##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




---

Form 10-K



---

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the Fiscal Year Ended June 30,
    2003                                                 
|OR        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-29175



---

Avanex Corporation

(Exact name of registrant as specified in its
charter)




---

|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 94-3285348                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

409l9 Encyclopedia Circle

Fremont, California 94538


(510) 897-4188


(Address, including zip code, and telephone
number,


including area code, of principal executive
offices)




---

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, $.001 par value


Preferred Share Rights (currently attached to
and trading only with Common Stock)


Indicate by check mark whether the Registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during preceding 12 months (or for such shorter period that
the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.     Yes þ          No  o

Indicate by check mark if disclosure of
delinquent filers pursuant to item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrants knowledge, in
definitive proxy or information statements incorporated by
reference to Part III of this Form 10-K or any
amendment to this
Form 10-K. þ

Indicate by check mark whether the Registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Act).     Yes þ          No o

As of December 28, 2002, the last business
day of the Registrants most recently completed second
fiscal quarter, the aggregate market value of voting stock held
by non-affiliates of the Registrant was approximately
$65,200,068 based upon the closing price on the Nasdaq National
Market reported for such date. As of September 15, 2003,
the Registrant had 128,077,936 outstanding shares of common
stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants Proxy Statement
which will be filed with the Commission pursuant to
Section 14(a) in connection with the 2003 Annual Meeting of
Stockholders are incorporated herein by reference in
Part III of this annual report on Form 10-K to the
extent stated herein. The Proxy Statement will be filed within
120 days of Registrants fiscal year ended
June 30, 2003.



---






---

TABLE OF CONTENTS



|              |                                                                                                         |  |  |  |  |  |  | 
|------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1: Business                                                                                       
|              | FACTORS THAT MAY AFFECT FUTURE RESULTS                                                                 
|              | Item 2. Properties                                                                                     
|              | Item 3. Legal Proceedings                                                                              
|              | Item 4. Submission of Matters to a Vote of Security Holders                                            
|              | EXECUTIVE OFFICERS                                                                                     
|PART II      
|              | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|              | Item 6. Selected Financial Data                                                                        
|              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|              | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|              | Item 8. Financial Statements and Supplementary Data                                                    
|              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.         
|              | Item 9A. Controls and Procedures                                                                       
|PART III     
|              | Item 10. Directors and Officers of the Registrant                                                      
|              | Item 11. Executive Compensation                                                                        
|              | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|              | Item 13. Certain Relationships and Related Transactions                                                
|              | Item 14. Principal Accounting Fees and Services                                                        
|PART IV      
|              | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|              | Schedule II -- Valuation and Qualifying Accounts Allowance For Doubtful Accounts:                      
|              | SIGNATURES                                                                                             
|EXHIBIT 10.8 
|EXHIBIT 10.10
|EXHIBIT 10.24
|EXHIBIT 14.1 
|EXHIBIT 21.1 
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 



---



##### Table of Contents



AVANEX CORPORATION

FORM 10-K

Year Ended June 30, 2003

TABLE OF CONTENTS

|                                                                                    |  |                                                                                                    |    |      |    | 
|----------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                                                                    |  |                                                                                                    |    | Page
|                                                                                    |  |                                                                                                    |    |     
|PART I                                                                             
|Item 1:                                                                             |  | Business                                                                                           |    |      | 1  | 
|                                                                                    |  | Factors That May Affect Future Results                                                             |    |      | 9  | 
|Item 2.                                                                             |  | Properties                                                                                         |    |      | 22 | 
|Item 3.                                                                             |  | Legal Proceedings                                                                                  |    |      | 23 | 
|Item 4.                                                                             |  | Submission of Matters to a Vote of Security
    Holders                                            |    |      | 24 | 
|                                                                                    |  | Executive Officers                                                                                 |    |      | 24 | 
|PART II                                                                            
|Item 5.                                                                             |  | Market for Registrants Common Equity and
    Related Stockholder Matters                          |    |      | 26 | 
|Item 6.                                                                             |  | Selected Financial Data                                                                            |    |      | 27 | 
|Item 7.                                                                             |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |    |      | 28 | 
|Item 7A.                                                                            |  | Quantitative and Qualitative Disclosures About
    Market Risk                                     |    |      | 44 | 
|Item 8.                                                                             |  | Financial Statements and Supplementary Data                                                        |    |      | 45 | 
|Item 9.                                                                             |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosures          |    |      | 75 | 
|Item 9A.                                                                            |  | Controls and Procedures                                                                            |    |      | 75 | 
|PART III                                                                           
|Item 10.                                                                            |  | Directors and Executive Officers of the Registrant                                                 |    |      | 75 | 
|Item 11.                                                                            |  | Executive Compensation                                                                             |    |      | 75 | 
|Item 12.                                                                            |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |    |      | 75 | 
|Item 13.                                                                            |  | Certain Relationships and Related Transactions                                                     |    |      | 75 | 
|Item 14.                                                                            |  | Principal Accounting Fees and Services                                                             |    |      | 76 | 
|PART IV                                                                            
|Item 15.                                                                            |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                |    |      | 76 | 
|Schedule II  Valuation and
    Qualifying Accounts Allowance for Doubtful Accounts |  |                                                                                                    | 76 |     
|Signatures                                                                          |  |                                                                                                    | 80 |     

i



---



##### Table of Contents



SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS

Certain statements contained in this annual
report on Form 10-K that are not purely historical are
forward-looking statements within the meaning of the
federal securities laws, including, without limitation,
statements regarding our expectations, beliefs, anticipations,
commitments, intentions and strategies regarding the future. In
some cases, you can identify forward-looking statements by terms
such as may, could, would,
might, will, should,
expect, plan, intend,
forecast, anticipate,
believe, estimate, predict,
potential, continue or the negative of
these terms or other comparable terminology. Actual results
could differ from those projected in any forward-looking
statements for the reasons, among others, detailed in
Item 1. Factors That May Affect Future Results.
The forward-looking statements are made as of the date of this
Form 10-K and we assume no obligation to update the
forward-looking statements, or to update the reasons why actual
results could differ from those projected in the forward-looking
statements.




PART I




Item 1:     Business

Recent Developments

In May 2003, we entered into a Share Acquisition
and Asset Purchase Agreement with Alcatel and Corning
Incorporated. Pursuant to the purchase agreement, in July 2003,
after the end of our fiscal year ended June 30, 2003, we
acquired all of the outstanding equity of Alcatel Optronics
France SA, a subsidiary of Alcatel that operated the optical
components business of Alcatel, and Alcatel assigned and
licensed certain intellectual property rights to us. We also
entered into a supply agreement with Alcatel whereby Alcatel
agreed to purchase seventy percent (70%) of its requirements for
certain qualified products from us for a period of three years,
subject to certain requirements. In addition, we acquired
certain assets of the optical components business of Corning,
and Corning assigned and licensed certain intellectual property
rights to us. As a result of these acquisitions we acquired
approximately 1,117 employees and manufacturing operations
located in Nozay, France, San Donato, Italy, Livingston, UK and
Erwin Park, New York. Pursuant to the purchase agreement, we
issued shares of our common stock to Alcatel and to Corning
representing 28% and 17%, respectively, of the outstanding
shares of our common stock on a post-transaction basis. The
transactions will be accounted for under the purchase method of
accounting.

As a result of these acquisitions, we offer a
substantially broader range of photonic processing solutions and
technologies, including passive and active optics,
optoelectronics integration and software and interface controls,
demonstrating our continuing commitment to become the leading
supplier of intelligent photonic solutions to telecommunications
system integrators and carriers worldwide.

In August 2003, we entered into an agreement to
acquire certain assets of Vitesse Semiconductor
Corporations Optical Systems Division located in San Jose,
California. Pursuant to the agreement, in August 2003 we
acquired substantially all of the assets of Vitesses
Optical Systems Division in exchange for approximately
1.2 million shares of our common stock. The transaction
will be accounted for under the purchase method of accounting.
This acquisition will enhance our presence in transponders and
expand our product offerings in subsystem products.

Overview

We are a global provider of cost-effective,
high-performance photonic processing solutions that enable
optical communications networks to achieve next-generation
performance.

Our photonic processing solutions are used by
telecommunications system integrators and their network carrier
customers to enhance system performance and increase network
speed and efficiency. Communications network carriers are
deploying fiber optic transmission systems to improve the
networks ability to transmit and manage the high volume of
voice, video and data traffic generated by the growth of the
Internet. Our photonic processing technologies are designed to
increase the performance of these optical transmission systems.

1



---



##### Table of Contents



Fundamentally, photonic processing technologies
increase the speed and capacity of fiber optic networks. More
specifically, they directly increase the number of wavelengths
of light that can travel on optical networks, and they extend
the distance an optical signal can travel without electrical
regeneration, a process which adds expense and complexity to
network transmission systems. Our photonic processing solutions
perform optical signal processing and influence systems
architecture. Our photonic processor solutions are micro-optics
based devices, modules or sub-systems with built-in optical
processing algorithms.

Prior to the acquisitions of the optical
components businesses of Alcatel and Corning, we were providing
photonic processing solutions in seven product families:
PowerFilter wavelength separators, PowerMux wavelength channel
processors, PowerExchanger optical add/drop processors,
PowerExpress amplification processors, PowerEqualizer dynamic
gain equalizers, PowerBlocker wavelength blocking processors,
and PowerShaper dispersion management processors.

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we have
significantly expanded our product portfolio and have
reorganized our product families into seven solution categories:
Multiplexing, Transmission, Amplification, Dispersion
Management, Switching and Routing, Monitoring, and Network
Managed Subsystems. Within each of these categories, we have
numerous products to address the needs of our customers.

To date, a substantial proportion of our sales
has been concentrated with a limited number of customers. During
fiscal 2003, Cisco Systems, Celestica Corporation and Sorrento
Networks each accounted for at least 10% of our net revenue, and
combined accounted for 69% of our net revenue. We do not expect
Sorrento Networks to account for greater than 10% of our net
revenue in future periods. During fiscal 2002, Cisco Systems,
Fujitsu, Nortel Networks, and MCI (formerly WorldCom) each
accounted for at least 10% of our net revenue, and combined
accounted for 79% of net revenue. As a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, we have substantially diversified our customer base,
although we expect that a substantial proportion of our sales
will remain concentrated with a limited number of customers.

We were incorporated in October 1997 as a
California corporation, and in January 2000, were reincorporated
as a Delaware corporation. Our principal executive office is
located at 40919 Encyclopedia Circle, Fremont, CA 94538.
Our telephone number is 510-897-4188, and our Internet home page
is located at www.avanex.com; however, the information in, or
that can be accessed through, our home page is not part of this
report. Our annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and
amendments to such reports are available, free of charge, on our
Internet home page as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the
Securities and Exchange Commission, or SEC.

Avanex and the Avanex logo are registered
trademarks of Avanex Corporation. This annual report on
Form 10-K also includes other trade names, trademarks and
service marks of us and other companies.

Industry

In response to growing bandwidth demand and a
desire to decrease system costs, telecommunications service
providers are deploying new or upgraded communications networks.
In addition to advances in switching technology that overcome
the limitations of circuit-switched networks, service providers
are upgrading the transport medium from copper-based electrical
transmission to fiber-based optical transmission. Because of its
inherent superiority in capacity, signal quality, and
transmission speed, optical transmission has become the
preferred medium of voice, video and data communication.

Optical transmission technology transfers voice,
data and video in the form of light pulses along optical fibers.
Optical systems convert electrical signals into specific
wavelengths of laser-generated light. The light pulses transmit
through glass fibers, which are bundled to create fiber optic
cable. Beyond lasers, many other optical components and
subsystems work to generate, clean, amplify, isolate, channel,
or otherwise enhance the signal.

The telecommunications industry experienced
substantial growth during the late 1990s through 2000,
characterized by rapid and considerable expansion of fiber optic
networks. Telecommunications service

2



---



##### Table of Contents



providers purchased optical transport systems and
related devices in anticipation of a continued rapid increase in
demand for bandwidth. In the past few years, there has been a
significant reduction in spending for infrastructure projects in
the telecommunications industry. While bandwidth demand
continues to increase, as evidenced by growing demand for cable
modems, digital subscriber line installations, and increasing
Internet usage, it has grown at a far slower pace than
previously anticipated. As a result, telecommunications service
providers acquired excess inventories of optical systems and
devices that now create a barrier to new sales opportunities.


This situation has created challenges for vendors
in the optical communications industry. Due to decreased unit
shipments and the resulting competition for fewer opportunities,
average selling prices have declined. In order to support their
preferred suppliers, buyers have begun to consolidate their
supply chains. These changes, coupled with the increasing
difficulty of supporting operating costs, have led to increased
consolidation throughout the industry. Fewer companies now
compete for a significantly smaller market.

We believe that, despite the current downturn in
our industry, there is still a long term need for optical
transport systems and related devices. It is difficult, however,
to predict the timing or extent of an industry recovery and the
impact to our business.

Products

As of June 30, 2003, our product offerings
consisted of passive optical processors, reconfigurable optical
processors, and active optical processors. The following
describes these products and their capabilities as well as
certain products in development and the product lines acquired
as a result of the acquisitions of the optical components
businesses of Alcatel and Corning:

PowerFilter.The
PowerFilter product family is designed to improve overall
performance and reduce the costs of thin-film dielectric
filter-based WDM multiplexers. The PowerFilters unique
integrated device configuration enables low insertion loss and
high isolation which improves overall system performance and
higher spectral utilization. In addition, PowerFilters
modular design enables system scalability and ease of migration
to higher channel counts. It is in production and shipping to
customers.

PowerMux.The
PowerMux product family is a next-generation wavelength division
multiplexer that enables optical networks to meet escalating
bandwidth demands. The PowerMux is ideal for systems requiring
high channel counts and scalability. The PowerMux is capable of
processing virtually any number of optical signals at any
channel spacing, at any bit rate. PowerMuxs modular design
enables system scalability and ease of migration to higher
channel modules. It is in production and shipping to customers.

PowerShaper.PowerShaper is a broadband chromatic dispersion compensation
processor which is specifically designed to correct the inherent
bandwidth and distance limitations in optical transmission
systems resulting from chromatic dispersion. The PowerShaper is
designed to restore the integrity of the light signals, allowing
signals to travel longer distances without electrical
regeneration. The PowerShaper family can act as a fixed or
variable dispersion compensator, which will permit system
providers to optimize their network for improved network
performance. The PowerShaper utilizes the VIPA technology for
tunable dispersion management products and the cascaded etalon
technology for fixed dispersion management products. It is in
production and shipping to customers.

PowerExchanger.The
PowerExchanger family of optical add/drop processors allows
channels to be added to or dropped from a fiber optic network.
The PowerExchanger utilizes a combination of our PowerMux and
PowerFilter products combined with our proprietary
Electro-strictive, Electro-optic and Magneto-optic technologies
that enable signal redirection in real time. Because this
redirection happens in the optical domain, signal quality and
integrity is maintained throughout the transmission. A
smart PowerExchanger, with built in power
attenuation, is also available. It is in production and shipping
to customers.

PowerExpress.The
PowerExpress metro amplifier allows a user to add and drop
wavelengths in service without reconfiguring units. It supports
bi-directional high bit transmission in the metro market. It is
in production and shipping to customers.

3



---



##### Table of Contents



PowerEqualizer.The
PowerEqualizer is specifically designed to enable
high-resolution dynamic equalization. It enables longer
transmission spans in long-haul applications and reduces the
need for costly optical-electrical conversions. It is also an
enabler for dynamic optical add/drop applications. It is in
production and shipping to customers.

PowerBlocker.The
PowerBlocker reconfigurable wavelength blocker combines dynamic
channel equalization with blocking capability. Dynamic channel
equalization improves network performance by ensuring that all
channels are at the same power level. Blocking allows users to
selectively terminate unwanted channels. It is in production and
shipping to customers.

PowerRouter.The
PowerRouter reconfigurable equalizing wavelength router allows a
user, via real-time remote control, to add and drop any
combination of wavelengths while dynamically equalizing power
levels across the spectrum. It is in development.

Due to the inherent complexities involved in
product development and manufacturing, we cannot be certain
when, or if, our products that are currently under development
will begin shipping.

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we have
significantly expanded our product portfolio and reorganized our
product families into seven solution categories: Multiplexing,
Transmission, Amplification, Dispersion Management, Switching
and Routing, Monitoring, and Network Managed Subsystems. Within
each of these categories, we have numerous products to address
the needs of our customers.

Multiplexing.The
Multiplexing family includes products that are utilized to add
and drop optical wavelengths to a signal without reconversion to
an electrical signal, or wavelength division multiplexing,
including products based on thin film filter, fiber Bragg
grating, or FBG, planar and interleaver technologies.

Transmission.The
Transmission family includes products that are utilized to
transmit and receive signals including laser diodes, avalanche
photo detectors and photodiodes with or without integrated
transimpedance amplifiers, modulators, transponders,
transmitters and receivers.

Amplification.The
Amplification family includes products that are utilized to
optically amplify signals. These include pump lasers, pump beam
stabilizers, gain flattening filters, dynamic gain equalizers,
erbium doped fiber amplifiers, Raman amplifiers, and
semiconductor optical amplifiers.

Dispersion Management.The Dispersion Management family
includes products that are utilized to compensate for dispersion
in transmission systems. This includes fixed and tunable
products based on dispersion compensating fiber, cascaded G-T
etalon, FBG, and virtually-imaged phased array, or VIPA,
technologies. These products address dispersion as well as
dispersion slope.

Switching and Routing.The Switching and Routing family
includes products that are utilized to provision wavelengths at
intermediate nodes in a transmission system. This includes fixed
optical add/drop multiplexing, or OADM, products based on thin
film filter, FBG, planar and interleaver technology, dynamic
products combining variable optical attenuators and detectors,
and reconfigurable products for reconfigurable OADM including
our wavelength blocker and routing products based on liquid
crystal and planar technologies.

Monitoring.The
Monitoring family includes products that are utilized to provide
information regarding network status and performance. These
include liquid crystal, tunable filter and planar-based optical
channel monitors and optical performance monitors.

Network Managed Subsystems.The Network Managed Subsystems family
includes products that interface directly with other network
elements using network level protocols. These products include
network managed versions of our multiplexing, amplification, and
switching and routing products.

Competition

The optical communications transport markets are
new and rapidly evolving. We expect these markets to continue to
be highly competitive in the future.

4



---



##### Table of Contents



We believe that our principal competitors in the
optical systems and component industry include Bookham
Technology, DiCon Fiberoptics, Finisar, Fujitsu, Hitachi Cable,
Hitachi Opnext, JDS Uniphase, NEC, Oplink Communications,
Triquint Semiconductor and WaveSplitter Technologies. We
differentiate ourselves from our competitors by offering higher
levels of customer value through cost-effective collaborative
system design, technology innovation, superior
optical/mechanical performance, and higher-orders of integration
and customization. We believe the principal competitive factors
upon which we compete with our competitors include selling
price, breadth of product line, availability, performance,
product reliability and innovation. We believe we compete
favorably with our competitors with respect to the foregoing
factors. However, we cannot assure you that we will be able to
compete successfully against either current or future
competitors.

Consolidation in the optical systems and
components industry could intensify the competitive pressures
that we face. For example, three of our historical competitors,
JDS Uniphase, SDL, and E-Tek Dynamics have merged over the past
several years to become a single, larger competitor.

We may also face competition from companies that
may expand into our industry in the future and introduce
additional competitive products. Existing and potential
customers are also our potential competitors. These customers
may develop or acquire additional competitive products or
technologies in the future, which may cause them to reduce or
cease their purchases from us. For additional information, see
Factors That May Affect Future Results  We
expect competition in our industry to increase, and if we are
unable to compete successfully our revenues could decline
further and harm our operating results.

Research and Development

Our research and development team possesses
expertise in the areas of optics, micro-optic design, network
system design and system-level software design. We also have
application engineers who assist our customers with the
deployment of our products. These engineers help define the
features that are required for our products to be successful in
specific applications. Our product development efforts focus on
enhancing our first generation of photonic processors,
developing additional optical network products and continuing to
develop next-generation technology to support growth in network
bandwidth requirements.

As of June 30, 2003, we employed
41 people in our research and development group in Fremont,
California. Our research and development expenses totaled
$37.9 million for the fiscal year ended June 30, 2001,
$24.1 million for the fiscal year ended June 30, 2002,
and $16.2 million for the fiscal year ended June 30,
2003.

As of August 1, 2003, as a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, we employed approximately 262 people in our
research and development organization.

Sales and Marketing

We employ a marketing strategy that is based on a
pull-push approach. Using the pull approach, we target
communications service providers, who can create demand for our
products by purchasing our products directly or by influencing
their optical systems providers to incorporate our products.
Using the push approach, we target optical systems providers,
who can buy our products and then resell them as a part of their
optical solutions.

Our marketing efforts are centered on
demonstration of and education about our products
performance at trade shows and through customer site visits,
continued publicity through paid advertising, direct mail and
Internet-based communication and promotion. We sell and market
our products through a combination of direct sales and
international distributors and representatives.

As of June 30, 2003, our direct sales
organization consisted of four sales account managers in the
United States supported by application engineers and product
line managers. We focus our direct sales efforts on service
providers and optical systems manufacturers. The direct sales
account managers cover the market on an assigned-account basis
and work as a team with systems engineers and product line
managers.

5



---



##### Table of Contents



In order to further our international sales
objectives, we have established relationships with two
distributors in Japan and one distributor in Israel.
Additionally, we have relationships with two supplier
manufacturer representatives, one in China and one in Italy.
These distributors and representatives have expertise in
distributing complex telecommunications equipment in their
markets and provide basic support required by our international
customers. We believe that support services are essential to the
successful installation and ongoing support of our products. We
deliver these services directly to major customers and
indirectly through our international distributors and
representatives. As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we have expanded
our distributor and representative relationships.

To date, a substantial proportion of our sales
has been concentrated with a limited number of customers. During
fiscal 2003, Cisco Systems, Celestica Corporation and Sorrento
Networks each accounted for at least 10% of our net
revenue, and combined accounted for 69% of our net revenue. We
do not expect Sorrento Networks to account for greater than 10%
of our net revenue in future periods. During fiscal 2002, Cisco
Systems, Fujitsu, Nortel Networks, and MCI each accounted for at
least 10% of our net revenue, and combined accounted for 79% of
net revenue. As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we have
substantially diversified our customer base, although we expect
that a substantial proportion of our sales will remain
concentrated with a limited number of customers.

As of June 30, 2003, we employed
14 people in sales and marketing. As a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, as of August 1, 2003 we employed approximately
86 people in sales and marketing.

Manufacturing

During fiscal 2003, we performed optical
sub-assembly, and final integration, and shipped the majority of
our products from our Fremont, California facility. Our in-house
manufacturing capabilities included product design, optical
assembly, optical, mechanical, and electronic integration of
final products, and thorough testing of all final components,
sub-assemblies and products.

The manufacturing of intelligent photonic
solutions requires the use of a highly skilled workforce
performing critical functions such as optical assembly, optical
alignment, soldering, component integration and testing. During
fiscal 2003, we continued to focus our resources in maintaining
the quality of our workforce, and we continued to look at
improving cycle time, data collection, and production yields. In
order to lower our labor costs, expand our capacity and increase
our flexibility in manufacturing, during fiscal 2003 we
continued to utilize the services of two contract manufacturers
in China to manufacture a portion of our subassemblies for us.
Although we are aggressively pursuing our manufacturing strategy
to outsource many of our high volume key components and
subassemblies, outsourced manufacturing requires considerable
attention of management and is expensive to implement. As a
result, to date we still retain the expertise to manage any
interruption in supply from these foreign sources. In the
future, we plan to manufacture increasingly greater proportions
of our products overseas.

The downturn in the fiber optics market has
greatly increased available capacity at our suppliers and in
many cases has reduced lead times. However, we currently
purchase several key components used in our products and
equipment from single or limited sources of supply, including
Lightconnect, Wave Precision, REO, VLOC and Browave. These key
components include filters, variable optical attenuators,
waveplates, and optical contact cavities. We have no guaranteed
supply arrangements with any of these suppliers and we typically
purchase our components and equipment through purchase orders.

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, our manufacturing
presence has expanded to a total of five locations which are:
Nozay, France; San Donato, Italy; Livingston, UK and Erwin Park,
New York, in addition to Fremont, California.

6



---



##### Table of Contents



Quality

Our quality policy reinforces our commitment to
deliver industry-leading products, on time, that meet or exceed
customer expectations. This policy is based on the mission and
values of Avanex as a leading supplier to the industry, and is
implemented and communicated throughout the organization,
beginning with senior management. We have established a quality
assurance system to continuously improve our ability to ensure
that our customers requirements are consistently met, in
compliance with the International Standard
ISO 9001: 2000 as certified by Det Norske Veritas, or
DNV, a leading international registrar to the ISO standards.

Our quality assurance system also covers product
reliability, assuring functional performance throughout and
beyond the expected useful life of the product. Our product
reliability policy forms a framework for product design and
development which is based on national and international
standards for qualification, safety, compatibility, reliability
and regulatory compliance.

Our quality assurance system extends to include
suppliers and partners throughout the value chain of the
manufacturing and order fulfillment process. Our supplier
quality system assures materials and product quality through
stringent supplier and product qualification. We also maintain
strict internal quality control processes and procedures,
including incoming material inspection, in-process testing and
outgoing quality assurance.

All of the sites acquired as a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, are currently certified to ISO 9001 standards. We
will continue to refine our quality processes as we integrate
our new operations to ensure that we maintain our high standards
of product quality and customer satisfaction and adhere to our
mission and values.

Patents and Intellectual Property

Our success and ability to compete depends
substantially upon our internally developed technology. As of
June 30, 2003, we had 65 patents issued and
68 applied for in the United States, of which 14 issued
patents are jointly held with Fujitsu and three patent
applications are jointly filed with Fujitsu. Further, as of the
same date, we had four patents issued and 24 applied for
outside of the United States, of which six patent applications
are jointly filed with Fujitsu.

As of June 30, 2003, our material patents
related to various aspects of our business, including optical
networking, applications for optical components, product
designs, and manufacturing processes. These technologies are
incorporated into our products and are covered by patents that
expire between June 2018 and August 2022.

Our engineering teams have significant expertise
in photonic, micro-optic and systems-level design and
manufacturing. While we rely on patent, copyright, trade secret
and trademark law to protect our technology, we also believe
that factors such as the technological and creative skills of
our personnel, new product developments, frequent product
enhancements and reliable product maintenance are essential to
establishing and maintaining a technology leadership position.

We license technology from Fujitsu that is
critical to our PowerShaper VIPA product. The license agreement
is subject to termination upon the acquisition of more than a
50% interest in us by certain major communications system
suppliers. Thus, if we are acquired by any of these specified
companies, we will lose this license. The existence of this
license termination provision may have an anti-takeover effect
in that it would discourage those specified companies from
making a bid to acquire us.

We generally enter into confidentiality or
license agreements with our employees, consultants and corporate
partners, and generally control access to and distribution of
our proprietary information.

As a result of our acquisitions of the optical
components businesses of Alcatel and Corning, we acquired
numerous domestic and foreign patents and patent applications
organized into approximately 420 different product
categories. The patents and patent applications assigned to us
as a result of these acquisitions cover a broad range of
photonics and optical communications products and technologies.
In addition, as a result of

7



---



##### Table of Contents



these acquisitions, we have been granted licenses
to use other intellectual property, including patents, of
Alcatel, Corning and various third parties.


Employees

As of June 30, 2003, we employed
212 people, including 136 in manufacturing, 41 in
research and development, 14 in sales and marketing, and
21 in general and administrative capacities. As a result of
the acquisitions of the optical components businesses of Alcatel
and Corning, as of August 1, 2003 we employed approximately
1,331 employees, primarily located in California, New York,
the United Kingdom, France and Italy.

As of June 30, 2003 none of our employees
were represented by a labor union. As a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, our hourly employees located in New York are
represented by the American Flint-Glass Workers Union AFL-CIO,
including Local Union No. 1000, and certain of our
employees located outside of the United States are represented
by labor organizations.

We have not experienced any work stoppages and we
consider our relations with our employees to be good. Our future
success also depends on our continuing ability to attract, train
and retain highly qualified technical, sales and managerial
personnel.

8



---



##### Table of Contents






FACTORS THAT MAY AFFECT FUTURE
RESULTS

In addition to the other information contained in
this annual report on Form 10-K, we have identified the
following risks and uncertainties that may have a material
adverse affect on our business, financial condition or results
of operations. Investors should carefully consider the risks
described below before making an investment decision. The risks
described below are not the only ones we face. Additional risks
not presently known to us or that we currently believe are
immaterial may also impair our business operations. Our business
could be harmed by any of these risks. The trading price of our
common stock could decline due to any of these risks and
investors may lose all or part of their investment. This section
should be read in conjunction with the Consolidated Financial
Statements and Notes thereto, and Managements Discussion
and Analysis of Financial Condition and Results of Operations
contained in this Form 10-K.

Market conditions in the telecommunications
industry may significantly harm our financial
position.

We sell our products primarily to a few large
customers in the telecommunications industry for use in
infrastructure projects. In the past few years, there has been a
significant reduction in spending for infrastructure projects in
the telecommunications industry. Certain large
telecommunications companies who were customers or potential
customers of ours have suffered severe business setbacks and
face uncertain futures. There is currently a perception that an
oversupply of communications bandwidth exists. This perceived
oversupply, coupled with the current economic downturn, may lead
to continued reductions in telecommunications infrastructure
spending, and our customers may continue to cancel, defer or
significantly reduce their orders for our products. Reduced
infrastructure spending has caused and may continue to cause
increased price competition, resulting in a decline in the
prices we charge for our products. If our customers and
potential customers continue to reduce their infrastructure
spending, our revenues may be adversely affected.

We have a history of losses, and such losses
are likely to continue if we are unable to increase our revenues
and further reduce our costs.

We have never been profitable. We have
experienced operating losses in each quarterly and annual period
since our inception in 1997, and we may continue to incur
operating losses for the foreseeable future. As of June 30,
2003, we had an accumulated deficit of $387 million. Also,
for the year ended June 30, 2003, we had negative operating
cash flow, and we may continue to incur negative operating cash
flow in future periods.

Due to insufficient cash generated from
operations, we have funded our operations primarily through the
sale of equity securities, bank borrowings and equipment lease
financings. Although we implemented cost reduction programs in
fiscal 2003, we continue to have significant fixed expenses, and
we expect to continue to incur considerable manufacturing, sales
and marketing, product development and administrative expenses.
In addition, we completed our acquisitions of the optical
components businesses of Alcatel and Corning in July 2003. The
costs and operating expenses of the combined company will be
significantly greater than the costs and operating expenses of
Avanex as a stand-alone company. As a result, the combined
operations of Avanex and the optical components businesses of
Alcatel and Corning will substantially increase the rate at
which Avanex will utilize its cash resources. If we fail to
generate higher revenues while containing our costs and
operating expenses, our financial position will be harmed
significantly. Our revenues may not grow in the future, and we
may never generate sufficient revenues to achieve profitability.

Difficulties in integrating our acquisitions
of the optical components businesses of Alcatel and Corning
could adversely impact our business.

We completed the acquisitions of the optical
components businesses of Alcatel and Corning in July 2003. These
acquisitions are the largest acquisitions we have completed, and
the complex process of integrating these businesses has
required, and will continue to require, significant resources.
Integrating the businesses acquired from Alcatel and Corning has
been and will continue to be time consuming, expensive and
disruptive to our business. This integration process has
resulted in the diversion of management and financial resources
from our core business objectives. Failure to achieve the
anticipated benefits of these acquisitions or to

9



---



##### Table of Contents



successfully integrate the operations of the
acquired businesses could harm our business, results of
operations and cash flows. We may not realize the benefits we
anticipate from these acquisitions because of the following
significant challenges:




| |   |                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | expected synergistic benefits from the
    acquisitions, such as lower costs, may not be realized or may be
    realized more slowly than anticipated, particularly with regard
    to costs associated with a reduction in headcount and facilities;
|
| |  | potentially incompatible cultural differences
    between the businesses;                                                                                                                                                                            
|
| |  | incorporating technology and products acquired
    from Alcatel and Corning into our current and future product
    lines;                                                                                                                           
|
| |  | generating market demand for an expanded product
    line;                                                                                                                                                                                           
|
| |  | integrating products acquired from Alcatel and
    Corning with our business;                                                                                                                                                                        
|
| |  | geographic dispersion of operations;                                                                                                                                                                                                                 
|
| |  | integrating Alcatel and Cornings technical
    teams with our engineering organization;                                                                                                                                                             
|
| |  | some of Alcatel and Cornings suppliers,
    distributors, customers and licensors are our competitors or
    work with our competitors, and as a result may terminate their
    business relationships with us; and                                 
|
| |  | our inability to retain previous customers or
    employees of Alcatel and Corning.                                                                                                                                                                  

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we acquired
approximately 1,117 employees from Alcatel and Corning,
primarily located in New York, the United Kingdom, France and
Italy. To date, most of our employees have been based at or near
our headquarters in Fremont, California. As a result, we will
face challenges inherent in efficiently managing an increased
number of employees over large geographic distances, including
the need to implement appropriate systems, policies, benefits
and compliance programs. The inability to successfully manage
the substantially larger and geographically diverse
organization, or any significant delay in achieving successful
management, could have a material adverse effect on us and, as a
result, on the market price of our common stock.

We have incurred and expect to continue to incur
significant costs and commit significant management time
integrating the operations, technology, development programs,
products, information systems, customers and personnel of the
businesses acquired from Alcatel and Corning. These costs have
been and will likely continue to be substantial and include
costs for:



| |   |                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | converting, integrating and upgrading information
    systems, including the extremely complex and time-consuming
    integration of data from Alcatel and Cornings incompatible
    enterprise resource planning systems with our system;
|
| |  | integrating and reorganizing operations,
    including combining teams, facilities and processes in various
    functional areas;                                                                                                          
|
| |  | identifying duplicative or redundant resources
    and facilities, developing plans for resource consolidation and
    implementing those plans;                                                                                           
|
| |  | professionals and consultants involved in
    completing the integration process;                                                                                                                                                          
|
| |  | vacating, subleasing and closing facilities;                                                                                                                                                                                               
|
| |  | employee relocation, redeployment or severance
    costs;                                                                                                                                                                                  
|
| |  | integrating technology and products; and                                                                                                                                                                                                   
|
| |  | our financial advisor, legal, accounting and
    financial printing fees.                                                                                                                                                                  

In addition to the significant costs associated
with converting and integrating Alcatels and
Cornings information systems, there are other significant
risks associated with this process. For example, while migrating
Alcatel or Corning data to our information system, we could lose
such data or such data may be

10



---



##### Table of Contents



inaccessible to us during the lengthy integration
process. In addition, we may need to upgrade our information
systems, which could be costly and further divert
managements attention.


Our future revenues and operating results are
inherently unpredictable, and as a result, we may fail to meet
the expectations of securities analysts or investors, which
could cause our stock price to decline.

Our revenues and operating results have
fluctuated significantly from quarter-to-quarter in the past,
and may continue to fluctuate significantly in the future.
Factors that are likely to cause these fluctuations, some of
which are outside of our control, include, without limitation,
the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the current economic downturn and other
    developments in the telecommunications industry, including the
    severe business setbacks of customers or potential customers and
    the current perceived oversupply of communications bandwidth;                                                                                                                  
|
| |  | our ability to control expenses, particularly in
    light of the current economic downturn;                                                                                                                                                                                                                                                                       
|
| |  | fluctuations in demand for and sales of our
    products, which will depend upon the speed and magnitude of the
    transition to an all-optical network, the acceptance of our
    products in the marketplace, and the general level of spending
    on infrastructure projects in the telecommunications industry;                                              
|
| |  | cancellations of orders and shipment rescheduling;                                                                                                                                                                                                                                                                                                                 
|
| |  | changes in product specifications required by
    customers for existing and future products;                                                                                                                                                                                                                                                                      
|
| |  | satisfaction of contractual customer acceptance
    criteria and related revenue recognition issues;                                                                                                                                                                                                                                                               
|
| |  | our ability to maintain appropriate manufacturing
    capacity, and particularly to limit excess capacity commensurate
    with the volatile demand levels for our products;                                                                                                                                                                                       
|
| |  | our ability to successfully complete a transition
    to an outsourced manufacturing model;                                                                                                                                                                                                                                                                        
|
| |  | the ability of our outsourced manufacturers to
    timely produce and deliver subcomponents, and possibly complete
    products in the quantity and of the quality we require;                                                                                                                                                                                     
|
| |  | the mix of our products sold;                                                                                                                                                                                                                                                                                                                                      
|
| |  | the current practice of companies in the
    telecommunications industry of sporadically placing large orders
    with short lead times;                                                                                                                                                                                                                           
|
| |  | competitive factors, including the introduction
    of new products and product enhancements by competitors and
    potential competitors, pricing pressures, and the competitive
    environment in the markets into which we sell our photonic
    processor solutions and products, including competitors with
    substantially greater resources than we have;
|
| |  | our ability to effectively develop, introduce,
    manufacture, and ship new and enhanced products in a timely
    manner without defects;                                                                                                                                                                                                                         
|
| |  | the availability and cost of components for our
    products;                                                                                                                                                                                                                                                                                                      
|
| |  | new product introductions that may result in
    increased research and development expenses and sales and
    marketing expenses that are incurred in one quarter, with
    revenues, if any, that are not recognized until a subsequent or
    later quarter;                                                                                                    
|
| |  | the unpredictability of customer demand and
    difficulties in meeting such demand; and                                                                                                                                                                                                                                                                           
|
| |  | costs associated with, and the outcome of, any
    litigation to which we are, or may become, a party.                                                                                                                                                                                                                                                             

A high percentage of our expenses, including
those related to manufacturing, engineering, sales and
marketing, research and development, and general and
administrative functions, is fixed in the short term. As a
result, if we experience delays in generating and recognizing
revenue, our quarterly operating results are likely to be
seriously harmed.

11



---



##### Table of Contents



Due to these and other factors, we believe that
quarter-to-quarter comparisons of our operating results may not
be meaningful. You should not rely on our results for one
quarter as any indication of our future performance. It is
possible that in future quarters our operating results may be
below the expectations of public market analysts or investors.
If this occurs, the price of our common stock would likely
decrease.

We rely on a limited number of customers for a
substantial portion of our revenue, and any decrease in revenues
from, or loss of, one or more of these customers without a
corresponding increase in revenues from other customers would
harm our operating results.

To date we have depended upon a small number of
customers for a substantial portion of our revenue. Three
customers accounted for an aggregate of 69% of our net revenue
in the year ended June 30, 2003. We expect that the
majority of our revenues will continue to depend on sales of our
products to a small number of customers. If current customers do
not continue to place significant orders, or if they cancel or
delay current orders, we may not be able to replace these
orders. In addition, any negative developments in the business
of existing customers could result in significantly decreased
sales to these customers, which could seriously harm our
revenues and results of operations. For example, MCI (formerly
WorldCom) accounted for approximately 16% of our net revenue for
the year ended June 30, 2002 and was not a customer in the
year ended June 30, 2003. MCI has experienced significant
business and financial difficulties. While we do not expect MCI
to be a significant customer in future periods and do not expect
the business and financial difficulties of MCI to have a
significant impact on our business or financial condition, the
business and financial difficulties of MCI or other customers
could result in the loss of future revenues for our products. We
have experienced, and in the future we may experience, losses as
a result of the inability to collect accounts receivable, as
well as the loss of ongoing business from customers experiencing
financial difficulties. If our customers fail to meet their
payment obligations, we could experience reduced cash flows and
losses in excess of amounts reserved. Because of our reliance on
a limited number of customers, any decrease in revenues from, or
loss of, one or more of these customers without a corresponding
increase in revenues from other customers would harm our
operating results.

We have a limited operating history, which
makes it difficult to evaluate our prospects.

We are in the photonic processor industry. We
were first incorporated in October 1997. Because of our limited
operating history, we have limited insight into trends that may
emerge in our industry and affect our business. The revenue and
income potential of the photonic processor industry, and our
business in particular, are unproven. As a result of our limited
operating history, we have limited financial data that you can
use to evaluate our business. You must consider our prospects in
light of the risks, expenses and challenges we might encounter
because we are in a new and rapidly evolving industry.

Our customers are under no obligation to buy
significant quantities of our products, and may cancel or delay
purchases with minimal advance notice to us.

Our customers typically purchase our products
pursuant to individual purchase orders. While we have executed
long-term contracts with some of our customers, and may enter
into additional long-term contracts with other customers in the
future, these contracts do not obligate our customers to buy
significant quantities of our products. Our customers may
cancel, defer or decrease purchases without significant penalty
and with little or no advance notice. Further, certain of our
customers have a tendency to purchase our products near the end
of a fiscal quarter. Cancellation or delays of such orders may
cause us to fail to achieve that quarters financial and
operating goals. Decreases in purchases, cancellations of
purchase orders, or deferrals of purchases may significantly
harm our business, particularly if they are not anticipated.

We may face risks related to a concentration
of research and development efforts on a limited number of key
industry standards and technologies.

In the past, we have concentrated our research
and development efforts on a limited number of technologies that
we believed had the best growth prospects. If we are unable to
develop commercially viable

12



---



##### Table of Contents



products using these technologies, or these
technologies do not become generally accepted, our business will
likely suffer.


Our future success depends on our ability to
develop and successfully introduce new and enhanced products
that meet the needs of our customers in a timely
manner.

We currently offer products in seven solution
categories: Multiplexing, Transmission, Amplification,
Dispersion Management, Switching and Routing, Monitoring, and
Network Managed Subsystems. The markets for our products are
characterized by rapid technological change, frequent new
product introduction, changes in customer requirements, and
evolving industry standards. Our future performance will depend
upon the successful development, introduction and market
acceptance of new and enhanced products that address these
changes. We may not be able to develop the underlying core
technologies necessary to create new or enhanced products, or to
license or otherwise acquire these technologies from third
parties. Product development delays may result from numerous
factors, including:



| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | changing product specifications and customer
    requirements;                             
|
| |  | difficulties in hiring and retaining necessary
    technical personnel;                    
|
| |  | difficulties in reallocating engineering
    resources and overcoming resource limitations;
|
| |  | changing market or competitive product
    requirements; and                               
|
| |  | unanticipated engineering complexities.                                                    

The development of new, technologically advanced
products is a complex and uncertain process requiring high
levels of innovation and highly skilled engineering and
development personnel, as well as the accurate anticipation of
technological and market trends. We cannot assure you that we
will be able to identify, develop, manufacture, market or
support new or enhanced products successfully, or on a timely
basis. In addition, the introduction of new and enhanced
products may cause our customers to defer or cancel orders for
existing products. To the extent customers defer or cancel
orders for existing products due to the expectation of a new
product release or if there is any delay in development or
introduction of our new products or enhancements of our
products, our operating results would suffer. Further, we cannot
assure you that our new products will gain market acceptance or
that we will be able to respond effectively to competitive
products, technological changes or emerging industry standards.
Any failure to respond to technological change would
significantly harm our business.

The vigorous competition in the optical
components industry has led to the continued erosion of sales
prices, and the failure to develop new products that are less
susceptible to price competition may adversely affect our
business.

Competition in the optical components industry
has contributed to substantial price-driven competition. As a
result, sales prices for specific products have tended to
decrease over time at varying rates, in some instances
significantly. Price pressure is exacerbated by the rapid
emergence of new technologies and the evolution of technical
standards, which can greatly diminish the value of products
relying on older technologies and standards. In addition,
overcapacity and the current economic and industry downturn in
the telecommunications industry have increased pricing pressures
in calendar 2002 and the first half of calendar 2003. Pricing
pressures are expected to continue for the foreseeable future,
which may adversely affect our operating results.

We expect competition in our industry to
increase, and if we are unable to compete successfully our
revenues could decline further and harm our operating
results.

We believe that our principal competitors in the
optical systems and components industry include Bookham
Technology, DiCon Fiberoptics, Finisar, Fujitsu, Hitachi Cable,
Hitachi Opnext, JDS Uniphase, NEC, Oplink Communications,
Triquint Semiconductor and WaveSplitter Technologies. We may
also face competition from companies that choose to expand into
our industry in the future.

13



---



##### Table of Contents



Some of our competitors have longer operating
histories and significantly greater financial, technical,
marketing and other resources than we have. As a result, some of
these competitors are able to devote greater resources to the
development, promotion, sale, and support of their products. In
addition, our competitors that have larger market capitalization
or cash reserves are better positioned than we are to acquire
other companies in order to gain new technologies or products
that may displace our product lines.

Consolidation in the optical systems and
components industry could intensify the competitive pressures
that we face. For example, three of our historical competitors,
JDS Uniphase, SDL, and E-Tek Dynamics have merged over the past
several years to become a single, more formidable competitor.
This merged company has announced its intention to offer more
integrated products that could make our products less
competitive.

Some existing customers and potential customers
are also our competitors. These customers may develop or acquire
additional competitive products or technologies in the future,
which may cause them to reduce or cease their purchases from us.
Further, these customers may reduce or discontinue purchasing
our products if they perceive us as a serious competitive threat
with regard to sales of products to their customers. As a result
of these factors, we expect that competitive pressures will
intensify and may result in price reductions, reduced margins
and loss of market share.

Delays, disruptions or quality control
problems in manufacturing could result in delays in shipments of
products to customers and adversely affect our
business.

We may experience delays, disruptions or quality
control problems in our manufacturing operations or the
manufacturing operations of our third party manufacturers, and,
as a result, product shipments to our customers could be delayed
beyond the shipment schedules requested by our customers, which
would negatively affect our business. Furthermore, even if we
are able to timely deliver products to our customers, we may be
unable to recognize revenue based on our revenue recognition
policies. In the past, we have experienced disruptions in the
manufacture of some of our products due to changes in our
manufacturing processes, which resulted in reduced manufacturing
yields, delays in the shipment of our products and deferral of
revenue recognition. Any disruptions in the future could
adversely affect our revenues, gross margins and results of
operations. Changes in our manufacturing processes or those of
our third party manufacturers, or the inadvertent use of
defective materials by our third party manufacturers or us,
could significantly reduce our manufacturing yields and product
reliability. Because the majority of our manufacturing costs are
relatively fixed, manufacturing yields are critical to our
results of operations. Lower than expected manufacturing yields
could delay product shipments and further impair our gross
margins. We may need to develop new manufacturing processes and
techniques that will involve higher levels of automation to
improve our gross margins and achieve the targeted cost levels
of our customers. If we fail to effectively manage this process
or if we experience delays, disruptions or quality control
problems in our manufacturing operations, our shipments of
products to our customers could be delayed.

If we are unable to accurately forecast
component and material requirements, our results of operations
will be adversely affected.

Through fiscal 2003 we used a rolling three-month
demand forecast based on anticipated and historical product
orders to determine our component and material requirements. It
is very important that we accurately predict both the demand for
our products and the lead times required to obtain the necessary
components and materials. It is very difficult to develop
accurate forecasts of product demand, especially given the
current uncertain conditions in the telecommunications industry.
Order cancellations and lower order volumes by our customers
have in the past created excess inventories. For example, the
inventory write-offs taken in the years ended June 30,
2003, June 30, 2002, and June 30, 2001, were primarily
the result of our inability to anticipate the sudden decrease in
demand for our products. Cumulatively, we have recorded
$47.3 million of inventory write-offs since our inception.
If we fail to accurately predict both the demand for our
products and the lead times required to obtain the necessary
components and materials in the future, we could incur
additional inventory write-offs. If we underestimate our
component and material requirements, we may have inadequate
inventory, which could interrupt our manufacturing and delay
delivery of our products to our customers. Any

14



---



##### Table of Contents



of these occurrences would negatively affect our
results of operations. As a result of the acquisitions of the
optical components businesses of Alcatel and Corning, we are
expecting in fiscal 2004 to change our policy regarding
estimating excess inventory to use a six-month to twelve-month
demand forecast.


If our customers do not qualify our
manufacturing processes they may not purchase our products, and
our operating results could suffer.

Certain of our customers will not purchase our
products prior to qualification of our manufacturing processes
and approval of our quality assurance system. The qualification
process determines whether the manufacturing line meets the
quality, performance and reliability standards of our customers.
These customers may also require that we, and any manufacturer
that we may use, be registered under international quality
standards, such as ISO 9001. In August 2000, we
successfully passed the ISO 9001 registration audit and
received formal registration of our quality assurance system at
our Fremont facility, and we have passed subsequent reviews as
well. Delays in obtaining customer qualification of our
manufacturing processes or approval of our quality assurance
system may cause a product to be removed from a long-term supply
program and result in significant lost revenue opportunity over
the term of that program.

All of the sites acquired as a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, are currently certified to ISO 9001.

We may lose orders and customers if we are
unable to commit to deliver sufficient quantities of our
products to satisfy customers needs.

Communications service providers and optical
systems manufacturers historically have required that suppliers
commit to provide specified quantities of products over a given
period of time. If we are unable to commit to deliver sufficient
quantities of our products to satisfy a customers
anticipated needs, we may lose the opportunity to make
significant sales to that customer over a lengthy period of
time. In addition, we may be unable to pursue large orders if we
do not have sufficient manufacturing capacity to enable us to
provide customers with specified quantities of products. If we
cannot deliver sufficient quantities of our products, we may
lose business, which could adversely impact our business,
financial condition, and results of operations.

Our dependence on independent manufacturers
may result in product delivery delays and may harm our
operations.

We rely on a small number of outsourced
manufacturers to manufacture a portion of our subassemblies. We
intend to develop further our relationships with these
manufacturers so that they will eventually manufacture many of
our high volume key components and subassemblies, and possibly a
substantial portion of our finished products, in the future. The
qualification of these independent manufacturers under quality
assurance standards is an expensive and time-consuming process.
Our independent manufacturers have a limited history of
manufacturing optical subcomponents, and have no history of
manufacturing our products on a turnkey basis. Any interruption
in the operations of these manufacturers, or any deficiency in
the quality or quantity of the subcomponents or products built
for us by these manufacturers, could impede our ability to meet
our scheduled product deliveries to our customers. As a result,
we may lose existing or potential customers.

We have very limited experience in working with
outsourced manufacturers, and do not have contracts in place
with many of these manufacturers. As a result, we may not be
able to effectively manage our relationships with these
manufacturers. If we cannot effectively manage our manufacturing
relationships, or if these manufacturers fail to deliver
components in a timely manner, we could experience significant
delays in product deliveries, which may have an adverse effect
on our business and results of operations. Increased reliance on
outsourced manufacturing, and the ultimate disposition of our
manufacturing capacity in the future, may result in impairment
charges relating to our long-lived assets in future periods,
which would have an adverse impact on our business, financial
condition and results of operations.

15



---



##### Table of Contents



If we do not reduce costs, introduce new
products or increase sales volume, our gross margin will
decline.

Our ability to achieve profitability depends on
our ability to control costs and expenses in relation to sales.
Over our limited operating history, the average selling prices
of our products have decreased, and we expect this trend to
continue. Future price decreases may be due to a number of
factors, including competitive pricing pressures, rapid
technological change and sales discounts. Therefore, to maintain
or improve our gross margin, we must develop and introduce new
products and product enhancements on a timely basis and reduce
our costs of production. Moreover, as our average selling prices
decline, we must increase our unit sales volume, or introduce
new products, to maintain or increase our revenues. If our
average selling prices decline more rapidly than our costs of
production, our gross margin will decline, which could adversely
impact our business, financial condition and results of
operations.

Our products may have defects that are not
detected until full deployment of a customers network,
which could result in a loss of customers and revenue and damage
to our reputation.

Our products are designed to be deployed in large
and complex optical networks and must be compatible with
existing and future components of such networks. Our products
can only be fully tested for reliability when deployed in
networks for long periods of time. Our products may not operate
as expected, and our customers may discover errors, defects, or
incompatibilities in our products only after they have been
fully deployed and are operating under peak stress conditions.
Our products are becoming more complex and involve an increasing
amount of software. If we are unable to fix errors or other
problems, we could experience:



| |   |                                                                     
| | - | --------------------------------------------------------------------
| |  | loss of customers or customer orders;                               
|
| |  | loss of or delay in revenues;                                       
|
| |  | loss of market share;                                               
|
| |  | loss or damage to our brand and reputation;                         
|
| |  | inability to attract new customers or achieve
    market acceptance;
|
| |  | diversion of development resources;                                 
|
| |  | increased service and warranty costs;                               
|
| |  | legal actions by our customers; and                                 
|
| |  | increased insurance costs.                                          

We may be required to indemnify our customers
against certain liabilities arising from defects in our
products. While we carry insurance policies covering this type
of liability, these policies may not provide sufficient
protection should a claim be asserted. To date, product defects
have not had a material negative effect on our business,
financial condition or results of operations. However, we cannot
be certain that product defects will not have a material
negative effect on our business, financial condition or results
of operations in the future.

We depend on key personnel to manage our
business effectively, and if we are unable to hire and retain
qualified personnel, our ability to sell our products could be
harmed.

Our future success depends, in part, on certain
key employees and on our ability to attract and retain highly
skilled personnel. The loss of the services of any of our key
personnel, the inability to attract or retain qualified
personnel, or delays in hiring required personnel, particularly
engineering, sales or marketing personnel, may seriously harm
our business, financial condition and results of operations.
None of our officers or key employees has an employment
agreement for a specific term, and these employees may terminate
their employment at any time. For example, four of our executive
officers left Avanex in the second quarter of fiscal 2003. We do
not have key person life insurance policies covering
any of our employees. Our ability to continue to attract and
retain highly skilled personnel will be a critical factor in
determining whether we will be successful in the future.
Competition for highly skilled personnel is frequently intense,
especially in the

16



---



##### Table of Contents



San Francisco Bay Area. We may not be
successful in attracting, assimilating or retaining qualified
personnel to fulfill our current or future needs.


While we have expanded our international
operations as a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we face risks that
could prevent us from successfully manufacturing, marketing and
distributing our products internationally.

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we expanded our
international operations, including expansion of overseas
product manufacturing, and we may continue to expand
internationally in the future. Further, we have increased
international sales and intend to further increase our
international sales and the number of our international
customers. This expansion has required and will require
significant management attention and financial resources to
successfully develop direct and indirect international sales and
support channels. We may not be able to maintain international
market demand for our products. We currently have little or no
experience in manufacturing, marketing and distributing our
products internationally. In addition, international operations
are subject to inherent risks, including, without limitation,
the following:



| |   |                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | greater difficulty in accounts receivable
    collection and longer collection periods;                                                                                                           
|
| |  | difficulties inherent in managing remote foreign
    operations;                                                                                                                                  
|
| |  | difficulties and costs of staffing and managing
    foreign operations with personnel who have expertise in optical
    network technology;                                                       
|
| |  | import or export licensing and product
    certification requirements;                                                                                                                            
|
| |  | tariffs, duties, price controls or other
    restrictions on foreign currencies or trade barriers imposed by
    foreign countries;                                                               
|
| |  | potential adverse tax consequences;                                                                                                                                                               
|
| |  | seasonal reductions in business activity in some
    parts of the world;                                                                                                                          
|
| |  | burdens of complying with a wide variety of
    foreign laws, particularly with respect to intellectual
    property, license requirements, employment matters and
    environmental requirements;
|
| |  | the impact of recessions in economies outside of
    the United States;                                                                                                                           
|
| |  | unexpected changes in regulatory or certification
    requirements for optical systems or networks; and                                                                                           
|
| |  | political and economic instability, terrorism and
    war.                                                                                                                                        

Historically our international revenues and
expenses have been denominated predominantly in
U.S. dollars; however, as a result of the acquisitions of
the optical components businesses of Alcatel and Corning, a
portion of our international revenues and expenses will be
denominated in foreign currencies in the future. Therefore,
fluctuations in the value of foreign currencies could have a
negative impact on the profitability of our global operations,
which would seriously harm our business, financial condition and
results of operations.

Our business and future operating results may
be adversely affected by events outside of our
control.

Our business and operating results are vulnerable
to interruption by events outside of our control, such as
earthquakes, fire, power loss, telecommunications failures and
uncertainties arising out of terrorist attacks throughout the
world, including the continuation or potential worsening of the
current global economic slowdown, the economic consequences of
additional military action and associated political instability,
and the effect of heightened security concerns on domestic and
international travel and commerce. We cannot be certain that the
insurance we maintain against fires, floods and general business
interruptions will be adequate to cover our losses for such
events in any particular case.

17



---



##### Table of Contents



We may incur costs and experience disruptions
complying with environmental regulations and other
regulations.

We handle hazardous materials as part of our
manufacturing activities and are subject to a variety of
governmental laws and regulations related to the use, storage,
recycling, labeling, reporting, treatment, transportation,
handling, discharge and disposal of such hazardous materials.
Although we believe that our operations conform to presently
applicable environmental laws and regulations, we may incur
costs in order to comply with current or future environmental
laws and regulations, including costs associated with
permitting, investigation and remediation of hazardous materials
and installation of capital equipment relating to pollution
abatement, production modification and/or hazardous materials
management. In addition, we currently sell products that
incorporate firmware and electronic components. The additional
level of complexity created by combining firmware and electronic
components with our optical components requires that we comply
with additional regulations, both domestically and abroad,
related to power consumption, electrical emissions and
homologation. Any failure to successfully obtain the necessary
permits or comply with the necessary laws and regulations could
have a material adverse effect on our operations.

The long sales cycles for sales of our
products to customers may cause operating results to vary from
quarter to quarter, which could continue to cause volatility in
our stock price, and may prevent us from achieving
profitability.

The period of time between our initial contact
with certain of our customers and the receipt of an actual
purchase order from such customers often spans a time period of
six to nine months, and sometimes longer. During this time,
customers may perform, or require us to perform, extensive and
lengthy evaluation and testing of our products and our
manufacturing processes before purchasing our products. While
our customers are evaluating our products before they place an
order with us, we may incur substantial sales and marketing and
research and development expenses, expend significant management
efforts, increase manufacturing capacity and order
long-lead-time supplies. If we increase capacity and order
supplies in anticipation of an order that does not materialize,
our gross margins will decline and we will have to carry or
write off excess inventory. Even if we receive an order, if we
are required to add additional manufacturing capacity in order
to service the customers requirements, such manufacturing
capacity may be underutilized in a subsequent quarter,
especially if an order is delayed or cancelled. Either situation
could cause our results of operations to be below the
expectations of investors and public market analysts, which
could, in turn, cause the price of our common stock to decline.

We will lose significant sales and may not be
successful if our customers do not qualify our products to be
designed into their products and systems.

In the telecommunications industry, service
providers and optical systems manufacturers often undertake
extensive qualification processes prior to placing orders for
large quantities of products such as ours, because these
products must function as part of a larger system or network.
Once they decide to use a particular suppliers product or
component, these potential customers design the product into
their system, which is known as a design-in win.
Suppliers whose products or components are not designed in are
unlikely to make sales to that company until the adoption of a
future redesigned system at the earliest. If we fail to achieve
design-in wins in potential customers qualification
process, we may lose the opportunity for significant sales to
such customers for a lengthy period of time.

If carriers for new telecommunications systems
deployments do not select our systems-level customers, our
shipments and revenues will be reduced.

The rate at which telecommunications service
providers and other optical network users have built new optical
networks or installed new systems in their existing optical
networks has fluctuated in the past and these fluctuations may
continue in the future. Sales of our components depend on sales
of fiber optic telecommunications systems by our systems-level
customers, which are shipped in quantity when telecommunications
service providers add capacity. Systems manufacturers compete
for sales in each capacity deployment. If systems manufacturers
that use our products in their systems do not win a contract,
their demand for our

18



---



##### Table of Contents



products will decline, reducing our future
revenues. Similarly, a telecommunications service
providers delay in selecting systems manufacturers for a
deployment could delay our shipments and revenues.


If the Internet does not continue to expand as
a widespread communication and commerce media, demand for our
products may decline further.

Our future success depends on the continued
growth and success of the telecommunications industry, including
the continued growth of the Internet as a widely used medium for
commerce and communication and the continuing demand for
increased bandwidth over communications networks. If the
Internet does not continue to expand as a widespread
communication medium and commercial marketplace, the need for
significantly increased bandwidth across networks and the market
for optical transmission products may not develop. As a result,
it would be unlikely that our products would achieve commercial
success.

If the communications industry does not
achieve a widespread transition to optical networks, our
business may not succeed.

The market for our products is relatively new and
evolving. Future demand for our products is uncertain and will
depend to a great degree on the speed of the widespread adoption
of optical networks. If the transition occurs too slowly or
ceases altogether, the market for our products and the growth of
our business will be significantly limited.

Our stock price is highly volatile.

The trading price of our common stock has
fluctuated significantly since our initial public offering in
February 2000, and is likely to remain volatile in the future.
The trading price of our common stock could be subject to wide
fluctuations in response to many events or factors, including
the following:



| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | quarterly variations in our operating results;                                                                                                                
|
| |  | significant developments in the businesses of
    telecommunications companies;                                                                               
|
| |  | changes in financial estimates by securities
    analysts;                                                                                                    
|
| |  | changes in market valuations or financial results
    of telecommunications-related companies;                                                                
|
| |  | announcements by us or our competitors of
    technology innovations, new products, or significant
    acquisitions, strategic partnerships or joint ventures;
|
| |  | any deviation from projected growth rates in
    revenues;                                                                                                    
|
| |  | any loss of a major customer or a major customer
    order;                                                                                                   
|
| |  | additions or departures of key management or
    engineering personnel;                                                                                       
|
| |  | any deviations in our net revenues or in losses
    from levels expected by securities analysts;                                                              
|
| |  | activities of short sellers and risk arbitrageurs;                                                                                                            
|
| |  | future sales of our common stock; and                                                                                                                         
|
| |  | volume fluctuations, which are particularly
    common among highly volatile securities of
    telecommunications-related companies.                          

In addition, the stock market has experienced
volatility that has particularly affected the market prices of
equity securities of many high technology companies, which often
has been unrelated or disproportionate to the operating
performance of these companies. These broad market fluctuations
may adversely affect the market price of our common stock. As
long as we continue to depend on a limited customer base and a
limited number of products, there is substantial risk that our
quarterly results will fluctuate. Furthermore, if our
stockholders sell substantial amounts of our common stock in the
public market during a short period of time, our stock price may
decline significantly.

19



---



##### Table of Contents



Subject to certain restrictions on transfer which
apply for a period of two years following the completion of our
acquisitions of the optical components businesses of Alcatel and
Corning, Alcatel or Corning may sell substantial amounts of our
common stock in the public market which could cause the market
price of our common stock to fall, and could make it more
difficult for us to raise capital through public offerings or
other sales of our capital stock. In particular, during the
quarter ending December 31, 2004, Alcatel will be permitted
to sell a greater number of shares of our common stock than it
will be permitted to sell during other quarters during this
two-year period.

Current and future litigation against us could
be costly and time consuming to defend.

We are regularly subject to legal proceedings and
claims that arise in the ordinary course of business. Litigation
may result in substantial costs and may divert managements
attention and resources, which may seriously harm our business,
financial condition, results of operations and cash flows.

In August 2001, two putative class action
lawsuits were filed against us, certain officers and directors,
and the underwriters of our initial public offering. The
lawsuits allege that the underwriters received excessive
commissions and manipulated our stock price after the initial
public offering. In addition, on May 31, 2002, High Hopes
Enterprises Ltd. and Hon Hai Precision Industry Co., Ltd. filed
an action in the Superior Court of California, County of
Alameda, against us alleging breach of an oral contract, breach
of the covenant of good faith and fair dealing, breach of
implied contract, promissory estoppel, deceit by fraud and
deceit by negligent misrepresentation. The complaint seeks
compensatory damages in an amount of no less than
$41,500,000, with interest thereon, as well as punitive
damages, attorneys fees and costs. While we believe we
have meritorious defenses and will vigorously defend ourselves
against these charges, an unfavorable result to this litigation
could be costly to us.

We may be unable to protect our proprietary
technology, which could significantly impair our ability to
compete.

We rely on a combination of patent, copyright,
trademark and trade secret laws, confidentiality agreements and
other contractual restrictions on disclosure to protect our
intellectual property rights. We also rely on confidentiality
agreements with our employees, consultants and corporate
partners, and controlled access to and distribution of our
technology, software, documentation and other confidential
information. We have numerous patents issued or applied for in
the United States and abroad, of which some may be jointly filed
or owned with other parties. We cannot assure you that any
patent applications or issued patents will protect our
proprietary technology, or that any patent applications or
patents issued will not be challenged by third parties. Our
intellectual property also consists of trade secrets, which
require more monitoring and control mechanisms to protect.
Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and
use our products or technology. Monitoring unauthorized use of
our products is difficult, and we cannot be certain that the
steps we take will prevent misappropriation or unauthorized use
of our technology. Further, other parties may independently
develop similar or competing technology or design around any
patents that may be issued to us.

We use various methods to attempt to protect our
intellectual property rights. However, we cannot be certain that
the steps we have taken will prevent the misappropriation of our
intellectual property. In particular, the laws in foreign
countries may not protect our proprietary rights as fully as the
laws in the United States.

If necessary licenses of third-party
technology become unavailable or very expensive, we may be
unable to develop new products and product enhancements, which
could prevent us from operating our current business.

From time to time we may be required to license
technology from third parties to develop new products or product
enhancements. We cannot assure you that third-party licenses
will be available to us on commercially reasonable terms, if at
all. The inability to obtain a necessary third-party license
required to develop new products and product enhancements could
require us to substitute technology of lower quality or
performance

20



---



##### Table of Contents



standards, or of greater cost, either of which
could prevent us from operating our business. For example,
Alcatel currently holds patent cross licenses with various third
parties that may be applicable to the optical components
business we acquired from Alcatel. We cannot guarantee that we
will be able to obtain these patent licenses from these third
parties, or that we will be able to obtain these licenses on
favorable terms. If we are not able to obtain licenses from
these third parties, then we may be subject to litigation to
defend against infringement claims from these third parties. In
addition, we license certain proprietary technology from Fujitsu
related to its proprietary virtually imaged phased array
technology, which is critical to our PowerShaper VIPA product.
The license agreement expires, unless earlier terminated, when
the latest issued patent covered by the agreement expires.
Currently, the latest expiring United States patent covered by
the agreement will expire on June 18, 2018. The license
agreement is also subject to termination upon the acquisition of
more than a 50% interest in us by certain major communications
system suppliers. Thus, if we are acquired by any of these
specified companies, we will lose this license. The existence of
this license termination provision may have an anti-takeover
effect in that it would discourage those specified companies
from acquiring us.


We may become subject to litigation regarding
intellectual property rights, which could divert resources,
cause us to incur significant costs, and restrict our ability to
utilize certain technology.

We may become a party to litigation in the future
to protect our intellectual property or we may be subject to
litigation to defend against infringement claims of others.
These claims and any resulting lawsuit, if successful, could
subject us to significant liability for damages and invalidation
of our proprietary rights. These lawsuits, regardless of their
success, would likely be time-consuming and expensive to resolve
and would divert management time and attention. Any potential
intellectual property litigation also could force us to do one
or more of the following:



| |   |                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | stop selling, incorporating or using our products
    that use the challenged intellectual property;                                                                                               
|
| |  | obtain from the owner of the infringed
    intellectual property right a license to sell or use the
    relevant technology, which license may not be available on
    reasonable terms, or at all;
|
| |  | redesign the products that use the technology; or                                                                                                                                                  
|
| |  | indemnify certain customers against intellectual
    property claims asserted against them.                                                                                                        

If we are forced to take any of these actions,
our business may be seriously harmed. Although we carry general
liability insurance, our insurance may not cover potential
claims of this type or may not be adequate to indemnify us for
all liability that may be imposed. We may in the future initiate
claims or litigation against third parties for infringement of
our proprietary rights in order to determine the scope and
validity of our proprietary rights or the proprietary rights of
competitors. These claims could result in costly litigation and
the diversion of our technical and management personnel.

Acquisitions and investments may adversely
affect our business.

We regularly review acquisition and investment
prospects that would complement our existing product offerings,
augment our market coverage, secure supplies of critical
materials or enhance our technological capabilities. For
example, in July 2003, we acquired the optical components
businesses of Alcatel and Corning, and in August 2003 we
acquired certain assets of the optical systems division of
Vitesse. Acquisitions or investments could result in a number of
financial consequences, including without limitation:



| |   |                                                                                              
| | - | ---------------------------------------------------------------------------------------------
| |  | potentially dilutive issuances of equity
    securities;                                     
|
| |  | reduced cash balances and related interest income;                                           
|
| |  | higher fixed expenses which require a higher
    level of revenues to maintain gross margins;
|
| |  | the incurrence of debt and contingent liabilities;                                           
|
| |  | amortization expenses related to intangible
    assets; and                                  
|
| |  | large one-time write-offs.                                                                   

21



---



##### Table of Contents



For example, as a result of our acquisitions of
Holographix and LambdaFlex, we recorded in the first quarter of
fiscal 2003 a goodwill impairment charge for all of our goodwill
of $37.5 million, in accordance with Statement of Financial
Accounting Standard No. 142 Goodwill and Other
Intangible Assets. Further, as a result of our disposal of
certain property, equipment and intellectual property rights, we
recorded in the second quarter of fiscal 2003 a reduction in
long-lived assets of $1.5 million, in accordance with
Statement of Financial Accounting Standard No. 144
Accounting for the Impairment or Disposal of Long-Lived
Assets.

Also, in March 2002, we entered into an Agreement
and Plan of Reorganization with Oplink Communications, pursuant
to which we intended to acquire all of the outstanding capital
stock of Oplink. The merger was subject to the approval of our
stockholders and the stockholders of Oplink. While our
stockholders approved the issuance of Avanex common stock in
connection with the merger, the stockholders of Oplink failed to
approve the merger in August 2002. We expensed $4.1 million
in related merger expenses during the first quarter of fiscal
2003.

Furthermore, acquisitions involve numerous
operational risks, including:



| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties integrating operations, personnel,
    technologies, products and the information systems of the
    acquired companies;
|
| |  | diversion of managements attention from
    other business concerns;                                                                
|
| |  | diversion of resources from our existing
    businesses, products or technologies;                                                   
|
| |  | risks of entering geographic and business markets
    in which we have no or limited prior experience; and                           
|
| |  | potential loss of key employees of acquired
    organizations.                                                                       

Certain provisions of our certificate of
incorporation and bylaws and Delaware law could delay or prevent
a change of control of us.

Certain provisions of our certificate of
incorporation and bylaws and Delaware law may discourage, delay
or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions allow us to issue preferred
stock with rights senior to those of our common stock and impose
various procedural and other requirements that could make it
more difficult for our stockholders to effect certain corporate
actions.

In addition, Alcatel and Corning own shares of
Avanex common stock representing 28% and 17%, respectively, of
the outstanding shares of Avanex common stock. Pursuant to the
stockholders agreement entered into by Avanex, Alcatel and
Corning, Alcatel and Corning are generally required to vote on
all matters as recommended by the board of directors of Avanex,
except, in the case of Alcatel, for proposals relating to
certain acquisition transactions between Avanex and certain
competitors of Alcatel. The concentration of ownership of our
shares of common stock, combined with the voting requirements
contained in the stockholders agreement, could have the
effect of delaying or preventing a change of control or
otherwise discourage a potential acquirer from attempting to
obtain control of us, unless the transaction is approved by our
board of directors.






|        |           
|------- | ----------
|Item 2. | Properties

We lease two buildings that total approximately
145,000 square feet, in Fremont, California. Building one, which
we occupy, is approximately 54,000 square feet of office,
research and development and manufacturing space, and serves as
our corporate headquarters. Building two is approximately 91,000
square feet, of which approximately 85,600 is available for
sublease. The terms of the leases, signed in 1999 and 2000, are
10 years.

We leased approximately 110,000 square feet of
additional space in two buildings in Newark, California in
December 2000. Building three is approximately 48,000 square
feet and building four is approximately 62,000 square feet. The
terms of the leases are 10 years. We do not currently
occupy these buildings, and we are attempting to sublease them.

22



---



##### Table of Contents



In addition to our facilities in California, we
also lease space in Richardson, Texas. The Richardson facility
is approximately 44,000 square feet, half of which we sublease.
The terms of the lease expires in 2010 and the sublease expires
in 2006.

Given the decline in capital spending in
telecommunications, we intend to sublease our excess facilities
in Newark, Fremont and Richardson as soon as practicable.

As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we now lease
properties consisting of approximately 202,000 square feet in
Nozay, France; 171,000 square feet in San Donato, Italy; 57,000
square feet in Livingston, UK and 279,000 square feet in Erwin
Park, New York.

We believe that existing facilities are adequate
for our needs. We are currently evaluating the most appropriate
use of our existing facilities including use for our existing
operations and the possibility of subleasing a portion of our
space to third parties.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

IPO Class Action Lawsuit

On August 6, 2001, Avanex, certain of its
officers and directors, and various underwriters in its initial
public offering (IPO) were named as defendants in a
class action filed in the United States District Court for the
Southern District of New York, captioned Beveridge v. Avanex
Corporation et al., Civil Action No. 01-CV-7256. This
action and other subsequently filed substantially similar class
actions have been consolidated into In re Avanex Corp.
Initial Public Offering Securities Litigation, Civil Action
No. 01 Civ. 6890. The consolidated amended complaint
in the action generally alleges that various investment bank
underwriters engaged in improper and undisclosed activities
related to the allocation of shares in Avanexs IPO.
Plaintiffs have brought claims for violation of several
provisions of the federal securities laws against those
underwriters, and also against Avanex and certain of its
directors and officers, seeking unspecified damages on behalf of
a purported class of purchasers of Avanexs common stock
between February 3, 2000, and December 6, 2000.
Various plaintiffs have filed similar actions asserting
virtually identical allegations against more than 40 investment
banks and 250 other companies. All of these IPO
allocation securities class actions currently pending in
the Southern District of New York have been assigned to Judge
Shira A. Scheindlin for coordinated pretrial proceedings as
In re Initial Public Offering Securities Litigation,
21 MC 92. On October 9, 2002, the claims
against Avanexs directors and officers were dismissed
without prejudice pursuant to a tolling agreement. The issuer
defendants filed a coordinated motion to dismiss all common
pleading issues, which the Court granted in part and denied in
part in an order dated February 19, 2003. The Courts
order did not dismiss the Section 10(b) or Section 11
claims against Avanex. A proposal has been made for the
settlement and release of claims against the issuer defendants,
including Avanex, which has been approved (subject to the
conditions noted below) by a special committee of our Board of
Directors. The settlement is subject to a number of conditions,
including approval of the proposed settling parties and the
court. If the settlement does not occur, and litigation against
Avanex continues, Avanex believes it has meritorious defenses
and intends to defend the action vigorously. Nevertheless, an
unfavorable result in litigation may result in substantial costs
and may divert managements attention and resources, which
could seriously harm our business, financial condition, results
of operations or cash flows.

High Hopes Enterprises and Hon Hai Precision
Industry Co. Litigation

On May 31, 2002, High Hopes Enterprises Ltd.
and Hon Hai Precision Industry Co., Ltd., filed an action in the
Superior Court of California, County of Alameda, against us
alleging breach of an oral contract, breach of the covenant of
good faith and fair dealing, breach of implied contract,
promissory estoppel, deceit by fraud and deceit by negligent
misrepresentation. The complaint seeks compensatory damages
in an amount of no less than $41,500,000, with interest
thereon, as well as punitive damages, attorneys fees
and costs. We challenged the sufficiency of the complaint by
demurrer in a motion that was heard by the Court on
September 25, 2002. The Court sustained the demurrer with
respect to the three breach of contract causes of action, with
leave to amend. The Court overruled the demurrer in connection
with the promissory estoppel, fraud and negligent
misrepresentation claims. The Court gave the plaintiffs the
opportunity to attempt to

23



---



##### Table of Contents



amend the complaint so that it sufficiently
alleged contract-based causes of action, and the
plaintiffs filed their amended Complaint on
October 28, 2002. We again challenged the sufficiency of
the Complaint with respect to the three contract-related causes
of action, however the Court overruled our second demurrer. The
Court has set a trial date of December 12, 2003. We are
currently conducting extensive discovery and will continue to do
so over the next several months. After reviewing the complaint
and the matters related thereto, we believe that the claims are
without merit and we intend to defend ourselves vigorously. We
believe that the resolution of this action will not have a
material adverse effect on our business or financial condition.
Nevertheless, an unfavorable result in litigation may result in
substantial costs and may divert managements attention and
resources, which could seriously harm our business, financial
condition, results of operations or cash flows.







|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

There were no matters submitted to a vote of
security holders during the fourth quarter of our 2003 fiscal
year.






EXECUTIVE OFFICERS


Our executive officers as of September 15,
2003 are as follows:

|                    |  |     |    |          |  |                                                                               
|------------------- |  | --- | -- | -------- |  | ------------------------------------------------------------------------------
|Name                |  | Age |    | Position
|                    |  |     |    |         
|Walter Alessandrini |  |     | 56 |          |  | Chairman of the Board of Directors, President and
    Chief Executive Officer 
|Bruce Pollock       |  |     | 60 |          |  | Chief Financial Officer and Vice President,
    Finance                       
|Giovanni Barbarossa |  |     | 42 |          |  | Chief Technology Officer and Vice President,
    Product Development          
|Anthony Florence    |  |     | 61 |          |  | Chief Governance Officer and Vice President,
    Corporate Affairs            
|Paul Negus          |  |     | 48 |          |  | Vice President, Operations                                                    
|Jaime Reloj         |  |     | 36 |          |  | Vice President, Sales and Product Marketing                                   
|Mark Weinswig       |  |     | 30 |          |  | Vice President, Business Development and Investor
    Relations               
|Philippe Bregi      |  |     | 52 |          |  | Vice President, Avanex Nozay                                                  
|Douglas Hall        |  |     | 50 |          |  | Vice President, Avanex Erwin Park and Senior
    Director, Product Development
|Richard Laming      |  |     | 41 |          |  | Vice President, Avanex UK                                                     
|David Parker        |  |     | 41 |          |  | Vice President, Avanex Fremont and Senior
    Director, Product Development   
|Adriano Zuccala     |  |     | 49 |          |  | Vice President, Avanex San Donato                                             

Walter Alessandrinihas served as one of our directors
since March 1999, as Chairman of the Board of Directors since
September 2000 and as Chairman since July 2001. He has also
served as our President and Chief Executive Officer since
November 2002. He previously served as our Chief Executive
Officer from March 1999 through June 2001 and as our President
from March 1999 until September 2000. Dr. Alessandrini was
President and Chief Executive Officer of Pirelli Cables and
Systems North America LLC, a manufacturer of cables and
communications systems, from November 1996 to March 1999.
Dr. Alessandrini received a doctorate degree in Mechanical
Engineering from the University of Genoa, Italy.

Bruce Pollockhas
served as our Chief Financial Officer and Vice President,
Finance since November 2002. Prior to joining Avanex,
Mr. Pollock served as Chief Financial Officer of
WaveSplitter Technologies, an optical component company, from
January 1999 to September 2002. Mr. Pollock served as
Senior Vice President and Chief Financial Officer of Reel.com,
an internet commerce company, from July 1998 until the sale of
Reel.com was completed in September 1998. From October 1994 to
June 1998, Mr. Pollock served as Senior Vice President and
Chief Financial Officer of Walker Interactive Systems, Inc., an
enterprise software company. Mr. Pollock received an MBA
from the Haas School of Business at the University of California,

24



---



##### Table of Contents



Berkeley, a law degree from the Boalt Hall School
of Law at UC Berkeley and a Bachelor of Science degree from the
University of Washington. He is a member of the State Bar of
California.


Giovanni Barbarossahas served as our Chief Technology
Officer and Vice President, Product Development since May 2002.
Dr. Barbarossa served as Vice President of Product
Development from May 2001 to May 2002. Prior to being promoted
to Vice President of Product Development, Dr. Barbarossa
was director of Research and Development from February 2000
until May 2001. From 1999 to February 2000, Dr. Barbarossa
served as a Project Manager in the Optical Networking Division
of Agilent Technologies, a communications infrastructure
company. Dr. Barbarossa held various positions, including
Team Leader in Product Development, in the Optical Application
Specific Integrated Circuits Department of Lucent Technologies,
a developer and manufacturer of communications products, from
1995 through 1999. Dr. Barbarossa received his Ph.D. degree
in Electronics Engineering from the University of Glasgow and a
B.S. degree in Electrical Engineering from the University of
Bari, Italy.

Anthony Florencehas
served as Chief Governance Officer and Vice President, Corporate
Affairs since August 2003 and previously served as Senior Vice
President, Corporate Affairs and Chief Governance Officer from
January 2003 to August 2003; as Vice President, Corporate
Marketing, Governance and Legal Affairs from October 2002 to
January 2003; as a consultant from October 2001 to October 2002;
as Vice President, Corporate Marketing and External Relations
from July 2001 to October 2001; and as Vice President, Investor
Relations and Corporate Marketing from November 1999 to July
2001. Mr. Florence was Vice President, Corporate and
Investor Relations, and Office of the Chairman at Ansaldo Signal
N.V., a company involved in the global signaling, automation and
control systems industry, from November 1996 to November 1999.
Mr. Florence received a B.A. degree in English from
Wheeling College and an M.A. degree in English from the
University of Dayton.

Paul Negushas
served as our Vice President, Operations since October 2002.
From September 2001 to June 2002, Mr. Negus was General
Manager of Clerios Inc., a high performance EDFA amplifier
company, which was acquired by Lightbit Corporation in June
2002. Mr. Negus served as Vice President Operations with
Tripath Technology, Inc., which designs amplifiers for the
communications markets, from April 1999 to September 2001.
Mr. Negus served as Vice President Operations with Ridge
Technologies Inc from May 1998 to April 1999. Mr. Negus
graduated from the Royal School of Military Engineering and the
Royal Military Academy Sandhurst.

Jaime Relojhas
served as Vice President, Sales and Product Marketing since
October 2002 and had previously served as Director of Product
Management since May 2000 and Director of Sales, West Region
since January 2000. Prior to joining Avanex, Mr. Reloj was
sales manager with Fujitsu Business Communications Systems, a
telecommunications company, from November 1996 to January 2000.
Mr. Reloj has a bachelors degree in Business
Administration from the University of San Francisco.

Mark Weinswighas
served as Vice President, Business Development and Investor
Relations since September 2003 and had previously served as
Director, Strategic Projects and Investor Relations since May
2000. Prior to joining Avanex, Mr. Weinswig was an analyst
from May 1998 to May 2000 with Morgan Stanley Dean Witters
Institutional Equity Research Group where he focused on the
telecommunications equipment industry. Mr. Weinswig
received a bachelors degree in Business Administration
from Indiana University.

Philippe Bregijoined Avanex in July 2003 as Vice
President, Avanex Nozay. Prior to joining Avanex, Mr. Bregi
served as Chief Operating Officer of Alcatel Optronics, the
optical components subsidiary of Alcatel, a telecommunications
company, from January 2000 to July 2003 and as Vice President
Marketing from April 1993 to January 2000. Mr. Bregi
received an engineering degree from Ecole Centrale de Lyon and a
masters degree in business administration from the
Institut dAdministration dEntreprises.

Douglas Halljoined
Avanex in July 2003 as Vice President, Erwin Park and Senior
Director, Product Development. Prior to joining Avanex,
Dr. Hall served as technology director for the Photonics
Technologies Division of Corning Incorporated, a technology
company, from November 1998 to July 2003. Dr. Hall has held
various other positions at Corning since 1983. Dr. Hall
received his bachelors degree in Physics from Occidental
College and he received his Ph.D. from the University of
California, Davis.

25



---



##### Table of Contents



Richard Lamingjoined Avanex in July 2003 as Vice
President, Avanex UK. Prior to joining Avanex, Dr. Laming
served as Chief Technology Officer of Alcatel Optronics UK Ltd
from September 2001 until July 2003. Dr. Laming was a
founder of Kymata and served as its Chief Technology Officer
from February 1998 to September 2001. Dr. Laming received a
degree in Mechanical Engineering from Nottingham University and
a Ph.D. in Electronics and Computer Science from Southampton
University.

David Parkerhas
served as Vice President, Avanex Fremont and Senior Director,
Product Development since August 2003 and had previously served
as Director of Project Management from September 2001 to July
2003 and Product Manager from May 1999 to October 1999. Prior to
joining Avanex, Mr. Parker was Director of Program
Management at Electoglas, a manufacturer of wafer probers, from
June 1998 to November 1998. Mr. Parker received his
bachelors degree in Physics and English from Williams
College and his masters degree in Electrical Engineering
and Engineering Management from Stanford University.

Adriano Zuccalajoined Avanex in July 2003 as Vice
President, Avanex San Donato. Prior to joining Avanex,
Dr. Zuccala served as Managing Director and Chief Executive
Officer of Corning OTI, a fiber optics subsidiary of Corning,
Incorporated, from December 2000 to July 2003. Dr. Zuccala
served as Managing Director and Chief Executive Officer of
Pirelli Componenti Ottici, an optical components company, from
February 2000 to December 2000. Dr. Zuccala served as
Director for Research and Development for photonic technologies
and components in Pirelli Cables and Systems from 1994 to
January 2000. Dr. Zuccala received a masters degree
in Industrial Chemistry at Milan University.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Our common stock is traded on the Nasdaq National
Market under the symbol AVNX. The following table
shows, for the periods indicated, the high and low per share
closing prices of common stock, as reported by the Nasdaq
National Market for each of the last eight quarters in the
period ended June 30, 2003:

|                            |  |      |      |     |  |   |      | 
|--------------------------- |  | ---- | ---- | --- |  | - | ---- | 
|                            |  | High |      | Low
|                            |  |      |      |    
|Fiscal 2002 Quarters Ended: |  |      |      |     |  |   |      | 
|September 30, 2001          |  | $    | 8.89 |     |  | $ | 2.82 | 
|December 31, 2001           |  | $    | 8.73 |     |  | $ | 2.81 | 
|March 31, 2002              |  | $    | 7.03 |     |  | $ | 3.26 | 
|June 30, 2002               |  | $    | 4.03 |     |  | $ | 1.66 | 
|Fiscal 2003 Quarters Ended: |  |      |      |     |  |   |      | 
|September 30, 2002          |  | $    | 2.60 |     |  | $ | 1.36 | 
|December 31, 2002           |  | $    | 1.69 |     |  | $ | 0.66 | 
|March 31, 2003              |  | $    | 1.33 |     |  | $ | 0.76 | 
|June 30, 2003               |  | $    | 4.48 |     |  | $ | 0.74 | 

On September 15, 2003, the last reported
sale price of our common stock on the Nasdaq National Market was
$6.10 per share. As of September 15, 2003, there were
approximately 776 stockholders of record of our common stock.
Because many of our shares of common stock are held by brokers
and other institutions on behalf of shareholders, we are unable
to estimate the total number of shareholders represented by
these record holders.

We have never declared or paid any cash dividends
on our common stock. We currently intend to retain any future
earnings to fund the development and growth of our business and
do not anticipate paying any cash dividends in the foreseeable
future.

Our Registration Statement on Form S-1 (File
No. 333-92097) was declared effective on February 3,
2000 and we commenced our IPO on February 4, 2000. In the
IPO, we sold an aggregate of 6,900,000 shares of common stock
(including 900,000 shares sold in connection with the exercise
of the underwriters over-allotment option) at $36.00 per
share. The sale of the shares of common stock generated
aggregate gross

26



---



##### Table of Contents



proceeds of approximately $248.4 million.
The aggregate net proceeds were approximately
$228.2 million, after deducting underwriting discounts and
commissions of approximately $17.4 million and directly
paying expenses of the offering of approximately
$2.8 million. Of the net proceeds, as of June 30,
2003, we have used approximately $114.7 million for general
corporate purposes, including working capital and capital
expenditures. Additionally, approximately $26.6 million of
the proceeds were used to repay short-term borrowings, long-term
debt and capital lease obligations.


The information required by this item regarding
equity compensation plans is incorporated by reference to the
information set forth in Item 12 of this annual report on
Form 10-K.






|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

You should read the following selected financial
data in conjunction with Managements Discussion and
Analysis of Financial Condition and Results of Operations
and our consolidated financial statements and the notes thereto
included elsewhere in this report. The statement of operations
data set forth below for the years ended June 30, 2003,
2002 and 2001 and the balance sheet data as of June 30,
2003 and 2002 are derived from, and are qualified by reference
to, our audited consolidated financial statements included
elsewhere in this report. The statement of operations data set
forth below for the years ended June 30, 2000 and 1999 and
the balance sheet data as of June 30, 2001, 2000 and 1999
are derived from audited financial statements not included in
this report.

|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |       |       | 
|---------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | -------- | ------ | ------ | ---- | ------- | ------ | ------ | ---- | -------- | ------ | ------- | - | ------- | ------ | ------ | - | ------ | ----- | ----- | 
|                                                                             |                                              |                                      
|                                                                             |                                              | Years Ended June 30,                 
|                                                                             |                                              |                                      
|                                                                             |                                              | 2003                                  |          | 2002   |        | 2001 |         | 2000   |        | 1999
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |     
|                                                                             |                                              |                                      
|                                                                             |                                              | (In thousands, except per share data)
|Consolidated Statement of Operations
    Data:                               |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|Net revenue                                                                  |                                              | $                                     | 21,416   |        |        | $    | 33,686  |        |        | $    | 131,244  |        |         | $ | 40,743  |        |        | $ | 510    |      
|Cost of revenue                                                              |                                              |                                       | 30,035   |        |        |      | 27,789  |        |        |      | 110,794  |        |         |   | 26,343  |        |        |   | 531    |      
|Stock compensation expense (recovery)                                        |                                              |                                       | (202     | )      |        |      | 166     |        |        |      | 8,764    |        |         |   | 2,732   |        |        |   | 394    |      
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|                                                                             | Gross profit (loss)                          |                                       |          | (8,417 | )      |      |         | 5,731  |        |      |          | 11,686 |         |   |         | 11,668 |        |   |        | (415  | )    
|Operating expenses:                                                          |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|                                                                             | Research and development                     |                                       |          | 16,170 |        |      |         | 24,076 |        |      |          | 37,856 |         |   |         | 15,587 |        |   |        | 4,086 |      
|                                                                             | Sales and marketing                          |                                       |          | 6,120  |        |      |         | 6,657  |        |      |          | 15,493 |         |   |         | 6,047  |        |   |        | 956   |      
|                                                                             | General and administrative                   |                                       |          | 9,033  |        |      |         | 8,043  |        |      |          | 11,862 |         |   |         | 5,702  |        |   |        | 723   |      
|                                                                             | Stock compensation expense (recovery)(1)     |                                       |          | (107   | )      |      |         | 16,482 |        |      |          | 41,589 |         |   |         | 28,688 |        |   |        | 3,070 |      
|                                                                             | Acquired in-process research and development |                                       |          |       |        |      |         | 5,445  |        |      |          | 4,700  |         |   |         |       |        |   |        |      |      
|                                                                             | Amortization of intangibles                  |                                       |          | 200    |        |      |         | 10,502 |        |      |          | 9,653  |         |   |         |       |        |   |        |      |      
|                                                                             | Reduction in long-lived assets               |                                       |          | 1,548  |        |      |         |       |        |      |          |       |         |   |         |       |        |   |        |      |      
|                                                                             | Restructuring charges (See Note 2)           |                                       |          | 22,438 |        |      |         | 16,656 |        |      |          | 22,586 |         |   |         |       |        |   |        |      |      
|                                                                             | Merger costs (See Note 10)                   |                                       |          | 4,126  |        |      |         |       |        |      |          |       |         |   |         |       |        |   |        |      |      
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|                                                                             |                                              | Total operating expenses              |          |        | 59,528 |      |         |        | 87,861 |      |          |        | 143,739 |   |         |        | 56,024 |   |        |       | 8,835 | 
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|Loss from operations                                                         |                                              |                                       | (67,945  | )      |        |      | (82,130 | )      |        |      | (132,053 | )      |         |   | (44,356 | )      |        |   | (9,250 | )    
|Interest and other income, net                                               |                                              |                                       | 2,533    |        |        |      | 4,353   |        |        |      | 12,521   |        |         |   | 5,671   |        |        |   | 29     |      
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|Loss before cumulative effect of an accounting
    change                    |                                              |                                       | (65,412  | )      |        |      | (77,777 | )      |        |      | (119,532 | )      |         |   | (38,685 | )      |        |   | (9,221 | )    
|Cumulative effect of an accounting change to
    adopt SFAS 142 (See Note 5) |                                              |                                       | (37,500  | )      |        |      |        |        |        |      |         |        |         |   |        |        |        |   |       |      
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|Net loss                                                                     |                                              |                                       | (102,912 | )      |        |      | (77,777 | )      |        |      | (119,532 | )      |         |   | (38,685 | )      |        |   | (9,221 | )    
|Stock accretion                                                              |                                              |                                       |         |        |        |      |        |        |        |      |         |        |         |   | (37,743 | )      |        |   |       |      
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      
|Net loss attributable to common stockholders                                 |                                              | $                                     | (102,912 | )      |        | $    | (77,777 | )      |        | $    | (119,532 | )      |         | $ | (76,428 | )      |        | $ | (9,221 | )    
|                                                                             |                                              |                                       |          |        |        |      |         |        |        |      |          |        |         |   |         |        |        |   |        |      

27



---



##### Table of Contents



|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |       | 
|-------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------- | -------- | ---- | - | ---- | ------- | ----- |  | ---- | -------- | ------ |  | - | ------- | ------ |  | - | ------ | ----- | 
|                                                                                                         |                            |                                      
|                                                                                                         |                            | Years Ended June 30,                 
|                                                                                                         |                            |                                      
|                                                                                                         |                            | 2003                                  |          | 2002 |   | 2001 |         | 2000  |  | 1999
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |     
|                                                                                                         |                            |                                      
|                                                                                                         |                            | (In thousands, except per share data)
|Basic and diluted net loss per common share                                                              |                            | $                                     | (1.51    | )    |   | $    | (1.21   | )     |  | $    | (2.07    | )      |  | $ | (3.07   | )      |  | $ | (4.97  | )    
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|Weighted average number of shares used in
    computing basic and diluted net loss per common share      |                            |                                       | 68,371   |      |   |      | 64,308  |       |  |      | 57,620   |        |  |   | 24,936  |        |  |   | 1,857  |      
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|Pro forma amounts assuming the change in
    accounting principle was applied retroactively (unaudited): |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|Adjusted net loss                                                                                        |                            | $                                     | (102,912 | )    |   | $    | (67,755 | )     |  | $    | (110,319 | )      |  | $ | (76,428 | )      |  | $ | (9,221 | )    
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|Basic and diluted adjusted net loss per common
    share                                                 |                            | $                                     | (1.51    | )    |   | $    | (1.05   | )     |  | $    | (1.91    | )      |  | $ | (3.07   | )      |  | $ | (4.97  | )    
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|(1) Below is the allocation of
    stock  compensation expense (recovery):                               |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|                                                                                                         | Research and development   |                                       | $        | (107 | ) |      | $       | 6,883 |  |      | $        | 32,216 |  |   | $       | 16,568 |  |   | $      | 1,445 | 
|                                                                                                         | Sales and marketing        |                                       |          | (199 | ) |      |         | 88    |  |      |          | 745    |  |   |         | 4,058  |  |   |        | 160   | 
|                                                                                                         | General and administrative |                                       |          | 199  |   |      |         | 9,511 |  |      |          | 8,628  |  |   |         | 8,062  |  |   |        | 1,465 | 
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      
|                                                                                                         |                            | $                                     | (107     | )    |   | $    | 16,482  |       |  | $    | 41,589   |        |  | $ | 28,688  |        |  | $ | 3,070  |      
|                                                                                                         |                            |                                       |          |      |   |      |         |       |  |      |          |        |  |   |         |        |  |   |        |      

|                                                  |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        |  
|------------------------------------------------- |  | -------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------ | -
|                                                  |  |               
|                                                  |  | June 30,      
|                                                  |  |               
|                                                  |  | 2003           |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                  |  |                |         |      |  |      |         |      |  |     
|                                                  |  |               
|                                                  |  | (In thousands)
|Consolidated Balance Sheet Data:                  |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        |  
|Cash, cash equivalents and short-term investments |  | $              | 87,591  |      |  | $    | 136,085 |      |  | $    | 204,591 |  |  | $ | 184,321 |  |  | $ | 3,724  |  
|Long-term investments                             |  | $              | 47,063  |      |  | $    | 40,984  |      |  | $    | 16,462  |  |  | $ | 56,943  |  |  | $ |       |  
|Working capital                                   |  | $              | 64,708  |      |  | $    | 118,911 |      |  | $    | 174,653 |  |  | $ | 185,534 |  |  | $ | 2,660  |  
|Total assets                                      |  | $              | 154,615 |      |  | $    | 250,397 |      |  | $    | 311,589 |  |  | $ | 278,141 |  |  | $ | 6,816  |  
|Long-term liabilities, excluding current portion  |  | $              | 28,173  |      |  | $    | 23,054  |      |  | $    | 14,992  |  |  | $ | 2,067   |  |  | $ | 563    |  
|Redeemable convertible preferred stock            |  | $              |        |      |  | $    |        |      |  | $    |        |  |  | $ |        |  |  | $ | 10,357 |  
|Total other stockholders equity (deficit)        |  | $              | 96,262  |      |  | $    | 197,998 |      |  | $    | 245,354 |  |  | $ | 257,157 |  |  | $ | (6,534 | )






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

You should read the following discussion and
analysis of our financial condition and results of operations
together with Selected Financial Data and our
consolidated financial statements and related notes appearing
elsewhere in this annual report on Form 10-K. This
discussion and analysis contains forward-looking statements that
involve risks, uncertainties and assumptions. The actual results
may differ materially from those anticipated in these
forward-looking statements as a result of certain factors,
including, but not limited to, those presented under
Factors That May Affect Future Results and elsewhere
in this annual report on Form 10-K.

For ease of reference, we refer to the fiscal
years ended June 30, 2003, June 30, 2002 and
June 30, 2001 as fiscal 2003, fiscal 2002 and fiscal 2001,
respectively.

Recent Developments

In May 2003, we entered into a Share Acquisition
and Asset Purchase Agreement with Alcatel and Corning
Incorporated. Pursuant to the purchase agreement, in July 2003,
after the end of our fiscal year ended

28



---



##### Table of Contents



June 30, 2003, we acquired all of the
outstanding equity of Alcatel Optronics France SA, a subsidiary
of Alcatel that operated the optical components business of
Alcatel, and Alcatel assigned and licensed certain intellectual
property rights to us. We also entered into a supply agreement
with Alcatel whereby Alcatel agreed to purchase seventy percent
(70%) of its requirements for certain qualified products from us
for a period of three years, subject to certain requirements. In
addition, we acquired certain assets of the optical components
business of Corning, and Corning assigned and licensed certain
intellectual property rights to us. As a result of these
acquisitions, we acquired approximately 1,117 employees and
manufacturing operations located in Nozay, France, San Donato,
Italy, Livingston, UK and Erwin Park, New York. Pursuant to the
purchase agreement, we issued shares of our common stock to
Alcatel and to Corning representing 28% and 17%, respectively,
of the outstanding shares of our common stock on a
post-transaction basis. The transactions will be accounted for
under the purchase method of accounting.


As a result of these acquisitions, we offer a
full range of solutions and technologies in passive and active
optics, optoelectronics integration and software and interface
controls, demonstrating our continuing commitment to become the
leading supplier of intelligent photonic solutions to system
integrators and carriers worldwide.

In August 2003, we entered into an agreement to
acquire certain assets of Vitesse Semiconductor
Corporations Optical Systems Division located in San Jose,
California. Pursuant to the agreement, in August 2003 we
acquired substantially all of the assets of Vitesses
Optical Systems Division in exchange for approximately
1.2 million shares of our common stock. The transaction
will be accounted for under the purchase method of accounting.
This acquisition will enhance our strong presence in
transponders and expand our product offerings in subsystem
products.

Overview

We design, manufacture and market fiber
optic-based products, known as photonic processors, which are
designed to increase the performance of optical networks. We
sell our products to communication service providers and optical
system manufacturers. We were founded in October 1997, and began
making volume shipments of our products during the quarter ended
September 30, 1999.

Like many of our competitors in the
communications equipment industry, we continue to be adversely
affected by the current general economic downturn, and
particularly by the significant reduction in telecommunications
equipment spending. Due to the continued weakness in the general
economy, and the telecommunications sector in particular,
revenue in fiscal 2003 was less than fiscal 2002, putting
downward pressure on our margins and profits.

Our operating results have fluctuated
significantly from quarter to quarter due to several factors.
Our expense levels are based in part on our managements
expectations of future revenues. Although management has taken
and will continue to take measures to reduce expense levels, if
revenue levels in a particular period are less than anticipated,
operating results will continue to be affected adversely.

In the first quarter, third quarter and fourth
quarter of fiscal 2003, we announced restructuring programs to
reduce our operating expenses. The restructurings have resulted
in, among other things, a significant reduction in the size of
our workforce, consolidation of our facilities and increased
reliance on outsourced, third party manufacturing. We anticipate
that we may initiate future restructuring actions, which are
likely to result in charges that could have a material effect on
our results of operations or financial position. The move to
outsourced manufacturing and the ultimate disposition of our
manufacturing capacity may result in impairment charges relating
to our long-lived assets in future periods.

As a result of our acquisitions of the optical
components businesses of Alcatel and Corning, we expect that our
costs and operating expenses will significantly increase in
fiscal 2004. As a result, the combined operations of Avanex and
the optical components businesses of Alcatel and Corning will
substantially increase the rate at which Avanex will utilize its
cash resources. We also anticipate that our revenue in fiscal
2004 will be significantly greater than our revenue in previous
fiscal years due to these acquisitions.

29



---



##### Table of Contents



Revenues.The market
for photonic processors is new and evolving and the volume and
timing of orders is difficult to predict. A customers
decision to purchase our products typically involves a
commitment of its resources and a lengthy evaluation and product
qualification process. This initial evaluation and product
qualification process typically takes several months and
includes technical evaluation, integration, testing, planning
and implementation into the equipment design. Implementation
cycles for our products, and the practice of customers in the
communications industry to sporadically place orders with short
lead times, may cause our revenues, gross margins, operating
results and the identity of our largest customers to vary
significantly and unexpectedly from quarter to quarter.

To date, our revenues have been principally
derived from sales of PowerFilter, PowerMux and PowerExchanger,
which together accounted for 91%, 89% and 99% of net revenue in
fiscal 2003, 2002 and 2001, respectively. A summary of our
revenues and other financial information by geographic location
is found in Note 14 to Notes to Consolidated Financial
Statements.

To date, a substantial proportion of our sales
has been concentrated with a limited number of customers. During
fiscal 2003, Cisco Systems, Celestica Corporation and Sorrento
Networks each accounted for at least 10% of our net revenue, and
combined accounted for 69% of our net revenue. We do not expect
Sorrento Networks to account for greater than 10% of our net
revenue in future periods. During fiscal 2002, Cisco Systems,
Fujitsu, Nortel Networks, and MCI each accounted for at least
10% of our net revenue, and combined accounted for 79% of net
revenue. As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we have
substantially diversified our customer base, although we expect
that a substantial proportion of our sales will remain
concentrated with a limited number of customers.

Cost of Revenue.Our
cost of revenue consists of costs of components and raw
materials, direct labor, warranty, manufacturing overhead,
payments to our contract manufacturers and inventory write-offs
for obsolete and excess inventory. We rely on a single or
limited number of suppliers to manufacture some key components
and raw materials used in our products, and we rely on the
outsourcing of some subassemblies.

Research and Development Expenses.Research and development expenses
consist primarily of salaries and related personnel costs, fees
paid to consultants and outside service providers, allocated
facilities, non-recurring engineering charges and prototype
costs related to the design, development, testing,
pre-manufacturing and significant improvement of our products.
We expense our research and development costs as they are
incurred. We believe that research and development is critical
to our strategic product development objectives. We further
believe that, in order to meet the changing requirements of our
customers, we must continue to fund investments in several
development projects in parallel.

Sales and Marketing Expenses.Sales and marketing expenses consist
primarily of marketing, sales, customer service and application
engineering support, allocated facilities, as well as costs
associated with promotional and other marketing expenses.

General and Administrative Expenses.General and administrative expenses
consist primarily of salaries and related expenses for
executive, finance, accounting, legal and human resources
personnel, allocated facilities, recruiting expenses,
professional fees and other corporate expenses.

Stock Compensation.In connection with the grant of stock
options to employees prior to our initial public offering and
certain grants subsequent to our initial public offering, we
recorded deferred stock compensation representing the difference
between the fair value of our common stock for accounting
purposes and the exercise price of these options at the date of
grant. Moreover, in connection with the assumption of unvested
stock options previously granted to employees of companies we
acquired, we recorded deferred compensation representing the
difference between the fair market value of our common stock on
the date of closing of each acquisition and the exercise price
of options granted by those companies which we assumed. Deferred
stock compensation is presented as a reduction of
stockholders equity, with accelerated amortization
recorded over the vesting period, which is typically three to
five years. The amount of deferred stock compensation expense to
be recorded in future periods could decrease if options for
which accrued but unvested compensation has been recorded are
forfeited prior to vesting.

30



---



##### Table of Contents



Acquired In-Process Research and Development.Acquired in-process research and
development represents the amount of purchase price allocated in
a business combination related to research and development
projects underway at the company being acquired that have not
reached the technologically feasible stage and have no
alternative future use.

Amortization of Intangibles.A portion of the purchase price in a
business combination is allocated to goodwill and intangibles.
Prior to July 1, 2002 goodwill and purchased intangibles
were amortized to expense over their estimated useful lives.
Subsequent to June 30, 2002, goodwill and intangible assets
with indefinite lives are no longer amortized but rather are
subject to an annual impairment test. Intangible assets with
definite lives continue to be amortized over their estimated
useful lives.

Reduction in Long-Lived Assets.Reduction of long-lived assets
generally includes charges related to long-lived assets such as
fixed assets and intangibles when the carrying value of those
assets is not recoverable from estimated future cash flows.

Restructuring Charges.Restructuring charges generally
include termination costs for employees and costs for excess
manufacturing equipment and facilities associated with formal
restructuring plans.

Merger Costs.Merger
costs include expenses incurred in connection with transactions
that were not completed.

Interest and Other Income (Expense), Net.Interest and other income (expense),
net consists primarily of interest earned from the investment of
our cash, offset by interest expense associated with borrowings
under our line of credit, capital lease obligations and
equipment loans.

Critical Accounting Policies and
Estimates

The preparation of our consolidated financial
statements in accordance with accounting principles generally
accepted in the United States, requires us to make estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures. We
believe our estimates and assumptions are reasonable; however,
actual results and the timing of the recognition of such amounts
could differ from these estimates. We believe the following are
the critical accounting policies because they contain the more
significant judgments and estimates used in the preparation of
our consolidated financial statements.

Revenue Recognition.Our revenue recognition policy follows
SEC Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition in Financial Statements.
Specifically, we recognize product revenue when persuasive
evidence of an arrangement exists, the product has been shipped,
title has transferred, collectibility is reasonably assured,
fees are fixed or determinable and there are no uncertainties
with respect to customer acceptance. For shipments to new
customers and evaluation units, including initial shipments of
new products, where the customer has the right of return through
the end of the evaluation period, we recognize revenue on these
shipments at the end of the evaluation period if not returned,
and when collection is reasonably assured.

We record a provision for estimated sales returns
in the same period as the related revenues are recorded which is
netted against revenue. These estimates are based on historical
sales returns, other known factors and our return policy. If
future sales returns differ from the historical data we use to
calculate these estimates, changes to the provision may be
required.

Allowance for Doubtful Accounts.We maintain an allowance for doubtful
accounts for estimated losses resulting from the failure of our
customers to make required payments. When we become aware,
subsequent to delivery, of a customers potential inability
to meet its payment obligations, we record a specific allowance
for doubtful accounts. For all other customers, we record an
allowance for doubtful accounts based on the length of time the
receivables are past due. If the financial condition of our
customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowances may be
required. This may be magnified due to the concentration of our
sales to a limited number of customers.

31



---



##### Table of Contents



Excess and Obsolete Inventory.We make inventory commitment and
purchase decisions in part based upon sales forecasts. To
mitigate component supply constraints that have existed in the
past and to fill orders with non-standard configurations, we
build inventory levels for certain items with long lead times
and enter into short-term commitments for certain items. We
write off 100% of the cost of inventory that we specifically
identify and consider obsolete or excessive to fulfill future
sales estimates. If we subsequently sell previously written-off
inventory, we will recognize revenue with no related cost of
sales. We define obsolete inventory as inventory that will no
longer be used in the manufacturing process. Excess inventory is
generally defined as inventory in excess of projected usage, and
is determined using our best estimate of future demand at the
time, based upon information then available to us.

In estimating excess inventory, through fiscal
2003, we used a three-month demand forecast. As a result of the
acquisitions of the optical components businesses of Alcatel and
Corning, we are expecting in fiscal 2004 to change our policy
regarding estimating excess inventory to use a six-month to
twelve-month demand forecast. We do not anticipate that this
change will have a material impact on our reported financial
results. We also consider: 1) parts and subassemblies that
can be used in alternative finished products, 2) parts and
subassemblies that are unlikely to be engineered out of our
products, and 3) known design changes which would reduce
our ability to use the inventory as planned. If either our
demand forecast or estimate of future uses of inventory is
inaccurate, we may need to make additional write-offs of
inventory in future periods or record additional benefits if we
utilize previously written off inventory in those future periods.

Impairment of Long-Lived Assets Including
Goodwill and Other Intangible Assets.We review long-lived assets other than
goodwill and intangible assets with indefinite lives for
impairment whenever events or changes in business circumstances
indicate that the carrying amount of the assets may not be fully
recoverable, such as a significant industry downturn,
significant decline in our market value, or significant
reductions in projected future cash flows. An impairment loss
would be recognized when estimated undiscounted future cash
flows expected to result from the use of the asset and its
eventual disposition is less than its carrying amount.
Impairment, if any, is assessed using discounted cash flows. In
assessing the recoverability of long-lived assets other than
goodwill and indefinite lived intangible assets we must make
assumptions regarding estimated future cash flows and other
factors to determine the fair value of the respective assets. If
circumstances arise that cause these estimates or their related
assumptions to change in the future we may be required to record
additional impairment charges for these assets.

In June 2001, the Financial Accounting Standards
Board, or FASB, issued Statement of Financial Accounting
Standards (SFAS) 142, Goodwill and Other Intangible
Assets. SFAS 142 prohibits the amortization of
goodwill and intangible assets with indefinite useful lives.
SFAS 142 requires that these assets be reviewed for
impairment at least annually. Prior to the adoption of
SFAS 142, we amortized goodwill and other intangible assets
over estimated useful lives of 3 to 5 years.

We adopted SFAS 142 on July 1, 2002. We
reclassified assembled workforce net of related amortization of
$314,000 to goodwill as required by SFAS 142 at the date of
adoption. SFAS 142 also requires that goodwill be tested
for impairment at the reporting unit level at adoption and at
least annually thereafter, utilizing a two-step methodology. The
initial step requires us to determine the fair value of each
reporting unit and compare it to the carrying value, including
goodwill, of such unit. We operate as one reporting unit. If the
fair value of the reporting unit exceeds the carrying value, no
impairment loss would be recognized. However, if the carrying
value of the reporting unit exceeds its fair value, the goodwill
of this unit may be impaired. The amount, if any, of the
impairment would then be measured in the second step.

In the first quarter of fiscal 2003, we completed
the required transitional impairment testing of goodwill and
indefinite lived intangible assets. As a result of this testing,
we have incurred a transitional impairment charge of
$37.5 million representing all of our goodwill. This
impairment charge is reflected as the cumulative effect of a
change in accounting principles.

Warranties.We
accrue for the estimated cost to provide warranty services at
the time revenue is recognized. Our estimate of costs to service
our warranty obligations is based on historical experience and
expectation of future conditions. To the extent we experience
increased warranty claim activity or increased

32



---



##### Table of Contents



costs associated with servicing those claims, our
warranty costs will increase resulting in decreases to gross
profit.


Restructuring.We
have recorded significant accruals in connection with our
restructuring programs. These accruals include estimates
pertaining to employee separation costs and related abandonment
of excess equipment and facilities. Actual costs may differ from
these estimates or our estimates may change.

Purchase Accounting.We account for business combinations
under the purchase method of accounting and accordingly, the
acquired assets and liabilities assumed are recorded at their
respective fair values. The recorded values of assets and
liabilities are based on third-party estimates and valuations.
The remaining values are based on our judgments and estimates,
and accordingly, our financial position or results of operations
may be affected by changes in these estimates and judgments.

Contingencies.We
are subject to proceedings, lawsuits and other claims related to
our initial public offering and other matters. We are required
to assess the likelihood of any adverse judgments or outcomes to
these matters as well as potential ranges of probable losses. A
determination of the amount of accrual required, if any, for
these contingencies is made after careful analysis of each
individual issue and consultation with legal counsel. The
required accrual may change in the future due to new
developments in each matter or changes in approach such as a
change in settlement strategy in dealing with these matters,
resulting in higher net loss.

Results of Operations



| |                                       
| | --------------------------------------
| | Comparison of Fiscal 2003 and
    2002



| |            
| | -----------
| | Net Revenue

Net revenue for fiscal 2003 was
$21.4 million, compared to $33.7 million for fiscal
2002. This decrease in net revenue was primarily due to the
decrease of shipments to customers, reflecting reduced capital
spending by telecommunication carriers, as well as a decrease in
average selling prices due to less demand and increased
competition. If declines in shipments or prices continue, our
net revenue will be adversely impacted in future periods. In
fiscal 2003, Cisco Systems, Celestica Corporation, and Sorrento
Networks each accounted for greater than 10% of net revenue and
combined accounted for 69% of net revenue. We do not expect
Sorrento Networks to account for greater than 10% of our net
revenue in future periods. This compares to four customers,
Fujitsu, Cisco Systems, MCI, and Nortel Networks that each
accounted for greater than 10% of net revenue in fiscal 2002 and
combined accounted for 79% of net revenue.



| |                
| | ---------------
| | Cost of Revenue

Cost of revenue increased to $30.0 million
for fiscal 2003 from $27.8 million for fiscal 2002. The increase
in cost of revenue was primarily due to a change in the mix of
products sold and underutilized manufacturing capacity resulting
from lower productions levels associated with lower sales. We
recorded a provision for excess and obsolete inventory of
$4.3 million in both fiscal 2003 and fiscal 2002. In fiscal
2003 the provision was due to $2.6 million of inventory
that became obsolete due to a change in a customers
product specification and $1.7 million of excess inventory
as a result of decreased demand for our products. In fiscal
2002, the provision was a result of decreased demand for our
products. In fiscal 2003 we sold inventory previously
written-off with an original cost totaling $4.3 million due
to unforeseen demand for such inventory, compared to
$5.4 million in fiscal 2002, which offset cost of revenue.
The majority of this inventory sold in each year had been
written-off in a prior year. In addition, we had a reduction in
cost of revenue of $3.3 million in fiscal 2003 attributable
to cost savings related to reductions in our workforce due to
the restructurings initiated in fiscal 2003. Cost of revenue in
fiscal 2002 also was offset by a $1.2 million favorable
settlement of non-cancelable purchase obligations and
$1.5 million reduction of the warranty accrual.

Our gross margin percentage decreased to negative
39% for fiscal 2003 from positive 17% for fiscal 2002. The
decrease in gross margin percentage was primarily due to
underutilized manufacturing capacity resulting from declining
sales. Our gross margins are and will be primarily affected by
changes in manufacturing volume, mix of products sold, and
changes in market prices. We expect cost of revenue, as a
percentage of net

33



---



##### Table of Contents



revenue, to fluctuate from period to period. In
addition, we expect continued pressure on our gross margin
percentage as a result of underutilized manufacturing capacity
and price competition.


As a result of the acquisitions of the optical
components businesses of Alcatel and Corning, we are expecting
in fiscal 2004 to change our policy regarding estimating excess
inventory to use a six-month to twelve-month demand forecast. We
do not anticipate that this change will have a material impact
on our financial statements.



| |                         
| | ------------------------
| | Research and Development

Research and development expenses decreased
$7.9 million to $16.2 million for fiscal 2003 from
$24.1 million for fiscal 2002. The decrease was primarily
attributable to cost savings related to reductions in our
workforce and to a lesser degree, to reduced material spending.
As a percentage of revenue, research and development expenses
increased to 75% for fiscal 2003 from 71% in fiscal 2002.



| |                    
| | -------------------
| | Sales and Marketing

Sales and marketing expenses decreased
$0.6 million to $6.1 million for fiscal 2003 from
$6.7 million for fiscal 2002. The decrease was primarily
attributable to cost savings related to reductions in our
workforce. As a percentage of revenue, sales and marketing
expenses increased to 29% in fiscal 2003 from 20% in fiscal 2002.



| |                           
| | --------------------------
| | General and Administrative

General and administrative expenses increased
$1.0 million to $9.0 million for fiscal 2003 from
$8.0 million for fiscal 2002. The increase was primarily
attributable to $0.9 million in payments associated with
the termination of employment of former company executives and
increased legal fees related to corporate matters. As a
percentage of revenue, general and administrative expenses
increased to 42% in fiscal 2003 from 24% in fiscal 2002.



| |                   
| | ------------------
| | Stock Compensation

Stock compensation decreased $16.9 million
to a recovery of $0.3 million for fiscal 2003 from an
expense of $16.6 million for fiscal 2002. From inception
through June 30, 2003, we have expensed a total of
$101.9 million of stock compensation, leaving an
unamortized balance of $0.8 million on our June 30,
2003 balance sheet. The decrease in stock compensation was
partially attributable to a recovery of previously amortized
stock compensation relating to former executive officers and
other terminated employees who left Avanex during fiscal 2003
prior to their options vesting. Additionally, the decrease was
due to decreased amortization of deferred stock compensation
recognized for the intrinsic value of the unvested options
assumed in acquisitions. The deferred stock compensation for
options assumed from acquisitions was recorded upon the closing
of the acquisition and is amortized over the remaining vesting
period of the unvested options.



| |                                                 
| | ------------------------------------------------
| | Acquired In-Process Research and
    Development

There was no expense for acquired in-process
research and development, or IPR&D, in fiscal 2003. For
fiscal 2002, we recorded $5.4 million of acquired IPR&D
resulting from the acquisition of LambdaFlex. This amount was
expensed on the acquisition date because the acquired technology
had not yet reached technological feasibility and had no future
alternative uses. While we did not incur an expense for
IPR&D as a result of the acquisitions of the optical
components businesses of Alcatel and Corning, there can be no
assurance that our acquisitions of other businesses, products or
technologies will not result in substantial charges for acquired
IPR&D that may cause fluctuations in our quarterly or annual
operating results.

IPR&D was identified and valued through
extensive interviews, analysis of data concerning developmental
products, their stage of development, the time and resources
needed to complete them, their expected income generating
ability, target markets and associated risks. The income
approach, which includes an analysis of the markets, cash flows
and risks associated with achieving such cash flows, was the
primary technique utilized in valuing the IPR&D.

34



---



##### Table of Contents



In valuing the IPR&D, we considered, among
other factors, the importance of each project to the overall
development plan, projected incremental cash flows from the
projects when completed and any associated risks. The projected
incremental cash flows were discounted back to their present
value using a discount rate of 30%. The discount rate was
determined after consideration of our weighted average cost of
capital and the weighted average return on assets. Associated
risks include the inherent difficulties and uncertainties in
completing each project and thereby achieving technological
feasibility, anticipated levels of market acceptance and
penetration, market growth rates and risks related to the impact
of potential changes in future target markets.

There were two significant projects, DGFF and
OWR, representing $3.2 million and $2.2 million,
respectively, of the IPR&D charge incurred in the LambdaFlex
transaction. Both DGFF and OWR strengthened our product
portfolio in wavelength management solutions for the metro
market as well as adaptive wavelength equalization for the long
haul and ultra long-haul markets. The DGFF project was 50%
complete at the date of acquisition in fiscal 2002 and was 100%
complete at June 30, 2003. From the date of acquisition to
June 30, 2003, we incurred $0.3 million of material
costs, which is consistent with our original expectations. The
OWR project was 50% complete at the date of acquisition in
fiscal 2002 and was 80% complete at June 30, 2003. From the
date of acquisition to June 30, 2003, we incurred
$0.5 million of material costs, which is consistent with
our original expectations. Due to uncertainty of market
conditions, this project has been put on hold.



| |                            
| | ---------------------------
| | Amortization of Intangibles

Amortization of intangibles decreased
$10.3 million to $0.2 million for fiscal 2003 from
$10.5 million for fiscal 2002. This decrease was due the
adoption of the non-amortization of goodwill provisions under
SFAS 142 commencing July 1, 2002. Additionally, no
intangible assets remain on our consolidated balance sheet as of
June 30, 2003.



| |                               
| | ------------------------------
| | Reduction in Long-Lived Assets

During the quarter ended December 31, 2002,
we committed to a plan to dispose of certain property, equipment
and intellectual property rights and entered into a non-binding
letter of intent to sell such assets to a group that included an
employee of Avanex. The sale was completed on January 10,
2003. In accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets
(SFAS 144), we were required to measure these assets held
for sale at the lower of their carrying amount or fair value
less costs to sell as of December 31, 2002. The reduction
in long-lived assets was $1.5 million of which
$0.2 million related to property and equipment and
$1.3 million related to intangibles.

Restructuring Charges



| |                          
| | -------------------------
| | Fiscal 2003 Restructuring

In the first quarter of fiscal 2003, we announced
a restructuring program to downsize our workforce, primarily in
our manufacturing operations. In addition, we announced the
closing of our facility in Richardson, Texas and the integration
of the functions in Richardson into our facility in Fremont,
California. We also consolidated our facilities in Fremont,
California. During the second quarter of fiscal 2003, we
reassessed our initial estimate of probable costs and the
sublease timeline associated with each of our abandoned excess
leased facilities. The reassessment was prompted by a further
decline in the real estate market in the cities where those
facilities are located. After considering information provided
to us by our real estate advisors, we concluded it was probable
these facilities could not be subleased at rates originally
contemplated nor could they be subleased in the timeframe
originally planned. During the third quarter of fiscal 2003, we
continued to restructure and downsize our workforce, primarily
in our manufacturing operations. Additionally, we further
consolidated our facilities in Fremont. In the fourth quarter of
fiscal 2003, we continued to downsize our workforce, primarily
in manufacturing.

35



---



##### Table of Contents





| |                    
| | -------------------
| | Workforce Reduction

We reduced our workforce by a total of 202
employees during fiscal 2003, primarily in our manufacturing
operations. We recorded charges of $3.0 million for
employee separations, which included termination benefits and
related expenses.



| |                                
| | -------------------------------
| | Abandonment of Excess Equipment

We abandoned excess equipment and leasehold
improvements and recorded charges of $3.5 million during
fiscal 2003. The equipment was abandoned because it was no
longer required to support expected operating levels and, given
the downturn in our industry, we concluded it could not be sold.



| |                                            
| | -------------------------------------------
| | Abandonment of Excess Leased
    Facilities

We are attempting to sublease approximately
85,600 square feet at our Fremont, California facility, as well
as the remaining portion of the facilities leased at our
Richardson, Texas facility. In September 2002, we engaged real
estate advisors to assist us in subleasing the vacated space
within these two buildings. Given the current real estate market
conditions, we do not expect to be able to sublease these
buildings before December 2004. We recorded charges of
$11.8 million during fiscal 2003 related to these excess
facilities.

These restructuring plans are expected to yield
cash savings of approximately $10.1 million annually,
largely relating to reduced employee-related costs, and are
expected to be realized primarily as $5.3 million in cost
of revenue, $3.0 million in research and development,
$0.9 million in sales and marketing and $0.9 million
in general and administrative. In fiscal 2003 we have realized
cash savings of $6.5 million which has been realized as
$3.3 million in cost of revenue, $2.0 million in
research and development, $0.6 million in sales and
marketing and $0.6 million in general and administrative.



| |                          
| | -------------------------
| | Fiscal 2001 Restructuring

During the fourth quarter of fiscal 2001, we
announced a restructuring program to realign resources in
response to the changes in our industry and customer demand. As
a result of the restructuring program, we recorded a
restructuring charge of $22.6 million in the fourth quarter
of fiscal 2001. During the third quarter of fiscal 2002, we
reassessed our initial estimate of probable costs and the
sublease timeline associated with abandoning excess leased
facilities in Newark, California and Richardson, Texas. The
reassessment was prompted by a further decline in the real
estate market in the cities where the facilities are located.
After considering information provided by our real estate
advisors, we concluded it was probable these facilities could
not be subleased at the rates originally contemplated nor could
they be subleased in the timeframe originally planned. As a
result, we recorded an additional charge of $17.2 million
relating to these facilities in the third quarter of fiscal
2002. In the second quarter of fiscal 2003, we again reassessed
our estimates associated with these abandoned leased facilities,
as discussed above. As a result, we recorded an additional
charge of $4.1 million in fiscal 2003 relating to the
Newark facilities. This additional charge considers current
lease rates for similar facilities as well as costs associated
with the estimated added holding period through December 2004.

Merger Costs

On March 18, 2002, we entered into an
Agreement and Plan of Reorganization with Oplink Communications
pursuant to which we intended to acquire all of the outstanding
capital stock of Oplink. The merger was subject to the approval
of our stockholders and the stockholders of Oplink. While our
stockholders approved the issuance of Avanex common stock in
connection with the merger, the stockholders of Oplink failed to
approve the merger on August 15, 2002. We expensed
$4.1 million in related merger costs in the first quarter
of fiscal 2003.

36



---



##### Table of Contents



Interest and Other Income (Expense),
Net

Interest and other income (expense), net,
decreased $1.9 million to $2.5 million in fiscal 2003
from $4.4 million in fiscal 2002. The decrease was
primarily due to lower yields on our cash investments and lower
cash, cash equivalents and investment balances.

Cumulative Effect of an Accounting Change to
Adopt SFAS 142

In accordance with the adoption of SFAS 142,
Goodwill and Other Intangible Assets, we performed
the required two-step impairment tests of goodwill and
indefinite-lived intangible assets as of July 1, 2002. In
the first step of the analysis, our assets and liabilities,
including existing goodwill and other intangible assets, were
assigned to our identified reporting units to determine their
carrying value. We believe we operate as one reporting unit.
After comparing the carrying value of the reporting unit to its
fair value, it was determined that the goodwill recorded was
impaired. After the second step of comparing the implied fair
value of the goodwill to its carrying value, we recognized a
transitional impairment loss of $37.5 million in the first
quarter of fiscal 2003. This loss was recognized as the
cumulative effect of an accounting change.

The fair value of the reporting unit was
determined using the income approach. The income approach
focuses on the income-producing capability of an asset,
measuring the current value of the asset by calculating the
present value of its future economic benefits such as cash
earnings, cost savings, tax deductions, and proceeds from
disposition. Value indications are developed by discounting
expected cash flows to their present value at a rate of return
that incorporates the risk-free rate for the use of funds, the
expected rate of inflation, and risks associated with the
particular investment.

As required by SFAS 142, intangible assets that
did not meet the criteria for recognition apart from goodwill
were reclassified to goodwill. We reclassified $314,000 of net
assembled workforce to goodwill as of July 1, 2002.



| |                                       
| | --------------------------------------
| | Comparison of Fiscal 2002 and
    2001



| |            
| | -----------
| | Net Revenue

Net revenue for fiscal 2002 was
$33.7 million, compared to $131.2 million for fiscal
2001. In fiscal 2002, Fujitsu, Cisco Systems, MCI, and Nortel
Networks each accounted for greater than 10% of net revenue and
combined accounted for 79% of net revenue. This compares to
three customers, Fujitsu, Nortel, and MCI that each accounted
for greater than 10% of net revenue in fiscal 2001 and combined
accounted for 77% of net revenue. This decrease in net revenue
was primarily due to the substantial decrease of shipments to
customers, reflecting reduced capital spending by
telecommunication carriers. There was no significant impact from
a decrease in average selling prices in fiscal 2002.



| |                
| | ---------------
| | Cost of Revenue

Cost of revenue decreased to $27.8 million
for fiscal 2002 from $110.8 million for fiscal 2001. The
decrease in cost of revenue was primarily due to the decrease in
revenue described above. Cost of revenue for fiscal 2001 was
high due to provisions of $34.7 million for excess and
obsolete inventory and $10.2 million of non-cancelable
purchase obligations as compared to $4.3 million in fiscal
2002 for excess and obsolete inventory. Cost of revenue for
fiscal 2002 was also reduced by: 1) the utilization and
sale at normal selling prices of previously written-off
inventory with an original cost of $5.4 million,
2) the $1.2 million favorable settlement of
non-cancelable purchase obligations, 3) $20.0 million
in savings from headcount reductions, and
4) $1.5 million reduction of the warranty accrual to
align the warranty accrual balance with our current estimate of
related costs.

Our gross profit percentage increased to 17% for
fiscal 2002 from 9% for fiscal 2001. The increase in gross
profit percentage was primarily due to the reduction in the
inventory write-off of $4.3 million recorded in fiscal 2002
compared to $34.7 million for excess and obsolete inventory
and $10.2 million of non-cancelable purchase obligations
recorded in fiscal 2001. The gross profit percentage increase
for fiscal 2002 was also due to: 1) the benefit from the
sale at normal selling prices in fiscal 2002 of inventory with
no associated cost of

37



---



##### Table of Contents



sales because the $5.4 million, original
cost thereof had previously been written-off compared to no
comparable benefit in fiscal 2001, 2) the $1.2 million
favorable settlement of non-cancelable purchase obligations,
3) $20.0 million in savings from headcount reductions
and 4) $1.5 million reduction of the warranty accrual
to align the warranty accrual balance with our current estimate
of related costs.




| |                         
| | ------------------------
| | Research and Development

Research and development expenses decreased
$13.8 million to $24.1 million for fiscal 2002 from
$37.9 million for fiscal 2001. The decrease was primarily
attributable to the implementation of new management processes
to increase our operating effectiveness and realign our research
and development projects with expected market demand, which
provided cost savings of $10.4 million in fiscal 2002.
Additionally, we realized cost savings of $3.4 million in
fiscal 2002 due to headcount reductions that occurred in the
quarters ended June 30, 2001 and September 30, 2001.



| |                    
| | -------------------
| | Sales and Marketing

Sales and marketing expenses decreased
$8.8 million to $6.7 million for fiscal 2002 from
$15.5 million for fiscal 2001. The decrease was primarily
attributable to the decreased sales commissions of
$2.5 million associated with lower net revenue,
$1.6 million cost savings related to headcount reductions
and decreased promotional and product marketing expenses of
$1.7 million. As a percentage of revenue, sales and
marketing expenses increased to 20% in fiscal 2002 from 12% in
fiscal 2001. This increase is primarily due to the significantly
lower revenue base in fiscal 2002.



| |                           
| | --------------------------
| | General and Administrative

General and administrative expenses decreased
$3.9 million to $8.0 million for fiscal 2002 from
$11.9 million for fiscal 2001. The decrease was primarily
attributable to cost savings of $1.8 million in fiscal 2002
related to headcount reductions for corporate administration and
human resources, and $1.7 million in fiscal 2002 related to
decreased recruiting and business development expenses.



| |                   
| | ------------------
| | Stock Compensation

Stock compensation expense decreased to
$16.6 million for fiscal 2002 from $50.4 million for
fiscal 2001. From inception through June 30, 2002, we
expensed a total of $102.2 million of stock compensation,
leaving an unamortized balance of $12.0 million on our
June 30, 2002 balance sheet. The decrease in stock
compensation expenses was partially attributable to decreased
amortization of deferred stock compensation resulting from
options cancelled as a result of headcount reductions in our
restructuring. Additionally, the decrease was due to decreased
amortization of deferred stock compensation recognized for the
intrinsic value of the unvested options assumed in acquisitions.
The deferred stock compensation for options assumed from
acquisitions was recorded upon the closing of the acquisition
and is amortized over the remaining vesting period of the
unvested options.



| |                                                 
| | ------------------------------------------------
| | Acquired In-Process Research and
    Development

For fiscal 2002, we recorded $5.4 million of
acquired IPR&D resulting from the acquisition of LambdaFlex.
This amount compares to $4.7 million recorded in fiscal
2001 relating to the acquisition of Holographix. These amounts
were expensed on the respective acquisition date because the
acquired technology had not yet reached technological
feasibility and had no future alternative uses.

One significant project, concave grating,
represented $3.5 million of the IPR&D charge incurred
in the Holographix acquisition in fiscal 2001. This project was
80% complete at the date of acquisition and was 100% complete at
June 30, 2002. From the date of acquisition to
June 30, 2002, we incurred $1.5 million of costs to
complete this project. This was consistent with our original
expectation.

There were two significant projects, DGFF and
OWR, representing $3.2 million and $2.2 million,
respectively, of the IPR&D charge incurred in the LambdaFlex
transaction. Both DGFF and OWR

38



---



##### Table of Contents



strengthened our product portfolio in wavelength
management solutions for the metro market as well as adaptive
wavelength equalization for the long haul and ultra long-haul
markets. The DGFF project was 50% complete at the date of
acquisition in fiscal 2002 and was 85% complete at June 30,
2002. From the date of acquisition to June 30, 2002, we
incurred $0.1 million of material costs. This is consistent
with our original expectation. The OWR project was 50% complete
at the date of acquisition in fiscal 2002 and was 75% complete
at June 30, 2002. From the date of acquisition to
June 30, 2002, we incurred $0.3 million of material
costs. This is consistent with our original expectation.


The nature of the efforts required to develop the
purchased IPR&D into commercially viable products
principally relate to the completion of all planning, designing,
prototyping, verification and testing activities that are
necessary to establish that the products can be produced to meet
their design specifications, including functions, features and
technical performance requirements. As such, the timing of
completion and ultimate commercial application are affected by
the successful completion of these activities and ultimately,
market acceptance.



| |                            
| | ---------------------------
| | Amortization of Intangibles

Amortization of intangibles increased to
$10.5 million for fiscal 2002 from $9.7 million for
fiscal 2001. This expense is primarily due to the amortization
of goodwill and other intangible assets recorded in connection
with our acquisition of Holographix, which was accounted for as
a purchase, and closed on July 25, 2000. These intangible
assets were previously being amortized over their estimated
remaining useful life of 3 to 5 years. The acquisition of
LambdaFlex was accounted for using the guidance of SFAS 141
and SFAS 142, thus the goodwill related to this transaction
is not being amortized as the transaction was completed after
June 30, 2001.

Restructuring Charges

During the fourth quarter of fiscal 2001, we
announced a restructuring program to downsize our organizational
structure, primarily in manufacturing and administration
functions in our Fremont, California facilities. Doing so
realigned resources with the then current business outlook and
lowered our cost structure. As a result of the restructuring
program, we recorded in the consolidated statements of
operations a total restructuring charge of $22.6 million in
the fourth quarter of fiscal 2001. This charge included excess
manufacturing equipment with a carrying value of
$14.7 million. This equipment was abandoned because its use
was no longer required to support expected operating levels and,
given the downturn in our industry, we concluded it could not be
sold. Through June 30, 2002, we sold and received total
proceeds of $545,000 for certain portions of this equipment.

During the third quarter of fiscal 2002 and
reconfirmed at the end of the fourth quarter of fiscal 2002, we
reassessed our initial estimate of probable costs and the
sublease timeline associated with abandoning excess leased
facilities. The reassessment was prompted by a further decline
in the real estate market in the city where the facilities are
located. After considering information provided by our leasing
agent, we concluded it was probable these facilities could not
be subleased at the rate originally contemplated nor could they
be subleased by June 30, 2002 as originally planned. As a
result, we recorded an additional charge of $17.2 million
relating to these facilities in fiscal 2002.

Our cost cutting strategies resulted in
annualized savings of approximately $26.8 million through
June 30, 2002, compared to the initial estimated savings of
$22.5 million. The increase in costs savings is mainly a
result of a larger than estimated headcount reductions and
changes in the mix of employees terminated. These savings
largely relate to reduced employee-related costs and are
realized primarily as $20 million in cost of revenue,
$3.4 million in research and development, $1.6 million
in sales and marketing and $1.8 million in general and
administrative.

39



---



##### Table of Contents



Interest and Other Income (Expense),
Net

Interest and other income (expense), net
decreased to $4.4 million in fiscal 2002 from
$12.5 million in fiscal 2001. The decrease was primarily
due to lower yields on our cash investments and additional
interest charges on capital lease obligations and bank debt.

Liquidity and Capital Resources

Prior to our initial public offering, we financed
our operations primarily through private sales of convertible
preferred stock. In February 2000, we received net proceeds of
approximately $238 million from the initial public offering
of our common stock and a concurrent sale of stock to corporate
investors. We have also financed our operations through bank
borrowings as well as through equipment lease financing.

As of June 30, 2003, we had cash and cash
equivalents and short-term investments of $87.6 million and
long-term investment holdings of $47.1 million.

Net cash used in operating activities was
$33.5 million in fiscal 2003, primarily reflecting a loss
from operations, an increase in inventory and a decrease in
other accrued expenses offset by a decrease in accounts
receivable and an increase in accrued restructuring. Our use of
cash was offset by non-cash charges related to the provision for
excess inventory, depreciation and amortization, restructuring
charges, merger expenses, reduction in long-lived assets and
cumulative effect of an accounting change. Net cash used in
operating activities was $33.7 million in fiscal 2002,
primarily reflecting a loss from operations, decreases in
accounts payable, other accrued expenses, deferred revenue and
accrued restructuring. Our use of cash was offset by a decrease
in accounts receivable and by non-cash charges related to the
provision for excess inventory, depreciation and amortization,
amortization of intangibles, stock compensation, restructuring
charges and acquired in-process research and development.

Cash provided by investing activities was
$20.9 million in fiscal 2003. Cash provided by investing
activities was primarily the result of maturities of
held-to-maturity securities, net of purchases, offset by costs
incurred related to the proposed merger with Oplink and
acquisitions of the optical components businesses of Alcatel and
Corning. Cash used in investing activities was
$10.1 million in fiscal 2002, principally due to purchases
of held-to-maturity securities, net of maturities, and by the
purchases of property and equipment.

Cash used in financing activities was
$6.5 million in fiscal 2003, primarily as a result of
payments on long-term debt and capital lease obligations and
payments on short-term borrowings, offset by proceeds from
payments of notes receivable from stockholders and proceeds from
short-term borrowings. Cash used in financing activities was
$5.8 million in fiscal 2002, primarily as a result of
payments on long-term debt and capital lease obligations and
payments on short-term borrowings, offset by proceeds from
payments of notes receivable from stockholders, proceeds from
short-term borrowings, and proceeds from issuance of common
stock.

Our principal source of liquidity as of
June 30, 2003 consisted of $134.7 million in cash,
cash equivalents and short-term and long-term investments.
Additionally, we have a revolving line of credit from a
financial institution, which allows maximum borrowings up to
$15.0 million, of which $3.1 million was drawn down at
June 30, 2003. The line of credit requires us to comply
with specified covenants. We were in compliance with the
specified covenants at June 30, 2003. The agreement expires
December 31, 2003, at which time all outstanding principal
and interest will be due. The credit line bears interest at the
prime rate plus 1.50%. We believe that if we are unable to renew
the line of credit, it will not have a significant impact on our
liquidity.

As of August 1, 2003, our cash, cash
equivalents and short-term and long-term investments were
approximately $260 million. We estimate that our combined
operations initially will generate negative operating cash flow
at a rate of at least $25 million per quarter. Additionally, we
estimate that we will use in excess of $50 million of our
cash resources over the first three quarters of fiscal 2004
to pay costs related to the acquisitions and to complete
restructuring actions intended to reduce the cost and improve
the efficiency of our post-acquisition business operations. We
believe, but can give no assurance, that our negative operating
cash flow can be reduced significantly after three quarters
of combined operations through a combination of restructuring,
other cost reduction measures and moderate revenue growth.

40



---



##### Table of Contents



From time to time, we may also consider the
acquisition of, or evaluate investments in, products and
businesses complementary to our business. Any acquisition or
investment may require additional capital. Although we believe
that our current cash and cash equivalents, short-term and
long-term investment balance will be sufficient to fund our
operations for at least 12 months, we cannot assure you
that we will not seek additional funds through public or private
equity or debt financing or from other sources within this time
frame or that additional funding, if needed, will be available
on terms acceptable to us, or at all.

Our contractual obligations and commitments have
been summarized in the table below (in thousands):

Contractual Obligations

|                                   |                                    |               |        |           |  |           |       |           |  |       |        |        |  |   |        |        |  |   |        |        | 
|---------------------------------- | ---------------------------------- | ------------- | ------ | --------- |  | --------- | ----- | --------- |  | ----- | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                   |                                    |              
|                                   |                                    | Due by Period
|                                   |                                    |              
|                                   |                                    |               |        | Less than |  |           |       | After 5  
|                                   |                                    | Total         |        | 1 year    |  | 1-3 years |       | 4-5 years |  | years
|                                   |                                    |               |        |           |  |           |       |           |  |      
|Long-term debt                     |                                    | $             | 890    |           |  | $         | 763   |           |  | $     | 127    |        |  | $ |       |        |  | $ |       |       
|Capital lease obligations          |                                    |               | 7,654  |           |  |           | 5,117 |           |  |       | 2,537  |        |  |   |       |        |  |   |       |       
|Operating leases                   |                                    |               | 44,349 |           |  |           | 5,778 |           |  |       | 11,920 |        |  |   | 12,642 |        |  |   | 14,009 |       
|Unconditional purchase obligations |                                    |               | 4,106  |           |  |           | 4,106 |           |  |       |       |        |  |   |       |        |  |   |       |       
|                                   |                                    |               |        |           |  |           |       |           |  |       |        |        |  |   |        |        |  |   |        |       
|                                   | Total contractual cash obligations |               | $      | 56,999    |  |           | $     | 15,764    |  |       | $      | 14,584 |  |   | $      | 12,642 |  |   | $      | 14,009 | 
|                                   |                                    |               |        |           |  |           |       |           |  |       |        |        |  |   |        |        |  |   |        |       

Other Commercial Commitments

|                          |                              |           |       |                                  |  |           |       |           |  |       |   |   |  |   |   |   |  |   |   |   | 
|------------------------- | ---------------------------- | --------- | ----- | -------------------------------- |  | --------- | ----- | --------- |  | ----- | - | - |  | - | - | - |  | - | - | - | 
|                          |                              |           |       |                                 
|                          |                              |           |       | Commitment Expiration Per Period
|                          |                              | Total     |       |                                 
|                          |                              | Amounts   |       | Less than                        |  |           |       | After 5  
|                          |                              | Committed |       | 1 year                           |  | 1-3 years |       | 4-5 years |  | years
|                          |                              |           |       |                                  |  |           |       |           |  |      
|Line of credit            |                              | $         | 3,141 |                                  |  | $         | 3,141 |           |  | $     |  |   |  | $ |  |   |  | $ |  |  
|Standby letters of credit |                              |           | 3,965 |                                  |  |           | 3,965 |           |  |       |  |   |  |   |  |   |  |   |  |  
|                          |                              |           |       |                                  |  |           |       |           |  |       |   |   |  |   |   |   |  |   |   |  
|                          | Total commercial commitments |           | $     | 7,106                            |  |           | $     | 7,106     |  |       | $ |  |  |   | $ |  |  |   | $ |  | 
|                          |                              |           |       |                                  |  |           |       |           |  |       |   |   |  |   |   |   |  |   |   |  

We have unconditional purchase obligations to
certain of our suppliers that support our ability to manufacture
our products. As of June 30, 2003, we had approximately
$4.1 million of purchase obligations, of which
$0.3 million is included on our balance sheet in accounts
payable.

Under operating leases we have included total
future minimum rent expense under non-cancelable leases for both
current and abandoned facilities. We have included in the
balance sheet $1.1 million and $29.7 million in
current and long-term restructuring liabilities for the
abandoned facilities as of June 30, 2003.

41



---



##### Table of Contents



Unaudited Quarterly Results of
Operation

The following table presents our unaudited
quarterly operating results for the eight quarters ended
June 30, 2003:

|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |        |        | 
|------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------ | ------ | --------- | ----- | -------- | ------- | --------- | ------ | -------- | ------- | --------- | ------ | -------- | ------- | --------- | ------ | - | ------- | ----- | ------ | - | ------- | ------ | ------ | - | ------- | ----- | ------ | - | ------- | ------ | ------ | 
|                                                                          |                                              |                                     
|                                                                          |                                              | Quarters Ended                      
|                                                                          |                                              |                                     
|                                                                          |                                              | June 30,                             |        | March 31, |       | Dec. 31, |         | Sept. 30, |        | June 30, |         | March 31, |        | Dec. 31, |         | Sept. 30,
|                                                                          |                                              | 2003                                 |        | 2003      |       | 2002     |         | 2002      |        | 2002     |         | 2002      |        | 2001     |         | 2001     
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |          
|                                                                          |                                              |                                     
|                                                                          |                                              | (In thousands except per share data)
|                                                                          |                                              | (Unaudited)                         
|Consolidated Statement of Operations
    Data:                            |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|Net revenue                                                               |                                              | $                                    | 5,464  |           |       | $        | 5,400   |           |        | $        | 5,337   |           |        | $        | 5,215   |           |        | $ | 8,026   |       |        | $ | 10,185  |        |        | $ | 8,297   |       |        | $ | 7,178   |       
|Cost of revenue                                                           |                                              |                                      | 6,030  |           |       |          | 6,698   |           |        |          | 6,705   |           |        |          | 10,602  |           |        |   | 6,175   |       |        |   | 7,182   |        |        |   | 4,961   |       |        |   | 9,471   |       
|Stock compensation                                                        |                                              |                                      | 5      |           |       |          | 13      |           |        |          | (237    | )         |        |          | 17      |           |        |   | 145     |       |        |   | 137     |        |        |   | (311    | )     |        |   | 195     |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|                                                                          | Gross profit (loss)                          |                                      |        | (571      | )     |          |         | (1,311    | )      |          |         | (1,131    | )      |          |         | (5,404    | )      |   |         | 1,706 |        |   |         | 2,866  |        |   |         | 3,647 |        |   |         | (2,488 | )     
|Operating expenses:                                                       |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|                                                                          | Research and development                     |                                      |        | 3,066     |       |          |         | 3,031     |        |          |         | 4,253     |        |          |         | 5,820     |        |   |         | 6,257 |        |   |         | 6,087  |        |   |         | 5,950 |        |   |         | 5,782  |       
|                                                                          | Sales and marketing                          |                                      |        | 1,447     |       |          |         | 1,859     |        |          |         | 1,500     |        |          |         | 1,314     |        |   |         | 1,928 |        |   |         | 1,698  |        |   |         | 1,562 |        |   |         | 1,469  |       
|                                                                          | General and administrative                   |                                      |        | 1,837     |       |          |         | 2,445     |        |          |         | 3,035     |        |          |         | 1,716     |        |   |         | 2,383 |        |   |         | 2,151  |        |   |         | 1,705 |        |   |         | 1,804  |       
|                                                                          | Stock compensation(1)                        |                                      |        | 337       |       |          |         | (2,358    | )      |          |         | 6         |        |          |         | 1,908     |        |   |         | 1,693 |        |   |         | 4,194  |        |   |         | 4,382 |        |   |         | 6,213  |       
|                                                                          | Acquired in-process research and development |                                      |        |          |       |          |         |          |        |          |         |          |        |          |         |          |        |   |         |      |        |   |         |       |        |   |         | 5,445 |        |   |         |       |       
|                                                                          | Amortization of intangibles                  |                                      |        |          |       |          |         |          |        |          |         | 80        |        |          |         | 120       |        |   |         | 2,632 |        |   |         | 2,632  |        |   |         | 2,619 |        |   |         | 2,619  |       
|                                                                          | Reduction in long-lived assets               |                                      |        |          |       |          |         |          |        |          |         | 1,548     |        |          |         |          |        |   |         |      |        |   |         |       |        |   |         |      |        |   |         |       |       
|                                                                          | Restructuring charges (recovery)             |                                      |        | (44       | )     |          |         | 4,750     |        |          |         | 4,987     |        |          |         | 12,745    |        |   |         | (9    | )      |   |         | 17,116 |        |   |         | (120  | )      |   |         | (331   | )     
|                                                                          | Merger costs                                 |                                      |        |          |       |          |         |          |        |          |         |          |        |          |         | 4,126     |        |   |         |      |        |   |         |       |        |   |         |      |        |   |         |       |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|                                                                          |                                              | Total operating expenses             |        |           | 6,643 |          |         |           | 9,727  |          |         |           | 15,409 |          |         |           | 27,749 |   |         |       | 14,884 |   |         |        | 33,878 |   |         |       | 21,543 |   |         |        | 17,556 | 
|Loss from operations                                                      |                                              |                                      | (7,214 | )         |       |          | (11,038 | )         |        |          | (16,540 | )         |        |          | (33,153 | )         |        |   | (13,178 | )     |        |   | (31,012 | )      |        |   | (17,896 | )     |        |   | (20,044 | )     
|Interest and other income, net                                            |                                              |                                      | 608    |           |       |          | 635     |           |        |          | 656     |           |        |          | 634     |           |        |   | 653     |       |        |   | 896     |        |        |   | 1,197   |       |        |   | 1,607   |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|Loss before cumulative effect of an accounting
    change                 |                                              | $                                    | (6,606 | )         |       | $        | (10,403 | )         |        | $        | (15,884 | )         |        | $        | (32,519 | )         |        | $ | (12,525 | )     |        | $ | (30,116 | )      |        | $ | (16,699 | )     |        | $ | (18,437 | )     
|Cumulative effect of an accounting change to
    adopt SFAS 142           |                                              |                                      |       |           |       |          |        |           |        |          |        |           |        |          | (37,500 | )         |        |   |        |       |        |   |        |        |        |   |        |       |        |   |        |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|Net loss                                                                  |                                              | $                                    | (6,606 | )         |       | $        | (10,403 | )         |        | $        | (15,884 | )         |        | $        | (70,019 | )         |        | $ | (12,525 | )     |        | $ | (30,116 | )      |        | $ | (16,699 | )     |        | $ | (18,437 | )     
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|Loss per share before cumulative effect of an
    accounting change       |                                              | $                                    | (0.10  | )         |       | $        | (0.15   | )         |        | $        | (0.23   | )         |        | $        | (0.48   | )         |        | $ | (0.19   | )     |        | $ | (0.45   | )      |        | $ | (0.26   | )     |        | $ | (0.30   | )     
|Loss per share after cumulative effect of an
    accounting change        |                                              |                                      |       |           |       |          |        |           |        |          |        |           |        |          | (0.56   | )         |        |   |        |       |        |   |        |        |        |   |        |       |        |   |        |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|Basic and diluted net loss per share                                      |                                              | $                                    | (0.10  | )         |       | $        | (0.15   | )         |        | $        | (0.23   | )         |        | $        | (1.04   | )         |        | $ | (0.19   | )     |        | $ | (0.45   | )      |        | $ | (0.26   | )     |        | $ | (0.30   | )     
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|(1) Below is the allocation of stock
    compensation expense (recovery): |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|                                                                          |                                              | Research and development             |        | $         | 277   |          |         | $         | (2,355 | )        |         | $         | 936    |          |         | $         | 1,035  |   |         | $     | (178   | ) |         | $      | 2,403  |   |         | $     | 2,578  |   |         | $      | 2,531  | 
|                                                                          |                                              | Sales and marketing                  |        |           | 14    |          |         |           | 14     |          |         |           | (128   | )        |         |           | (99    | ) |         |       | 51     |   |         |        | 50     |   |         |       | (220   | ) |         |        | 207    | 
|                                                                          |                                              | General and administrative           |        |           | 46    |          |         |           | (17    | )        |         |           | (802   | )        |         |           | 972    |   |         |       | 1,820  |   |         |        | 1,741  |   |         |       | 2,024  |   |         |        | 3,475  | 
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       
|                                                                          |                                              | $                                    | 337    |           |       | $        | (2,358  | )         |        | $        | 6       |           |        | $        | 1,908   |           |        | $ | 1,693   |       |        | $ | 4,194   |        |        | $ | 4,382   |       |        | $ | 6,213   |       
|                                                                          |                                              |                                      |        |           |       |          |         |           |        |          |         |           |        |          |         |           |        |   |         |       |        |   |         |        |        |   |         |       |        |   |         |       

We believe this information reflects all
adjustments (consisting only of normal recurring adjustments)
that we consider necessary for a fair presentation of such
information in accordance with generally accepted accounting
principles in the United States.

42



---



##### Table of Contents



Our revenues and operating results are likely to
vary significantly from quarter to quarter. See Factors
That May Affect Future Results  Our future revenues
and operating results are inherently unpredictable, and as a
result, we may fail to meet the expectations of securities
analysts or investors, which could cause our stock price to
decline. Due to these and other factors, we believe that
quarter to quarter comparisons of our operating results will not
be meaningful, and you should not rely on our results for one
quarter as any indication of our future performance.

Recently Issued Accounting
Pronouncements

In June 2002, the Financial Accounting Standards
Board, or FASB, issued SFAS No. 146 Accounting for
Costs Associated with Exit or Disposal Activities
(SFAS 146), effective for exit or disposal activities that
are initiated after December 31, 2002. Under SFAS 146,
a liability for the cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under
prior guidance, a liability for such costs could be recognized
at the date of commitment to an exit plan. The provisions of
SFAS 146 are required to be applied prospectively after the
adoption date to newly initiated exit activities, and will
affect the timing of recognizing future restructuring costs, as
well as the amounts recognized.

In November 2002, the Emerging Issues Task Force,
or EITF, reached a consensus on EITF 00-21 Accounting
for Revenue Arrangements with Multiple Deliverables.
EITF 00-21 sets out criteria for when revenue on a
deliverable can be recognized separately from other deliverables
in a multiple deliverable arrangement. EITF 00-21 will be
effective for fiscal years beginning after June 15, 2003.
We believe that the adoption of this standard will have no
material impact on our financial statements.

In November 2002, the FASB issued FASB
Interpretation No. 45, or FIN 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 requires that a liability be recorded
in the guarantors balance sheet upon issuance of a
guarantee. In addition, FIN 45 requires disclosures about
the guarantees that an entity has issued, including a
reconciliation of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement
provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim
or annual periods ending after December 15, 2002. The
adoption of this standard had no material impact on our
financial statements.

In December 2002, the FASB issued SFAS
No. 148 Accounting for Stock-Based Compensation,
Transition and Disclosure. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also requires that disclosures
of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed
more prominently and in a tabular format. Additionally, SFAS
No. 148 requires disclosure of the pro forma effect in
interim financial statements. The transition and annual
disclosure requirements are effective for fiscal years ended
after December 15, 2002. The interim disclosure
requirements are effective for interim periods ending after
December 15, 2002. We adopted the disclosure requirements
of SFAS No. 148 in the second quarter of fiscal 2003. We
will continue to account for our stock purchase plan and stock
option plans under the provisions of APB No. 25.

In January 2003, the FASB issued FASB
Interpretation No. 46 (FIN 46) Consolidation of
Variable Interest Entities, an Interpretation of ARB
No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective immediately for all
new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 must be applied for the first interim or annual
period beginning after June 15, 2003. We believe that the
adoption of this standard will have no material impact on our
financial statements.

43



---



##### Table of Contents








|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Interest Rate Risk

Our exposure to market risk for changes in
interest rates relates primarily to our investment portfolio. We
place our investments with high quality credit issuers in
short-term and long-term securities with maturities ranging from
overnight up to 36 months. The average maturity of the
portfolio will not exceed 30 months. The portfolio includes
only marketable securities with active secondary or resale
markets to ensure portfolio liquidity. We have no investments
denominated in foreign country currencies and therefore our
investments are not subject to foreign exchange risk. We have
one equipment loan with a fixed rate of interest of 9.406% with
outstanding principal and interest of $890,000 at June 30,
2003, which approximates fair market value.

The following table summarizes the expected
maturity, average interest rate and fair market value of the
short-term and long-term securities held by Avanex (dollars in
thousands).

As of June 30, 2003

|                            |  |                       |        |           |  |        |        |       |  |   |         |  |  |   |         | 
|--------------------------- |  | --------------------- | ------ | --------- |  | ------ | ------ | ----- |  | - | ------- |  |  | - | ------- | 
|                            |  |                       |        |           |  |       
|                            |  | Years Ending June 30, |        | Total     |  | Fair  
|                            |  |                       |        | Amortized |  | Market
|                            |  | 2004                  |        | 2005      |  | Cost   |        | Value
|                            |  |                       |        |           |  |        |        |      
|Held-to-maturity securities |  | $                     | 76,952 |           |  | $      | 47,063 |       |  | $ | 124,015 |  |  | $ | 124,340 | 
|Average interest rate       |  |                       | 2.2    | %         |  |        | 2.2    | %     |  |   |         |  |  |   |         | 

As of June 30, 2002

|                            |  |                       |         |           |  |        |        |       |  |   |         |  |  |   |         | 
|--------------------------- |  | --------------------- | ------- | --------- |  | ------ | ------ | ----- |  | - | ------- |  |  | - | ------- | 
|                            |  |                       |         |           |  |       
|                            |  | Years Ending June 30, |         | Total     |  | Fair  
|                            |  |                       |         | Amortized |  | Market
|                            |  | 2003                  |         | 2004      |  | Cost   |        | Value
|                            |  |                       |         |           |  |        |        |      
|Held-to-maturity securities |  | $                     | 106,346 |           |  | $      | 40,984 |       |  | $ | 147,330 |  |  | $ | 148,057 | 
|Average interest rate       |  |                       | 3.0     | %         |  |        | 3.3    | %     |  |   |         |  |  |   |         | 

Exchange Rate Risk

Historically our international revenues and
expenses have been denominated predominantly in
U.S. dollars; however, as a result of the acquisitions of
the optical components businesses of Alcatel and Corning, a
portion of our international revenues and expenses will be
denominated in foreign currencies in the future. Therefore,
fluctuations in the value of foreign currencies could have a
negative impact on the profitability of our global operations,
which could seriously harm our business, financial condition and
results of operations.

44



---



##### Table of Contents








|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

The supplementary data required by Item 8 is
presented in Item 7, Managements Discussion and
Analysis of Financial Condition and Results of Operations.

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                   |                                                   |                                                     |  |    |    | 
|---------------------------------- | ------------------------------------------------- | --------------------------------------------------- |  | -- | -- | 
|Consolidated Financial Statements: |                                                   |                                                     |  |   
|                                   |                                                   | Report of Independent Auditors                      |  |    | 46 | 
|                                   |                                                   | Consolidated Balance Sheets                         |  |    | 47 | 
|                                   |                                                   | Consolidated Statements of Operations               |  |    | 48 | 
|                                   |                                                   | Consolidated Statements of Stockholders
    Equity |  |    | 49 | 
|                                   |                                                   | Consolidated Statements of Cash Flows               |  |    | 50 | 
|                                   |                                                   | Notes to Consolidated Financial Statements          |  |    | 51 | 
|Financial Statement Schedule:      |                                                   |                                                     |  |   
|                                   | Schedule IIValuation and Qualifying
    Accounts |                                                     |  | 76 |   

45



---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Avanex Corporation


We have audited the accompanying consolidated
balance sheets of Avanex Corporation as of June 30, 2003
and 2002, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended June 30, 2003. Our audits also
include the financial statement schedule listed in the Index at
Item 15(a). These financial statements and schedule are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Avanex Corporation at
June 30, 2003 and 2002, and the consolidated results of its
operations and its cash flows for each of the three years in the
period ended June 30, 2003, in conformity with accounting
principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the
information set forth therein.

As discussed in Note 5 to Notes to Consolidated
Financial Statements, in fiscal 2003 Avanex Corporation changed
its method of accounting for goodwill and other purchased
intangible assets.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

San Jose, California

July 25, 2003


46



---



##### Table of Contents



AVANEX CORPORATION

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |          |         | 
|---------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                         |                                                                                                                                                                                                      |                                           
|                                         |                                                                                                                                                                                                      | June 30,                                  
|                                         |                                                                                                                                                                                                      |                                           
|                                         |                                                                                                                                                                                                      | 2003                                       |        | 2002    
|                                         |                                                                                                                                                                                                      |                                            |        |         
|                                         |                                                                                                                                                                                                      |                                           
|                                         |                                                                                                                                                                                                      | (In thousands, except share               
|                                         |                                                                                                                                                                                                      | and per share data)                       
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         | Cash and cash equivalents                                                                                                                                                                            |                                            | $      | 10,639   |         |  | $      | 29,739   |        
|                                         | Short-term investments                                                                                                                                                                               |                                            |        | 76,952   |         |  |        | 106,346  |        
|                                         | Accounts receivable (net of allowance for
    doubtful accounts of $478 at 2003 and $920 at 2002                                                                                                     |                                            |        | 2,614    |         |  |        | 4,855    |        
|                                         | Inventories                                                                                                                                                                                          |                                            |        | 3,613    |         |  |        | 6,515    |        
|                                         | Other current assets                                                                                                                                                                                 |                                            |        | 1,070    |         |  |        | 801      |        
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total current assets                       |        |          | 94,888  |  |        |          | 148,256 | 
|Long-term investments                    |                                                                                                                                                                                                      |                                            | 47,063 |          |         |  | 40,984 |         
|Property and equipment, net              |                                                                                                                                                                                                      |                                            | 5,455  |          |         |  | 18,872 |         
|Intangibles, net                         |                                                                                                                                                                                                      |                                            |       |          |         |  | 1,477  |         
|Goodwill, net                            |                                                                                                                                                                                                      |                                            |       |          |         |  | 37,500 |         
|Other assets                             |                                                                                                                                                                                                      |                                            | 7,209  |          |         |  | 3,308  |         
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total assets                               |        | $        | 154,615 |  |        | $        | 250,397 | 
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         | Short-term borrowings                                                                                                                                                                                |                                            | $      | 3,141    |         |  | $      | 6,035    |        
|                                         | Accounts payable                                                                                                                                                                                     |                                            |        | 5,647    |         |  |        | 2,539    |        
|                                         | Accrued compensation and related expenses                                                                                                                                                            |                                            |        | 2,279    |         |  |        | 2,942    |        
|                                         | Other accrued expenses                                                                                                                                                                               |                                            |        | 5,772    |         |  |        | 3,947    |        
|                                         | Warranty                                                                                                                                                                                             |                                            |        | 2,707    |         |  |        | 3,842    |        
|                                         | Current portion of long-term obligations                                                                                                                                                             |                                            |        | 4,190    |         |  |        | 5,020    |        
|                                         | Current portion of restructuring costs                                                                                                                                                               |                                            |        | 6,400    |         |  |        | 4,349    |        
|                                         | Deferred revenue                                                                                                                                                                                     |                                            |        | 44       |         |  |        | 671      |        
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total current liabilities                  |        |          | 30,180  |  |        |          | 29,345  | 
|Long-term liabilities:                   |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         | Restructuring costs                                                                                                                                                                                  |                                            |        | 26,055   |         |  |        | 16,689   |        
|                                         | Other obligations                                                                                                                                                                                    |                                            |        | 2,118    |         |  |        | 6,365    |        
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total liabilities                          |        |          | 58,353  |  |        |          | 52,399  | 
|Commitments and contingencies            |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|Stockholders equity:                    |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         | Preferred stock, $0.001 par value, 10,000,000
    shares authorized, no shares issued and outstanding at
    June 30, 2003 and 2002                                                                  |                                            |        |         |         |  |        |         |        
|                                         | Common stock, $0.001 par value, 300,000,000
    shares authorized at June 30, 2003 and 2002; 69,472,560 and
    69,496,441 shares issued and outstanding at June 30, 2003
    and 2002, respectively |                                            |        | 69       |         |  |        | 69       |        
|                                         | Additional paid-in capital                                                                                                                                                                           |                                            |        | 484,028  |         |  |        | 495,288  |        
|                                         | Notes receivable from stockholders                                                                                                                                                                   |                                            |        |         |         |  |        | (1,265   | )      
|                                         | Deferred compensation                                                                                                                                                                                |                                            |        | (828     | )       |  |        | (11,999  | )      
|                                         | Accumulated deficit                                                                                                                                                                                  |                                            |        | (387,007 | )       |  |        | (284,095 | )      
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total stockholders equity                 |        |          | 96,262  |  |        |          | 197,998 | 
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                                                      | Total liabilities and stockholders equity |        | $        | 154,615 |  |        | $        | 250,397 | 
|                                         |                                                                                                                                                                                                      |                                            |        |          |         |  |        |         

See accompanying notes.

47



---



##### Table of Contents



AVANEX CORPORATION

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |        |         | 
|--------------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | -------- | ------ | ------ | ---- | ------- | ------ | ------ | - | -------- | ------ | ------- | 
|                                                                                                    |                                              |                                      
|                                                                                                    |                                              | Years Ended June 30,                 
|                                                                                                    |                                              |                                      
|                                                                                                    |                                              | 2003                                  |          | 2002   |        | 2001
|                                                                                                    |                                              |                                       |          |        |        |     
|                                                                                                    |                                              |                                      
|                                                                                                    |                                              | (In thousands, except per share data)
|Net revenue                                                                                         |                                              | $                                     | 21,416   |        |        | $    | 33,686  |        |        | $ | 131,244  |       
|Cost of revenue                                                                                     |                                              |                                       | 30,035   |        |        |      | 27,789  |        |        |   | 110,794  |       
|Stock compensation expense (recovery)                                                               |                                              |                                       | (202     | )      |        |      | 166     |        |        |   | 8,764    |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    | Gross profit (loss)                          |                                       |          | (8,417 | )      |      |         | 5,731  |        |   |          | 11,686 |        
|Operating expenses:                                                                                 |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    | Research and development                     |                                       |          | 16,170 |        |      |         | 24,076 |        |   |          | 37,856 |        
|                                                                                                    | Sales and marketing                          |                                       |          | 6,120  |        |      |         | 6,657  |        |   |          | 15,493 |        
|                                                                                                    | General and administrative                   |                                       |          | 9,033  |        |      |         | 8,043  |        |   |          | 11,862 |        
|                                                                                                    | Stock compensation expense (recovery)(1)     |                                       |          | (107   | )      |      |         | 16,482 |        |   |          | 41,589 |        
|                                                                                                    | Acquired in-process research and development |                                       |          |       |        |      |         | 5,445  |        |   |          | 4,700  |        
|                                                                                                    | Amortization of intangibles                  |                                       |          | 200    |        |      |         | 10,502 |        |   |          | 9,653  |        
|                                                                                                    | Reduction in long-lived assets               |                                       |          | 1,548  |        |      |         |       |        |   |          |       |        
|                                                                                                    | Restructuring charges                        |                                       |          | 22,438 |        |      |         | 16,656 |        |   |          | 22,586 |        
|                                                                                                    | Merger costs                                 |                                       |          | 4,126  |        |      |         |       |        |   |          |       |        
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    |                                              | Total operating expenses              |          |        | 59,528 |      |         |        | 87,861 |   |          |        | 143,739 | 
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Loss from operations                                                                                |                                              |                                       | (67,945  | )      |        |      | (82,130 | )      |        |   | (132,053 | )     
|Interest and other income                                                                           |                                              |                                       | 4,167    |        |        |      | 7,258   |        |        |   | 14,443   |       
|Interest and other expense                                                                          |                                              |                                       | (1,634   | )      |        |      | (2,905  | )      |        |   | (1,922   | )     
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Loss before cumulative effect of an accounting
    change                                           |                                              |                                       | (65,412  | )      |        |      | (77,777 | )      |        |   | (119,532 | )     
|Cumulative effect of an accounting change to
    adopt SFAS 142                                     |                                              |                                       | (37,500  | )      |        |      |        |        |        |   |         |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Net loss                                                                                            |                                              | $                                     | (102,912 | )      |        | $    | (77,777 | )      |        | $ | (119,532 | )     
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Loss per share before cumulative effect of an
    accounting change                                 |                                              | $                                     | (0.96    | )      |        | $    | (1.21   | )      |        | $ | (2.07    | )     
|Cumulative effect of an accounting change to
    adopt SFAS 142                                     |                                              |                                       | (0.55    | )      |        |      |        |        |        |   |         |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Basic and diluted net loss per common share                                                         |                                              | $                                     | (1.51    | )      |        | $    | (1.21   | )      |        | $ | (2.07    | )     
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|Weighted average number of shares used in
    computing basic and diluted net loss per common share |                                              |                                       | 68,371   |        |        |      | 64,308  |        |        |   | 57,620   |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|(1) Below is the allocation of stock
    compensation expense (recovery):                           |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    |                                              | Research and development              |          | $      | (107   | )    |         | $      | 6,883  |   |          | $      | 32,216  | 
|                                                                                                    |                                              | Sales and marketing                   |          |        | (199   | )    |         |        | 88     |   |          |        | 745     | 
|                                                                                                    |                                              | General and administrative            |          |        | 199    |      |         |        | 9,511  |   |          |        | 8,628   | 
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       
|                                                                                                    |                                              | $                                     | (107     | )      |        | $    | 16,482  |        |        | $ | 41,589   |       
|                                                                                                    |                                              |                                       |          |        |        |      |         |        |        |   |          |       

See accompanying notes.

48



---



##### Table of Contents



AVANEX CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |               |  |   |         |         |   |   |          |          |   |   |         |          |  
|------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------------------- | -- | ---------- | - | ------------ | ------- | ------------ | - | ----------- | ------ | ------------- |  | - | ------- | ------- | - | - | -------- | -------- | - | - | ------- | -------- | -
|                         |                                                                                                                                                  |                                                 |    |            |   | Notes        |         |              |   |             |        |              
|                         |                                                                                                                                                  |                                                 |    | Additional |   | Receivable   |         | Deferred     |   |             |        | Total        
|                         |                                                                                                                                                  | Common                                          |    | Paid-in    |   | From         |         | Stock        |   | Accumulated |        | Stockholders
|                         |                                                                                                                                                  | Stock                                           |    | Capital    |   | Stockholders |         | Compensation |   | Deficit     |        | Equity       
|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |              
|                         |                                                                                                                                                  |                                                
|                         |                                                                                                                                                  | (In thousands, except share and per share data)
|Balance at June 30, 2000 |                                                                                                                                                  | $                                               | 64 |            |   | $            | 385,198 |              |   | $           | (5,173 | )             |  | $ | (36,146 | )       |   | $ | (86,786  | )        |   | $ | 257,157 |         
|                         | Issuance of 1,251,132 shares of common stock upon
    exercise of stock options and share purchase rights                                        |                                                 |    | 1          |   |              |         | 2,918        |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 2,919    |  
|                         | Issuance of 34,216 shares of common stock
    relating to employee stock purchase plan                                                           |                                                 |    |           |   |              |         | 1,414        |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 1,414    |  
|                         | Payments received on stockholders notes
    receivable                                                                                          |                                                 |    |           |   |              |         |             |   |             |        | 3,125         |  |   |         |        |   |   |          |         |   |   |         | 3,125    |  
|                         | Issuance of 501,880 shares of common stock and
    assumption of options for 709,047 shares of common stock upon
    acquisition of Holographix  |                                                 |    | 1          |   |              |         | 96,069       |   |             |        |              |  |   |         | (43,579 | ) |   |          |         |   |   |         | 52,491   |  
|                         | Repurchase of 766,667 shares of common stock                                                                                                     |                                                 |    | (1         | ) |              |         | (2,572       | ) |             |        |              |  |   |         |        |   |   |          |         |   |   |         | (2,573   | )
|                         | Issuance of common stock options to consultants                                                                                                  |                                                 |    |           |   |              |         | 6,360        |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 6,360    |  
|                         | Deferred compensation associated with options
    canceled                                                                                       |                                                 |    |           |   |              |         | (8,725       | ) |             |        |              |  |   |         | 8,725   |   |   |          |         |   |   |         |         |  
|                         | Deferred stock compensation                                                                                                                      |                                                 |    |           |   |              |         | 7,553        |   |             |        |              |  |   |         | (7,553  | ) |   |          |         |   |   |         |         |  
|                         | Amortization of deferred stock compensation                                                                                                      |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         | 43,867  |   |   |          |         |   |   |         | 43,867   |  
|                         | Issuance of 28,729 shares of common stock upon
    exercise of warrants                                                                          |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         |          |  
|                         | Other                                                                                                                                            |                                                 |    |           |   |              |         | 126          |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 126      |  
|                         | Net loss and comprehensive loss                                                                                                                  |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         |        |   |   |          | (119,532 | ) |   |         | (119,532 | )
|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |               |  |   |         |         |   |   |          |          |   |   |         |         
|Balance at June 30, 2001 |                                                                                                                                                  |                                                 | 65 |            |   |              | 488,341 |              |   |             | (2,048 | )             |  |   | (34,686 | )       |   |   | (206,318 | )        |   |   | 245,354 |         
|                         | Issuance of 1,478,423 shares of common stock upon
    exercise of stock options and share purchase rights                                        |                                                 |    | 1          |   |              |         | 874          |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 875      |  
|                         | Issuance of 134,828 shares of common stock
    relating to employee stock purchase plan                                                          |                                                 |    |           |   |              |         | 539          |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 539      |  
|                         | Payments received on stockholders notes
    receivable                                                                                          |                                                 |    |           |   |              |         |             |   |             |        | 657           |  |   |         |        |   |   |          |         |   |   |         | 657      |  
|                         | Forgiveness of stockholders notes receivable                                                                                                    |                                                 |    |           |   |              |         |             |   |             |        | 126           |  |   |         |        |   |   |          |         |   |   |         | 126      |  
|                         | Issuance of 2,750,318 shares of common stock and
    assumption of options for 106,804 shares of common stock upon
    acquisition of LambdaFlex |                                                 |    | 3          |   |              |         | 12,363       |   |             |        |              |  |   |         | (577    | ) |   |          |         |   |   |         | 11,789   |  
|                         | Repurchase of 178,011 shares of common stock                                                                                                     |                                                 |    |           |   |              |         | (191         | ) |             |        |              |  |   |         |        |   |   |          |         |   |   |         | (191     | )
|                         | Issuance of common stock options to consultants                                                                                                  |                                                 |    |           |   |              |         | 28           |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 28       |  
|                         | Deferred compensation associated with options
    canceled                                                                                       |                                                 |    |           |   |              |         | (14,271      | ) |             |        |              |  |   |         | 14,271  |   |   |          |         |   |   |         |         |  
|                         | Deferred stock compensation                                                                                                                      |                                                 |    |           |   |              |         | 7,961        |   |             |        |              |  |   |         | (7,961  | ) |   |          |         |   |   |         |         |  
|                         | Amortization of deferred stock compensation                                                                                                      |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         | 16,954  |   |   |          |         |   |   |         | 16,954   |  
|                         | Other                                                                                                                                            |                                                 |    |           |   |              |         | (356         | ) |             |        |              |  |   |         |        |   |   |          |         |   |   |         | (356     | )
|                         | Net loss and comprehensive loss                                                                                                                  |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         |        |   |   |          | (77,777  | ) |   |         | (77,777  | )
|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |               |  |   |         |         |   |   |          |          |   |   |         |         
|Balance at June 30, 2002 |                                                                                                                                                  |                                                 | 69 |            |   |              | 495,288 |              |   |             | (1,265 | )             |  |   | (11,999 | )       |   |   | (284,095 | )        |   |   | 197,998 |         
|                         | Issuance of 748,887 shares of common stock upon
    exercise of stock options and share purchase rights                                          |                                                 |    | 1          |   |              |         | 253          |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 254      |  
|                         | Issuance of 326,016 shares of common stock
    relating to employee stock purchase plan                                                          |                                                 |    |           |   |              |         | 389          |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 389      |  
|                         | Payments received on stockholders notes
    receivable                                                                                          |                                                 |    |           |   |              |         |             |   |             |        | 1,107         |  |   |         |        |   |   |          |         |   |   |         | 1,107    |  
|                         | Forgiveness of stockholders notes receivable                                                                                                    |                                                 |    |           |   |              |         |             |   |             |        | 3             |  |   |         |        |   |   |          |         |   |   |         | 3        |  
|                         | Repurchase of 1,098,784 shares of common stock                                                                                                   |                                                 |    | (1         | ) |              |         | (419         | ) |             |        | 155           |  |   |         |        |   |   |          |         |   |   |         | (265     | )
|                         | Deferred compensation associated with options
    canceled                                                                                       |                                                 |    |           |   |              |         | (11,556      | ) |             |        |              |  |   |         | 11,556  |   |   |          |         |   |   |         |         |  
|                         | Amortization of deferred stock compensation                                                                                                      |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         | (385    | ) |   |          |         |   |   |         | (385     | )
|                         | Stock based compensation related to stock options
    to consultants                                                                             |                                                 |    |           |   |              |         | 39           |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 39       |  
|                         | Stock based compensation related to acceleration
    of an option                                                                                |                                                 |    |           |   |              |         | 34           |   |             |        |              |  |   |         |        |   |   |          |         |   |   |         | 34       |  
|                         | Net loss and comprehensive loss                                                                                                                  |                                                 |    |           |   |              |         |             |   |             |        |              |  |   |         |        |   |   |          | (102,912 | ) |   |         | (102,912 | )
|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |               |  |   |         |         |   |   |          |          |   |   |         |         
|Balance at June 30, 2003 |                                                                                                                                                  | $                                               | 69 |            |   | $            | 484,028 |              |   | $           |       |               |  | $ | (828    | )       |   | $ | (387,007 | )        |   | $ | 96,262  |         
|                         |                                                                                                                                                  |                                                 |    |            |   |              |         |              |   |             |        |               |  |   |         |         |   |   |          |          |   |   |         |         

See accompanying notes.

49



---



##### Table of Contents



AVANEX CORPORATION

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |        |         |         |  
|------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------------- | ------------------------------------------------------- | ------ | ------ | ------- | -------- | ------ | ------- | ------- | -------- | ------ | ------- | ------- | -
|                                                                                |                                              |                                            
|                                                                                |                                              | Years Ended June 30,                       
|                                                                                |                                              |                                            
|                                                                                |                                              | 2003                                        |                                                         | 2002   |        | 2001   
|                                                                                |                                              |                                             |                                                         |        |        |        
|                                                                                |                                              |                                            
|                                                                                |                                              | (In thousands)                             
|Operating activities                                                            |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Net loss                                                                        |                                              | $                                           | (102,912                                                | )      |        | $       | (77,777  | )      |         | $       | (119,532 | )     
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|                                                                                | Depreciation and amortization                |                                             |                                                         | 9,534  |        |         |          | 10,478 |         |         |          | 9,622  |        
|                                                                                | Amortization of intangibles                  |                                             |                                                         | 200    |        |         |          | 10,502 |         |         |          | 9,653  |        
|                                                                                | Stock compensation expense (recovery)        |                                             |                                                         | (309   | )      |         |          | 16,648 |         |         |          | 50,353 |        
|                                                                                | Acquired in-process research and development |                                             |                                                         |       |        |         |          | 5,445  |         |         |          | 4,700  |        
|                                                                                | Non-cash portion of restructuring charges    |                                             |                                                         | 3,814  |        |         |          | 17,216 |         |         |          | 14,680 |        
|                                                                                | Provision for excess inventory               |                                             |                                                         | 4,327  |        |         |          | 4,345  |         |         |          | 34,661 |        
|                                                                                | Provision for doubtful accounts              |                                             |                                                         | 82     |        |         |          | 307    |         |         |          | 557    |        
|                                                                                | Provision (reduction) for warranty accrual   |                                             |                                                         | (987   | )      |         |          | (1,507 | )       |         |          | 3,871  |        
|                                                                                | Charge for merger costs                      |                                             |                                                         | 4,126  |        |         |          |       |         |         |          |       |        
|                                                                                | Reduction in long-lived assets               |                                             |                                                         | 1,548  |        |         |          |       |         |         |          |       |        
|                                                                                | Cumulative effect of an accounting change    |                                             |                                                         | 37,500 |        |         |          |       |         |         |          |       |        
|                                                                                | Changes in operating assets and liabilities: |                                             |                                                         |        |        |         |          |        |         |         |          |        |        
|                                                                                |                                              | Accounts receivable                         |                                                         |        | 2,159  |         |          |        | 8,820   |         |          |        | (4,527  | )      
|                                                                                |                                              | Inventories                                 |                                                         |        | (1,425 | )       |          |        | (4,409  | )       |          |        | (27,510 | )      
|                                                                                |                                              | Other current assets                        |                                                         |        | (53    | )       |          |        | 59      |         |          |        | 1,048   |        
|                                                                                |                                              | Other assets                                |                                                         |        | 99     |         |          |        | 187     |         |          |        | 1,114   |        
|                                                                                |                                              | Accounts payable                            |                                                         |        | 729    |         |          |        | (11,138 | )       |          |        | 504     |        
|                                                                                |                                              | Accrued compensation and related expenses   |                                                         |        | (662   | )       |          |        | (1,843  | )       |          |        | 1,744   |        
|                                                                                |                                              | Accrued restructuring                       |                                                         |        | 10,844 |         |          |        | (5,976  | )       |          |        | 9,798   |        
|                                                                                |                                              | Warranty                                    |                                                         |        | (148   | )       |          |        | (240    | )       |          |        | (223    | )      
|                                                                                |                                              | Other accrued expenses and deferred revenue |                                                         |        | (1,990 | )       |          |        | (4,770  | )       |          |        | 2,834   |        
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|                                                                                |                                              |                                             | Net cash used in operating activities                   |        |        | (33,524 | )        |        |         | (33,653 | )        |        |         | (6,653  | )
|Investing activities                                                            |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Purchases of held-to-maturity securities                                        |                                              |                                             | (79,943                                                 | )      |        |         | (193,233 | )      |         |         | (129,420 | )     
|Maturities of held-to-maturity securities                                       |                                              |                                             | 103,258                                                 |        |        |         | 187,793  |        |         |         | 137,980  |       
|Purchases of property and equipment                                             |                                              |                                             | (416                                                    | )      |        |         | (2,261   | )      |         |         | (22,807  | )     
|Other assets                                                                    |                                              |                                             | (1,988                                                  | )      |        |         | (2,618   | )      |         |         |         |       
|Acquisition of subsidiaries, net of cash assumed                                |                                              |                                             |                                                        |        |        |         | 234      |        |         |         | (3,047   | )     
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|                                                                                |                                              |                                             | Net cash provided by (used in) investing
    activities |        |        | 20,911  |          |        |         | (10,085 | )        |        |         | (17,294 | )
|Financing activities                                                            |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Payments on long-term debt and capital lease
    obligations                    |                                              |                                             | (5,078                                                  | )      |        |         | (7,389   | )      |         |         | (2,820   | )     
|Payments on short-term borrowings                                               |                                              |                                             | (6,035                                                  | )      |        |         | (4,510   | )      |         |         |         |       
|Proceeds from short-term borrowings and long-term
    debt                      |                                              |                                             | 3,141                                                   |        |        |         | 4,057    |        |         |         | 10,231   |       
|Proceeds from issuance of common stock, net of
    repurchases                  |                                              |                                             | 378                                                     |        |        |         | 1,414    |        |         |         | 1,760    |       
|Proceeds from payments of stockholders
    notes receivable                    |                                              |                                             | 1,107                                                   |        |        |         | 657      |        |         |         | 3,125    |       
|Other                                                                           |                                              |                                             |                                                        |        |        |         | (65      | )      |         |         |         |       
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|                                                                                |                                              |                                             | Net cash provided by (used in) financing
    activities |        |        | (6,487  | )        |        |         | (5,836  | )        |        |         | 12,296  |  
|Net decrease in cash and cash equivalents                                       |                                              |                                             | (19,100                                                 | )      |        |         | (49,574  | )      |         |         | (11,651  | )     
|Cash and cash equivalents at beginning of year                                  |                                              |                                             | 29,739                                                  |        |        |         | 79,313   |        |         |         | 90,964   |       
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Cash and cash equivalents at end of year                                        |                                              | $                                           | 10,639                                                  |        |        | $       | 29,739   |        |         | $       | 79,313   |       
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Supplemental disclosures of non-cash
    transactions                           |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Equipment acquired under capital leases                                         |                                              | $                                           |                                                        |        |        | $       | 1,187    |        |         | $       | 15,561   |       
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Supplemental disclosures of cash flow
    information                           |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       
|Interest paid                                                                   |                                              | $                                           | 1,334                                                   |        |        | $       | 2,492    |        |         | $       | 1,299    |       
|                                                                                |                                              |                                             |                                                         |        |        |         |          |        |         |         |          |       

See accompanying notes.

50



---



##### Table of Contents



AVANEX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

June 30, 2003




|   |                                               
|-- | ----------------------------------------------
|1. | Summary of Significant Accounting
    Policies



| |                                           
| | ------------------------------------------
| | Organization and Basis of
    Presentation

Avanex Corporation (Avanex or
the Company) manufactures and markets fiber
optic-based products, known as photonic processors, which are
designed to increase the performance of optical networks.

The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries.
Intercompany accounts and transactions have been eliminated in
consolidation.



| |                 
| | ----------------
| | Use of Estimates

The preparation of consolidated financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.
Actual results could differ materially from those estimates.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash and cash equivalents consist of cash, money
market funds, and other highly liquid investments with
maturities of three months or less when purchased.



| |                                        
| | ---------------------------------------
| | Fair Value of Financial
    Instruments

The carrying value of cash, cash equivalents,
short-term and long-term investments, accounts receivable, notes
receivable from stockholders, accounts payable, other accrued
expenses, short-term borrowings and long-term obligations
approximates fair value.



| |            
| | -----------
| | Investments

Management determines the appropriate
classification of its investments in debt securities at the time
of purchase and reevaluates such designation as of each balance
sheet date. Debt securities are classified as held-to-maturity
when the Company has the positive intent and ability to hold the
securities to maturity. Held-to-maturity securities are stated
at cost.

Debt securities not classified as
held-to-maturity are classified as available-for-sale.
Available-for-sale securities are stated at fair value, based
upon quoted market prices of the securities, with the unrealized
gains and losses reported in a separate component of other
stockholders equity. Management has classified its entire
investment portfolio as held-to-maturity.

The cost of debt securities classified as
held-to-maturity or available-for-sale is adjusted for
amortization of premiums and accretion of discounts to maturity,
or in the case of mortgage-backed securities, over the estimated
life of the security. Such amortization and interest on the
securities are included in interest income. The cost of
securities sold is based on the specific identification method.



| |                             
| | ----------------------------
| | Concentration of Credit Risk

Financial instruments, which subject the Company
to potential credit risk, consist of demand deposit accounts,
money market accounts, short-term and long-term investments,
notes receivable from stockholders and accounts receivable. The
Company maintains its demand deposit accounts, money market
accounts and short-term and long-term investments primarily with
two financial institutions. The Company invests its excess cash
principally in debt securities.

51



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company sells primarily to large
communication vendors. The Company extends reasonably short
collection terms but does not require collateral. The Company
provides reserves for potential credit losses. The Company has
not experienced significant credit losses to date.
Concentrations of credit risk, with respect to these financial
instruments, exist to the extent of amounts presented in the
financial statements.



| |                    
| | -------------------
| | Revenue Recognition

The Companys revenue recognition policy
follows SEC Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition in Financial Statements.
Specifically, the Company recognizes product revenue when
persuasive evidence of an arrangement exists, the product has
been shipped, title has transferred, collectibility is
reasonably assured, fees are fixed or determinable and there are
no uncertainties with respect to customer acceptance. For
shipments to new customers and evaluation units, including
initial shipments of new products, where the customer has the
right of return through the end of the evaluation period, the
Company recognizes revenue on these shipments at the end of an
evaluation period, if not returned, and when collection is
reasonably assured. The Company records a provision for
estimated sales returns in the same period as the related
revenues are recorded which is netted against revenue. These
estimates are based on historical sales returns, other known
factors and the Companys return policy.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost less
accumulated depreciation and amortization. Depreciation is
provided on the straight-line method over the useful lives of
the assets, generally two to five years. Leasehold improvements
are amortized over the shorter of the lease term or the
estimated useful life.



| |                  
| | -----------------
| | Intangible Assets

Intangible assets result from acquisitions.
Intangible assets with indefinite lives are no longer amortized,
but rather are subject to an annual impairment test. Intangible
assets with definite lives will be amortized over their
estimated useful lives. Prior to the adoption of SFAS 142,
the Company amortized goodwill and other intangible assets over
their estimated useful lives of 3 to 5 years.



| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

The Company reviews long-lived assets, including
property, equipment and intangibles, for impairment whenever
events or changes in business circumstances indicate that the
carrying amount of the assets may not be fully recoverable. An
impairment loss would be recognized when estimated undiscounted
future cash flows expected to result from the use of the asset
and its eventual disposition is less than its carrying amount.
Impairment, if any, is determined using discounted cash flows.



| |                                   
| | ----------------------------------
| | Research and Development
    Costs

Research and development costs are expensed as
incurred.



| |                         
| | ------------------------
| | Stock-Based Compensation

Stock based awards to employees are accounted for
under the intrinsic value method. Accordingly, deferred stock
compensation is recognized for an option or share purchase right
that has an exercise price that is less than the fair value of
the common shares and is calculated as the difference between
the option price or share purchase right exercise price at the
date of grant and the fair value of the Companys common
shares at that date. Such deferred stock compensation is
amortized over the vesting period, generally a maximum of four
years.

52



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Equity instruments granted to consultants are
accounted for under the fair value method using the
Black-Scholes option pricing model and are subject to periodic
revaluations over their vesting terms. The expense is recognized
as the instruments vest.



| |                                                                    
| | -------------------------------------------------------------------
| | Pro Forma Disclosures of the Effect of
    Stock-Based Compensation

Pro forma information regarding net loss and net
loss per common share under the fair value method for options
and share repurchase rights granted prior to the Companys
initial public offering was estimated at the date of grant using
the minimum value method. The fair value of stock options, share
purchase rights and shares issued under the employee stock
purchase plan (collectively the options) granted
subsequent to the initial public offering were valued using
Black-Scholes valuation model based on the actual stock closing
price on the day previous to the date of grant. The option
valuation models were developed for use in estimating the fair
value of traded options that have no vesting restrictions and
are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions. Because the
Companys stock-based awards have characteristics
significantly different from those of traded options and because
changes in the subjective input assumptions can materially
affect the fair value estimate, in managements opinion,
the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards. The fair
value of these options was estimated at the date of grant using
the following weighted-average assumptions:

|                               |  |                            |         |                              |  |      |         |      |  |      |         |      |  |  |           |  |  |  |           |  |  |  |           | 
|------------------------------ |  | -------------------------- | ------- | ---------------------------- |  | ---- | ------- | ---- |  | ---- | ------- | ---- |  |  | --------- |  |  |  | --------- |  |  |  | --------- | 
|                               |  |                            |         |                             
|                               |  | Employee Stock Option Plan |         | Employee Stock Purchase Plan
|                               |  |                            |         |                             
|                               |  |                            |         |                             
|                               |  | Years Ended June 30,       |         | Years Ended June 30,        
|                               |  |                            |         |                             
|                               |  | 2003                       |         | 2002                         |  | 2001 |         | 2003 |  | 2002 |         | 2001
|                               |  |                            |         |                              |  |      |         |      |  |      |         |     
|Risk-free interest rate        |  |                            | 2.2%    |                              |  |      | 3.7%    |      |  |      | 5.5%    |      |  |  | 1.7%      |  |  |  | 3.1%      |  |  |  | 5.7%      | 
|Weighted-average expected life |  |                            | 3 years |                              |  |      | 3 years |      |  |      | 3 years |      |  |  | 0.5 years |  |  |  | 0.5 years |  |  |  | 0.5 years | 
|Volatility                     |  |                            | 1.13    |                              |  |      | 1.01    |      |  |      | 0.90    |      |  |  | 1.26      |  |  |  | 1.01      |  |  |  | 0.90      | 
|Dividend yield                 |  |                            |        |                              |  |      |        |      |  |      |        |      |  |  |          |  |  |  |          |  |  |  |          | 

For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over
the options vesting period. The Companys pro forma
information is as follows (in thousands, except per share data):

|                                             |                                                                                                              |                      |   |          |   |      |   |         |   |  |   |          |  
|-------------------------------------------- | ------------------------------------------------------------------------------------------------------------ | -------------------- | - | -------- | - | ---- | - | ------- | - |  | - | -------- | -
|                                             |                                                                                                              |                     
|                                             |                                                                                                              | Years Ended June 30,
|                                             |                                                                                                              |                     
|                                             |                                                                                                              | 2003                 |   | 2002     |   | 2001
|                                             |                                                                                                              |                      |   |          |   |     
|Net loss:                                    |                                                                                                              |                      |   |          |   |      |   |         |   |  |   |         
|                                             | As reported                                                                                                  |                      | $ | (102,912 | ) |      | $ | (77,777 | ) |  | $ | (119,532 | )
|                                             | Stock-based employee compensation expense
    (recovery) included in reported net loss                       |                      |   | (351     | ) |      |   | 16,561  |   |  |   | 46,598   |  
|                                             | Total stock-based employee compensation expense
    determined under fair value based methods for all awards |                      |   | (2,626   | ) |      |   | (38,029 | ) |  |   | (93,473  | )
|                                             |                                                                                                              |                      |   |          |   |      |   |         |   |  |   |         
|                                             | Pro forma                                                                                                    |                      | $ | (105,889 | ) |      | $ | (99,245 | ) |  | $ | (166,407 | )
|                                             |                                                                                                              |                      |   |          |   |      |   |         |   |  |   |         
|Basic and diluted net loss per common share: |                                                                                                              |                      |   |          |   |      |   |         |   |  |   |         
|                                             | As reported                                                                                                  |                      | $ | (1.51    | ) |      | $ | (1.21   | ) |  | $ | (2.07    | )
|                                             | Pro forma                                                                                                    |                      | $ | (1.55    | ) |      | $ | (1.54   | ) |  | $ | (2.89    | )

The pro forma impact of options on the
consolidated net loss attributable to common stockholders for
the years ended June 30, 2003, 2002 and 2001 is not
representative of the effects on consolidated net income

53



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

(loss) attributable to common stockholders for
future years, as future years will include the effects of
additional stock option grants.



| |            
| | -----------
| | Inventories

Inventories consist of raw materials,
work-in-process and finished goods and are stated at the lower
of cost or market. Cost is computed on a currently adjusted
standard basis (which approximates actual costs on a first-in,
first-out basis).

The Company writes off 100% of the cost of
inventory that the Company specifically identifies and considers
obsolete or excessive to fulfill future sales estimates. The
Company defines obsolete inventory as inventory that will no
longer be used in the manufacturing process. Excess inventory is
generally defined as inventory in excess of projected usage, and
is determined using managements best estimate of future
demand at the time, based upon information then available to the
Company.

In estimating excess inventory, through
June 30, 2003, the Company used a three-month demand
forecast. The Company also considers: 1) parts and
subassemblies that can be used in alternative finished products,
2) parts and subassemblies that are unlikely to be
engineered out of the Companys products, and 3) known
design changes which would reduce the Companys ability to
use the inventory as planned.



| |             
| | ------------
| | Income Taxes

The Company uses the liability method to account
for income taxes. Under this method, deferred tax assets and
liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities.
Deferred tax assets and liabilities are measured using enacted
tax rates and laws that will be in effect when the differences
are expected to reverse.



| |                  
| | -----------------
| | Advertising Costs

The Company expenses advertising costs as
incurred. Advertising expenses for the years ended June 30,
2003, 2002 and 2001 were $251,000, $638,000 and $932,000,
respectively, and are included in sales and marketing expenses.



| |                                     
| | ------------------------------------
| | Recent Accounting
    Pronouncements

In June 2002, the Financial Accounting Standards
Board (FASB) issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities
(SFAS 146), effective for exit or disposal activities that
are initiated after December 31, 2002. Under SFAS 146,
a liability for the cost associated with an exit or disposal
activity is recognized when the liability is incurred. Under
prior guidance, a liability for such costs could be recognized
at the date of commitment to an exit plan. The provisions of
SFAS 146 are required to be applied prospectively after the
adoption date to newly initiated exit activities, and will
affect the timing of recognizing future restructuring costs, as
well as the amounts recognized.

In November 2002, the Emerging Issues Task Force
(EITF) reached a consensus on EITF 00-21 Accounting
for Revenue Arrangements with Multiple Deliverables.
EITF 00-21 sets out criteria for when revenue on a
deliverable can be recognized separately from other deliverables
in a multiple deliverable arrangement. EITF 00-21 will be
effective for fiscal years beginning after June 15, 2003.
The Company believes that the adoption of this standard will
have no material impact on its financial statements.

In November 2002, the FASB issued FASB
Interpretation No. 45 (FIN 45) Guarantors
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN 45
requires that a liability be recorded in the guarantors
balance sheet upon issuance of a guarantee. In addition,
FIN 45 requires disclosures about the guarantees that an
entity has issued, including a reconciliation

54



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement
provisions are applicable on a prospective basis to guarantees
issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim
or annual periods ending after December 15, 2002. The
Company believes that the adoption of this standard had no
material impact on its financial statements.

In December 2002, the FASB issued SFAS
No. 148 Accounting for Stock-Based Compensation,
Transition and Disclosure. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also requires that disclosures
of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed
more prominently and in a tabular format. Additionally, SFAS
No. 148 requires disclosure of the pro forma effect in
interim financial statements. The transition and annual
disclosure requirements are effective for fiscal years ended
after December 15, 2002. The interim disclosure
requirements are effective for interim periods ending after
December 15, 2002. The Company adopted the disclosure
requirements of SFAS No. 148 in the second quarter of
fiscal 2003. The Company will continue to account for its stock
purchase plan and stock option plans under the provisions of APB
No. 25.

In January 2003, the FASB issued FASB
Interpretation No. 46 (FIN 46) Consolidation of
Variable Interest Entities, an Interpretation of ARB
No. 51. FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have
the characteristics of a controlling financial interest or do
not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support
from other parties. FIN 46 is effective immediately for all
new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of
FIN 46 must be applied for the first interim or annual
period beginning after June 15, 2003. The Company believes
that the adoption of this standard will have no material impact
on its financial statements.



|   |                      
|-- | ---------------------
|2. | Restructuring Charges



| |                          
| | -------------------------
| | Fiscal 2003 Restructuring

In the first quarter of fiscal 2003, the Company
announced a restructuring program to downsize its workforce,
primarily in its manufacturing operations. In addition, the
Company announced the closing of its facility in Richardson,
Texas and the integration of the functions in Richardson into
its facility in Fremont, California. The Company also
consolidated its facilities in Fremont. During the second
quarter of fiscal 2003, the Company reassessed its initial
estimate of probable costs and the sublease timeline associated
with abandoning each of its excess leased facilities. The
reassessment was prompted by a further decline in the real
estate market in the cities where those facilities are located.
After considering information provided to the Company by its
real estate advisors, the Company concluded it was probable
these facilities could not be subleased at rates originally
contemplated nor could they be subleased in the timeframe
originally planned. During the third quarter of fiscal 2003, the
Company continued to restructure and downsize its workforce,
primarily in its manufacturing operations. Additionally, the
Company further consolidated its facilities in Fremont. In the
fourth quarter of fiscal 2003, the Company continued to downsize
its workforce, primarily in manufacturing.



| |                    
| | -------------------
| | Workforce Reduction

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

55



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                
| | -------------------------------
| | Abandonment of Excess Equipment

The Company abandoned excess equipment and
leasehold improvements and recorded charges of $3.5 million
during fiscal 2003. The equipment was abandoned because it was
no longer required to support expected operating levels and,
given the downturn in its industry, the Company concluded it
could not be sold.



| |                                            
| | -------------------------------------------
| | Abandonment of Excess Leased
    Facilities

The Company is attempting to sublease
approximately 85,600 square feet at its Fremont, California
facility, as well as the remaining portion of the facilities
leased at its Richardson, Texas facility. In September 2002, the
Company engaged real estate advisors to assist it in subleasing
the vacated space within these two buildings. Given the current
real estate market conditions, the Company does not expect to be
able to sublease these buildings before December 2004. The
Company recorded charges of $11.8 million during fiscal
2003 related to these excess facilities.

A summary of the accrued restructuring charges is
as follows (in thousands):

|                                        |       |               |       |          |  |         |       |           |  |            |      |               |   |   |        |        |   |   |        |        |   |   |        |        | 
|--------------------------------------- | ----- | ------------- | ----- | -------- |  | ------- | ----- | --------- |  | ---------- | ---- | ------------- | - | - | ------ | ------ | - | - | ------ | ------ | - | - | ------ | ------ | 
|                                        |       | Charge in     |       |          |  |         |       |           |  |            |      |              
|                                        |       | September     |       |          |  |         |       |           |  |            |      | Restructuring
|                                        |       | 2002 and      |       | Charge   |  | Charge  |       | Non-Cash  |  | Cash       |      | Accrual at   
|                                        |       | December 2002 |       | in March |  | in June |       | Credit/   |  | Receipts   |      | June 30,     
|                                        |       | Adjustment    |       | 2003     |  | 2003    |       | (Charges) |  | (Payments) |      | 2003         
|                                        |       |               |       |          |  |         |       |           |  |            |      |              
|Workforce Reduction                     |       | $             | 2,114 |          |  | $       | 700   |           |  | $          | 198  |               |   | $ |       |        |   | $ | (2,895 | )      |   | $ | 117    |       
|Abandonment of excess equipment         |       |               | 3,103 |          |  |         | 631   |           |  |            | (242 | )             |   |   | (3,814 | )      |   |   | 322    |        |   |   |       |       
|Abandonment of excess leased facilities |       |               | 8,390 |          |  |         | 3,419 |           |  |            |     |               |   |   | 573    |        |   |   | (940   | )      |   |   | 11,442 |       
|                                        |       |               |       |          |  |         |       |           |  |            |      |               |   |   |        |        |   |   |        |        |   |   |        |       
|                                        | Total |               | $     | 13,607   |  |         | $     | 4,750     |  |            | $    | (44           | ) |   | $      | (3,241 | ) |   | $      | (3,513 | ) |   | $      | 11,559 | 
|                                        |       |               |       |          |  |         |       |           |  |            |      |               |   |   |        |        |   |   |        |        |   |   |        |       

Remaining cash expenditures relating to workforce
reduction will be paid through the second quarter of fiscal
2004. Amounts related to the abandonment of excess leased
facilities are expected to be paid as the lease payments are due
through the remainder of the lease terms ending in 2010.



| |                          
| | -------------------------
| | Fiscal 2001 Restructuring

During the fourth quarter of fiscal 2001, the
Company announced a restructuring program to realign resources
in response to the changes in its industry and customer demand.
As a result of the restructuring program, the Company recorded a
restructuring charge of $22.6 million in the fourth quarter
of fiscal 2001. During the third quarter of fiscal 2002, the
Company reassessed its initial estimate of probable costs and
the sublease timeline associated with abandoning excess leased
facilities in Newark, California and Richardson, Texas. The
reassessment was prompted by a further decline in the real
estate market in the cities where the facilities are located.
After considering information provided by its real estate
advisors, the Company concluded it was probable these facilities
could not be subleased at the rates originally contemplated nor
could they be subleased in the timeframe originally planned. As
a result, the Company recorded an additional charge of
$17.2 million relating to these facilities in the third
quarter of fiscal 2002. In the second quarter of fiscal 2003,
the Company again reassessed its estimates associated with these
abandoned leased facilities. As a result, the Company recorded
an additional charge of $4.1 million relating to the Newark
facilities in fiscal 2003. This additional charge considers
current lease rates for similar facilities as well as costs
associated with the estimated added holding period through
December 2004.

56



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A summary of the accrued restructuring charges is
as follows (in thousands):

|                                        |       |               |        |             |  |            |       |               |  |   |        |        |   |   |        |        | 
|--------------------------------------- | ----- | ------------- | ------ | ----------- |  | ---------- | ----- | ------------- |  | - | ------ | ------ | - | - | ------ | ------ | 
|                                        |       | Restructuring |        | Adjustment  |  | Cash       |       | Restructuring
|                                        |       | Accrual at    |        | in December |  | Receipts   |       | Accrual at   
|                                        |       | June 30, 2002 |        | 2002        |  | (Payments) |       | June 30, 2003
|                                        |       |               |        |             |  |            |       |              
|Abandonment of excess equipment         |       | $             |       |             |  | $          | (21   | )             |  | $ | 21     |        |   | $ |       |       
|Abandonment of excess leased facilities |       |               | 18,574 |             |  |            | 4,146 |               |  |   | (3,354 | )      |   |   | 19,366 |       
|Capital leases                          |       |               | 2,464  |             |  |            |      |               |  |   | (934   | )      |   |   | 1,530  |       
|                                        |       |               |        |             |  |            |       |               |  |   |        |        |   |   |        |       
|                                        | Total |               | $      | 21,038      |  |            | $     | 4,125         |  |   | $      | (4,267 | ) |   | $      | 20,896 | 
|                                        |       |               |        |             |  |            |       |               |  |   |        |        |   |   |        |       

Amounts related to the abandonment of excess
leased facilities will be paid as the payments are due through
the remainder of the lease term through 2010. Capital leases
payments are due over the term of the leases through the third
quarter of fiscal 2005.

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

|                             |  |          |        |          |  |   |        | 
|---------------------------- |  | -------- | ------ | -------- |  | - | ------ | 
|                             |  | June 30, |        | June 30,
|                             |  | 2003     |        | 2002    
|                             |  |          |        |         
|Total restructuring accruals |  | $        | 32,455 |          |  | $ | 21,038 | 
|Less current portion         |  |          | 6,400  |          |  |   | 4,349  | 
|                             |  |          |        |          |  |   |        | 
|Long-term portion            |  | $        | 26,055 |          |  | $ | 16,689 | 
|                             |  |          |        |          |  |   |        | 



|   |                   
|-- | ------------------
|3. | Net Loss Per Share

The following table presents the calculation of
basic and diluted net loss per share (in thousands, except per
share data):

|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|--------------------------------------------------------------------------------------------------- |  | -------------------- | -------- | ---- |  | ---- | ------- | - |  | - | -------- | -
|                                                                                                    |  |                     
|                                                                                                    |  | Years Ended June 30,
|                                                                                                    |  |                     
|                                                                                                    |  | 2003                 |          | 2002 |  | 2001
|                                                                                                    |  |                      |          |      |  |     
|Loss before cumulative effect of an accounting
    change                                           |  | $                    | (65,412  | )    |  | $    | (77,777 | ) |  | $ | (119,532 | )
|Cumulative effect of an accounting change to
    adopt SFAS 142                                     |  |                      | (37,500  | )    |  |      |        |   |  |   |         |  
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|Net loss                                                                                            |  | $                    | (102,912 | )    |  | $    | (77,777 | ) |  | $ | (119,532 | )
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|Basic and diluted:                                                                                  |  |                      |          |      |  |      |         |   |  |   |          |  
|Weighted-average number of shares of common stock
    outstanding                                   |  |                      | 69,285   |      |  |      | 68,082  |   |  |   | 65,181   |  
|Less: weighted-average number of shares subject
    to repurchase                                   |  |                      | (914     | )    |  |      | (3,774  | ) |  |   | (7,561   | )
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|Weighted-average number of shares used in
    computing basic and diluted net loss per common share |  |                      | 68,371   |      |  |      | 64,308  |   |  |   | 57,620   |  
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|Loss per share before cumulative effect of an
    accounting change                                 |  | $                    | (0.96    | )    |  | $    | (1.21   | ) |  | $ | (2.07    | )
|Cumulative per share effect of an accounting
    change to adopt SFAS 142                           |  |                      | (0.55    | )    |  |      |        |   |  |   |         |  
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  
|Basic and diluted net loss per common share                                                         |  | $                    | (1.51    | )    |  | $    | (1.21   | ) |  | $ | (2.07    | )
|                                                                                                    |  |                      |          |      |  |      |         |   |  |   |          |  

During all periods presented, the Company had
options outstanding, which could potentially dilute basic
earnings per share in the future, but were excluded from the
computation of diluted net loss per share, as their

57



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

effect would have been antidilutive. Options
outstanding were 8,825,000 at June 30, 2003, 12,697,000 at
June 30, 2002 and 7,288,000 at June 30, 2001.



|   |                                  
|-- | ---------------------------------
|4. | Consolidated Balance Sheet Detail



| |                                                           
| | ----------------------------------------------------------
| | Cash Equivalents, Short-Term and Long-Term
    Investments

The Company generally invests its excess cash in
debt instruments of the U.S. Treasury, government agencies
and corporations with strong credit ratings. Such investments
are made in accordance with the Companys investment
policy, which establishes guidelines relative to diversification
and maturities designed to maintain safety and liquidity. These
guidelines are periodically reviewed and modified to take
advantage of trends in yields and interest rates. To date, the
Company has not experienced any significant losses on its
investments.

Cash equivalents, short-term and long-term
investments consist of the following (in thousands):

|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |        |         | 
|-------------------------------------------------------------- | --------------------------------- | ------------- | ------ | ---------- | ------- | ---------- | --- | ---------- | --- |  | --- | --- | --- | - | ------ | ------ | ------- | 
|                                                               |                                   |              
|                                                               |                                   | June 30, 2003
|                                                               |                                   |              
|                                                               |                                   |               |        | Gross      |         | Gross      |     |           
|                                                               |                                   | Amortized     |        | Unrealized |         | Unrealized |     | Estimated 
|                                                               |                                   | Cost          |        | Gains      |         | Losses     |     | Fair Value
|                                                               |                                   |               |        |            |         |            |     |           
|Cash Equivalents                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               | Money Market Funds                |               | $      | 10,714     |         |            | $   | 15         |     |  | $   |    |     |   | $      | 10,729 |        
|Short Term Investments                                         |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               | Corporate Notes                   |               |        | 7,677      |         |            |     |           |     |  |     | (45 | )   |   |        | 7,632  |        
|                                                               | Certificate of Deposits           |               |        | 2,376      |         |            |     |           |     |  |     |    |     |   |        | 2,376  |        
|                                                               | Auction Rate Receipts             |               |        | 3,875      |         |            |     |           |     |  |     |    |     |   |        | 3,875  |        
|                                                               | Market Auction Preferreds         |               |        | 19,463     |         |            |     |           |     |  |     | (13 | )   |   |        | 19,450 |        
|                                                               | United States Government Agencies |               |        | 36,639     |         |            |     | 99         |     |  |     |    |     |   |        | 36,738 |        
|                                                               | Corporate Bonds                   |               |        | 4,897      |         |            |     | 44         |     |  |     |    |     |   |        | 4,941  |        
|                                                               | Medium Term Notes                 |               |        | 2,025      |         |            |     | 4          |     |  |     |    |     |   |        | 2,029  |        
|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               |                                   |               | 76,952 |            |         |            | 147 |            |     |  | (58 | )   |     |   | 77,041 |       
|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|Long Term Investments  due between one
    year and two years |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               | Corporate Bonds                   |               |        | 8,677      |         |            |     | 45         |     |  |     |    |     |   |        | 8,722  |        
|                                                               | United States Government Agencies |               |        | 38,386     |         |            |     | 191        |     |  |     |    |     |   |        | 38,577 |        
|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               |                                   |               | 47,063 |            |         |            | 236 |            |     |  |    |     |     |   | 47,299 |       
|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       
|                                                               |                                   | Total         |        | $          | 134,729 |            |     | $          | 398 |  |     | $   | (58 | ) |        | $      | 135,069 | 
|                                                               |                                   |               |        |            |         |            |     |            |     |  |     |     |     |   |        |       

58



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |        |         | 
|-------------------------------------------------------------- | --------------------------------- | ------------- | ------- | ---------- | ------- | ---------- | --- | ---------- | --- |  | -- | -- | -- | - | ------- | ------ | ------- | 
|                                                               |                                   |              
|                                                               |                                   | June 30, 2002
|                                                               |                                   |              
|                                                               |                                   |               |         | Gross      |         | Gross      |     |           
|                                                               |                                   | Amortized     |         | Unrealized |         | Unrealized |     | Estimated 
|                                                               |                                   | Cost          |         | Gains      |         | Losses     |     | Fair Value
|                                                               |                                   |               |         |            |         |            |     |           
|Cash Equivalents                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               | Money Market Funds                |               | $       | 30,420     |         |            | $   |           |     |  | $  |   |    |   | $       | 30,420 |        
|Short Term Investments                                         |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               | Commercial Paper                  |               |         | 2,239      |         |            |     |           |     |  |    |   |    |   |         | 2,239  |        
|                                                               | Corporate Notes                   |               |         | 6,260      |         |            |     | 85         |     |  |    |   |    |   |         | 6,345  |        
|                                                               | Certificate of Deposits           |               |         | 4,737      |         |            |     |           |     |  |    |   |    |   |         | 4,737  |        
|                                                               | Market Auction Preferreds         |               |         | 14,520     |         |            |     |           |     |  |    |   |    |   |         | 14,520 |        
|                                                               | United States Government Agencies |               |         | 46,439     |         |            |     | 218        |     |  |    | (1 | )  |   |         | 46,656 |        
|                                                               | Corporate Bonds                   |               |         | 12,435     |         |            |     | 16         |     |  |    |   |    |   |         | 12,451 |        
|                                                               | Foreign Debt Securities           |               |         | 9,469      |         |            |     | 74         |     |  |    |   |    |   |         | 9,543  |        
|                                                               | Medium Term Notes                 |               |         | 10,247     |         |            |     | 25         |     |  |    | (1 | )  |   |         | 10,271 |        
|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               |                                   |               | 106,346 |            |         |            | 418 |            |     |  | (2 | )  |    |   | 106,762 |       
|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|Long Term Investments  due between one
    year and two years |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               | Certificate of Deposits           |               |         | 750        |         |            |     |           |     |  |    |   |    |   |         | 750    |        
|                                                               | Corporate Notes                   |               |         | 3,119      |         |            |     | 27         |     |  |    |   |    |   |         | 3,146  |        
|                                                               | Corporate Bonds                   |               |         | 5,072      |         |            |     | 49         |     |  |    |   |    |   |         | 5,121  |        
|                                                               | United States Government Agencies |               |         | 29,987     |         |            |     | 218        |     |  |    |   |    |   |         | 30,205 |        
|                                                               | Medium Term Notes                 |               |         | 2,056      |         |            |     | 17         |     |  |    |   |    |   |         | 2,073  |        
|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               |                                   |               | 40,984  |            |         |            | 311 |            |     |  |   |    |    |   | 41,295  |       
|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       
|                                                               |                                   | Total         |         | $          | 177,750 |            |     | $          | 729 |  |    | $  | (2 | ) |         | $      | 178,477 | 
|                                                               |                                   |               |         |            |         |            |     |            |     |  |    |    |    |   |         |       

Estimated fair value is based upon market prices
quoted on the last day of the respective fiscal year.

During fiscal 2002, the Company sold
$5.3 million of held-to-maturity securities. The realized
loss on these sales was not significant. There were no such
sales in fiscal 2003. The Company requires that investments have
specific credit ratings, in accordance with its investment
policy. The credit ratings for the two investments which were
sold, had been reduced to a level which was not in accordance
with the investment policy, therefore the investments were sold
prior to maturity.



| |            
| | -----------
| | Inventories

Inventories consist of the following (in
thousands):

|                |  |          |       |      |  |   |       | 
|--------------- |  | -------- | ----- | ---- |  | - | ----- | 
|                |  |         
|                |  | June 30,
|                |  |         
|                |  | 2003     |       | 2002
|                |  |          |       |     
|Raw materials   |  | $        | 2,228 |      |  | $ | 2,560 | 
|Work-in-process |  |          | 845   |      |  |   | 3,145 | 
|Finished goods  |  |          | 540   |      |  |   | 810   | 
|                |  |          |       |      |  |   |       | 
|                |  | $        | 3,613 |      |  | $ | 6,515 | 
|                |  |          |       |      |  |   |       | 

In fiscal 2003, the Company recorded charges to
cost of revenue of $4.3 million for excess and obsolete
inventory which were due to $2.6 million of inventory that
became obsolete due to a change in a customers

59



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

product specification and $1.7 million of
excess inventory as a result of decreased demand for the
Companys products. In fiscal 2002, the Company recorded
charges to cost of revenue of $4.3 million for excess and
obsolete inventory, which was due to significant decrease in
demand for the Companys products. At the time these
charges were recorded, management did not believe it could sell
or use this inventory in the future based on current forecasts
of demand. However, actual results have differed and may
continue to differ from such forecasts, which has been the
experience in the past several quarters.

The Company sold inventory previously written-off
with original cost totaling $4.3 million in fiscal 2003 and
$5.4 million in fiscal 2002. The majority of this inventory
sold in each year had been written-off in a prior year. As a
result, cost of revenue associated with the sale of this
inventory was zero. The selling price of the finished goods that
included these components was similar to the selling price of
products that did not include components that were written-off.
These items were subsequently used and sold because customers
ordered products (that included these components) in excess of
the Companys estimates.

The total cost of inventory written-off to date
is approximately $47.3 million, including receipts under
previously accrued non-cancelable purchase obligations. Of this
amount, items representing $9.6 million have been sold,
items representing $1.5 million have been consumed in
research and development activities, items representing
$14.7 million have been discarded, and items representing
$21.5 million are on hand. The ultimate disposition of the
inventory items on hand will occur as the Company integrates its
new acquisitions and transitions its manufacturing to
third-party manufacturers in Asia.



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment consist of the following
(in thousands):

|                                         |  |          |         |      |  |   |         |  
|---------------------------------------- |  | -------- | ------- | ---- |  | - | ------- | -
|                                         |  |         
|                                         |  | June 30,
|                                         |  |         
|                                         |  | 2003     |         | 2002
|                                         |  |          |         |     
|Computer hardware and software           |  | $        | 1,318   |      |  | $ | 1,278   |  
|Production and engineering equipment     |  |          | 24,136  |      |  |   | 26,466  |  
|Office equipment, furniture and fixtures |  |          | 746     |      |  |   | 1,565   |  
|Leasehold improvements                   |  |          | 771     |      |  |   | 5,333   |  
|Construction in progress                 |  |          |        |      |  |   | 295     |  
|                                         |  |          |         |      |  |   |         |  
|                                         |  |          | 26,971  |      |  |   | 34,937  |  
|Accumulated depreciation                 |  |          | (21,516 | )    |  |   | (16,065 | )
|                                         |  |          |         |      |  |   |         |  
|                                         |  | $        | 5,455   |      |  | $ | 18,872  |  
|                                         |  |          |         |      |  |   |         |  



| |             
| | ------------
| | Other Assets

Other assets consist of the following (in
thousands):

|                          |  |          |       |      |  |   |       | 
|------------------------- |  | -------- | ----- | ---- |  | - | ----- | 
|                          |  |         
|                          |  | June 30,
|                          |  |         
|                          |  | 2003     |       | 2002
|                          |  |          |       |     
|Prepaid acquisition costs |  | $        | 6,620 |      |  | $ | 2,618 | 
|Deposits and other assets |  |          | 589   |      |  |   | 690   | 
|                          |  |          |       |      |  |   |       | 
|                          |  | $        | 7,209 |      |  | $ | 3,308 | 
|                          |  |          |       |      |  |   |       | 

60



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |           
| | ----------
| | Warranties

The Company accrues for the estimated cost to
provide warranty services at the time revenue is recognized. The
Companys estimate of costs to service its warranty
obligations is based on historical experience and expectation of
future conditions. To the extent the Company experiences
increased warranty claim activity or increased costs associated
with servicing those claims, the Companys warranty costs
will increase resulting in decreases to gross profit.

Changes in the Companys product warranty
accrual for fiscal 2003 and fiscal 2002 are as follows (in
thousands):

|                                                                                |  |                      |        |      |  |   |        |  
|------------------------------------------------------------------------------- |  | -------------------- | ------ | ---- |  | - | ------ | -
|                                                                                |  |                     
|                                                                                |  | Years Ended June 30,
|                                                                                |  |                     
|                                                                                |  | 2003                 |        | 2002
|                                                                                |  |                      |        |     
|Balance at beginning of year                                                    |  | $                    | 3,842  |      |  | $ | 5,589  |  
|Accrual for warranties issued during the period                                 |  |                      | 733    |      |  |   | 217    |  
|Cost of warranty repair                                                         |  |                      | (148   | )    |  |   | (240   | )
|Accrual related to pre-existing warranties
    (including changes in estimates) |  |                      | (1,720 | )    |  |   | (1,724 | )
|                                                                                |  |                      |        |      |  |   |        |  
|Balance at end of year                                                          |  | $                    | 2,707  |      |  | $ | 3,842  |  
|                                                                                |  |                      |        |      |  |   |        |  

5.     Goodwill

In accordance with the adoption of Statement of
Financial Accounting Standard No. 142 Goodwill and
Other Intangible Assets (SFAS 142), the Company has
performed the required two-step impairment tests of goodwill and
indefinite-lived intangible assets as of July 1, 2002. In
the first step of the analysis, the Companys assets and
liabilities, including existing goodwill and other intangible
assets, were assigned to its identified reporting units to
determine their carrying value. The Company believes it operates
as one reporting unit. After comparing the carrying value of the
reporting unit to its fair value, it was determined that the
goodwill recorded was impaired. After the second step of
comparing the implied fair value of the goodwill to its carrying
value, the Company recognized a transitional impairment loss of
$37.5 million in the first quarter of fiscal 2003. This
loss was recognized as the cumulative effect of an accounting
change.

The fair value of the reporting unit was
determined using the income approach. The income approach
focuses on the income-producing capability of an asset,
measuring the current value of the asset by calculating the
present value of its future economic benefits such as cash
earnings, cost savings, tax deductions, and proceeds from
disposition. Value indications are developed by discounting
expected cash flows to their present value at a rate of return
that incorporates the risk-free rate for the use of funds, the
expected rate of inflation, and risks associated with the
particular investment.

As required by SFAS 142, intangible assets
that did not meet the criteria for recognition apart from
goodwill were reclassified to goodwill. The Company reclassified
$314,000 of net assembled workforce to goodwill as of
July 1, 2002.

61



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following financial information reflects
consolidated results adjusted as though the accounting for
goodwill and other intangible assets was consistent in all
periods presented (in thousands, except per share data):

|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|-------------------------------------------------------------------------------------------------- |  | -------------------- | -------- | ---- |  | ---- | ------- | - |  | - | -------- | -
|                                                                                                   |  |                     
|                                                                                                   |  | Years Ended June 30,
|                                                                                                   |  |                     
|                                                                                                   |  | 2003                 |          | 2002 |  | 2001
|                                                                                                   |  |                      |          |      |  |     
|Reported net loss before cumulative effect of an
    accounting change                             |  | $                    | (65,412  | )    |  | $    | (77,777 | ) |  | $ | (119,532 | )
|Add back goodwill (including assembled workforce)
    amortization                                 |  |                      |         |      |  |      | 10,022  |   |  |   | 9,213    |  
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Adjusted net loss before cumulative effect of an
    accounting change                             |  |                      | (65,412  | )    |  |      | (67,755 | ) |  |   | (110,319 | )
|Cumulative effect of an accounting change                                                          |  |                      | (37,500  | )    |  |      |        |   |  |   |         |  
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Adjusted net loss                                                                                  |  | $                    | (102,912 | )    |  | $    | (67,755 | ) |  | $ | (110,319 | )
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Adjusted basic and diluted net loss per share:                                                     |  |                      |          |      |  |      |         |   |  |   |          |  
|Reported basic and diluted net loss per share                                                      |  | $                    | (0.96    | )    |  | $    | (1.21   | ) |  | $ | (2.07    | )
|Add back goodwill (including assembled workforce)
    amortization                                 |  |                      |         |      |  |      | 0.16    |   |  |   | 0.16     |  
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Adjusted basic and diluted net loss per share
    before cumulative effect of an accounting change |  |                      | (0.96    | )    |  |      | (1.05   | ) |  |   | (1.91    | )
|Cumulative effect of an accounting change                                                          |  |                      | (0.55    | )    |  |      |        |   |  |   |         |  
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Adjusted basic and diluted net loss per share                                                      |  | $                    | (1.51    | )    |  | $    | (1.05   | ) |  | $ | (1.91    | )
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  
|Shares used in computing basic and diluted net
    loss and adjusted net loss per share            |  |                      | 68,371   |      |  |      | 64,308  |   |  |   | 57,620   |  
|                                                                                                   |  |                      |          |      |  |      |         |   |  |   |          |  

The following table reflects the changes in the
carrying amount of goodwill including assembled workforce (in
thousands):

|                                  |  |   |         |  
|--------------------------------- |  | - | ------- | -
|Balance at July 1, 2002           |  | $ | 37,186  |  
|Workforce transferred to goodwill |  |   | 314     |  
|                                  |  |   |         |  
|Adjusted balance at July 1, 2002  |  |   | 37,500  |  
|Transitional impairment loss      |  |   | (37,500 | )
|                                  |  |   |         |  
|Balance June 30, 2003             |  | $ |        |  
|                                  |  |   |         |  

6.     Long-Lived
Assets

During the quarter ended December 31, 2002,
the Company committed to a plan to dispose of certain property,
equipment and intellectual property rights and entered into a
non-binding letter of intent to sell such assets to a group that
included an employee of the Company. The sale was completed on
January 10, 2003. In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS 144), the Company was required to
measure these assets held for sale at the lower of their
carrying amount or fair value less costs to sell as of
December 31, 2002. The carrying value of the assets held
for sale was $1.8 million with a fair value of
$0.3 million resulting in a reduction in long-lived assets
of $1.5 million in the quarter ended December 31,
2002, of which $0.2 million related to property and
equipment and $1.3 million related to intangibles.

62



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The gross carrying amount of intangible assets as
of June 30, 2002 was $2.4 million. Related accumulated
amortization was $0.9 million for a net carrying amount of
$1.5 million. These amounts reflect the value of
intangibles after reclassification of assembled workforce to
goodwill described in Note 5. The net carrying value of
intangible assets was zero as of June 30, 2003.
Amortization expense on these intangible assets in fiscal 2003
was $0.2 million.

7.     Related Party
Transactions

In September 2000, the Company loaned $150,000 to
an officer in connection with his acceptance of employment. The
interest rate on the promissory note was 6.50% per annum. The
Company forgave the principal amount of the note in fiscal 2002
and the accrued interest due on the note was paid in fiscal
2002. The forgiveness of the loan was pursuant to the terms of
his employment, which guaranteed a $150,000 bonus or forgiveness
of the loan. The principal amount forgiven is included in
general and administrative expense in the accompanying
consolidated statement of operations.

In connection with the exercise of certain stock
options and share purchase rights granted under the
Companys stock option plan, the Company has received
promissory notes equal to the total exercise price of these
stock options and share purchase rights. These full recourse
promissory notes, which bore interest at rates ranging from
4.99% to 6.21% per annum, and accrued interest were payable in
full to the Company, generally four to five years from the date
each of the promissory notes was issued. Promissory notes for
the exercise of certain stock options and share purchase rights
totaling $1,265,000 were outstanding as of June 30, 2002.
These notes were repaid in fiscal 2003. These notes are
classified as a reduction of stockholders equity.

During fiscal 2002, the Company forgave $75,000
due under a promissory note for the exercise of certain stock
options from a former executive officer as part of a separation
agreement. Additionally, the Company forgave a total of $50,850
due under promissory notes for the exercise of certain stock
options from two executive officers. This forgiveness was in
consideration of the executive officers continued
employment with the Company, pursuant to the terms and
conditions of their respective promissory notes and related
agreements. See also Note 11 for other related party stock
transactions.

One of the Companys directors is a senior
vice president of MCI. MCI accounted for 0%, 16%, and 35% of the
Companys net revenue for the years ended June 30,
2003, 2002 and 2001, respectively.

8.     Commitments
and Contingencies



| |                 
| | ----------------
| | Operating Leases

In September 1999, the Company entered into an
operating lease for a corporate headquarters and manufacturing
facility. Upon the expiration of the lease in October 2009, the
Company has an option to extend the lease term for an additional
five-year period.

63



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Future minimum lease payments under
non-cancelable operating leases having initial terms in excess
of one year as of June 30, 2003 are as follows (in
thousands):

|                      |      |                              |        |                 |        |            |        |       |        |  |       |       |       | 
|--------------------- | ---- | ---------------------------- | ------ | --------------- | ------ | ---------- | ------ | ----- | ------ |  | ----- | ----- | ----- | 
|                      |      |                              |        | Amount Included |        |           
|                      |      |                              |        | in Accrued      |        |           
|                      |      | Total Cash                   |        | Restructuring   |        | Remaining 
|                      |      | Obligation                   |        | Liability       |        | Obligation
|                      |      |                              |        |                 |        |           
|Years ending June 30, |      |                              |        |                 |        |            |        |       |        |  |       |      
|                      | 2004 |                              | $      | 5,778           |        |            | $      | 4,533 |        |  | $     | 1,245 |      
|                      | 2005 |                              |        | 5,866           |        |            |        | 4,682 |        |  |       | 1,184 |      
|                      | 2006 |                              |        | 6,054           |        |            |        | 4,873 |        |  |       | 1,181 |      
|                      | 2007 |                              |        | 6,250           |        |            |        | 5,053 |        |  |       | 1,197 |      
|                      | 2008 |                              |        | 6,392           |        |            |        | 5,220 |        |  |       | 1,172 |      
|Remaining years       |      |                              | 14,009 |                 |        |            | 12,515 |       |        |  | 1,494 |      
|                      |      |                              |        |                 |        |            |        |       |        |  |       |      
|                      |      | Total minimum lease payments |        | $               | 44,349 |            |        | $     | 36,876 |  |       | $     | 7,473 | 
|                      |      |                              |        |                 |        |            |        |       |        |  |       |      

The Companys rental expense under operating
leases was approximately $2,696,000, $3,309,000 and $5,564,000
for the years ended June 30, 2003, 2002 and 2001,
respectively. Future minimum sublease rentals to be received on
a restructured facility are $177,000, $157,000, $196,000 and
$118,000 for the years ending June 30, 2004, 2005, 2006 and
2007.



| |              
| | -------------
| | Contingencies



| |                 
| | ----------------
| | E-Tek Litigation

On December 7, 1999, before the effective
date of the Companys initial public offering, E-Tek
Dynamics, Inc. (E-Tek), now a subsidiary of JDS Uniphase, filed
a complaint with the Superior Court of California, County of
Santa Clara. E-Tek initially named the Company and Ma Li, a
third party individual not associated with Avanex Corporation,
as defendants in the complaint. E-Tek amended its complaint to
add Edward Ning, an employee of Avanex, as an additional named
defendant. This litigation was dismissed with prejudice in the
second quarter of fiscal 2003.



| |                         
| | ------------------------
| | IPO Class Action Lawsuit

On August 6, 2001, the Company, certain of
the Companys officers and directors, and various
underwriters in its initial public offering (IPO)
were named as defendants in a class action filed in the United
States District Court for the Southern District of New York,
captioned Beveridge v. Avanex Corporation et al., Civil
Action No. 01-CV-7256. This action and other subsequently
filed substantially similar class actions have been consolidated
into In re Avanex Corp. Initial Public Offering Securities
Litigation, Civil Action No. 01 Civ. 6890. The
consolidated amended complaint in the action generally alleges
that various investment bank underwriters engaged in improper
and undisclosed activities related to the allocation of shares
in the Companys IPO. Plaintiffs bring claims for violation
of several provisions of the federal securities laws against
those underwriters, and also against the Company and certain of
the Companys directors and officers, seeking unspecified
damages on behalf of a purported class of purchasers of the
Companys common stock between February 3, 2000, and
December 6, 2000. Various plaintiffs have filed similar
actions asserting virtually identical allegations against more
than 40 investment banks and 250 other companies. All of
these IPO allocation securities class actions
currently pending in the Southern District of New York have been
assigned to Judge Shira A. Scheindlin for coordinated pretrial
proceedings as In re Initial Public Offering Securities
Litigation, 21 MC 92. On October 9, 2002, the
claims against the Companys directors and officers were
dismissed without prejudice pursuant to a tolling agreement. The
issuer defendants filed a coordinated motion to dismiss all
common pleading issues, which the Court granted in part and
denied

64



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

in part in an order dated February 19, 2003.
The Courts order did not dismiss the Section 10(b) or
Section 11 claims against the Company. A proposal has been
made for the settlement and release of claims against the issuer
defendants, including the Company, which has been approved
(subject to the conditions noted below) by a special committee
of the Board of Directors. The settlement is subject to a number
of conditions, including approval of the proposed settling
parties and the court. If the settlement does not occur, and
litigation against the Company continues, the Company believes
it has meritorious defenses and intends to defend the action
vigorously. Nevertheless, an unfavorable result in litigation
may result in substantial costs and may divert managements
attention and resources, which could seriously harm its
business, financial condition, results of operations or cash
flows.



| |                                                                         
| | ------------------------------------------------------------------------
| | High Hopes Enterprises and Hon Hai Precision
    Industry Co. Litigation

On May 31, 2002, High Hopes Enterprises Ltd.
and Hon Hai Precision Industry Co., Ltd., filed an action in the
Superior Court of California, County of Alameda, against Avanex
alleging breach of an oral contract, breach of the covenant of
good faith and fair dealing, breach of implied contract,
promissory estoppel, deceit by fraud and deceit by negligent
misrepresentation. The complaint seeks compensatory damages
in an amount of no less than $41,500,000, with interest
thereon, as well as punitive damages, attorneys fees
and costs. The Company challenged the sufficiency of the
complaint by demurrer in a motion that was heard by the Court on
September 25, 2002. The Court sustained the demurrer with
respect to the three breach of contract causes of action, with
leave to amend. The Court overruled the demurrer in connection
with the promissory estoppel, fraud and negligent
misrepresentation claims. The Court gave the plaintiffs the
opportunity to attempt to amend the complaint so that it
sufficiently alleged contract-based causes of action, and the
plaintiffs filed their amended Complaint on
October 28, 2002. The Company again challenged the
sufficiency of the Complaint with respect to the three
contract-related causes of action, however the Court overruled
the Companys second demurrer. The Court has set a trial
date of December 12, 2003. The Company is currently
conducting extensive discovery and will continue to do so over
the next several months. After reviewing the complaint and the
matters related thereto, the Company believes that the claims
are without merit and intends to defend itself vigorously. The
Company believes that the resolution of this action will not
have a material adverse effect on its business or financial
condition. Nevertheless, an unfavorable result in litigation may
result in substantial costs and may divert managements
attention and resources, which could seriously harm its
business, financial condition, results of operations or cash
flows.

From time to time, the Company may be subject to
other claims, which arise in the normal course of business.
Although the amount of any liability with respect to such
litigation cannot be determined, in the opinion of management,
the ultimate disposition of these claims will not have a
material adverse effect on the Companys financial
position, cash flows or results of operations. However,
depending on the amount and timing, an unfavorable resolution of
a matter could materially affect the Companys future
results of operations or cash flows in a particular period.

9.     Financing
Arrangements



| |                     
| | --------------------
| | Short-Term Borrowing

In June 2003, the Company renewed a revolving
line of credit from a financial institution, which allows
maximum borrowings up to $15 million. This line of credit
requires the Company to comply with specified covenants. At
June 30, 2003 and 2002, the Company had borrowings of
$3,141,000 and $6,035,000 against this line, respectively. The
agreement terminates on December 31, 2003, at which time
all outstanding principal and interest are due. The line bears
interest at prime plus 1.50% and, at June 30, 2003 the
effective interest rate was 4.00%. The Company has pledged all
of its assets as collateral for this line.

65



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |               
| | --------------
| | Long-Term Debt

In February 2001, the Company entered into a loan
and security agreement with a financial institution whereby the
financial institution agreed to loan to the Company an aggregate
principal amount of $3,000,000 to be used to finance the
acquisition of equipment, which is collateral for the
outstanding loan under the agreement. The designated interest
rate for the loan was 10.4%. This loan was repaid in fiscal 2002.

In February 2001, the Company entered into a loan
agreement with a financial institution to borrow $2,269,000 to
be used to finance equipment, which is collateral for the
outstanding loan under the agreement. The designated interest
rate is 9.406%. As of June 30, 2003 and 2002, the Company
had $840,000 and $1,542,000 outstanding, respectively.

Payments due under financing arrangements as of
June 30, 2003 are as follows (in thousands):

|                                        |                |   |     |     | 
|--------------------------------------- | -------------- | - | --- | --- | 
|Years ending June 30,                   |                |   |     |    
|2004                                    |                | $ | 763 |    
|2005                                    |                |   | 127 |    
|                                        |                |   |     |    
|                                        | Total payments |   |     | 890 | 
|Amounts representing interest           |                |   | (50 | )  
|                                        |                |   |     |    
|Present value of net remaining payments |                |   | 840 |    
|Less current portion                    |                |   | 714 |    
|                                        |                |   |     |    
|Long-term portion                       |                | $ | 126 |    
|                                        |                |   |     |    



| |                          
| | -------------------------
| | Capital Lease Obligations

The Company leases certain of its equipment and
other fixed assets under capital lease agreements. The assets
and liabilities under capital leases are recorded at the lesser
of the present value of aggregate future minimum lease payments,
including estimated bargain purchase options, or the fair value
of the assets under lease. Assets under capital leases are
amortized over the shorter of the lease term or useful life of
the assets.

Payments due under capital lease agreements for
certain equipment as of June 30, 2003 are as follows (in
thousands):

|                                            |                              |            |       |                 |  |            |       |       |  |   |       |       | 
|------------------------------------------- | ---------------------------- | ---------- | ----- | --------------- |  | ---------- | ----- | ----- |  | - | ----- | ----- | 
|                                            |                              |            |       | Amount Included |  |           
|                                            |                              |            |       | in Accrued      |  |           
|                                            |                              | Total Cash |       | Restructuring   |  | Remaining 
|                                            |                              | Obligation |       | Liability       |  | Obligation
|                                            |                              |            |       |                 |  |           
|Years ending June 30,                       |                              |            |       |                 |  |            |       |       |  |   |       |      
|2004                                        |                              | $          | 5,117 |                 |  | $          | 1,244 |       |  | $ | 3,873 |      
|2005                                        |                              |            | 2,537 |                 |  |            | 473   |       |  |   | 2,064 |      
|                                            |                              |            |       |                 |  |            |       |       |  |   |       |      
|                                            | Total minimum lease payments |            |       | 7,654           |  |            |       | 1,717 |  |   |       | 5,937 | 
|Amount representing interest                |                              |            | (657  | )               |  |            | (188  | )     |  |   | (469  | )    
|                                            |                              |            |       |                 |  |            |       |       |  |   |       |      
|Present value of net minimum lease payments |                              |            | 6,997 |                 |  |            | 1,529 |       |  |   | 5,468 |      
|Less current portion                        |                              |            | 4,554 |                 |  |            | 1,078 |       |  |   | 3,476 |      
|                                            |                              |            |       |                 |  |            |       |       |  |   |       |      
|Long-term portion                           |                              | $          | 2,443 |                 |  | $          | 451   |       |  | $ | 1,992 |      
|                                            |                              |            |       |                 |  |            |       |       |  |   |       |      

At June 30, 2003 and 2002, equipment
amounting to approximately $15,726,000 was capitalized under
capital leases. Related accumulated amortization at
June 30, 2003 and 2002 amounted to approximately
$12,884,000 and $7,002,000, respectively. The lease agreements
are payable in monthly installments through

66



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

May 2005, bearing interest at rates between 8.5%
and 15.5% per annum, and are fully secured by the related
equipment.

10.     Acquisitions

On November 19, 2001, the Company acquired
LambdaFlex Inc. (LambdaFlex), a start-up Company
that had been developing intelligent optical modules for
increased network flexibility. The transaction was accounted for
as a purchase and accordingly, the accompanying financial
statements include the results of operations of LambdaFlex
subsequent to the acquisition date. The total purchase price of
approximately $12.7 million included consideration of
2,750,318 shares of Avanex common stock, the issuance of
options to purchase an aggregate of 106,804 shares of
Avanex common stock in exchange for options to purchase
LambdaFlex common stock and direct transaction costs.

On July 25, 2000, the Company acquired
substantially all of the assets and liabilities of Holographix,
a developer and manufacturer of holographic diffraction
gratings. The transaction was accounted for as a purchase and
accordingly, the accompanying consolidated financial statements
include the results of operations of Holographix subsequent to
the acquisition date. The total purchase price of
$99.1 million included consideration of 501,880 shares of
Avanex common stock, the issuance of 709,047 Avanex stock
options in exchange for Holographix options and direct
transaction costs.

The following is a summary of the consideration
paid by the Company (in thousands):

|                               |  |             |        |            |  |   |        | 
|------------------------------ |  | ----------- | ------ | ---------- |  | - | ------ | 
|                               |  | Holographix |        | LambdaFlex
|                               |  |             |        |           
|Value of securities issued     |  | $           | 40,287 |            |  | $ | 11,936 | 
|Assumption of options          |  |             | 55,783 |            |  |   | 429    | 
|                               |  |             |        |            |  |   |        | 
|                               |  |             | 96,070 |            |  |   | 12,365 | 
|Transaction costs and expenses |  |             | 3,077  |            |  |   | 366    | 
|                               |  |             |        |            |  |   |        | 
|                               |  | $           | 99,147 |            |  | $ | 12,731 | 
|                               |  |             |        |            |  |   |        | 

The following is a summary of the purchase price
allocation for each acquisition (in thousands):

|                           |                                   |                                     |                      |            |        |        |   |     |       |        | 
|-------------------------- | --------------------------------- | ----------------------------------- | -------------------- | ---------- | ------ | ------ | - | --- | ----- | ------ | 
|                           |                                   | Holographix                         |                      | LambdaFlex
|                           |                                   |                                     |                      |           
|Purchase Price Allocation: |                                   |                                     |                      |            |        |        |   |    
|                           | Tangible net assets (liabilities) |                                     | $                    | (1,509     | )      |        | $ | (46 | )    
|                           | Intangible assets acquired:       |                                     |                      |            |        |        |   |     |      
|                           |                                   | Developed technology                |                      |            | 2,400  |        |   |     |      |       
|                           |                                   | Assembled workforce                 |                      |            | 300    |        |   |     | 155   |       
|                           |                                   | In-process research and development |                      |            | 4,700  |        |   |     | 5,445 |       
|                           |                                   | Deferred compensation               |                      |            | 43,579 |        |   |     | 577   |       
|                           |                                   | Goodwill                            |                      |            | 49,677 |        |   |     | 6,600 |       
|                           |                                   |                                     |                      |            |        |        |   |    
|                           |                                   |                                     | Total purchase price |            | $      | 99,147 |   |     | $     | 12,731 | 
|                           |                                   |                                     |                      |            |        |        |   |    

In valuing the IPR&D, the Company considered,
among other factors, the importance of each project to the
overall development plan, projected incremental cash flows from
the projects when completed and any associated risks. The
projected incremental cash flows were discounted back to their
present value using a discount rate of 25% for Holographix and
30% for LambdaFlex. The discount rate was determined after
consideration of the Companys weighted average cost of
capital and the weighted average return on assets. Associated
risks include the inherent difficulties and uncertainties in
completing each project and thereby

67



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates
and risks related to the impact of potential changes in future
target markets.

Deferred compensation is recognized for the
intrinsic value of the unvested Avanex options exchanged for
options held by employees of Holographix and LambdaFlex, and is
being amortized over the remaining vesting period, of
approximately 4 years and 3 years, respectively.
Deferred compensation relating to an option that Holographix
granted to one consultant is accounted for using the
Black-Scholes method and the option is subject to periodic
revaluations over the vesting terms. The expense is recognized
as the option vests.

Goodwill represents the excess of the purchase
price over the fair value of the underlying net identifiable
assets and deferred compensation. See Note 5 regarding the
impairment of goodwill.

On March 18, 2002, Avanex entered into an
Agreement and Plan of Reorganization with Oplink Communications
pursuant to which Avanex intended to acquire all of the
outstanding capital stock of Oplink. The merger was subject to
the approval of Avanex stockholders and the stockholders of
Oplink. While Avanex stockholders approved the issuance of
Avanex common stock in connection with the merger, the
stockholders of Oplink failed to approve the merger on
August 15, 2002. Avanex expensed $4.1 million in
related merger costs in the first quarter of fiscal 2003.

11.     Stockholders
Equity



| |                          
| | -------------------------
| | Stock Option/Rights Plans

The Company adopted the 1998 Stock Plan (the
Option Plan), under which officers, employees,
directors, and consultants may be granted Incentive Stock
Options (ISOs) and Nonstatutory Stock Options
(NSOs) to purchase shares of the Companys
common stock.

The Option Plan permits ISOs and NSOs to be
granted at an exercise price of not less than 100% of the fair
value on the date of grant as determined by the Board of
Directors. Options that expire (generally ten years from the
grant date) or are canceled are returned to the Option Plan. The
term of the Option Plan is ten years. Options may be granted
with different vesting terms as determined by the Board of
Directors. The options typically vest over four years.

The authorized shares under the Option Plan
automatically increase each July 1 by an amount equal to the
lesser of (i) 6,000,000 shares, (ii) 4.9% of the
Companys outstanding shares, or (iii) a smaller
amount determined by the Companys Board of Directors.

In January 2000, the Company adopted the 1999
Director Option Plan (the Director Plan).
Non-employee directors are entitled to participate in the
Director Plan. A total of 600,000 shares of the Companys
common stock have been reserved for issuance under the Director
Plan. The Director Plan also provides for automatic annual
increases each July 1, by an amount equal to the lesser of
(i) 150,000 shares, (ii) 0.25% of the outstanding
shares on that date, or (iii) a smaller amount determined
by the Companys Board of Directors. The Director Plan
generally provides for an automatic initial grant of an option
to purchase 40,000 shares of Avanex common stock to each
non-employee director on the date when a person first becomes a
non-employee director. After the initial grant, each
non-employee director will automatically be granted subsequent
options to purchase 10,000 shares of the Companys
common stock each year on the date of the Companys annual
stockholders meeting. Grants generally shall have a term
of 10 years. Each initial option grant will vest as to 25%
of the shares subject to the option on each anniversary of its
date of grant. Each subsequent option grant will fully vest on
the anniversary of its date of grant. The exercise price of all
options will be 100% of the fair market value per share of
Avanex common stock on the date of grant.

In July 2000, the Company assumed options to
purchase 709,047 shares (on a converted basis) in
connection with the acquisition of all of the assets and some
liabilities of Holographix. The assumed stock options are
governed by the terms and conditions of their respective
Holographix stock option agreements and

68



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the Holographix 2000 Stock Plan. Options expire
ten years after the grant date or earlier upon termination of an
optionees services to the Company. Generally, the
Holographix options vest as to 25% of the shares on the first
anniversary of the grant date and  1/48 per month
thereafter.

In November 2001, the Company assumed options to
purchase 106,804 shares in connection with the acquisition
of LambdaFlex. The assumed stock options are governed by the
terms and conditions of their respective LambdaFlex stock option
agreements and the LambdaFlex, Inc. 2000 Stock Plan. Options
expire ten years after the grant date or earlier upon
termination of an optionees services to the Company.
Generally, LambdaFlex options vest as to 25% of the shares on
the first anniversary of the grant date and  1/48 per month
thereafter.

Stock option activity under the option plans and
the director plan is as follows:

|                         |                                            |                     |            |                  |   |   |       |       | 
|------------------------ | ------------------------------------------ | ------------------- | ---------- | ---------------- | - | - | ----- | ----- | 
|                         |                                            |                    
|                         |                                            | Outstanding Options
|                         |                                            |                    
|                         |                                            | Number of           |            | Weighted-Average
|                         |                                            | Shares              |            | Exercise Price  
|                         |                                            |                     |            |                 
|Balance at June 30, 2000 |                                            |                     | 3,989,006  |                  |   | $ | 10.45 |      
|                         | Options granted                            |                     |            | 4,338,608        |   |   |       | 44.76 | 
|                         | Options assumed in Holographix acquisition |                     |            | 709,047          |   |   |       | 3.85  | 
|                         | Options exercised                          |                     |            | (1,161,132       | ) |   |       | 2.51  | 
|                         | Options canceled                           |                     |            | (587,527         | ) |   |       | 53.67 | 
|                         |                                            |                     |            |                  |   |   |       |      
|Balance at June 30, 2001 |                                            |                     | 7,288,002  |                  |   |   | 28.02 |      
|                         | Options granted                            |                     |            | 8,878,170        |   |   |       | 5.03  | 
|                         | Options assumed in LambdaFlex acquisition  |                     |            | 106,804          |   |   |       | 0.39  | 
|                         | Options exercised                          |                     |            | (478,423         | ) |   |       | 1.82  | 
|                         | Options canceled                           |                     |            | (3,097,405       | ) |   |       | 33.45 | 
|                         |                                            |                     |            |                  |   |   |       |      
|Balance at June 30, 2002 |                                            |                     | 12,697,148 |                  |   |   | 11.38 |      
|                         | Options granted                            |                     |            | 3,892,545        |   |   |       | 0.92  | 
|                         | Options exercised                          |                     |            | (748,887         | ) |   |       | 0.34  | 
|                         | Options canceled                           |                     |            | (7,015,384       | ) |   |       | 10.34 | 
|                         |                                            |                     |            |                  |   |   |       |      
|Balance at June 30, 2003 |                                            |                     | 8,825,422  |                  |   | $ | 8.52  |      
|                         |                                            |                     |            |                  |   |   |       |      

|                         |                |               |  |                  |           |                |  |               |      |                |  |   |       |  |  |  |           |  |  |   |       | 
|------------------------ | -------------- | ------------- |  | ---------------- | --------- | -------------- |  | ------------- | ---- | -------------- |  | - | ----- |  |  |  | --------- |  |  | - | ----- | 
|                         |                |               |  |                 
|                         |                | Outstanding   |  | Exercisable     
|                         |                |               |  |                 
|                         |                |               |  | Weighted-Average |           |                |  |               |      |               
|                         |                | Number of     |  | Remaining        |           | Weighted-      |  | Number of     |      | Weighted-     
|                         |                | Shares As of  |  | Contractual Life |           | Average        |  | Shares As of  |      | Average       
|Range of Exercise Prices |                | June 30, 2003 |  | (in years)       |           | Exercise Price |  | June 30, 2003 |      | Exercise Price
|                         |                |               |  |                  |           |                |  |               |      |               
|$                        | 0.03 -  0.73   |               |  |                  | 638,740   |                |  |               | 8.68 |                |  | $ | 0.64  |  |  |  | 146,393   |  |  | $ | 0.41  | 
|                         | 0.74 -  0.80   |               |  |                  | 1,756,453 |                |  |               | 9.63 |                |  |   | 0.80  |  |  |  | 185,096   |  |  |   | 0.80  | 
|                         | 0.81 -  1.08   |               |  |                  | 1,236,411 |                |  |               | 9.43 |                |  |   | 1.01  |  |  |  | 96,482    |  |  |   | 1.01  | 
|                         | 1.24 -  4.89   |               |  |                  | 815,375   |                |  |               | 7.67 |                |  |   | 3.43  |  |  |  | 571,890   |  |  |   | 3.55  | 
|                         | 4.90 -  4.90   |               |  |                  | 2,592,880 |                |  |               | 8.35 |                |  |   | 4.90  |  |  |  | 1,048,790 |  |  |   | 4.90  | 
|                         | 5.05 - 19.38   |               |  |                  | 1,129,876 |                |  |               | 7.76 |                |  |   | 9.93  |  |  |  | 691,498   |  |  |   | 10.58 | 
|                         | 28.00 - 142.00 |               |  |                  | 655,687   |                |  |               | 6.97 |                |  |   | 69.30 |  |  |  | 521,669   |  |  |   | 68.34 | 
|                         |                |               |  |                  |           |                |  |               |      |                |  |   |       |  |  |  |           |  |  |   |       | 
|$                        | 0.03 - 142.00  |               |  |                  | 8,825,422 |                |  |               | 8.54 |                |  | $ | 8.52  |  |  |  | 3,261,818 |  |  | $ | 15.46 | 
|                         |                |               |  |                  |           |                |  |               |      |                |  |   |       |  |  |  |           |  |  |   |       | 

69



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Under the Option Plan, the Company may also grant
share purchase rights either alone, in addition to, or in tandem
with other awards granted under the Option Plan and/or cash
awards granted outside the Option Plan. Exercise of these share
purchase rights are made pursuant to restricted stock purchase
agreements containing provisions established by the Board of
Directors. These provisions give the Company the right to
repurchase the shares at the original sales price. This right
expires at a rate determined by the Board of Directors,
generally at a rate of 25% after one year and  1/48 per
month thereafter. During the years ended June 30, 2002 and
2001, the Company issued 1,000,000 and 90,000 share
purchase rights, respectively, under the Option Plan. There were
no share purchase rights issued in the year ended June 30,
2003. Shares subject to repurchase were 171,668 shares as
of June 30, 2003, 2,037,418 shares as of June 30, 2002
and 5,039,922 shares as of June 30, 2001. For the year
ended June 30, 2003, 2002 and 2001, the Company repurchased
1,098,784, 178,011 and 766,667 shares, respectively, under
the Option Plan.

The weighted-average fair value of stock options
granted at fair value during fiscal 2003 was $0.74. The
weighted-average fair value of stock options and share purchase
rights granted at fair value and below fair value during fiscal
2002 was $3.98 and $6.24, respectively. The weighted-average
fair value of stock options and share purchase rights granted at
fair value and below fair value during fiscal 2001 was $33.70
and $77.22, respectively.

For the years ended June 30, 2003, 2002 and
2001, the Company recorded deferred stock compensation of $0,
$8,538,000, and $51,132,000, respectively, representing the
difference between the exercise price and the fair value for
accounting purposes of the Companys common stock on the
date such stock options and share purchase rights were granted.
The fair value of stock options and share purchase rights
granted was based on the actual stock closing price on the day
previous to the date of grant. For the years ended June 30,
2003, 2002 and 2001, the Company recorded amortization
(recovery) of deferred stock compensation of $(385,000),
$16,954,000 and $43,867,000, respectively. At June 30,
2003, the Company had $828,000 of remaining unamortized deferred
compensation. Such amount is included as a reduction of
stockholders equity and is being amortized over the
vesting period.

For the years ended June 30, 2003, 2002 and
2001, the Company recorded stock compensation expense of
$39,000, $28,000 and $6,360,000, respectively related to common
stock options granted to consultants. The value of the options
was estimated using the Black-Scholes option pricing model with
the following assumptions: weighted-average risk free interest
rate of 5.2% in fiscal 2002 and 5.5% in fiscal 2001, contractual
life of ten years, volatility of 1.01 in fiscal 2002 and 0.90 in
fiscal 2001, and no dividend yield. There were no options
granted to consultants in fiscal 2003.



| |                                      
| | -------------------------------------
| | 1999 Employee Stock Purchase
    Plan

In January 2000, the Company adopted the 1999
Employee Stock Purchase Plan (the Stock Purchase
Plan) for its employees. The Stock Purchase Plan provides
for automatic annual increases each July 1, to shares
reserved for issuance by an amount equal to the lesser of
(i) 750,000 shares, (ii) 1% of the outstanding shares
on that date, or (iii) a smaller amount determined by the
Companys Board of Directors. The Stock Purchase Plan
permits participants to purchase the Companys common stock
through payroll deductions of up to 10% of the
participants compensation. The maximum number of shares a
participant may purchase during each offering period is 3,000
shares. The price of common stock purchases will be 85% of the
lower of the fair market value at the beginning of the offering
period and the ending of the offering period. As of
June 30, 2003, 495,060 shares have been issued under
the Stock Purchase Plan.

70



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                
| | ---------------
| | Shares Reserved

Common stock reserved for future issuance is as
follows:

|                             |                                                 |               |           |            | 
|---------------------------- | ----------------------------------------------- | ------------- | --------- | ---------- | 
|                             |                                                 | June 30, 2003
|                             |                                                 |              
|Stock options:               |                                                 |               |           |           
|                             | Options outstanding                             |               |           | 8,825,422  | 
|                             | Reserved for future grants                      |               |           | 12,183,056 | 
|Employee stock purchase plan |                                                 |               | 2,020,627 |           
|                             |                                                 |               |           |           
|                             | Total common stock reserved for future issuance |               |           | 23,029,105 | 
|                             |                                                 |               |           |           



|    |            
|--- | -----------
|12. | 401(k) Plan

The Company maintains a savings and retirement
plan under Section 401(k) of the Internal Revenue Code. All
employees are eligible to participate on the first day of the
month following their hire date with the Company. Under the
plan, employees may contribute up to 15% of their pre tax
salaries per year but not more than the statutory limits. The
Company has not contributed to the plan.



|    |             
|--- | ------------
|13. | Income Taxes

There has been no provision for U.S. federal,
U.S. state or foreign income taxes for any annual period as the
Company has incurred operating losses since inception for all
jurisdictions.

Deferred income taxes reflect the net tax effects
of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amounts
used for income tax purposes.

Significant components of the Companys
deferred tax assets are as follows (in thousands):

|                          |                                  |                                |         |        |        |   |         |        |        |  
|------------------------- | -------------------------------- | ------------------------------ | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                          |                                  |                               
|                          |                                  | Years Ended June 30,          
|                          |                                  |                               
|                          |                                  | 2003                           |         | 2002  
|                          |                                  |                                |         |       
|Deferred tax assets:      |                                  |                                |         |        |        |   |         |       
|                          | Net operating loss carryforwards |                                | $       | 46,549 |        |   | $       | 36,632 |       
|                          | Tax credit carryforwards         |                                |         | 3,063  |        |   | $       | 2,680  |       
|                          | Inventory reserves               |                                |         | 8,941  |        |   |         | 13,279 |       
|                          | Restructuring charges            |                                |         | 12,580 |        |   |         | 6,676  |       
|                          | Other                            |                                |         | 4,931  |        |   |         | 5,726  |       
|                          |                                  |                                |         |        |        |   |         |       
|                          |                                  | Total deferred tax assets      |         |        | 76,064 |   |         |        | 64,993 |  
|Valuation allowance       |                                  |                                | (76,064 | )      |        |   | (63,113 | )     
|                          |                                  |                                |         |        |        |   |         |       
|Net deferred tax assets   |                                  |                                |        |        |        |   | 1,880   |       
|                          |                                  |                                |         |        |        |   |         |       
|Deferred tax liabilities: |                                  |                                |         |        |        |   |         |       
|                          | Purchased intangibles            |                                |         |       |        |   |         | (1,880 | )     
|                          |                                  |                                |         |        |        |   |         |       
|                          |                                  | Total deferred tax liabilities |         |        |       |   |         |        | (1,880 | )
|                          |                                  |                                |         |        |        |   |         |       
|Net deferred tax assets   |                                  | $                              |        |        |        | $ |        |       
|                          |                                  |                                |         |        |        |   |         |       

Realization of the deferred tax assets is
dependent upon future earnings, if any, the timing and amount of
which are uncertain. Accordingly, the net deferred tax assets
have been fully offset by a valuation allowance. The valuation
allowance increased by $13.0 million, $10.8 million,
and $35.3 million in the years ended June 30, 2003,
2002 and 2001, respectively.

71



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Deferred tax assets related to net operating loss
carryforwards at June 30, 2003 include approximately
$12.8 million associated with stock option activity for
which any subsequently recognized tax benefits will be credited
directly to stockholders equity.

As of June 30, 2003, the Company has net
operating loss and research and development tax credit
carry-forwards for federal income tax purposes of approximately
$125.5 million and $1.8 million, respectively, which
expire in years 2012 through 2023. The Company also has net
operating loss and research and development tax credit
carry-forwards for state income tax purposes of approximately
$64.5 million and $1.8 million, respectively. The
state net operating loss carryforwards expire in the years 2008
through 2014 and the research and development tax credit can be
carried forward indefinitely. Utilization of the Companys
net operating loss may be subject to a substantial annual
limitation due to the ownership change limitations provided by
the Internal Revenue Code and similar state provisions. Such an
annual limitation could result in the expiration of the net
operating loss before utilization.



|    |                                                                                   
|--- | ----------------------------------------------------------------------------------
|14. | Market Sales, Export Sales, Significant
    Customers, and Concentration of Supply

The Companys chief operating decision maker
is considered to be the Companys Chief Executive Officer
(CEO). The CEO reviews the Companys financial
information presented on a consolidated basis substantially
similar to the accompanying consolidated financial statements.
Therefore, the Company has concluded that it operates in one
segment, to manufacture and market photonic processors, and
accordingly has provided only the required enterprise wide
disclosures.

The Company had net sales by geographical region
based on the location of the entity purchasing the
Companys products as follows (in thousands):

|                  |  |                      |        |      |  |      |        |  |  |   |         | 
|----------------- |  | -------------------- | ------ | ---- |  | ---- | ------ |  |  | - | ------- | 
|                  |  |                     
|                  |  | Years Ended June 30,
|                  |  |                     
|                  |  | 2003                 |        | 2002 |  | 2001
|                  |  |                      |        |      |  |     
|United States     |  | $                    | 17,584 |      |  | $    | 23,695 |  |  | $ | 81,824  | 
|Japan             |  |                      | 261    |      |  |      | 6,642  |  |  |   | 40,392  | 
|Italy             |  |                      | 2,859  |      |  |      | 1,604  |  |  |   | 7,852   | 
|Rest of the world |  |                      | 712    |      |  |      | 1,745  |  |  |   | 1,176   | 
|                  |  |                      |        |      |  |      |        |  |  |   |         | 
|                  |  | $                    | 21,416 |      |  | $    | 33,686 |  |  | $ | 131,244 | 
|                  |  |                      |        |      |  |      |        |  |  |   |         | 

To date, revenues have been principally derived
from sales of PowerFilter, PowerMux and PowerExchanger, which
accounted for 91%, 89% and 99% of net revenues in fiscal 2003,
2002 and 2001, respectively.

72



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information on
customers that accounted for over 10% of revenue:

|         |  |                        |    |               |  |      |    |            |  |      |    |   |  |  |    |   |  |  |    | 
|-------- |  | ---------------------- | -- | ------------- |  | ---- | -- | ---------- |  | ---- | -- | - |  |  | -- | - |  |  | -- | 
|         |  |                        |    |               |  |      |    |           
|         |  |                        |    |               |  |      |    | Percent of
|         |  |                        |    |               |  |      |    | Accounts  
|         |  |                        |    | Receivable at
|         |  | Percent of Net Revenue |    | June 30,     
|         |  |                        |    |              
|Customer |  | 2003                   |    | 2002          |  | 2001 |    | 2003       |  | 2002
|         |  |                        |    |               |  |      |    |            |  |     
|A        |  |                        | 34 |               |  |      | 32 |            |  |      | *  |   |  |  | 15 |   |  |  | 14 | 
|B        |  |                        | *  |               |  |      | 19 |            |  |      | 30 |   |  |  | *  |   |  |  |   | 
|C        |  |                        |   |               |  |      | 16 |            |  |      | 36 |   |  |  |   |   |  |  | 12 | 
|D        |  |                        | *  |               |  |      | 12 |            |  |      | 11 |   |  |  | *  |   |  |  | 24 | 
|E        |  |                        | 23 |               |  |      | *  |            |  |      | *  |   |  |  | 45 |   |  |  | *  | 
|F        |  |                        | 12 |               |  |      | *  |            |  |      | *  |   |  |  | *  |   |  |  | *  | 
|         |  |                        |    |               |  |      |    |            |  |      |    |   |  |  |    |   |  |  |    | 
|Total    |  |                        | 69 | %             |  |      | 79 | %          |  |      | 77 | % |  |  | 60 | % |  |  | 50 | 
|         |  |                        |    |               |  |      |    |            |  |      |    |   |  |  |    |   |  |  |    | 



---



|  |              
|- | -------------
|* | less than 10%

The Company currently purchases several key parts
and components used to manufacture its products from limited
sources of supply.



|    |                              
|--- | -----------------------------
|15. | Subsequent Events (unaudited)



| |                                                                
| | ---------------------------------------------------------------
| | Acquisition of Alcatel Optronics and
    Corning Asset Purchase

In July 2003, the Company acquired all of the
outstanding equity of Alcatel Optronics France SA, a subsidiary
of Alcatel that operated the optical components business of
Alcatel, and Alcatel assigned and licensed certain intellectual
property rights to the Company. In addition, the Company
acquired certain assets of the optical components business of
Corning, and Corning assigned and licensed certain intellectual
property rights to the Company. In consideration for the above,
the Company issued shares of its common stock to Alcatel and to
Corning, representing 28% and 17%, respectively, of the
outstanding shares of the Companys common stock. The
transactions will be accounted for under the purchase method of
accounting.

The purchase price is as follows (in thousands):

|                                         |  |           |        |               |  |   |        | 
|---------------------------------------- |  | --------- | ------ | ------------- |  | - | ------ | 
|                                         |  | Alcatel   |        | Corning Asset
|                                         |  | Optronics |        | Purchase     
|                                         |  |           |        |              
|Value of securities issued               |  | $         | 63,064 |               |  | $ | 38,289 | 
|Estimated transaction costs and expenses |  |           | 4,978  |               |  |   | 3,022  | 
|                                         |  |           |        |               |  |   |        | 
|Total estimated purchase price           |  | $         | 68,042 |               |  | $ | 41,311 | 
|                                         |  |           |        |               |  |   |        | 

73



---



##### Table of Contents



AVANEX CORPORATION


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Under the purchase method of accounting, the
total estimated purchase price as shown in the table above is
allocated to the net tangible and intangible assets based on
their estimated fair values as of the date of the completion of
the transaction. Based on the preliminary independent valuation,
and subject to material changes upon receipt of the final
valuation the preliminary purchase price allocation as of
July 31, 2003 is as follows (in thousands):

|                                                               |  |                   |         |               |  |   |         |  
|-------------------------------------------------------------- |  | ----------------- | ------- | ------------- |  | - | ------- | -
|                                                               |  |                   |         | Corning Asset
|                                                               |  | Alcatel Optronics |         | Purchase     
|                                                               |  |                   |         |              
|Cash, cash equivalents and short term investments              |  | $                 | 108,876 |               |  | $ | 20,024  |  
|Other long-term investments                                    |  |                   | 5,829   |               |  |   |        |  
|Accounts receivable                                            |  |                   | 8,050   |               |  |   |        |  
|Inventories                                                    |  |                   | 12,969  |               |  |   | 11,896  |  
|Other current assets                                           |  |                   | 13,943  |               |  |   |        |  
|Due from related party                                         |  |                   | 12,578  |               |  |   | 11,450  |  
|Property and equipment                                         |  |                   | 10,885  |               |  |   | 11,564  |  
|Accounts payable                                               |  |                   | (15,564 | )             |  |   |        |  
|Restructuring                                                  |  |                   | (70,843 | )             |  |   | (4,983  | )
|Other accrued expenses                                         |  |                   | (15,122 | )             |  |   |        |  
|Warranty                                                       |  |                   | (1,406  | )             |  |   | (12,450 | )
|Supply Agreement                                               |  |                   |        |               |  |   | (3,387  | )
|Other long-term obligations                                    |  |                   | (10,120 | )             |  |   |        |  
|                                                               |  |                   |         |               |  |   |         |  
|Tangible net assets                                            |  |                   | 60,075  |               |  |   | 34,114  |  
|Intangible assets acquired  Core and
    developed technology |  |                   | 7,967   |               |  |   | 5,940   |  
|Goodwill                                                       |  |                   |        |               |  |   | 1,257   |  
|                                                               |  |                   |         |               |  |   |         |  
|Total estimated purchase price                                 |  | $                 | 68,042  |               |  | $ | 41,311  |  
|                                                               |  |                   |         |               |  |   |         |  

Avanex acquired developed technology from
Alcatel, which is comprised of products that are technologically
feasible, primarily includes DWDM lasers, photodetectors,
optical amplifiers, high-speed interface modules and passive
optical devices. Core technology and patents represent a
combination of Alcatels Optronics division processes,
patents and trade secrets. Avanex expects to amortize the
developed technology on a straight-line basis over an estimated
life of 3-5 years.

Avanex acquired developed technology from
Corning, which is comprised of products that are technologically
feasible, primarily includes amplifiers, dispersion compensation
modules and modulators. Core technology and patents represent a
combination of the optical components business of Corning
processes, patents and trade secrets. Avanex expects to amortize
the developed technology on a straight-line basis over an
estimated life of 3-5 years.



| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | Acquisition of Certain Assets of Vitesse
    Semiconductor Corporations Optical Systems
    Division

On August 22, 2003, the Company entered into
an agreement to acquire certain assets of Vitesse Semiconductor
Corporations Optical Systems Division located in San Jose,
California. Pursuant to the agreement, the Company acquired
substantially all of the assets of Vitesses Optical
Systems Division in exchange for approximately 1.2 million
shares of Avanex common stock with a value of $5.9 million.
Under the terms of the agreement, the Company will also buy up
to $2 million in products from Vitesse over the next three
years. The transaction will be accounted for under the purchase
method of accounting.

74



---



##### Table of Contents








|        |                                                                                               
|------- | ----------------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial
    Disclosures.

Not applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation
of disclosure controls and procedures.

Our management evaluated, with the participation
of our Chief Executive Officer, our Chief Financial Officer and
our Chief Governance Officer, the effectiveness of our
disclosure controls and procedures as of the end of the period
covered by this annual report on Form 10-K. Based on this
evaluation, our Chief Executive Officer, our Chief Financial
Officer and our Chief Governance Officer have concluded that our
disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that we file
or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.



| |                                                           
| | ----------------------------------------------------------
| | Changes in internal controls over financial
    reporting.

There was no change in our internal control over
financial reporting that occurred during the period covered by
this annual report on Form 10-K that has materially
affected, or is reasonably likely to materially affect, our
internal control over financial reporting.




PART III






|         |                                             
|-------- | --------------------------------------------
|Item 10. | Directors and Officers of the
    Registrant

The information required by this item concerning
our directors is incorporated by reference to the information
set forth in the sections entitled Election of
Directors and Section 16(a) Beneficial
Ownership Reporting Compliance in our Proxy Statement for
our 2003 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission not later than 120 days
after the end of our fiscal year, except that the information
required by this item concerning our executive officers is
incorporated by reference to the information set forth in the
section entitled Executive Officers at the end of
Part I of this annual report on Form 10-K.

We have adopted a code of ethics that applies to
our principal executive officer, principal financial officer,
principal accounting officer and controller, and persons
performing similar functions, which is filed as an exhibit to
this annual report on Form 10-K. We will disclose
amendments to, or waivers from, this code of ethics in
accordance with SEC rules.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this item is
incorporated by reference to the sections entitled
Director Compensation and Executive
Compensation in the Proxy Statement.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information required by this item is
incorporated by reference to the section entitled Security
Ownership of Certain Beneficial Owners and Management and
Equity Compensation Plan Information in the Proxy
Statement.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this item is
incorporated by reference to the section entitled Certain
Transactions in the Proxy Statement.

75



---



##### Table of Contents








|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accounting Fees and
    Services

The information required by this item is
incorporated by reference to the section entitled
Ratification of Appointment of Independent
Auditors  Fee Disclosure in the Proxy Statement.




PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) Financial Statements

(1) Index to Financial
Statements

The Financial Statements required by this item
are submitted in Part II, Item 8 of this report.

(2) Financial Statements
Schedules

The following financial statement schedule of
Avanex Corporation for each of the past three years in the
period ended June 30, 2003 should be read in conjunction
with the Consolidated Financial Statements of Avanex Corporation.




Schedule II  Valuation
and Qualifying Accounts Allowance For Doubtful
Accounts:

|                         |  |              |           |            |  |               |         |            |  |  |         |  |  |   |           | 
|------------------------ |  | ------------ | --------- | ---------- |  | ------------- | ------- | ---------- |  |  | ------- |  |  | - | --------- | 
|                         |  |              |           | Additions  |  |               |         |           
|                         |  | Balance at   |           | Charged to |  |               |         | Balance at
|                         |  | Beginning of |           | Costs and  |  | Deductions    |         | End of    
|                         |  | Period       |           | Expenses   |  | Write-Offs(1) |         | Period    
|                         |  |              |           |            |  |               |         |           
|Year ended June 30, 2001 |  | $            | 452,000   |            |  |               | 557,000 |            |  |  |        |  |  | $ | 1,009,000 | 
|Year ended June 30, 2002 |  | $            | 1,009,000 |            |  |               | 307,000 |            |  |  | 396,000 |  |  | $ | 920,000   | 
|Year ended June 30, 2003 |  | $            | 920,000   |            |  |               | 82,000  |            |  |  | 524,000 |  |  | $ | 478,000   | 



---



|    |                                                                                                 
|--- | ------------------------------------------------------------------------------------------------
|(1) | Represents uncollectable accounts written off and
    reversal of charges to costs and expenses.

All other schedules have been omitted because
they are not applicable or are not required or the information
required to be set forth therein is included in the Consolidated
Financial Statements or Notes thereto.



| |     |         
| | --- | --------
| | (3) | Exhibits

|        |   |    |  |                         |  |                                                                                                                                                                                                                                                                                                   
|------- | - | -- |  | ----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |    |  |                        
|Number  |   |    |  | Description of Exhibits
|        |   |    |  |                        
|        | 2 | .1 |  |                         |  | Share Acquisition and Asset Purchase Agreement,
    dated as of May 12, 2003, by and between Avanex
    Corporation, Alcatel and Corning Incorporated (which is
    incorporated herein by reference to Exhibit 2.1 of the
    Registrants Current Report on Form 8-K filed on
    May 16, 2003).
|        | 3 | .1 |  |                         |  | Certificate of Incorporation of the Registrant,
    as amended to date (which is incorporated herein by reference
    to Exhibit 3.1 of the Registrants Quarterly Report on
    Form 10-Q filed on May 16, 2000).                                                                                
|        | 3 | .2 |  |                         |  | Bylaws of the Registrant (which are
    incorporated herein by reference to Exhibit 3.2 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                                                                                                      
|        | 3 | .3 |  |                         |  | Certificate of Amendment of Bylaws of the
    Registrant (which is incorporated herein by reference to
    Exhibit 3.1 of the Registrants Quarterly Report on
    Form 10-Q filed on October 29, 2002).                                                                                          
|        | 4 | .1 |  |                         |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                        
|        | 4 | .2 |  |                         |  | Specimen Common Stock Certificate (which is
    incorporated herein by reference to Exhibit 4.1 of the
    Registrants Amendment No. 2 to Registration Statement
    No. 333-92097 on Form S-1 filed on January 14,
    2000).                                                                   

76



---



##### Table of Contents



|        |    |      |  |                         |  |                                                                                                                                                                                                                                                                                                                                                    
|------- | -- | ---- |  | ----------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |                        
|Number  |    |      |  | Description of Exhibits
|        |    |      |  |                        
|        | 4  | .3   |  |                         |  | Preferred Stock Rights Agreement, dated as of
    July 26, 2001, between the Registrant and the EquiServe
    Trust Company, N. A. (which is incorporated herein by
    reference to Exhibit 4.5 of the Registrants
    Form 8-A filed on August 24, 2001).                                                                                       
|        | 4  | .4   |  |                         |  | First Amendment to the Preferred Stock Rights
    Agreement dated as of March 18, 2002, between the
    Registrant and the EquiServe Trust Company, N. A. (which
    is incorporated herein by reference to Exhibit 4.2 of the
    Registrants Form 8-A/ A filed on March 28,
    2002).                                                          
|        | 4  | .5   |  |                         |  | Second Amendment to the Preferred Stock Rights
    Agreement dated as of March 18, 2002, between the
    Registrant and the EquiServe Trust Company, N. A. (which
    is incorporated herein by reference to Exhibit 4.3 of the
    Registrants Form 8-A/ A filed on May 30,
    2003).                                                           
|        | 10 | .1*  |  |                         |  | Form of Indemnification Agreement between
    Registrant and each of its directors and officers (which is
    incorporated herein by reference to Exhibit 10.1 of the
    Registrants Registration Statement No. 333-92027 on
    Form S-1 filed on December 3, 1999).                                                                            
|        | 10 | .2*  |  |                         |  | 1998 Stock Plan, as amended, and forms of
    agreement thereunder (which is incorporated herein by
    reference to Exhibit 10.2 of the Registrants
    Amendment No. 2 to Registration Statement
    No. 333-92097 on Form S-1 filed on January 14,
    2000).                                                                                  
|        | 10 | .3*  |  |                         |  | 1999 Employee Stock Purchase Plan, as amended
    (which is incorporated herein by reference to
    Exhibit 4.2 of the Registrants Registration Statement
    on Form S-8 filed on September 17, 2002).                                                                                                                                           
|        | 10 | .4*  |  |                         |  | 1999 Director Option Plan, as amended (which
    is incorporated herein by reference to Exhibit 4.3 of the
    Registrants Registration Statement on Form S-8 filed
    on September 17, 2002).                                                                                                                                                   
|        | 10 | .5*  |  |                         |  | Holographix Inc. 2000 Stock Option Plan, as
    amended (which is incorporated herein by reference to
    Exhibit 4.2 of the Registrants Registration Statement
    on Form S-8 filed on August 3, 2000).                                                                                                                                         
|        | 10 | .6*  |  |                         |  | Form of Restricted Stock Purchase Agreement
    between the Registrant certain of its executive officers
    (which is incorporated herein by reference to
    Exhibit 10.8 of the Registrants Registration
    Statement No. 333-92027 on Form S-1 filed on
    December 3, 1999).                                                               
|        | 10 | .7*  |  |                         |  | Form of stock option agreement between the
    Registrant and certain of its executive officers (which is
    incorporated herein by reference to Exhibit 10.9 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                                                                                
|        | 10 | .8*  |  |                         |  | Form of stock option agreement between the
    Registrant and certain of its executive officers.                                                                                                                                                                                                                                                   
|        | 10 | .9*  |  |                         |  | Forms of stock option agreements between the
    Registrant and certain of its directors (which are
    incorporated herein by reference to Exhibit 10.10 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                                                                                     
|        | 10 | .10* |  |                         |  | Forms of stock option agreements between the
    Registrant and certain of its directors.                                                                                                                                                                                                                                                          
|        | 10 | .11* |  |                         |  | Terms of Employment dated January 6, 2003
    between the Registrant and Walter Alessandrini (which is
    incorporated herein by reference to Exhibit 10.1 of the
    Registrants Quarterly Report on Form 10-Q filed on
    February 7, 2003).                                                                                                  
|        | 10 | .12* |  |                         |  | Terms of Employment between the Registrant and
    Paul Engle dated September 19, 2000 (which is
    incorporated herein by reference to Exhibit 10.33 of the
    Registrants Quarterly Report on Form 10-Q filed on
    November 15, 2000).                                                                                                      
|        | 10 | .13* |  |                         |  | Restricted Stock Award Agreements dated as of
    September 19, 2000, February 14, 2001, and
    August 16, 2001, between the Registrant and Paul Engle
    (which are incorporated herein by reference to
    Exhibit 10.7 of the Registrants Amendment No. 2
    to Registration Statement No. 333-85906 on Form S-4
    filed on May 30, 2002).
|        | 10 | .14* |  |                         |  | Stock Option Agreements dated as of
    April 30, 2001, and November 5, 2001, between the
    Registrant and Paul Engle (which are incorporated herein by
    reference to Exhibit 10.8 of the Registrants
    Amendment No.2 to Registration Statement No. 333-85906 on
    Form S-4 filed on May 30, 2002).                                     

77



---



##### Table of Contents



|        |    |      |  |                         |  |                                                                                                                                                                                                                                                                                                                                                 
|------- | -- | ---- |  | ----------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |                        
|Number  |    |      |  | Description of Exhibits
|        |    |      |  |                        
|        | 10 | .15* |  |                         |  | Severance Agreement and Release dated
    November 18, 2002 between Paul Engle and the Registrant
    (which is incorporated herein by reference to
    Exhibit 10.2 of the Registrants Quarterly Report on
    Form 10-Q filed on February 7, 2003).                                                                                          
|        | 10 | .16  |  |                         |  | Lease between the Registrant and Stevenson
    Business Park LLC for Building B of 40919 Encyclopedia
    Circle, Fremont, California dated September 8, 1999
    (which is incorporated herein by reference to
    Exhibit 10.25 of the Registrants Registration
    Statement No. 333-92027 on Form S-1 filed on
    December 3, 1999).      
|        | 10 | .17  |  |                         |  | Lease Agreement between Stevenson Business Park,
    LLC and the Registrant for Building C of
    40919 Encyclopedia Circle, Fremont, California dated
    March 1, 2000 (which is incorporated herein by reference
    to Exhibit 10.38 of the Registrants Quarterly Report
    on Form 10-Q filed on May 16, 2000).                          
|        | 10 | .18  |  |                         |  | Amended and Restated Revolving Credit and
    Security Agreement between Comerica Bank-California and the
    Registrant dated July 10, 2000 (which is incorporated
    herein by reference to Exhibit 10.31 of the
    Registrants Annual Report on Form 10-K filed on
    September 21, 2000).                                               
|        | 10 | .19  |  |                         |  | Lease Agreement between GAL-LPC Stevenson
    Boulevard, LP and the Registrant for Buildings A and E of
    39611 and 39630 Eureka Boulevard, Newark, California dated
    August 9, 2000 (which is incorporated herein by
    reference to Exhibit 10.35 of the Registrants
    Quarterly Report on Form 10-Q filed on November 15,
    2000).
|        | 10 | .20  |  |                         |  | Lease Agreement between CFH Realty II/
    Glenville, L.P. and the Registrant for the building at
    1801 N. Glenville Drive, Richardson, Texas dated
    August 9, 2000 (which is incorporated herein by
    reference to Exhibit 10.36 of the Registrants
    Quarterly Report on Form 10-Q filed on November 15,
    2000).                
|        | 10 | .21  |  |                         |  | Second Amendment to Revolving Credit and Security
    Agreement between Comerica Bank-California and the Registrant
    dated January 2, 2001 (which is incorporated herein by
    reference to Exhibit 10.37 of the Registrants
    Quarterly Report on Form 10-Q filed on February 15,
    2001).                                            
|        | 10 | .22  |  |                         |  | Third Amendment to Amended and Restated Revolving
    Credit and Security Agreement dated July 19, 2001 between
    the Registrant and Comerica Bank-California (which is
    incorporated herein by reference to Exhibit 10.38 of the
    Registrants Annual Report on Form 10-K filed on
    September 17, 2001).                            
|        | 10 | .23  |  |                         |  | Fourth Amendment to Amended and Restated
    Revolving Credit and Security Agreement dated September 26,
    2002 between the Registrant and Comerica Bank-California
    (which is incorporated herein by reference to the
    Registrants Quarterly Report on Form 10-Q filed on
    October 29, 2002).                                      
|        | 10 | .24  |  |                         |  | Fifth Amendment to Amended and Restated Revolving
    Credit and Security Agreement dated June 18, 2003 between
    the Registrant and Comerica Bank-California.                                                                                                                                                                                
|        | 14 | .1   |  |                         |  | Code of Ethics for Principal Executive and Senior
    Financial Officers.                                                                                                                                                                                                                                                                       
|        | 21 | .1   |  |                         |  | List of subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                         
|        | 23 | .1   |  |                         |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                                                                                                                                                                                                                                                         
|        | 24 | .1   |  |                         |  | Power of Attorney (See page 80).                                                                                                                                                                                                                                                                                                                
|        | 31 | .1   |  |                         |  | Certification of Chief Executive Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                         
|        | 31 | .2   |  |                         |  | Certification of Chief Financial Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                         
|        | 32 | .1   |  |                         |  | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                                                                                                                      



---



|  |                                                                       
|- | ----------------------------------------------------------------------
|* | Indicates management contract or compensatory
    plan or arrangement.

78



---



##### Table of Contents



(b) Reports on Form 8-K

On April 30, 2003, the Registrant filed a
current report on Form 8-K furnishing its press release
regarding its financial results for the third quarter ended
March 31, 2003.

On May 16, 2003, the Registrant filed a
current report on Form 8-K reporting that it entered into a
Share Acquisition and Asset Purchase Agreement by and between
the Registrant, Alcatel, a société anonyme
organized under the laws of the Republic of France and Corning
Incorporated, a Delaware corporation.

79



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this annual report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Fremont, County of Alameda, State of
California, on September 26, 2003.



| |                   
| | ------------------
| | AVANEX CORPORATION



| |     |                  
| | --- | -----------------
| | BY: | /s/ BRUCE POLLOCK

| |                            
| | ---------------------------
| |                            
| | Bruce Pollock              
| | Vice President, Finance and
| | Chief Financial Officer    

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each
person whose signature appears below constitutes and appoints
Walter Alessandrini and Bruce Pollock, and each of them, as his
or her true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him or her and in
his or her name, place, and stead, in any and all capacities, to
sign any and all amendments to this report, and to file the
same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he
or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of
them or their or his substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this annual report on Form 10-K has
been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.

|                                           |  |                                                                                                          |  |                    |  | 
|------------------------------------------ |  | -------------------------------------------------------------------------------------------------------- |  | ------------------ |  | 
|                                           |  |                                                                                                          |  |                   
|Signature                                  |  | Title                                                                                                    |  | Date              
|                                           |  |                                                                                                          |  |                   
|/s/ WALTER ALESSANDRINIWalter Alessandrini |  | President, Chief Executive Officer, Director and
    Chairman of the Board (principal executive officer) |  | September 26, 2003
|                                          
|/s/ BRUCE POLLOCKBruce Pollock             |  | Vice President, Finance and Chief Financial
    Officer (principal financial and accounting officer)     |  | September 26, 2003
|                                          
|/s/ VINTON CERFVinton Cerf                 |  | Director                                                                                                 |  | September 26, 2003
|                                          
|/s/ TODD BROOKSTodd Brooks                 |  | Director                                                                                                 |  | September 26, 2003
|                                          
|/s/ JOEL A. SMITH IIIJoel A. Smith III     |  | Director                                                                                                 |  | September 26, 2003
|                                          
|/s/ SUSAN WANGSusan Wang                   |  | Director                                                                                                 |  | September 26, 2003

80



---



##### Table of Contents



EXHIBIT INDEX

|        |    |      |  |                         |  |                                                                                                                                                                                                                                                                                                   
|------- | -- | ---- |  | ----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |                        
|Number  |    |      |  | Description of Exhibits
|        |    |      |  |                        
|        | 2  | .1   |  |                         |  | Share Acquisition and Asset Purchase Agreement,
    dated as of May 12, 2003, by and between Avanex
    Corporation, Alcatel and Corning Incorporated (which is
    incorporated herein by reference to Exhibit 2.1 of the
    Registrants Current Report on Form 8-K filed on
    May 16, 2003).
|        | 3  | .1   |  |                         |  | Certificate of Incorporation of the Registrant,
    as amended to date (which is incorporated herein by reference
    to Exhibit 3.1 of the Registrants Quarterly Report on
    Form 10-Q filed on May 16, 2000).                                                                                
|        | 3  | .2   |  |                         |  | Bylaws of the Registrant (which are
    incorporated herein by reference to Exhibit 3.2 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                                                                                                      
|        | 3  | .3   |  |                         |  | Certificate of Amendment of Bylaws of the
    Registrant (which is incorporated herein by reference to
    Exhibit 3.1 of the Registrants Quarterly Report on
    Form 10-Q filed on October 29, 2002).                                                                                          
|        | 4  | .1   |  |                         |  | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                        
|        | 4  | .2   |  |                         |  | Specimen Common Stock Certificate (which is
    incorporated herein by reference to Exhibit 4.1 of the
    Registrants Amendment No. 2 to Registration Statement
    No. 333-92097 on Form S-1 filed on January 14,
    2000).                                                                   
|        | 4  | .3   |  |                         |  | Preferred Stock Rights Agreement, dated as of
    July 26, 2001, between the Registrant and the EquiServe
    Trust Company, N. A. (which is incorporated herein by
    reference to Exhibit 4.5 of the Registrants
    Form 8-A filed on August 24, 2001).                                      
|        | 4  | .4   |  |                         |  | First Amendment to the Preferred Stock Rights
    Agreement dated as of March 18, 2002, between the
    Registrant and the EquiServe Trust Company, N. A. (which is
    incorporated herein by reference to Exhibit 4.2 of the
    Registrants Form 8-A/ A filed on March 28,
    2002).         
|        | 4  | .5   |  |                         |  | Second Amendment to the Preferred Stock Rights
    Agreement dated as of March 18, 2002, between the
    Registrant and the EquiServe Trust Company, N. A. (which
    is incorporated herein by reference to Exhibit 4.3 of the
    Registrants Form 8-A/ A filed on May 30,
    2003).          
|        | 10 | .1*  |  |                         |  | Form of Indemnification Agreement between
    Registrant and each of its directors and officers (which is
    incorporated herein by reference to Exhibit 10.1 of the
    Registrants Registration Statement No. 333-92027 on
    Form S-1 filed on December 3, 1999).                           
|        | 10 | .2*  |  |                         |  | 1998 Stock Plan, as amended, and forms of
    agreement thereunder (which is incorporated herein by
    reference to Exhibit 10.2 of the Registrants
    Amendment No. 2 to Registration Statement
    No. 333-92097 on Form S-1 filed on January 14,
    2000).                                 
|        | 10 | .3*  |  |                         |  | 1999 Employee Stock Purchase Plan, as amended
    (which is incorporated herein by reference to
    Exhibit 4.2 of the Registrants Registration Statement
    on Form S-8 filed on September 17, 2002).                                                                                          
|        | 10 | .4*  |  |                         |  | 1999 Director Option Plan, as amended (which
    is incorporated herein by reference to Exhibit 4.3 of the
    Registrants Registration Statement on Form S-8 filed
    on September 17, 2002).                                                                                                  
|        | 10 | .5*  |  |                         |  | Holographix Inc. 2000 Stock Option Plan, as
    amended (which is incorporated herein by reference to
    Exhibit 4.2 of the Registrants Registration Statement
    on Form S-8 filed on August 3, 2000).                                                                                        
|        | 10 | .6*  |  |                         |  | Form of Restricted Stock Purchase Agreement
    between the Registrant certain of its executive officers
    (which is incorporated herein by reference to
    Exhibit 10.8 of the Registrants Registration
    Statement No. 333-92027 on Form S-1 filed on
    December 3, 1999).              
|        | 10 | .7*  |  |                         |  | Form of stock option agreement between the
    Registrant and certain of its executive officers (which is
    incorporated herein by reference to Exhibit 10.9 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                               
|        | 10 | .8*  |  |                         |  | Form of stock option agreement between the
    Registrant and certain of its executive officers.                                                                                                                                                                                                  
|        | 10 | .9*  |  |                         |  | Forms of stock option agreements between the
    Registrant and certain of its directors (which are
    incorporated herein by reference to Exhibit 10.10 of the
    Registrants Annual Report on Form 10-K filed on
    September 20, 2002).                                                    
|        | 10 | .10* |  |                         |  | Forms of stock option agreements between the
    Registrant and certain of its directors.                                                                                                                                                                                                         



---



##### Table of Contents



|        |    |      |  |                         |  |                                                                                                                                                                                                                                                                                                                                                    
|------- | -- | ---- |  | ----------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |      |  |                        
|Number  |    |      |  | Description of Exhibits
|        |    |      |  |                        
|        | 10 | .11* |  |                         |  | Terms of Employment dated January 6, 2003
    between the Registrant and Walter Alessandrini (which is
    incorporated herein by reference to Exhibit 10.1 of the
    Registrants Quarterly Report on Form 10-Q filed on
    February 7, 2003).                                                                                                  
|        | 10 | .12* |  |                         |  | Terms of Employment between the Registrant and
    Paul Engle dated September 19, 2000 (which is
    incorporated herein by reference to Exhibit 10.33 of the
    Registrants Quarterly Report on Form 10-Q filed on
    November 15, 2000).                                                                                                      
|        | 10 | .13* |  |                         |  | Restricted Stock Award Agreements dated as of
    September 19, 2000, February 14, 2001, and
    August 16, 2001, between the Registrant and Paul Engle
    (which are incorporated herein by reference to
    Exhibit 10.7 of the Registrants Amendment No. 2
    to Registration Statement No. 333-85906 on Form S-4
    filed on May 30, 2002).
|        | 10 | .14* |  |                         |  | Stock Option Agreements dated as of
    April 30, 2001, and November 5, 2001, between the
    Registrant and Paul Engle (which are incorporated herein by
    reference to Exhibit 10.8 of the Registrants
    Amendment No.2 to Registration Statement No. 333-85906 on
    Form S-4 filed on May 30, 2002).                                     
|        | 10 | .15* |  |                         |  | Severance Agreement and Release dated
    November 18, 2002 between Paul Engle and the Registrant
    (which is incorporated herein by reference to
    Exhibit 10.2 of the Registrants Quarterly Report on
    Form 10-Q filed on February 7, 2003).                                                                                             
|        | 10 | .16  |  |                         |  | Lease between the Registrant and Stevenson
    Business Park LLC for Building B of 40919 Encyclopedia
    Circle, Fremont, California dated September 8, 1999
    (which is incorporated herein by reference to
    Exhibit 10.25 of the Registrants Registration
    Statement No. 333-92027 on Form S-1 filed on
    December 3, 1999).         
|        | 10 | .17  |  |                         |  | Lease Agreement between Stevenson Business Park,
    LLC and the Registrant for Building C of
    40919 Encyclopedia Circle, Fremont, California dated
    March 1, 2000 (which is incorporated herein by reference
    to Exhibit 10.38 of the Registrants Quarterly Report
    on Form 10-Q filed on May 16, 2000).                             
|        | 10 | .18  |  |                         |  | Amended and Restated Revolving Credit and
    Security Agreement between Comerica Bank-California and the
    Registrant dated July 10, 2000 (which is incorporated
    herein by reference to Exhibit 10.31 of the
    Registrants Annual Report on Form 10-K filed on
    September 21, 2000).                                                  
|        | 10 | .19  |  |                         |  | Lease Agreement between GAL-LPC Stevenson
    Boulevard, LP and the Registrant for Buildings A and E of
    39611 and 39630 Eureka Boulevard, Newark, California dated
    August 9, 2000 (which is incorporated herein by
    reference to Exhibit 10.35 of the Registrants
    Quarterly Report on Form 10-Q filed on November 15,
    2000).   
|        | 10 | .20  |  |                         |  | Lease Agreement between CFH Realty II/
    Glenville, L.P. and the Registrant for the building at
    1801 N. Glenville Drive, Richardson, Texas dated
    August 9, 2000 (which is incorporated herein by
    reference to Exhibit 10.36 of the Registrants
    Quarterly Report on Form 10-Q filed on November 15,
    2000).                   
|        | 10 | .21  |  |                         |  | Second Amendment to Revolving Credit and Security
    Agreement between Comerica Bank-California and the Registrant
    dated January 2, 2001 (which is incorporated herein by
    reference to Exhibit 10.37 of the Registrants
    Quarterly Report on Form 10-Q filed on February 15,
    2001).                                               
|        | 10 | .22  |  |                         |  | Third Amendment to Amended and Restated Revolving
    Credit and Security Agreement dated July 19, 2001 between
    the Registrant and Comerica Bank-California (which is
    incorporated herein by reference to Exhibit 10.38 of the
    Registrants Annual Report on Form 10-K filed on
    September 17, 2001).                               
|        | 10 | .23  |  |                         |  | Fourth Amendment to Amended and Restated
    Revolving Credit and Security Agreement dated September 26,
    2002 between the Registrant and Comerica Bank-California
    (which is incorporated herein by reference to the
    Registrants Quarterly Report on Form 10-Q filed on
    October 29, 2002).                                         



---



##### Table of Contents



|        |    |     |  |                         |  |                                                                                                                                                                                           
|------- | -- | --- |  | ----------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |     |  |                        
|Number  |    |     |  | Description of Exhibits
|        |    |     |  |                        
|        | 10 | .24 |  |                         |  | Fifth Amendment to Amended and Restated Revolving
    Credit and Security Agreement dated June 18, 2003 between
    the Registrant and Comerica Bank-California.                          
|        | 14 | .1  |  |                         |  | Code of Ethics for Principal Executive and Senior
    Financial Officers.                                                                                                                 
|        | 21 | .1  |  |                         |  | List of subsidiaries of the Registrant.                                                                                                                                                   
|        | 23 | .1  |  |                         |  | Consent of Ernst & Young LLP,
    Independent Auditors.                                                                                                                                   
|        | 24 | .1  |  |                         |  | Power of Attorney (See page 80).                                                                                                                                                          
|        | 31 | .1  |  |                         |  | Certification of Chief Executive Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                   
|        | 31 | .2  |  |                         |  | Certification of Chief Financial Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                   
|        | 32 | .1  |  |                         |  | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.



---



|  |                                                                       
|- | ----------------------------------------------------------------------
|* | Indicates management contract or compensatory
    plan or arrangement.