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Executives

Brooke Deterline – IR

Giovanni Barbarossa – Interim CEO

Mark Weinswig – VP of Finance and Interim CFO

Analysts

Paul Bonenfant – Morgan Keegan

John Harmon – Needham & Company

Tim Savageaux – Merriman

Sam Dubinsky – Oppenheimer

Todd Koffman – Raymond James

Ajit Pai – Thomas Weisel Partners

Subu Subrahmanyan – Sanders Morris-Harris Group

Avanex Corporation (AVNX) F4Q08 (Qtr End 06/30/08) Earnings Call Transcript August 21, 2008 4:30 PM ET

Operator

Good day and welcome to the Avanex Corporation fourth quarter fiscal year 2008 conference call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Brooke Deterline, Investor Relation. Please go ahead ma’am.

Brooke Deterline

Thank you operator and thank you everyone for joining us today. I would like to remind everyone that today’s call contains forward-looking statements about our expectations, future events, and the 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 earnings release, Form 8-K, and our most recent 10-K and 10-Q. Avanex does not intend to update any forward-looking statements, including guidance as a result of new developments or otherwise. In addition, because non-GAAP information is presented on today’s call, and in order to comply with SEC regulation, please note that Avanex has provided a reconciliation table and other information attached to today’s earnings release, which can be found on our website at www.avanex.com.

I would like to take this opportunity to inform you that the company will present at the Merriman Curhan Ford Investor Conference on September 15, in San Francisco. As events are scheduled during the quarter, we will make additional announcements.

With that I would like to turn the call over to Giovanni.

Giovanni Barbarossa

Good afternoon and welcome to our 2008 fiscal fourth quarter and year end earnings call. It is my appointment to the position of interim CEO in early July. I spent a significant amount of time meeting the Avanex customers and employees worldwide. As being very encouraged by the (inaudible) for Avanex, its trends in the markets and its product offerings and has being in placed by the commitment of the global Avanex team. Our strong position and expanding development efforts with key customers will enable us to announce our bit growth product offerings and increase our market share.

During my recent visit to Asia combined with one of the largest Japanese OEMs. We expected strong interest in our product; in particular our market leading tunable dispersion compensators. This is one example of our opportunities to expand economic relationship into a more strategic partnership.

Fiscal year 2008, it was a successful time for the company. We completed our restructuring activities and we now have confectioned our focus to investing in growing markets. We would like to take a moment to highlight the number of important milestones the company achieved during the fiscal year. Most notably, we achieved profitability on a GAAP and non-GAAP basis for the entire fiscal year. This took a tremendous amount of focus and effort by the Avanex team and we are very pleased with our progress and success over the first year.

Second, we released the number of new products and platforms to address some of the fastest growing markets, including tunable transponders, tunable dispersion compensators and control amplifies. Third, we continue to strengthen and expand our relationships with customers and build our presence in key market. On the customer front, we extended our supply agreement with Alcatel-Lucent and had a number of new design wins with multiple customers. Additionally, as part of our strategy to expand in high growth regions, we increased our development sales and operation teams in Asia.

Looking to fiscal 2009, we will continue to execute in our revenue growth strategy, while leveraging our low cost operating model. In the optical telecommunications equipment industry time-to-market is the key difference between winning and losing. Key to our growth strategy is to improve our execution in order to accelerate our time-to-market and maximize the potential for new part of design wins. Specifically, we will target our efforts on product development and sales and marketing. As we leverage our team’s expensive experience at long spending customer relationships to expertise these efforts.

We’ve been encouraged our recent design wins and we see significant opportunities for our new products, such as tunable transponders and ROADM modules. These should enable us to compete more effectively in growing markets and achieve higher margins and keep other platforms. During the fourth quarter, we achieved our financial targets. The sequential revenue of 5% to $51.8 million and our best stock split adjusted net income to diluted shares of $0.08.

Turning to our key business areas, after analyzing our key product lines, we are refining the way we categorize them. We’ve broken it into three key areas Transmission, Regeneration and Wavelength Management, (inaudible) that provides key market drivers; it highlights our quarterly revenue performance and gives some color on that performance. We believe that this new classification we provide later insight and will enable us to better track our progress as we walk to strengthen our product portfolio and expanding to global market.

Revenue from our transmission products, which includes transceivers, transponder and modulators showed a 25% increase in the fourth quarter. Today this business is approximately one-third of the company’s revenue. In addition, over 50% of our design wins came from transmission in the fiscal fourth quarter.

Transmission is currently the largest and fastest growing market in the industry. The key drivers in this market include the move to higher transmission rate such as 40G and new modulation format, longer transmission businesses. In addition, we continue to see the trends over the tunable resolution. Looking ahead we believe that there is a considerable opportunity to increase revenue from transmission products as we leverage our next-generation product including our new tunable transponder platforms and modulators.

Revenue from our regeneration product, which includes sophisticated control in amplifiers, gain blocks, dispersion compensation modules and integrated optical performance monitoring products declined by 12% from the third quarter. Approximately, 50% of the company’s revenue and 30% revolver design wins came from regeneration products in the fiscal fourth quarter.

Avanex continues to be a performance in market leader regeneration products. With the market moving to 40G deployment to new technologies to enable higher transmission rates are critical to meet growth bandwidth demand. We see a significant opportunity for our regeneration products as a result of this trend.

In particular, we saw increase traction with customers during the quarter for our new tunable dispersion compensation product especially in next-generation submarine systems and 40G applications. We’re happy to announce that our new Oasis amplifier platform as a strong design wins in the quarter. As a reminder Oasis is combined configurable electronic with the standard optical platform. This results and it reduced development time and costs for our customers due to the integration of software and hardware in a single platform.

Revenue from our wavelength management products, which includes both fixed and reconfigurable wavelength routing products, increased 10% sequentially in the fourth quarter. This business is approximately 15% of the company’s revenue today and more than 20% of our design wins came from this area in the fourth quarter. In fact we have seeing a significant amount of interest in this product. In meetings with customers we have receive the strong support for our R&D road map in these area our growing portfolio with ROADM solutions will increase our goals prospect and help us to finish it our sales in the market.

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

Mark Weinswig

Thanks, Giovanni. First let me take this opportunity to tell all of you how to sign I am to be back at the company. Avanex is a very dynamic organization with excellent technology and outstanding team and a variety of market opportunity, please not that all of the per share data would discuss this quarter and for the fiscal year takes into our account to reverse split, which became effective at the close of market on August 12.

Net revenue for the fiscal fourth quarter was $51.8 million of 5% from $49.6 million last quarter and that 1% from $51.1 million in the same period last year. With the quarter sequential growth was driven by a $1.2 million one-time increase related to the legal settlement with 3S Photonics and then an increase in our transmission products.

Fiscal year 2008 revenue was $208.1 million down 2% from $212.8 million in fiscal year 2007. On a geographic basis North America was 43% of revenues, Europe was 32% and Asia was 25%. Of particular note is the fact there was the 30% increased in revenues from Asia this quarter over the prior quarter. 10% customers in the quarter were Alcatel 27% and Tellabs at 22%. Other large customers included Nortel and Walkway.

Gross margin was 32% for the fourth quarter roughly flat with the fiscal third quarter and up from 24% in the year ago quarter on a normalized basis. Excluding a number of benefits primarily related to the distribution agreement and settlement with 3S Photonics our gross margin would have been lower by 5% to 6%.

I will now provide some further detail on these benefits. In the fiscal fourth quarter gross profit increase by $3.1 million primarily from a $1.2 million improvement to the recognition our previously deferred revenue and other items a $700,000 improvement due to the pre-product credit and a $1.2 million improvement due to the settlement of the 3S Photonics legal proceedings relating to the distribution agreement. We do not expect any of these benefits to continuing the future quarters.

In the first quarter of fiscal year 2009 we expect gross margin to be between 20% and 23% due to a number of factors first, we are forecasting lower revenues for the first quarter of fiscal 2009, which Giovanni will discussing shortly.

Second, we have seen a temporary mixture towards to the lower margin products. Third, we are experiencing pricing pressure from one customer in particularly on a legacy system and finally, we are investing a new capacity for key products such as ROADMs and tunable transponders. Investment in capacity will continue for the next few quarters as we began to ramp up our new products.

Total operating expenses for the fourth quarter were $16 million or 31% of revenue this compares to $14.1 million or 29% of revenue in the third quarter and $18.1 million or 35% revenue in the same period last year. Excluding the one-time benefit of $2 million from the return of escrow funds from 3S Photonics last quarter, operating expenses were relatively flat sequentially. We anticipate R&D expenses will increase slightly during the first quarter of fiscal 2009 in absolute dollars as we invest the new products to address the growing markets.

Operating income in the fourth quarter was $690,000 down from $2 million and up from a loss of $6 million in the same period last year. Net income was $1.3 million or $0.08 per diluted share for the fourth quarter, this compares to net income of $3.3 million or $0.22 per diluted share last quarter and a net loss of $5.7 million or loss of $0.38 per diluted share for the same period last year.

Please note that our fiscal fourth quarter 2008 GAAP net income, benefited by $3.1 million due to the global distribution agreement, arrangements of customers and settlement with our former French subsidiary as mentioned earlier. For fiscal year 2008, net income was $4.8 million of $0.31 per diluted share compared to a loss of $30.6 million or loss of $2.16 per diluted share for fiscal year 2007.

Our fiscal year 2008 GAAP net income benefited by $3.7 million from the distribution agreement and subsequent settlement as noted above. Non-GAAP basis, net income for the fourth quarter was $1.6 million or $0.11 per diluted share compared to $2.9 million or $0.19 per diluted share in the third quarter. This compares to break-even net income in the same period last year.

Moving on to the balance sheet, we increased our cash and investments to end the quarter with $59 million versus $54 million last quarter. At the end of the quarter, total headcount was 576 up from 566 in the prior quarter. With that I will turn it back to Giovanni who will discuss our outlook for the first fiscal quarter of 2009.

Giovanni Barbarossa

Thanks, Mark. In fiscal 2008 the Avanex being continue to execute on its long-term strategy to grow revenues and improve the company’s cost structure. The key focus for fiscal 2009 will be improving execution and time to market our new products. We are expanding our customer presence with our next generation products to improve our market position and to help faster most strategic relationship. We are also investing in product development to announce our product portfolio to compete effectively in some of the fastest growing markets. We will be updating you on our progress in future quarters.

Now let me turn to guidance for the fiscal to the fiscal year 2009. We expect revenue to be in the range of $44 million to $48 million. The sequential decline is primarily due to a market slowdown in Asia and the pricing pressure that was mentioned earlier. In addition we are reducing our sales on some of our very low margin legacy products. We expect gross margins to be between 20% and 23%. As Mark discussed in the near-term gross margins will decrease to a mix sift towards larger business in transmission products, which typically at lower margins.

Some reasons price of actions on legacy products increases our investment in manufacturing capacity related to new product. We are taking actions to improve our margins in future periods and believe that revenue for new products will help us to expand the margins. We expect operating expenses to increase in the first quarter of fiscal 2009 due to investments in R&D associated with new products and accepted departures. Quarterly funding R&D its keep to increasing our growth in new product revenue. Based on kind of part of the investments we are expect to see solid revenue growth for fiscal 2009 excluding revenue from 3S Photonics generated in fiscal year 2008. In summary we are very encouraged by the opportunities in front Avanex.

I’d like to take this opportunity to thank the entire Avanex team for their hard and dedication. Over the next few quarter the Avanex team will be very focused on improving execution, accelerating time to market, strengthening our customer relationships and delivering on our strategic plan. Avanex will be showcasing it’s products that equals in threshold to September and we hope to see you’d, we are now ready for the Q&A section of the call.

Question and Answer Session

Operator

(Operator instructions) And we’ll go first Paul Bonenfant with Morgan Keegan.

Paul Bonenfant – Morgan Keegan

Thank you. Couple of questions, first your revenue going down sequentially. Can you tell us how much of that reflects the lower sales versus the pricing pressure that you’re experiencing?

Giovanni Barbarossa

Hi, Paul this is Giovanni. What I think is a combination of that, I what exactly split in percentages; there is no doubt that we’ve been overly optimistic about the production of new product and from our side as well as the, I would say the adaptation from our customers for some of our new products. So it’s a combination of the two.

Paul Bonenfant – Morgan Keegan

Okay and some of the pressure on the gross margin, on past calls you’ve talked about the mix of products and some product categories being above and below gross margin modules, for example being grater than subsystems transmission being below other areas, and I’m wondering if you can talk to how you see the mix changing in the quarter, just to give us some inside to may what’s providing the drag?

Mark Weinswig

Paul, this is Mark Weinswig. Just real quickly, if you looking at between Q3 and Q4 we saw significant increase on sales to Asia, actually of a 30% and a significant increase in transmission product, as a result of that we did see some margin pressure in Q4. Moving to Q1 really the major driver for our reduction gross margins in Q1, is really the reduction in revenue. So that’s one of the big items. In addition, we are continuing to see the mix shift towards more transmission product, which typically had some lower margins.

Paul Bonenfant – Morgan Keegan

Okay and last question if I may, you talked about slowing in Asia and pricing pressure and also reducing sales of lower margin and legacy products. These things don’t some like there temporary items, so should we not expect to snap back in sales any time soon?

Giovanni Barbarossa

Well, as we said, we expected solid growth over the fiscal year 2009. So we are still committed to revenue growth strategy and what we’re doing, we will be executing as we said on the new product introduction and focus the company on product development and sales to market and we’ll increase the relationship, the partnerships with our customers, the customer intimacy, but most fundamentally the new product introduction will be our focus to achieve that goal of solid growth through fiscal 2009.

Paul Bonenfant – Morgan Keegan

Okay and I might just squeezes in one more, you talked about 9% ASP declines last quarter. How your ASP declines in the last quarter and going forward relative to that number?

Mark Weinswig

I can distribute some evidence, we had one customer particular, where we had double digit sequential decline in ASPs and that was one of our highest revenue items. Typically in previous calls we’ve talked about between 15% and 20% year-over-year decline in ASPs that’s typically, its just that we did see some significant price pressure in on of our big runners, but that should just have a negative impact for us.

Paul Bonenfant – Morgan Keegan

Thank you for taking my questions.

Operator

And we’ll go next to John Harmon with Needham & Company.

John Harmon – Needham & Company

Hi, good afternoon.

Giovanni Barbarossa

Hi, John.

John Harmon – Needham & Company

I was wondering if you had an organic growths figure handy for fiscal ’09 picking up through you have some, if I see you have $12 million, I get about 4% does that number sound like its in the right ballpark or..

Giovanni Barbarossa

As you know, we only provide guidance for one quarter ahead and as we said we we’ll grow over the course of the fiscal year, but so far we’ve given an update of the next call, our guidance is restricted to one quarter.

John Harmon – Needham & Company

I’m sorry, you didn’t understand my question very well, let me re-ask and the reason to a second question, in fiscal ’08, your recorded growth was negative 2% and I was wonder if you had a figure for organic growth, taking out three years, the year before, in any case I get a number in the low single digits and the question that this leads up to is what do you think the contribution could be in fiscal ’09 from new product. I understand that you are not going as fast as the market. What areas do you think will contribute the most growth fiscal ’09? How much if you have an idea?

Mark Weinswig

Let me first give you some quick information. You’re exactly right actually year-over-year if you exclude the 3SP revenue our revenue growth was actually very low single digit. So, that’s the first part and I’ll move the call to Giovanni, let him actually talk about the revenue growth prospects of this year.

Giovanni Barbarossa

Well again, as we said we expect the new products to kick in and as a solid growth over the entire fiscal year, right now as I said we are seen the strong bookings in tunable dispersion of the lines, we are broadening the middlemen selection, which offsetting we are bringing to customers the next generation high-speed modulators, primarily around six modulation and small firm factor tunable transponders so this is a number of products we are working hard to go back into a growth trajectory which I as I said will believe is our goal for the solid fiscal year 2009.

John Harmon – Needham & Company

Okay. Thank you and I believe you said you said you expected R&D to be up in Q1, do you have kind of a ballpark figure for operating expenses in Q1?

Mark Weinswig

We haven’t disclosing anything yet of the, in terms of R&T terms, the only think I would like to say is that we did mentioned that R&D cost will increase quarter-to-quarter and also went from additional cost relating to certain severance payment.

John Harmon – Needham & Company

Okay that leads to my next question, it appears that most of your researching is done, yet you still have some reserves and some charges in the financials. What’s happening and what’s causing that?

Mark Weinswig

Yes John, those reserves on the balance sheet, thank you for the question are actually relation to facility leases. Back in the heyday 2000, 2001 we actually leased some buildings for more than 10 years, so we actually never end up staying in those buildings at all, so we actually reserve for them and that we are actually paying that offer up until 2011. It’s about $800,000 per quarter.

John Harmon – Needham & Company

Thanks and finally how many employees did you end the fiscal year with

Mark Weinswig

We ended the year actually with 576 employees.

John Harmon – Needham & Company

Great thank you very much.

Mark Weinswig

Thank you John.

Giovanni Barbarossa

Thanks.

Operator

And we’ll go next to Tim Savageaux with Merriman.

Tim Savageaux – Merriman

Hi, good afternoon. Do you expect that you will be profitable for the full year 2009?

Giovanni Barbarossa

As we said, we expect solid growth, our model it’s to reach break even at around $50 million. So right now we need to investing new capacity to increase revenue on the new product and especially with the higher margin products so, this going to be our focus.

Tim Savageaux – Merriman

I apologies that I did jump on a bit late. With regard to the expectations for, pretty significant sequential drop in revenue. I know you talked about pricing maybe the failure of new products to ramp as anticipated. Is there anything from the customer standpoint that’s contributing to that or just a confluence of several factors or one broad win, did you see a broad base reduction in demand dynamics or just more something specific to you and your customers?

Giovanni Barbarossa

As I said, it is a combination of our ability to introduce new products to the markets as well as the ability of our customers to adopt some of our available new products in the system. So it’s a combination of the two and that’s kind of compounded for Q1, may be the last week we see a very strong interest for the new platforms, as I said in this meeting, the way this control of our amplifiers as the (inaudible) portfolio, the Tunable Dispersion Compensation product, as I said high sped moderate, So its really a strong interest, but there has been a delay in our ability to being the product to market in some cases we been kind of delayed by the customers being able to adopt new product.

Tim Savageaux – Merriman

Okay, and just one quick follow on, yesterday JBLC sited some supply constraints or capacity constraints as well I think particularly pointing at the road in market, but maybe some others in moving some revenue out our quarter or so. Is that part of which you’re talking about, or is just more customer driven activity?

Giovanni Barbarossa

Well we don’t add capacity constrains for the product we currently have active ultimately. Our business model, with the contract manufacturing outsourced manufacturing it gives us the flexibility to ramp up as needed. So, that’s wasn’t the reason for the decline. Does that answer your question?

Tim Savageaux – Merriman

Yes, thank you.

Giovanni Barbarossa

All right. Thanks, Tim.

Operator

And we’ll go next to Sam Dubinsky with Oppenheimer.

Sam Dubinsky – Oppenheimer

Hey guys, there is a couple of quick questions. Could you maybe disclose what your new operating model is, I know the past management team sort off vocal about targets. Could you just maybe disclose what you’re going to strive to over the next 12 months, or may be even 12 to 18?

Giovanni Barbarossa

So, as I said our break-even module right now is at around $50 million and so we don’t anticipate changes from the perspective from an operation standpoint.

Sam Dubinsky – Oppenheimer

What about the gross margin targets and things like that?

Giovanni Barbarossa

No we’re setting gross margin targets at this point.

Sam Dubinsky – Oppenheimer

Okay and also maybe if you can tell by your business model, I always assume that being fabulous to some extent minimize the margin volatility. It seems like margins are pretty volatile. At some point, do you think this is the right business model to be in or do you think you need to have a fab going forward to capture more margin?

Mark Weinswig

Hi, this is Mark Weinswig. Just real quickly, it really was the short fall in Q1 is already coming in from the lower revenue base more than anything else. We actually believe that actually having the fabulous models we currently have, they keep outsourcing everything is very good for us, as you know I mean though fiscal year ‘08 we are profitable on both GAAP and non-GAAP basis. So our model has worked very well in the past and I think as Giovanni just mentioned we need to continue to ramp up new products to basically replace some of the existing products, that we had for some time, the legacy products that have lower margins in that cycle and that just need to expertise.

Sam Dubinsky – Oppenheimer

Okay and on newer products, how do you transmission it before you guys report. I know that was supposed to be a lower gross margin business. Is the transmission segment even tougher priced than you initially thought and how can you prove the margin in that business?

Giovanni Barbarossa

Well, I’d was say that these tougher in terms of availability to replace existing legacy products at lower margin with new products with higher margin and also as I the ability of our customers to adopt quickly our higher margin solutions. So, from that prospective there is a shift due to this two compounded reasons.

Sam Dubinsky – Oppenheimer

My last question, can I just talk about ROADM revenue this quarter and that’s sort of a new focus for you guys and the industry capacity constrained, how was ROADM demand tracking and how do you signed up more than one customer for this?

Giovanni Barbarossa

We currently have two tier 1 customers engaged and there is one tier-1 customer vehicles to selecting us. It is also other customers that are interested in our platforms of course. As I said what we need to do is focus on execution and further development and bring the products to market faster, than we anticipated. So we need to focus on the new product introduction in the several months to come.

Sam Dubinsky – Oppenheimer

Did you ship ROADM revenue this quarter to anyone?

Giovanni Barbarossa

Very little

Sam Dubinsky – Oppenheimer

Okay, thank you.

Operator

And we’ll go next to Todd Koffman with Raymond James.

Giovanni Barbarossa

Hello, Todd.

Todd Koffman – Raymond James

Can you hear me now?

Giovanni Barbarossa

Yes, hi Todd.

Todd Koffman – Raymond James

A Couple of question in the June quarter, your margins on a normalized basis. Gross margin was sounds like about 26% and they had been significantly higher than that. What transpired in the June quarter that led to a significant shortfall in your product profitability in the June quarter?

Mark Weinswig

Hi, Todd its Mark Weinswig. Just a quick direct there were three major reasons, first of all with an increased in sales to Asia and an increase in our transmission business both of which have typically lower margins. In addition we also saw some pricing pressure on one of our products that goes into one of our customers legacy systems and so that was one of our highest runners that we actually saw some further pricing declines that what we’re expecting and then further we were expecting to have some additional products on the market actually generating higher revenue dollars than what they did. So, I think those were the key things that basically let us to kind of be closer to 26% to 27% gross margin range.

Todd Koffman – Raymond James

Can I ask as a follow-up at what point in the quarter did you realize that your mix was sifting more towards transmission more toward Asia and at what point in the quarter did you experienced the pretty sharp price pressure that you just referenced, in June quarter now I am talking about specially.

Mark Weinswig

As you know we said about 12% customers make 90% of our revenue and was really month-to-month evolution. So, that was in the any specific point in the quarter well we couldn’t identify this.

Todd Koffman – Raymond James

So this was starting at the beginning of the quarter you saw this pretty significant mix shift and it was working its way through the end of the quarter as well as this price adjustment also happened early in the quarter, middle in the quarter or late in the quarter?

Mark Weinswig

Todd just one quick thing we basically had been saying that transmission was going to be a bigger part of our revenue actually coming into the quarter it was actually a more significant part of our backlog. If you look at last quarter’s conference call, well before you can see that a lot more of our design was coming from transmission. So it’s better trend for us to have more and more business towards transmission. In terms of Asia was everything going on with Olympics, as we mentioned in last quarter we have been seeing a significant increase actually in our business to Asia primarily China due to the build of getting ready for the Olympics games.

Todd Koffman – Raymond James

Can I ask have there’ve been any other senior management departures aside from the Jo Major and Marla Sanchez in recent times?

Giovanni Barbarossa

No, in fact we are not section 16 officers. There has been no change in the senior management.

Todd Koffman – Raymond James

And when the Board made the decision to change out the prior management, it would seem as though the Board was pretty vocal that the changes were not due to strategy or business fundamentals. Yet it seems as though there has been a pretty dramatic change in the business fundamentals not just in the June quarter, but now going forward. My question, is there going to be any change in strategy from the existing management as it relates to the business operations versus the old strategy of the prior management?

Giovanni Barbarossa

Well, a fact that I want to remind you that Marla Sanchez resigned from the company, so it wasn’t the Board decision. In terms of Jo Major, as we said in multiple times that this was really due to the inability of Jo and the Board of Directors to work together effectively, so as we said there has been no desire to change the strategy at this point.

Todd Koffman – Raymond James

Okay. So, it’s just a complete coincidence that the business on rather than conjunction with the change fair enough, just a follow-up question, it’s sounding like as you look forward, there is new price pressure. You talked about the guidance and it reflects lower revenue and you’ve got these price pressures, but Avanex historically has experienced the most aggressive price pressure sort of in the end of the calendar year going into the March quarter where the prior management goes to a lot details as the pricing adjustments. Why is the pricing going through another adjustment sort of middle year going towards the back half of the year it seems unusual.

Giovanni Barbarossa

Well Todd as we said we didn’t experienced pricing pressure on all of the product lines and all the SKUs we said. I said its primarily related to hide on the profit line to one customer on the legacy system and so its not something we see across the board, but it was unexpected and driven by our customer and so we decided to accommodate the customer request to maintain the largest share of the business.

Todd Koffman – Raymond James

Thank you very much.

Mark Weinswig

Thanks, Todd.

Operator

And we’ll go next to Ajit Pai with Thomas Weisel Partners.

Ajit Pai – Thomas Weisel Partners

Yes, for the fiscal first half of 2009, do you expect to be cash flow positive?

Mark Weinswig

We’ve not given any guidance at this time about our cash position going forward. I can tell though that in the June quarter, we did generate over $5 million of cash and our cash position and cash investments are very solid $59 million as of right now and we have as you see on the balance sheet we have virtually no debt.

Ajit Pai – Thomas Weisel Partners

Right, but just given the sharp drop off in revenue growing from June into September, and then just base in your guidance and the color you haven’t given the specific point at which you’re trying to go through your breakeven point. Does the company still expect to be generating cash through 2009 or do you expect to be burning some of the cash that you have in your balance sheet in this period?

Mark Weinswig

Actually just to clarify one point we did mention that our breakeven points are about $50 million in revenues on a quarterly basis.

Ajit Pai – Thomas Weisel Partners

Yes.

Mark Weinswig

And right now we are investing a new capacity for the ramp up that we do actually see in the second half of the year. As we mentioned we do expect our revenue to increase year-over-year excluding the 3SP revenue that we recognized in fiscal year ’08, that’s not continuing. So if we actually exclude that revenue, we did mention we’re going to have solid revenue growth this period timing.

Ajit Pai – Thomas Weisel Partners

Got it, but when you’re looking at the kind of capacity expansion they’re having, can you give some idea of the CapEx that’s involved over there and whether that equipment that will offset any kind of cash flow from operations, spent on the CapEx side over there?

Mark Weinswig

Yes, at this point we’re now going to give kind of further details on that than what we’ve given at this time.

Ajit Pai – Thomas Weisel Partners

Okay, but the CapEx is related to the purchase of equipment. It is expanding facilities, additional facilities. Is there some color you can gives as to what kind of investment is required for enhancing capacity?

Mark Weinswig

Yes, so just to cap of on that point. Giovanni mentioned we do see three or four new product lines coming in that could be very successful for us including our tunable dispersion compensation line, our WSS/ROADM area and then also some of our new transmission products including assets of transponders. So we are going to be investing in capacity for manufacturing and test stations for those areas.

Ajit Pai – Thomas Weisel Partners

Got it, and then when you’re looking at the overall sort of pricing environment, I think in answer to the couple of questions you’ve talked about not seeing any deterioration in the overall pricing environment, but only having some company’s or the products that the customer’s specific issues. Is that broadly accurate what I’ve heard that you’re not seeing any change in the broader pricing environment, that the first calendar quarter of this year the kind of pricing that you saw which is broad based. You’re not seeing that trend continued through the rest of the year?

Giovanni Barbarossa

Well, okay so let me answer this question, this is Giovanni. So there is a price pressure across all product line. What I said before is that with one customer in particular on one product line, which is high runner in the legacy system we’ve seen higher than expected price pressure. So we do annual negotiations with all of our customers and we expect that the pricing pressure to be there and we don’t see an increasing price pressure above what has been typical over the past several quarters.

Ajit Pai – Thomas Weisel Partners

Yes, but you expected the price pressure in the first quarter when you’re resetting contacts to be greater and then for the rest of the year sort of moderate. So, is that still the trend you’re seeing, or are seeing the kind of price pressure you saw in the first quarter or the first calendar quarter continue in the June quarter and then also progressing into the September quarter on an overall basis.

Giovanni Barbarossa

Typically the first calendar quarters, the price pressure has been higher than the other quarter. So we expect to see that in the future.

Ajit Pai – Thomas Weisel Partners

Got it and then when you are looking at the M&A environment, there’s been a lot of consolidation in the industry so far. You’ve had announcements made, you’ve had a few closed, but couple of large acquisition or merges haven’t closed completely. Do you expect the pricing environment to improve once they close and also if Avanex also pursuing potentially being an active participant in the consolidation in the industry?

Giovanni Barbarossa

So the first question, yes I believe pricing environment should improve driven by consolidation. That’s one of the hopes. With respect to Avanex of course we are definitely, we believe in consolidation that we have been in the driver seat few years ago of consolidation and we think that’s very important for the benefit of our industry.

Ajit Pai – Thomas Weisel Partners

Right now is your pipeline of potential acquisitions, are you all potentially merging with someone, is it looking higher or lower than it did three months ago or six months ago and even active talks with anyone.

Giovanni Barbarossa

Well again as I said our focus now is to really work on execution, improve our new product introduction. We need to bring products to market faster and at the right time. That’s going to be our challenge and our focus, is going to be really around keeping the team focused on bringing new products to market.

Ajit Pai – Thomas Weisel Partners

Got it thank you so much.

Giovanni Barbarossa

You are welcome.

Operator

And we will go next to Subu Subrahmanyan.

Subu Subrahmanyan – Sanders Morris-Harris Group

Great thanks. Mark me be you can start up by just give a little bit more color and can you run though some of that numbers on 3S in terms of ’07, ’08 revenues and also the impact on revenues in gross margin for the quarter, you just reporting because clearly it has some implications for actual growth rate and if I understand right for ’09 you are expecting growth excluding 3S impact.

Mark Weinswig

Yes, so just to give you some number 3SP for our 3S Photonics revenue for fiscal year ‘08, was roughly around $10 million as we’ve disclosed previously.

Subu Subrahmanyan – Sanders Morris-Harris Group

And was some of that in the current quarter, the June quarter.

Mark Weinswig

For the June quarter actually we had no 3SP revenues, but going to your second question kind of on what were the gross margin improvements that we saw in the quarter? I know we’ve had a couple of answers there, so let me go through that real quickly. There was $3.1 million of gross profit improvement in Q4; it was due to a $1.2 million improvement due to the recognition of previously deferred revenue and certain other items. Number two was the $700,000 due to the free products that we’ve been receiving each quarter for the last few quarters and the third item was the $1.2 million improvement in our gross profit, due to the settlement of legal proceedings.

Subu Subrahmanyan – Sanders Morris-Harris Group

Got it and the product credit was also limited to 3 SP?

Mark Weinswig

Yes.

Subu Subrahmanyan – Sanders Morris-Harris Group

Okay, got it. So moving on to kind of the new product question and you mentioned up front that might have been a little aggressive initial in terms of the expectation recognition. Can you talk about kind of just, which ones you think happened sooner rather than later, which of these areas if you had to pick one seems to have the largest kind of revenue potential and the timing when you start seeing some of this ramp given your adjusted time line growth for those areas?

Giovanni Barbarossa

I think it really depends on a customer-by-customer basis and the product-line by-product-line basis. Not all customers are aligned in terms of their needs, so that our customers that are looking for grade reflectors which are at the most urgent pile from other customers. As we said for example in the submarine case they are more interested in the tunable dispersions compensation product. So importantly for us all these activities are running parallel. So, I would say that in some customers it would be one product and other customers it will be another product. So, I wouldn’t necessarily kind of focus on a product line in particular.

Subu Subrahmanyan – Sanders Morris-Harris Group

Understood and then for the break-even model, you mentioned a $15 million revenue and I understand that it obviously carries some operating expense assumptions as well as gross margin assumption that accompany the $50 million, so can you just kind of talk about; is OpEx kind of up from this quarter and then flat in those levels, gross margin back to the high 20 level and what is the mix, which gets us to the break-even of $50 million?

Mark Weinswig

Hi, this is Mark Weinswig. Just to give you some details, if you look over at the operating expenses over the last year we’ll see that expenses have been increasing slightly and mainly in certain places such as R&D etc, but we do see kind of those numbers flattening out as we start to get through the development cycles from these products. You’re right; before we’re ramping up, we’re doing a lot of sampling, we’re doing a lot of material purchases that can increase some of the R&D expenses in the second quarter and then of course we see the ramp in revenue which then ups the both the top and the bottom line.

In terms of gross margin guidance in our target model we’ve not given that out at the time. We look forward to doing that in future quarters, but right now we’re seeing pretty committed to the $50 million breakeven.

Subu Subrahmanyan – Sanders Morris-Harris Group

Got it, and finally for the revenue guidance just down to midpoint of about $6 million, you mentioned slower Asia, is that related to the post kind of Olympic slowdown in China and any color where that Asia slowdown will come from?

Giovanni Barbarossa

Yes, it partially includes that slowdown from Asia. As you know there’s been the Chinese Government kind of stopping deployment of new gears around China and that the slowdown of purchasing of systems by the service providers and so we can be affected by that. So we expect to be over with that slowdown in the next several quarters.

Subu Subrahmanyan – Sanders Morris-Harris Group

And the reduced sales of low margin legacy products, can you just talk about which category that would form in terms of mission regeneration or wavelength management, this legacy product?

Giovanni Barbarossa

So, it depends on the customers. It’s primarily regeneration and transmission.

Subu Subrahmanyan – Sanders Morris-Harris Group

Got it, thank you.

Giovanni Barbarossa

You’re welcome.

Operator

And we’ll next to John Harmon.

Mark Weinswig

Hi, John

John Harmon – Needham & Company

Hi again. I’d like to probe a little bit more on the gross margin question. You gave the full affect on gross margin, but some of them are temporary and some of them are not, if I could ask the question again, are your gross margins permanently set to a lower level or how long adding everything up would it take for these temporary factors to subside?

Giovanni Barbarossa

As I said, the introduction of new products, which has been as lower than anticipated, will drive gross margins up and that this is what has been the issue with Q1. So again by focusing on execution and other introduction we’ll introduce those other platforms which will drive margin up in the future.

John Harmon – Needham & Company

Okay. So it’s the new products that are going to carry margins higher and then my next question, the math on this is pretty simple, but I just want to hear you say it. If your breakeven level is $50 million and you’re guiding for 44 to 48, its unlikely that you’ll be profitable in the first quarter right?

Mark Weinswig

As we said John our breakeven is $50 million in revenue at this time.

John Harmon – Needham & Company

Okay. Thank you.

Mark Weinswig

Thank you.

Operator

And we will go next to Todd Koffman with Raymond James.

Mark Weinswig

Hi, Todd.

Giovanni Barbarossa

We can’t hear you, Todd.

Operator

Mr. Koffman, your line is open.

Todd Koffman – Raymond James

Yes, can you hear me? I have a follow-up question on the with regard to your comment relating to overly optimistic on the new product; which product specifically where you overly optimistic on, just as a clarification. Thank you.

Giovanni Barbarossa

Well we were in fact in reach with the platform, in which we are overly optimistic.

Todd Koffman – Raymond James

And as it relates to the acquired upstart efforts in Melbourne, Florida, the SX group, any update on how things are going out of that group there? Thank you.

Giovanni Barbarossa

The are going pretty well. I mean with the many reasons we acquired that team in Florida was to really boost our pricing transmission and you’ve seen the increase in design wins in the quarter is working really well. We anticipate new platforms as I side I talked about as a multiple factor, tunable transponder which is for us a new platform as well as a cost reduced platforms for existing tunable transponder platforms. So there is really a dual effort introduction of new platforms as well as the introduction of cost reduced platform for existing total line.

Todd Koffman – Raymond James

Are those tunable products shipping for revenue in the June quarter?

Giovanni Barbarossa

Absolutely.

Todd Koffman – Raymond James

Thank you very much.

Operator

And we will go next to Tim Savageaux with Merriman.

Tim Savageaux – Merriman

Hi, just a quick follow-up, not to get too much into some antiques here, but you did mention that ex 3SP you saw a very low single digit revenue growth in 2008, which I guess I would call modest to very modest. You’re talking about solid growth in ’09; I assume you mean probably something better than that, but I would look it get your potential clarification on that. Thank you.

Mark Weinswig

Yes, we haven’t detailed that out at this time, but as Giovanni mentioned throughout the call, we are focusing a lot on new products and new development efforts that we think will actually have some good results in fiscal year ’09, but at this point we’re just going to keep with kind of the one quarter guidance and the fact that we are going to see some solid growth in fiscal year ’09.

Operator

And there appears to be no further questions at this time. I’d like to turn the conference back over to our speaker’s for any closing or additional remark.

Brooke Deterline

Thank you very much for joining us on today’s call. We look forward to seeing you at ECOC.

Giovanni Barbarossa

Thank you very much.

Operator

This does conclude today's conference. We thank you for your participation and you may now disconnect.

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Source: Avanex Corporation F4Q08 (Qtr End 06/30/08) Earnings Call Transcript
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