Avanex F3Q07 (Qtr End 3/31/07) Earnings Call Transcript

| About: Avanex Corp. (AVNX)
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Avanex Corporation (AVNX)

F3Q07 Earnings Call

May 03, 2007 4:30 pm ET

Executives

Maria Riley - Director of Communications

Jo Major - Chairman and President & CEO

Marla Sanchez - SVP and CFO

Analysts

Jeff Osborne - CIBC

John Harmon - Needham & Company

Dave Kang - Roth Capital

Hugh Mai - First Albany

Subu Subrahmanyan - SMH Capital

Presentation

Operator

Good afternoon, my name is Jerald and I'll be your conference operator. At this time, I would like to welcome to Avanex Fiscal 2007 Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise.

After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). With us on today's conference is, Jo Major, Chairman, President and Chief Executive Officer; and Marla Sanchez, Senior Vice President and Chief Financial Officer. Thank you, I will now turn the conference over to Ms. Maria Riley. Ma'am, please go ahead.

Maria Riley

Good afternoon and thank you for joining us today. I would like to remind you that this call contains forward-looking statements about future events and the future performance of the company.

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 news release on Form 8-K and the risk factor section of our most recent Form 10-Q. Avanex assumes no obligation and does not intend to update any forward-looking statement, including guidance as a result of new developments or otherwise.

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

I would like to take this opportunity to remind you that the company will present at the Piper Jaffrey Semiconductor and Communications Conference in New York City on May 10, and the Cowen and Company Investor Conference on May 30, also in New York City.

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

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Jo Major

Thanks, Maria. Good afternoon, everyone, and thank you for joining us today. I would like to start today's call, by saying how very pleased I am with the company's performance this quarter.

We maintain revenues in the heels of an exceptionally strong second quarter. Revenue for the quarter was $55.1 million compared with $55.6 million in the prior quarter, and up 37% from the third quarter of the prior fiscal year.

We saw a strong year-over-year growth driven by our integrated amplifier developed for next generation network deployments, dispersion compensation products, and solid growth from our transmission products those at the module and component levels.

For the second consecutive quarter, we had outstanding sales from Alcatel-Lucent and Tellabs at 30% and 20% of revenue respectively. Other strong customers in the quarter included Infinera, Cisco, CIENA.

We are also quite pleased with our gross margin performance this quarter. We maintained our gross margin at 19% in a quarter where about 40% of our revenue is affected by annual pricing negotiations, moving the continued health of our overall operating structure and the programs focus on improving it.

Margin expansion will continue to remain the key initiative for the company, throughout the remainder of fiscal 2007 and beyond. I am very proud of the team's consistent execution, as shown by our continued non-GAAP net loss improvement. On a non-GAAP basis, net loss in the quarter was $3 million or a loss of $0.01 per share, a 16% improvement over the previous quarter's non-GAAP net loss.

Subsequent to the quarter, we divested a 90% interest in our subsidiary in France, which include our indium phosphid and gallium arsenide semiconductor fabs. The divested product lines include our laser, terrestrial pump, submarine pump and Fiber Bragg Grating product lines, which accounted for approximately $3.2 million of the third quarter's revenues.

This divestiture marks the final and major step in our restructuring efforts. We have succeeded in evolving our operating structure into a low-cost, flexible model that has the ability to react quickly to market demand and provides us with a solid foundation for future growth.

On the new product front, our execution continues to deliver exciting new products. As you may recall in the December timeframe, we began discussion of our WSS solution for ROADMs, and in March, we showcased the compact module that can provide tunable dispersion management.

Today, I would like to discuss new amplifier product suite that we debuted at OFC. This platform represents a remarkable change in direction in the fundamental design of amplification systems.

The theme started with underlying intellectual property developed over the last several years that enables advanced optical performance through sophisticated digital control algorithms

Our patented approach changes the amplification game in many ways, and alters the amplifier value proportion in a way that we believe our competitors will not be able to follow.

The vision behind these products turns optical customization into simple firmware configuration, allowing our customers to implement solutions considerably faster and cheaper than competitive products.

The combination of exciting technical features in a highly manufactureable platform also leads to a significant reduction of our cycle times, decreasing our inventory exposure and helping our customers with short lead times, which lessen their lean initiatives and reduce inventory.

Before I turn the call over to Marla for a detailed look at our financials, I would like to take a few minutes to discuss our current view of the market, and our revenue outlook for the fiscal fourth quarter.

We remain extraordinarily confident in the overall long-term trends and growth of our markets. We see strong customer demand for low cost solutions that enable flexible networks.

In these markets, we see increasing demand from bandwidth at the consumer level driven by bandwidth intensive services such as High-Definition TV, IPTV, Internet video exchange services, online gaming and mobile multimedia devices.

In addition to the previously announced large capital spending at the carrier level, over the past couple of weeks, several new public announced have reaffirmed our confidence in the strength and growth of our long-term markets. Including increasing installation trends for fiber and solid booking trends announced by our customers.

We have already experienced the beginning of this growth cycle, as shown by several quarters of exceptionally strong sales. In the near term, our revenue with two key customers has tied a capacity expansion projects that are moving from the build phase to the deployment phase.

We are confident that we have healthy relationships with these customers, and that we are very well positioned to capitalize on new design wins with them for future builds. We also have good visibility into future growth with these, and we anticipate to return to revenue growth in the latter part of the calendar year.

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

Marla Sanchez

Thank you, Jo. Revenue in the third quarter of fiscal 2007 was $55.1 million compared with $55.6 million in the prior quarter, up 37% when compared with revenue of $40.1 million in the third quarter of the prior fiscal year.

Revenue in the third quarter included $3.2 million from Avanex brands, which we divested on April 16. Sequentially, we were able to maintain our revenue levels, even though our annual pricing adjustments occurred during the quarter.

The year-over-year revenue growth was driven by demand for modules and subsystems such as amplification, dispersion, management and transponders, and certain key component technologies including modulators.

During the quarter, we maintained gross margins at 19%, flat with the previous quarter and an increase of 15 percentage points from 4% in the third quarter of the previous year. We continue to see cost improvements in the five programs we launched three quarters ago, aimed at reducing inventory charges, improving our supply chain, and managing our product portfolio.

We expect to see further improvements in our cost structure, and are still expecting gross margins to be in the 20% to 25% range in the June quarter. Excess and obsolete charges, including contingent liabilities for the quarter decreased sequentially by $1.3 million to $2.7 million.

Continuing to focus on managing these charges down in the coming quarters remains a top priority. And as such we are currently reevaluating our vendor selection, increasing our local sourcing, and developing new product platforms to have more interchangeable piece parts.

On a GAAP basis, operating expenses in the quarter decreased to $17.1 million compared with $19.9 million in the prior quarter. We continue to watch our operating expenses and have programs in place to reduce spending overtime.

Combined R&D, sales and marketing, and G&A expenses were 28% of revenue compared with 34% in the previous quarter, and 31% in the third quarter of the prior year.

GAAP net loss in the quarter decreased to $6.7 million or a loss of $0.03 a share, and $1.9 million decrease when compared with a net loss of $8.6 million or a loss of $0.04 a share in the prior quarter. Net loss in the third quarter of the previous fiscal year was $10.2 million or a loss of $0.06 a share.

Non-GAAP net loss in the third quarter of fiscal 2007 decreased by 16% to $3 million, compared with $3.5 million in the previous quarter. Non-GAAP net loss on a per share basis was $0.01 in the third quarter of fiscal 2007, compared with a loss of $0.02 in the prior quarter.

For a reconciliation of non-GAAP items, please refer to our reconciliation table included in today's press release. As we have mentioned before, our target operating model which we expect to reach in the next 12 to 15 months is to have 35% gross margins and operating expenses at 25% of revenue.

Moving on to the balance sheet. At the end of the second quarter, cash and investment balances were $67.1 million, which includes $8.7 million in net proceeds from an equity private placement of $10.8 million on March 1, 2007.

Cash and investment balances at the end of the December quarter were $57.9 million. Excluding the net proceeds from the fiber placement, our cash burn $9.5 million, primarily attributed to $7.1 million in receivables that came in few days after the quarters close and a decrease in total payables at $13.7 million sequentially.

I am also very pleased to note that the remainder of the long-term convertible debt and the amount of $5 million with exercise during the third quarter. The company now has no debt on its balance sheet.

As Jo mentioned, we divested 90% of our ownership of Avanex France to 3S Photonics and closed this transaction two weeks into our fourth fiscal quarter. With this divestiture, approximately $8 million of our restructuring and pension liabilities will be transferred to 3S Photonics.

At the end of the third quarter, worldwide headcount was 669 employees compared with 665 at the end of the prior quarter. At the close of the divestiture, our total headcount decreased by 138 and we now have a total of 531 employees, 43% of which are located in Asia.

With that I'd like to turn it back to Jo for a recap and a look at our guidance for fourth quarter of fiscal 2007.

Jo Major

Thank you, Marla. For the fourth fiscal quarter of 2007, we are forecasting revenue to be in the range of $47 million to $52 million, just primarily impacted by the cyclical deployment patterns of large expansion projects I previously mentioned.

We were confident in the overall growth of our business, and expect to return to growth in the latter part of this calendar year. For the fourth quarter, we expect gross margins to be in the 20% to 25% range. We expect to reach non-GAAP EBITDA breakeven no later than the September quarter.

With that, we now welcome your questions. And we will turn the call over to the Operator.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Jeff Osborne with CIBC.

Jeff Osborne - CIBC

Great, thank you, a couple of questions. Congratulations on the performance in the quarter. Just Marla, on the E&O charges, when should we look for those to go down sub $1 million a quarter? Can you kind of give us a picture of the trajectory of that looking ahead?

Marla Sanchez

Looking ahead we have been targeting to try and get to the $2 million to $2.5 million. We would very much likely to get to the sub $1 million, which you would like to get. To get to one the range that we were heading to the 2.5 million, I think we were pretty close this quarter. We were at 2.7 and we will continue along this trajectory.

So I think we will hit our stated targets fairly soon. To get to 1 million, would be unlikely to predict that we do that?

Jo Major

In the next couple of quarters?

Marla Sanchez

Right. In the next couple of quarters.

Jeff Osborne - CIBC

I was mainly trying to handicap with the comment about over the next 12 to 15 months being at 35% gross margin. Now if you back it up being [around] this quarter, you are really at 25, you know at the high end of your range for next quarter. To be at 35 and say 15 months, so I would assume we would have to pretty negligible or not necessarily?

Marla Sanchez

It would have to be lower than it currently is, you are absolutely correct. Some of the other things that we would end up doing to try and get to the 35% are also trying to work on the margin expansion programs that we've talked about with our product introduction and with our product portfolio management.

We also accept some improvement relative to our divestiture of our French facility. So all three of those big programs we expect to give us good expansion.

Jo Major

So, a couple of things that are a little bit longer range. So, when we get into the 12 to 15 months type of timeframe Jeff. One is we talk about key technologies and then being an underlying driver for margin expansion.

So, if you look at the ROADM that we're bringing out, it’s all. The key technologies that are all developed in-house and are managed within our own supply chain. If you look at tunable dispersion compensation and that product line that’s coming out, a lot of the technologies are owned by us. The IP is owned by us and the addition of those key technologies of those products really helps us drive margins.

Marla also made a comment, when we are really talking about driving E&O down there is short-term action like working on forecast accuracy, but there is also much deeper action. When we are talking about the amplifier suite, we talked about interchangeable parts and changing things for software firmware as oppose to using a lot of different parts to build custom products.

And so, when we design products now, there is a lot of attention to making sure that we design a platform with a lot of interchangeable parts that drive E&O down. So, E&O is a part of it. As France comes [offshore], you will a real nice increase in our margin structure. The programs themselves drive things. There are several pieces in play that we're going to continue to derive margins on.

Jeff Osborne - CIBC

Very good. And just two other questions on the typical breakout you gave us long-haul versus Metro [split]. If you just update us there for the quarter. And then also, you mentioned pricing and renegotiations. I think you mentioned 40% of your volume or revenue was renegotiated at the start of the calendar year.

I was wondering if you just peel back the onion on pricing and talk about pricing for some of your legacy products in relation to some of the newer products, what you're seeing in particular on the ROADM side?

Jo Major

Let’s see, some of them try and play back the -- we've been writing down your questions as you been giving it. So the first one is, is long-haul and Metro and we'll go back and check the exact number. But we're roughly a company that's half and half.

If you want a kind of an updated view of where we think the markets are, we do think that the growth drivers that we spoke about for both metro and long haul are in pretty good shape.

We did earlier comment about the metro side of this market growing faster than long-haul this year as it did last year, and I think those thing will still be true. And to be honest I kind of forget the second question that you had if you could repeat that?

Jeff Osborne - CIBC

Yes, it was pricing and the renegotiations at the start of the calendar year. So I would assume most of those renegotiations are for products that you’ve been selling historically. Longer term design wins, if you can just talk about what the trend is there? And then also, in particular on the ROADM market where there is about 20 competitors going after 5 or 10 equipment companies. It’s an extremely comparative space where one vendor has about 50% to 60% share. I was just trying to get a sense of what the strategy was there to both increase gross margins, but also drive revenue.

Jo Major

Okay. So the first past is, again about 40% of our revenues stream, couple of key customers out there, really go with annual pricing negotiations. And it does not matter whether you’ve got the product there for three months or 3 years, you have to renegotiate pricing on it. So it's really not a legacy issue.

It drives ASP declines to be a point higher in the March quarter than they are in the other quarters of the calendar year. So we have to work extra hard in this quarter to our margin performance in good shape, where other quarters the pricing pressures are a little lower.

On the ROADM side, first of all there are a lot of competitors out there. I don't think that if you ask the question, how many of them can really manufacture this and deliver it. It actually isn't quite as big a field as you think, and I don't think it’s as competitive as it feels when you say there are 20 folks out there.

I think the other thing that really needs to be stressed is we think that ROADM work best when they are very highly manufactureable with very, very low inherent cost structures. And we have created our ROADM with that strategy in mind.

So I think we have some real nice features that we are going sell on, but we think it has a really great cost structure. So we are in a real nice position if we have to compete on price and they can go across a breadth of the market from access all the way up into long-haul application.

Jeff Osborne - CIBC

Very good. Thanks a lot.

Operator

Your next question comes from John Harmon with Needham & Company.

John Harmon - Needham & Company

Hi. Good afternoon.

Jo Major

Hi John

John Harmon - Needham & Company

And congratulation on getting the divestiture done. Just a couple of questions. One just the obvious question. Given what one of your competitors said last night, have you felt the effect of these supply chain shortenings, and secondly the Lucent-Alcatel merger, what effect has that had on your business?

Jo Major

I will help people understand if they didn't read the other scripts. Both last quarter and this quarter, there has been some discussion of the fact that companies like Nortel and Cisco have publicly announced manufacturing initiatives along the line of lean.

And lean is simply a look at how you can remove inventory from your system. So you look to your suppliers to provide shorter lead times and again that's a real fundamental attribute of the new amplifiers suite, it’s a really fundamental attribute of the idea of bringing tunable dispersion compensation out to manage inventory.

But the lean initiatives had met in some areas. You’ve seen some pull backs on purchasing, because they would have had 15 weeks of inventory and they want to move that down to 5.

We have in certain places felt that. And I think most of the places that we have seen the inventory adjustments popping out, we are actually starting to see the orders come back. We had some effect in this quarter, but it really wasn’t big enough to talk about.

Go ahead Marla, if you have a comment. No. John, I can’t remember what the second part of your question was about?

John Harmon - Needham & Company

The Alcatel-Lucent merger.

Jo Major

Yeah, with Alcatel, we always remain in real good contact with Alcatel and try and understand what they need, and do our utmost to service their needs. We want a tremendously huge supplier in Lucent. So we have been working very diligently to understand what’s out there and the opportunities for us.

So we are really encouraged by some of the new opportunities you see on the Lucent side of that merger. There hasn’t been a real pronounced negative effect to us. We have worked through it I think pretty peacefully just because we have hustled to keep in contact with what’s going on with them.

John Harmon - Needham & Company

Great, thank you. And my last question is, you express your optimism about a pickup in your business in the back half of the year. I guess [somatically] that implies the very end of the year. But how much visibility do you have into the September quarter at present?

Jo Major

You shouldn’t read when we say latter half of the year. You shouldn’t read too much into the fine details there. The visibility that we have in is fairly standard for this industry. It is a cyclical industry the orders come and go. Over any given period of time, we think its growing very robustly.

So if you look backwards, this company is growing very, very robustly over the last several years. But you've seen quarters every now and then, we have a down quarter. We do see signals from a lot of our customers that their general business outlook is pretty optimistic. I think it’s a little bit too early to call a September quarter, but we do see a lot of positive signals out there.

I think the other thing to sort of remind everybody is we have been pretty vocal about saying the market is cyclical, even when we are having really nice revenue quarters. And we are also fairly vocal about designing a company that has a low fixed cost structure. So that we were going to be profitable when the market has gone up, we would be profitable when there is a brief pause in the market.

And we're actually pretty bullish as we look at our new cost structure. Even in quarters where we have a little bit of revenue pause, the financial structure of the company is going to start to look pretty good.

John Harmon - Needham & Company

Great, thank you very much.

Operator

Your next question comes from Dave Kang with Roth Capital.

Dave Kang - Roth Capital

Thank you, good afternoon. First question is regarding operating more OpEx going forward. What would the operating model be now that French fab has been divested?

Marla Sanchez

On the open, overall we expect to see about $3 million to $4 million savings at the bottom-line with the French fab coming off. That will be spread over all the line items, but it will be coming off cost of goods sold, also from some of the operating line items, in particular some of the G&A line items and sales and marketing.

The R&D, we are keeping some of the engineering in line in France, and we will end up reinvesting from other programs on the R&D area. So, we won’t see quite as dramatic an improvement on the R&D line as we would see on the G&A and sales line. And again as a long-term model, we are expecting to get our operating expenses down to 25% level?

Jo Major

So Dave just to reiterate and it's useful to talk about it several times. The quarter that we just finished up, the French divestiture was a little bit more than $3 million in revenue. So that's the other piece that we've been discussing with the bottom line.

Again, we're really excited, it helps the cost structure and the cost of goods, it helps make the company easier to manage, it really gets our operational expenses in line with where we want to go, and it allows us to reinvest some additional funds into key technical and key growth markets that we're really excited about.

Dave Kang - Roth Capital

Okay. And I think I missed these numbers, but can you repeat what Alcatel and Tellabs were during the quarter?

Marla Sanchez

30% of the revenue was for Alcatel and 20% for Tellabs.

Dave Kang - Roth Capital

Looking at your guidance, if you strip out that French fab then your revenue was around 52. So your guidance is basically flat to down about $5 million. So, looking at the low end of the guidance of $47 millionish, it sounds like lean initiative is not having real impact on your business. So what would cause your revenue to drop to $47 million in the current quarter?

Jo Major

Just as a clarification, you said a lot of things there. So let’s talk about the guidance there, 47 to 52. One of the statements that you made is, [filing] the divestiture you took the whole $3.2 million out. That impacted just for clarification. There is two weeks of France and there is some minor transitional agreements between the two companies. So it's not a pure and complete withdrawal of that revenues line Dave.

Dave Kang - Roth Capital

Okay.

Jo Major

You can talk that way, but I want you to understand that there is a little bit more texture to it than that. It's not a bad way to model the company and that's why we've been telling you there’s $3 million at the top line and improvement of 3 or 4 to bottom. But it’s not quite that simple.

Anyway if we are talking about where do we get at the lower end of guidance? We are transitioning several customers right now to some of the new products that we've announced recently. So getting the design wins out and making sure that they hit their revenue number is one way that we see our way to some of the upsides.

We have been moving with some nice progress into Asia, so those are new design wins and new customers. If we are looking at how do we get at the higher end of the guidance, we really accelerate that and get some strong pull there.

There are some opportunities that have been afforded to us, some of our larger customers, as we work through largest quarter, capitalizing on those types of opportunities and that drives us to the higher end also.

Conversely you can take all of those and say it in a negative way and that's kind of what takes us to the lower end. It is important and I want to make sure that people do take this away. We did put the cost structure idea in place, the deal, the fact that this is a rapidly growing, but a little bit cyclical market.

And we are really confident in our cost structure and are pretty excited as we think we can actually improve overall financial performance even in a quarter where the revenues are little bit down.

Dave Kang - Roth Capital

Okay. And just lastly, were there any areas of weakness among products that kind of stood out in the last quarter?

Jo Major

In last quarter? No, not really. In Q2 and Q3 we have a very, very, very strong amplification group performance. And when you look at the two customers that are a little bit slowing down in the quarter we are in, they are big amplifier customers.

So if you have talked about this quarter we are in right now, amplifiers would be a product line that’s feeling the slow down from those two customers [nose]. But in the past two quarters, amplifiers have done very, very well.

Dave Kang - Roth Capital

Got it. Thank you.

Jo Major

Sure.

Operator

Your next question comes from the Subu Subrahmanyan with SMH Capital.

Subu Subrahmanyan - SMH Capital

Thank you. A couple of housekeeping questions first. Could you talk a little bit about the G&A line seems to have formed fairly significantly on a sequential basis? I know there are some one-time things we are taking out of that, and also about interest income number?

Marla Sanchez

Sure. On the G&A line, last quarter we had $2.1 million approximately for outside service fees that we used in looking at a potential acquisitions that we didn’t have all those expenses carrying forward for this quarter.

Last quarter we had also had higher outside services both just for SOX and for audit expenses. Those are back in line this quarter. So, those were the primary factors from last quarter that had a higher G&A last quarter. Relative to interest income. Interest income was actually in line with about where we usually run. We usually run about 300,000 a quarter, and we were about 308 last quarter, we were 274 this quarter.

Subu Subrahmanyan - SMH Capital

Okay. But the net was about a 129 [right], interest for other income?

Marla Sanchez

Yes, and that was about that.

Subu Subrahmanyan - SMH Capital

And is that kind of the going forward level we should assume?

Marla Sanchez

Now that we've got the financing in place, and are actually trying to make a concerted effort to watch our cash management a little bit better and get a little bit more control over our cash management. We actually hope that will go up slightly.

Subu Subrahmanyan - SMH Capital

Got it. And just to understand from the fabs that you are closing in France. You announced that on the 1st of March, can you just talk us through the timeline, if there was any benefits from that at all in terms of OpEx in the March quarter, will we see a full quarter benefit in June.

And then I know you said it would run through mostly in those line items. Is it split fairly evenly between OpEx and cost of goods sold to $3 million to $4 million per quarter in savings?

Marla Sanchez

Okay. In March, the fab would have been in our expenses. For the June, we will have two weeks, because the closing date was April 16. So we will have two weeks worth of expenses with the entire fab on our books. Then going from the middle of April forward, we will have the expenses for the remaining 20 people R&D, good 20 plus people R&D group that we will have on that.

And then going forward into the September quarter, it will be the first full quarter, where we will have had a complete split between product lines that we were keeping and the product lines that we divested.

The split, in terms of an estimate of the line items that we will be coming off as the cost of goods line versus the operating expense line. It’s roughly almost equal if you take it across all of the line items. If you take cost of goods and then take all of OpEx together you'll get fairly close to equal.

Subu Subrahmanyan - SMH Capital

Got it. And I just had a follow-up for Jo. Jo, I think this question was asked earlier too but you tried to take a different tack at it. If you look at the second half of the year and you look at kind of lead time for orders, they are usually at least 4 to 6 weeks.

Are the indications already there that things start to get better in September, now that we are into May. And if not, how the dialogue with the customer has gone? And then from the lean manufacturing initiatives, Cisco and Nortel have been significant futures in the past. So, for your category of products was there just a big enough revenue inventory build that you're not filling it. Can you just talk about that qualitatively?

Jo Major

Okay. So I'll answer the questions backwards. I made a comment that it wasn’t a huge effect in this quarter. Probably a better way to describe that is, on a customer-by-customer basis it's very typical for us to see revenues moving up and down. And a lot of times when the customer A moves down, customer B moves up, and we just keep the business moving quite nicely forward.

We did see some pullback from both of those customers. But, it was just a sort of the order of magnitude that other product lines and other customers covered it. With regards for the second half of the year, most of the feedback we don't give.

We are not going to give Q1 and Q2 guidance, other than to say that the feedback that we get from our customers have been pretty positive. It is about where they see the business going. We've also seen a lot of positive indicators that are long-term indicators.

It is really striking and it should be striking to the investment community that fiber, which is one of the indicators of the long-term health of our industry. Fiber sales are growing quite nicely and Corning in fact reversed a decision to [mark] a factory or rather a factory that had been [marked] for a long time. It’s not being brought online to meet the serving demand.

So those things are positive indicators. We don't really want to get in a position here of giving extended multi-quarter guidance other than qualitative guidance wherever we see our customers and our markets going. And both of those are pretty positive for us.

Subu Subrahmanyan - SMH Capital

Okay. Got it. Thank you.

Operator

Your next question comes from the Hugh Mai of First Albany.

Hugh Mai - First Albany

Can you please comment on the pricing environment, like it is backing the pricing negotiations?

Jo Major

The general pricing environment is we would call it as, so we are hardware and optical hardware company. And just like other environments, we expect and then rebuild into our product development and our manufacturing structure, pricing declines to be part of our business. And I would characterize the pricing declines that we are seeing right now as sort of normal for a hardware business like we are.

Hugh Mai - First Albany

Okay.

Jo Major

I don't think that there’s anything excessive. We do have one quarter where we get zinged a little bit hard and we do everything we can to pull together and keep our margin together in the March quarter. We also did a really good job. But other than that if we take it at aside I think I would just describe them as normal.

Hugh Mai - First Albany

Okay. Thank you. Given the ongoing reduction in lead time. How should we think about your outsourced manufacturing model versus the in-house manufacturing employed by the other guys? Would it be at this event that you are at an advantage or does it really matter?

Jo Major

I think I’d argue that the bigger issue is, and we have taken a very active stance here right. Our operating model is based on low fixed cost, and it’s based on a very consolidated and streamlined manufacturing group.

So we took the step quite early on in our restructuring to put everything that we had in terms of all of our manufacturing assets that control the supply chain, they were thinking about purchasing, planning logistics, shipping. All of that resides in a single streamline location. And I think that does a really good job at helping us understand things like E&O, helping us understand things are cost structure, helping us drive inefficiencies out of an overall manufacturing system.

But the fact that the touch labor that we used to build our products isn’t on our payroll, is pretty secondary to the discussion. I think we’ve got a good manufacturing strategy, and whether or not we have an internal factory here or there is sort of secondary of that.

Marla Sanchez

One of the other advantages that I think been having, the contract manufacturing model actually forces you into the [health] of the lead times is that we have to make sure that when we have a product ready to go into the manufacturing floor, that all the kinks are pretty well ironed out in terms of manufacturability.

When you tend to have it in-house, a lot of times, you put into the manufacturing floor and then continuously keep tweaking at, because you’ve got the engineers and you’ve got [floor] both on site.

When you have to turn it over to a contract manufacturer, if forces you into the discipline of making sure that by the time you send it for manufacturability, it really can go very smoothly through the process. Because you don’t have that same luxury. So it instills a discipline in the whole process of getting the product ready for the floor that you don’t necessarily have to impose on yourself otherwise.

Jo Major

I think another way of getting at that question is, lead time is one manufacturing metric that’s very important to our customers, so is on-time delivery. On-time delivery to their customers plus quality and return rates.

And most of those metrics involve managing your supply chain part and your manufacturing floor. And we've been very successful in continually improving those metrics in a contract manufacturing environment.

Hugh Mai - First Albany

Well okay. And just another quick question on gross margin. I guess you are expecting an uptick for next quarter? How much of that was because of the divestiture? Have you ever quantified how many basis points you are getting just permanently because of the divestiture?

Jo Major

We have it in the press release that we're talking about. If you look at the quarter that we just finished, we would be in the range of 25 or 26 percentage points of margin had we not had France in the mix of things.

Hugh Mai - First Albany

Okay.

Jo Major

So, it’s pretty healthy bump. And of course as we bring the revenue back up, we have very nice flow through. So, I think it’s a really good statement, when we said, look gross margins are going to be rising on revenue that’s flat to down a little bit, that’s really positive.

And the second thing that’s really positive is, we have a pretty nice and improving flow through situation. So as we return to growth, we're going to have a nice situation with flow through, to flow through to the bottom-line.

Hugh Mai - First Albany

Okay. Thank you very much.

Operator

(Operator Instructions). Your next question is a follow-up question from Subu Subramanian with SMH Capital.

Subu Subrahmanyan - SMH Capital

Just had a quick question. As you move the company towards profitability, what the fully diluted share account would be?

Marla Sanchez

Actually we’ll have to get back to you on that. We haven't actually calculated it out for this call.

Jo Major

For the call we don't have it. But that's in the Qs and stuff. So it is publicly available information.

Marla Sanchez

And we did file our Q today. It actually went out pretty much at the same time as our press release.

Subu Subrahmanyan - SMH Capital

Alright, thank you. I'll check on that.

Jo Major

Subu it’s public information. If you need us to point you to it, that's no issue.

Subu Subrahmanyan - SMH Capital

Okay, thank you.

Jo Major

Sorry we don't have it right at the top of our heads.

Subu Subrahmanyan - SMH Capital

Okay.

Jo Major

Operator, are there any other questions out there?

Operator

No sir, there are no further congestions in queue.

Jo Major

Okay. Thank you everybody for attending our call, and have a nice evening, bye-bye.

Operator

Ladies and gentlemen this concludes the Avanex fiscal 2007 third quarter earnings conference cost. You may now all disconnect.

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