in the quarter were Alcatel and Infinera. Tellabs and Nortel were also significant customers in the quarter just missing the 10% mark.

Let's move onto operational highlights. As we discussed on our last conference call we implemented five programs to improve our margin structure. Three of these programs, specifically new product introduction, portfolio management, and material cost reduction programs, are targeted to improve our direct margins.

We're happy to report that these initiatives have began to take hold, and we've now seen our direct margins rise for two quarters in a row. We further -- we expect further direct margin expansion in the December quarter. The other two programs implemented focus on decreasing negative hits to our cost of goods sold, primarily from inventory-related charges.

During the quarter, our operational metrics continued to improve. In Q1, return rates were the lowest we have seen, and we also saw yield and on-time shipments improve. In the quarter we saw record revenue in our transponder, modulator, and dispersion compensation product lines.

During the quarter, we participated in the 32nd European Conference and Exhibition on Optical Communication in Cannes, France and introduced three exciting new products. Our submarine product line launched a family of high-performance 980-nanometer single mode pump chips for use in our PowerDeep submarine pump module, which we also launched during the quarter. These products were developed for deployment and highly repeatable, highly reliable repeaters throughout next generation submerged fiber networks.

Our amplifier product line launched an amplifier with integrated optical performance monitoring. This product is already in volume deployment in the backbone network of a tier 1, next-generation FTTH deployment. This product seamlessly combines advanced optical monitoring and amplifier control capabilities within a single module. This new product was a strong contributor to our revenue performance this quarter.

During the quarter, the entire company achieved TL 9000 certification. We believe that TL 9000 will become the new manufacturing standard across the telecom industry.

At the end of the first quarter, worldwide headcount was 659 employees compared with 608 at June 30, 2006. During the quarter, North American and European headcount increased from 407 to 424 and headcount in Asia increased from 201 to 235.

The increase in headcount in Asia is due to hiring 21 full-time employees in Thailand as well as an increase in temporary contractors to perform our second physical inventory count. The increase in North American and European headcount is due to temporary resources for SAP implementation, SOX testing and yearend activities.

From a market perspective we remain optimistic about our markets and the overall trend we see. In metro and long haul we see continued growth driven by next generation network deployments. In the long-term we see this growth driven by very healthy fundamentals. Our orders are, however, associated with large customers' deployments, and as such order patterns may fluctuate from quarter-to-quarter in the short term.

On last quarter's call we discussed our strategy. We said that we are primarily a modules and subsystems company and that we will continue to focus at that level of sale. At the component level we believe in having a few key technologies that will contribute solutions to implementing flexible, optical communication networks. We believe the most attractive technologies will have a relatively small number of competitors and be strongly differentiated.

Today, I'd like to talk about our strategic approach to the road in market. Reconfigurable optical Add/Drop Multiplexers are historically fairly costly, and as a result used primarily in high-end applications. It is our review that a stronger value proposition problem is to address the metro and metro edge markets. To address these markets, we are developing a rhodium with more modest functionality, but at a substantially lower price point.

We already see positive responses from our customers, and we expect to showcase this product at OSC in March of next calendar year. As we mentioned on last quarter's call, we see substantial opportunities in the submarine market firming up for calendar 2007. During the first quarter, we received a multimillion-dollar design win for submarine pumps from a leading Asian customer, and we are already seeing firm bookings against those wins in the second quarter.

I'll now turn the call over to Marla for details on the financials.

Marla Sanchez

Thank you, Jo. Before I begin, I'd like to say I'm real happy to join Avanex. I look forward to being a key contributor to the team, leading the Company to profitable growth.

Now, I'll begin our financial review of the quarter. Revenue in the first quarter of fiscal 2007 was up 12% to $50.9 million compared with $45.5 million in the prior quarter, and up 23% when compared with revenue of $41.2 million in the first quarter of the prior fiscal year.

On a percentage basis, our transponder dispersion compensating, and modulator product line drove the revenue growth in the quarter. On an absolute dollar basis, our transponder product line and new amplifier product led the revenue growth.

Gross margin in the quarter was 9% compared with 4% in the prior quarter and 5% in the first quarter of the previous year. The increase in gross margin was driven by higher direct product margin and lower negative hits to cost of goods sold. We are starting to see our direct margins improve, and we see them continuing to improve over the coming quarter.

From Q1 '06 to Q1 '07, we had a significant reduction in negative hits to cost of goods sold. And we improved our visibility to inventory usage to Q2 '07, we booked a contingent liability in Q1 for part of Q2's E&O. On a GAAP basis operating expenses in the quarter were $15.6 million compared with $10.6 million in the prior quarter, which included a $5.2 million benefit from onetime events.

Operating expenses in Q1 included our SOX testing, SAP implementation, and year-end activities, which will decrease in the next two quarters. Combined R&D, sales and marketing, and G&A operating expenses were 29% of revenue compared with 28% in the fourth quarter of '06 and 39% in the first quarter of the prior year.

GAAP net loss in the quarter was $9.8 million or $0.05 share compared with a net loss of $9.1 million or $0.04 share in the prior quarter, and a net loss of $17 million or $0.12 share in the first quarter of the prior year. GAAP net loss in the fourth quarter was improved by a $3 million credit.

In the first quarter of 2007, our non-GAAP net loss was $7.2 million, or $0.03 per share, compared with the net loss for Q1 of $9.1 million or $0.04 per share, and a non-GAAP net loss of $14.7 or $0.10 a share for the first quarter of the year. Non-GAAP net loss excludes share-based payments, amortization of intangibles, restructuring charges, and gains and losses on the disposal of fixed property and equipment.

Moving on to the balance sheet, at the end of the first quarter, cash and investment balances were $61.9 million compared with $74.3 million at the end of fiscal '06. In Q1 of fiscal '07, we used $13 million in cash.

Cash usage increased during the quarter due to late invoicing issues related to our SAP implementation, which have been corrected. These invoicing issues caused our accounts receivables to spike in the quarter by $12.6 million. We expect our accounts receivables to return to more typical levels in the December quarter.

At the end of the first quarter, 2006, the outstanding principle carrying amount of our long-term convertible notes was $4.3 million compared with $4.6 million at the end of the prior quarter -- in each case, net of prepaid interest that is carried at no discount.

With that, I would like to turn it back to Jo for a recap and a look at our guidance of fiscal Q2 of '07. Jo?

Jo Major

Thank you, Marla.

We're happy with our improving operating fundamentals and our cost structure. We have programs in place to continue improving our margin structure over the next quarters, and we're really excited about the increase in activity that we're seeing in the submarine market. For the second fiscal quarter of 2007, we're forecasting revenue to be in the range of $52 million to $55 million. And we expect to continue to see gross margins improve.

With that, we now welcome your questions and will turn the call over to the operator.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions].

Our first question comes from John Harmon, Needham and Company. Sir, you may ask your question.

John Harmon - Needham and Company

Hi, good afternoon.

Jo Major

Hi, John, how are you?

John Harmon - Needham and Company

Good. Thank you. I guess first a question for Marla. Do you have an EBITDA number or cash spread number that you, give us, please.

Marla Sanchez

We have a non-EBIT -- non-GAAP…

Jo Major

So John, we haven't been providing performing EBITDA. I'll go back and say a couple of things that should help you out. The total cash we use in the quarter is little bit less than $13 million. If you look at the -- our accounts receivable, we had a situation with European SAP, which is kind of a simple statutory issue, which meant that some of our invoicing was delayed.

So we saw a run-up in accounts receivable of about the same amount of money. If we were to look at those netting against each other, you can get some idea that the cash -- the cash burn for the overall company without that increase in accounts receivable would be pretty low.

John Harmon - Needham and Company

Okay. Thank you. And I think you mentioned three things. SOX compliance, SAP, and yearend expenses, but on a reach on a pro forma basis G&A expense doubled sequentially. Is that mostly onetime item than would you expect that to kind of come back down to average levels for fiscal '06 for the rest of the year?

Marla Sanchez

G&A didn't -- I don't think it quite doubled. We do expect it to normalize a little bit more. It was abnormally low in Q4 because of onetime expenses. And --

Jo Major

Onetime credits.

Marla Sanchez

One-time credits. But it was actually only up by $1 million quarter-over-quarter.

Jo Major

There was -- as Marla described in the financial section, there was a credit in that it was favorable to G&A. And so if you look at the Q4 G&A to Q1 it looks like it bumped up a lot. It was actually relatively flat, John. We do expect consulting use for SOX and for IT implementation to obviously trail down over the next couple quarters quite nicely.

John Harmon - Needham and Company

Okay. Thank you. Thanks, I see the credit now. On your last call and this call you talked about some additional opportunities in the under sea market. Can you sketch out the rough timing, when do the orders -- do you think the orders get placed for the equipment, and when will those result in component orders?

Jo Major

What we talked about today is -- is we did get multimillion dollar PO coverage that was booked in this quarter, John? So the revenue for that will start to occur in Q3 and Q4. The exact timing of when -- so there's piece that are bought early in those programs, to get the qualification programs going.

And it's essentially to get the manufacturing lines primed on their side. We don't have real clear visibility as to when the big ramp into production of volumes occur. But we'll start to see the early revenues start in Q3.

John Harmon - Needham and Company

Okay. And the figure you mentioned last quarter was a pretty big number. You mentioned that you shared with another component manufacturer. Does it fall in one quarter or two quarters, or ramp and fall off, or…

Jo Major

We provided that that revenue would be split over a few quarters within -- we thought basically when it was calendar '07, most of that revenue would come into the combination of a couple companies that serve that market.

John Harmon - Needham and Company

Okay. Thank you very much.

Jo Major

Yes. Sure.

Operator

Todd Koffman with Raymond James, you may ask your question. Mr. Koffman, please check your mute button.

Todd Koffman - Raymond James

Can you hear me now?

Jo Major

Yes. How are you, Todd?

Todd Koffman - Raymond James

You compared in your opening remarks the 9% gross margin this quarter to I think it was a 4% number in the June quarter. But in the June quarter, you had talked about that margin of 4% was actually depressed by about $6.2 million of a variety of different charges that hit the cost of goods sold last quarter.

You didn't break them out, but you threw that out. I was wondering is there an ongoing number of different variety of charges that hit the cost of goods sold this quarter that are already baked into the 9% gross margin?

Jo Major

One of the things that Marla walked you through and I'll -- I'll try and make sure that we understand the $6.2. We commented that the $6.2 was the -- the net charge that was taken last quarter. We did comment that it -- it wasn't typical for the Company to have zero charge, and that something like a $2.5 million charge or so was normal. So that gives you something like a 4% increase in total charge.

We did see a nice decrease in the negative hits to the cost of goods sold. As Marla's been working a lot on the inventory side and we're starting to get more clarity, one of the things that Marla did is look at what we anticipated what -- what we already know to be E&O charges that we'll take in Q2.

And we booked a contingent liability against that on our Q1 books. So in effect we've taken part of the Q2 charge of E&O and placed it on the Q1 financials. Marla, maybe you can describe how that works.

Marla Sanchez

We have some inventory that we know that we will end up coming back to us from our contract manufacturer. We've already done all of the research on it and expect that that inventory will actually end up being excess. We've gone ahead and taken the provision for that already.

Jo Major

But In some sense, Todd, what we've done is we've -- we've taken a little bit of a hit of Q2 already on Q1 books because we knew it and it's well understood by us. Again, we see direct margins rising pretty nicely. And we see that the negative variances themselves or the negative hits of P&L decreasing both in this quarter and the quarter coming.

Todd Koffman - Raymond James

How much was that inventory charge provision that you took in this quarter?

Jo Major

No. We haven't given for line-by-line guidance on -- or line-by-line information all in charges time.

Todd Koffman - Raymond James

Okay. In the formal release and maybe you've had it in prior quarters, but I don't remember it. There's a sentence that says that the results are subject to review of accounting for cost reductions and the Company's contract manufacturer, which may affect costs of goods sold. What's that about?

Marla Sanchez

Part of that is we're just trying to make sure that we have all of the charges from our contract manufacturers accounted for correctly. If there is anything that is not going to be the case, we actually expect it to be in our favor on that. But we are reviewing that with our auditors right now and making sure that we are in a good position.

Todd Koffman - Raymond James

Okay.

Jo Major

Just -- we feel comfortable with the numbers. I think one of the things that's kind of interesting, we have had with our auditors, there's times when they're in the process of looking at something and understanding our position on something. So it's not all that unusual for us to put a footnote in the release.

One of the things that's interesting is as our cost reduction programs really take place, we're seeing significant, forward-looking cost savings in -- that's coming into the inventory thing. So that that statement means that value of the inventory is changing as we purchase new products at lower prize.

We're buying similar products at substantially lower prices, and I think that we're working closely with Deloitte so that we account for the fact that the cost of goods is dropping as we manufacture products.

Todd Koffman - Raymond James

Thank you. Good luck.

Jo Major

Thank, Todd.

Operator

Dave Kang, Roth Capital. You may ask your question.

Dave Kang - Roth Capital

Thank you, good afternoon. First question is in the June quarter, you guys talked about supply constraints. Any update on that? Do you have the similar problem, or did that pretty much go away during the September quarter?

Jo Major

Sure. I think our supply chain is doing a significantly better job in getting parts available. There are some places, long lead parts particularly on some chips that we buy optical -- excuse me -- electronic chips that we buy for thee products, where the lead times are fairly long, and that's still a little bit of a hindrance to revenue growth.

But, you know, I think it's a real good sign when after restructuring we're able to grow quarter-on-quarter double-digit for several quarters in a row. So it's not as big a problem as it has been. There are a couple of product-specific places where materials flow coming into the Company or hanging us up a little bit. But in general I think we improve.

Dave Kang - Roth Capital

Okay. Can you talk about pricing and lead time for your products?

Jo Major

And when you mean pricing, you mean pricing stability or…

Dave Kang - Roth Capital

Yes. Pricing environment. Is it pretty stable or…

Jo Major

We're in a place where people always need to be bidding competitively. I think that the average decline in prices has slowed somewhat and has moderated because I think that there is some pretty healthy demand out there. We don't really give real specific information on price ASP erosion. And I'm sorry -- I can't remember your second question.

Dave Kang - Roth Capital

Well, pricing and lead time. I mean, are your lead times stretching as well like your chips, or…

Jo Major

So in some of our products we're in a position where our lead times are really haven't moved out. And some of the products where we've got a lot of demand coming into the Company, we are seeing the capacity of the lines be more full and that's leading to a situation where our lead times have pushed out a little bit.

Obviously to help our customers we're working everything possible to make sure that we get the capacity in the right place for the demand and bring the lead times back to where our customers need them to bid nice.

Dave Kang - Roth Capital

Okay. And on your guidance for gross margin, can you just give us a little bit more color in terms of your gross margin assumption. And a few quarters ago, you talked about -- I think you used number 20%. And yet gross margin was only 9%. So how quickly should we expect you to get to that 20% level?

Jo Major

So there's -- today we won't be providing specific numbers for gross margin guidance. I think that there's a couple pieces that we believe. I think Marla can address these in a second. But I think we both agree that direct margins are rising pretty nicely due to cost reduction programs.

And that we're starting to really understand the negative hits to margin, and that we see healthy increases in margins for the next couple of quarters. Based on the success of these programs and where we're starting to see our cost structure evolve to, we're feeling like organically we can get the Company's gross margins now beyond 20 and into the range more like 25%.

Maybe you can provide some color there, Marla.

Marla Sanchez

We look at gross margin and we tend to divide it into three sections that we really tend to focus on. One of them is the direct product margin where we've been seeing improvements. And Joe kind of alluded to this when he was talking about the constant price reductions that we're driving with our contract manufacturer. As we play those into the direct margin standard cost, those price reductions are helping.

We also are seeing fewer negative hits to our gross margins. We are trying to get better visibility and trying to be very proactive about managing our E&O process. We are seeing that come down. And we expect to continue to see that come down in terms of the number of charges that we have to take. And then the third piece that we look at is the fixed overhead. And we are always constantly driving to reduce our fixed overhead on that.

Dave Kang - Roth Capital

Sure. Jo, on your comment of about 20% to 25%, is that something that can happen maybe sometimes this year, I mean this fiscal year, or is it more of a fiscal '08 or not even fiscal '08, any comment on that?

Jo Major

Visibility into margins increasing, you know, our visibility in the cost reduction programs typically goes up two or three quarters, Dave.

Dave Kang - Roth Capital

Okay. And just lastly on your -- can you comment on the competitive landscape. I know Optium has gone public. And there is lot of noise of our new comments and some of the others. Is the actually competitive landscape getting worse, or -- I mean maybe I guess -- that picture is improving but maybe some of these private companies are getting stronger, as well. I mean, can you just comment on that, please.

Jo Major

Sure. It was interesting to see Optium come out. I think it speaks to the general strength of the market and kind of the overall bullishness of the industry, what the demand picture is going to be looking like. You know, I think the competitive landscape is becoming more interesting as we see a few of the privates want to step up and get the capital raised from going public.

The kind of interesting part about that is that the -- it will change the structure of the Company, so that I think it will take them a little time to get used to. They had been pretty interesting competitors for us. I think that the growth curve of this company, and I think the fact that we're starting to see a good trajectory in front of us on margins, gives us confidence that we can compete quite nicely.

I do still think that there is some really interesting and strategic opportunities in the market for consolidation. And I've been a pretty clear and consistent fan of saying that for the market to get really healthy, I think a fair amount of consolidation need to occur. So I think, you know, that's a market dynamic I want to keep out in front of everybody. But I think the market can get substantially healthy -- healthier through further consolidation.

Dave Kang - Roth Capital

Got it. Thank you.

Operator

Hamed Khorsand, BWS Financial. You may ask your question.

Hamed Khorsand - BWS Financial

Good afternoon. My question, my first question was related to headcount. Seems that it's only been about a year since you guys did the restructuring. That now you're adding new employees. Is this -- was this a one-time event, or should we see this going forward with revenues rising?

Jo Major

On the North American side, we'll be winding down the folks that we've added. So you'll -- that's a kind of temporary thing with year end. On the -- as we're looking at Bangkok in particular, that is a real strong part of the Company and place for the Company that we're likely to continue gently growing. So we do add 21 full headcounts there. And it's likely that you'll see us continue to add headcount.

We track very closely on metric that is basically how many dollars of revenue do we get per dollar of loaded salary. And we've driven that up by 300% since I started this job. And it's not something that we're going to go backwards on. So the amount of costs that we add to the Company in any sort of permanent basis will always be very, very less than the revenue that we're in.

Hamed Khorsand - BWS Financial

Okay. My other question was related to gross margin. You made reference to the E&O being basically charging in Q1. Will -- going forward if your margins are improving, would you be looking to charge against future quarters as well in the Q3 -- into Q2?

Marla Sanchez

If we have the visibility and we are able to do that we would probably take some more conservative stance and continue to do that.

Jo Major

I think that's true. So as we get better and better visibility into how our inventory works, that becomes kind of the financially prudent thing to do. So please don't be double-counting the pop that comes from booking a contingent liability. What it does is it depressed the margin in Q1 and it will make the increase into Q2 look a little bigger. But it's not something that keeps on giving after that because you're continually booking on for the next quarter.

Hamed Khorsand - BWS Financial

Okay. All right. Thank you.

Jo Major

Yes. Sure.

Operator

Jeff Osborne, CIBC World Markets. You may ask your question.

Jeff Osborne - CIBC World Markets

Thank you. Good afternoon. I had a couple questions. I was wondering if you could update us on the inventory situation that your key customers on the long call and both the submarine side, as well? And I had a few others they were follow-ups, as well. Thank you.

Jo Major

Sure. As far as we can tell, the inventory situation and our customers doesn't seem to be getting out of hand. In other words, they're not -- they're not struggling with the situation whether their shelves are full of products. And they're seeking to turn off orders and back away from revenue.

We have a couple customers that, you know, we run into situations every now and then, Jeff, where a customer will be looking at a ramp and they're really trying to get ahead of the curve. And they'll place heavy order on us. And we'll ship faster than their contract manufacturer can make stuff or we'll ship faster than some of their other suppliers, so they'll throttle us back a little bit.

But I don't know that that's what I would call an inventory problem so much as if we get out ahead of the curve on being a good supplier, every now and then people will throttle us back. I don't think we have big inventory issue with our customers. Every now and then if we get ahead of the curve and we're shipping ahead of -- of their capacity or we're shipping ahead of other suppliers will throttle back a little bit.

Jeff Osborne - CIBC World Markets

Great. Thank you. Just two other questions. In terms of the new products that you introduced, you had quite a few at the [OSP] show last year. Earlier in this year, excuse me. Is there any way to gauge the success of these new products in terms of percentage of revenue?

You know, how much some of the new innovation that you've had have driven the growth of the Company that we've seen this quarter? Is that something you've considered breaking out in the future? Either, you know products that have mainly introduced in the last 12 or 24 months?

Jo Major

I guess we -- certainly we collect a lot of information on design win pipelines. So as these new products go to market, we really have targeted opportunities and targeted customers and chased those sort of relentlessly to the ground. We also track the success of how much of our revenue is coming from the design-win chains. And we've talked about it qualitatively.

We haven't given -- I guess we haven't really considered it to believe just as background, Jeff, we haven't given to date absolute dollar figures for new products introductions other than to say things like in this quarter as an example, we had a really nice product introduction at ECOC this integrated a high functionality optical performance monitoring into a dual stage amplifier.

And it's really taken off and been a strong revenue runner for us as an amplifier that goes into essentially the back bone for one of the large FTTH deployment. So every now and then we'll get color on which products are really taking off and being successful in the market. But we'll go back and think about that. We -- we have been trying to give a lot of color about which products have been taking off.

In this year in particular I think our growth is being driven quite nicely by the new products that have been coming out of the Company post restructuring. As you guys have heard me say, when you're restructuring and you're really pulling a lot of headcount out, it's hard to develop high -- highly differentiated, high margin products that are generating a lot to the revenue stream.

And we've been pretty happy with our development groups as they get done restructuring. They've given us a lot of new product, and they've given us the confidence on this call to really start talking about what we're going to take our [road] in and what part of the role in market we're going to play in.

Jeff Osborne - CIBC World Markets

Great. And the last question I had is two parts. I think it's somewhat interrelated. Is there any way that you could just share with us how the board is measuring your success as we enter a new fiscal year and also at what point you think you would be able to share a long-term operating model, either that yourself is aiming for or the Board is trying to achieve?

You know, I know you throughout 20% to 25% in terms of gross margins. Is there any EBIT margin goal that you're trying to achieve or the board is attempting to achieve, you know, whether it's this fiscal year or next fiscal year, would be -- anything would be helpful.

Jo Major

Sure. So the primary metric that the Board measures me on is revenue growth and profitability. And our annual operating plan quarter-by-quarter lays out where we want to be on profitability and where we want to be on revenue achievements. So that plan, there is a plan of record with the board. And that plan of record takes the Company to a nice situation of profitability.

We haven't shared that publicly. But we have shared publicly is that, you know, we are a technology company. So we need to have long-term plans that get our margins close to 30% so that we can have a healthy investment in R&D. And for us to be interesting to investors we really feel like we have to have a 10% EBIT line. Though again, those are the two places, 10% EBIT, we need to see margins significantly above 30% so that we can have that and still invest in R&D.

And the other part is when you're asking how the Board is measuring me, the Board is measuring me on revenue performance and profitability. The plan of record that we have with the Board, we're not going to share timeframes here, but the plan of record with the Board, holding my feet to fire on, takes us to profitability.

Jeff Osborne - CIBC World Markets

Great. One last quick one. Can you just remind us historically the submarine products that Alcatel and Corning Vitesse to sell? How that relates in terms of profitability related to the existing product mix?

Jo Major

Sure. In -- in the submarine markets, an interesting market in that you have to hold a lot of assets online in a very cyclical market. And because of that, there's not many companies that tend to compete there. The other thing is that the reliable that you have to be able to prove is high.

So typically there's not many competitors. And if those competitors essentially have a tax placed on them in the down years of holding these assets online when there is no market, the margin structures tend to be pretty attractive compared to other products that we're selling.

So in general, from a margin perspective, I think it's really exciting for the Company as we start to -- start to see the submarine market come back. We sell two kinds of products into submarine, and we sell a lot of submarine pumps. We're essentially one of two current major players there.

The additional product that we sell is we sell fiber bread grading which are used as gain-flattening filter and amplifiers. And both of those products will be likely, nice revenue streams for us in calendar 2007.

Jeff Osborne - CIBC World Markets

Great. Thank you.

Jo Major

Yeah. Sure.

Operator

[Operator Instructions].

Michael [Klenk], Primarius Capital. You may ask your question.

Michael Klenk - Primarius Capital

Hi, nice quarter, Jo. And nice to have you on the call, Marla.

Marla Sanchez

Thank you.

Michael Klenk - Primarius Capital

I came on a little bit late. So I wondered if you could just -- forgive me if I'm asking this again, but who are your top three customers and what percent of revs do they represent?

Jo Major

So our 10 % of customers in the quarter were, Alcatel was our largest customer Infinera, was greater than 10% customer in the quarter. Just underneath 10%, Michael, were Nortel and Tell Labs.

Michael Klenk - Primarius Capital

Nortel and Tell Labs. And they were so close to 10% then?

Jo Major

Nortel and Tell Labs just barely missed the bar this quarter. Infinera was -- both Infinera and Alcatel were significantly more.

Michael Klenk - Primarius Capital

Got you. Good. And then also on the submarine business, you mentioned that -- I wasn't sure if I caught this, a multimillion-dollar PO. Was that was from one or two OEMs or more OEMs for that matter? It's not many of a nudge.

Jo Major

Probably -- so we talked about a Japanese customer.

Michael Klenk - Primarius Capital

Okay. So does that suggest the possibility for, say, in a European customer to come on line there?

Jo Major

We like European customers, too. So sure, we'd like to get as -- you know, we're -- it's a fairly small universe, Michael. And we're talking with virtually everybody that's going to be making submarines, Peter has been asking them what their needs are. Part of -- part of the equation here is as the next submarine contracts are awarded it will be clear who has what business. And at that time we'll see significantly, provided that we get the design wins, we'll see significantly stronger order coverage come in almost overnight.

Michael Klenk - Primarius Capital

Right. And then is that to suggest, well can you maybe -- I'm not that close to it so forgive me for this question if it's too -- but of -- [audio gap] Hello?

Marla Sanchez

Hello.

Operator

I'm sorry. His line disconnected from the conference.

Marla Sanchez

Mike, it did?

Operator

Yes, madam. One moment.

Jo Major

We can welcome him back on if --

Operator

[Operator Instructions].

Marla Sanchez

Michael, are you on the call?

Michael Klenk - Primarius Capital

Yes, can you hear me?

Marla Sanchez

Yes, we can hear you.

Jo Major

So we didn't catch your question. You cut off.

Michael Klenk - Primarius Capital

Yes. Sorry about that. So I think what I was asking was how many deals are out there currently, how many have been awarded? Maybe you can answer that one.

Jo Major

So we gave a fair amount of -- of detail of the submarine programs and their breakdown in both the public names and the anticipated revenue size at our level of business, Michael. If you look at the current presentation that's on the web site, you can grab all those numbers. The big opportunities lie in the Pacific right now.

Michael Klenk - Primarius Capital

Okay.

Jo Major

Basically there's a couple of -- there's a couple of big channel that's are being discussed that are sort of billion-dollar class projects to connect China to the United States. There's also some projects, easy connects, Europe down to South Africa along the east coast of Africa.

There's also a couple of projects that are in the water now or being discussed to be in the water, basically starting at India -- one of them going up north and one of them going on down south. But again, right off the top of my head, I don't have my notes in front of me.

I don't have all the acronyms and all the names. But you can either go to the last presentation we gave or just give me a call afterwards. It's all in the public domain. And I can walk you through that presentation.

Michael Klenk - Primarius Capital

That's great. Super, all right. Nice job this quarter. Thanks a lot.

Jo Major

Thank you.

Marla Sanchez

Thank you.

Operator

There are no further questions at this time.

Marla Sanchez

Thank you all for joining us. This concludes our call for today.

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Source: Avanex Corporation F1Q07 (Qtr End 9/30/06) Earnings Call Transcript
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