3. Net Loss per Common

Basic and diluted net loss per common share is presented in co Standards Board's (FASB's) Statement of Financial Accounting Standards No. 128, "Earn presented. In accordance with FAS 128, basic and diluted net loss per common share ha number of shares of common stock outstanding during the period less the weighted-aver subject to repurchase. All redeemable convertible preferred stock, warrants for commo subject to repurchase have been excluded from the calculation of diluted net loss per antidilutive for all periods presented.

The following table presents the calculation of basic and dilu per share data):

                                 Three Months Ended        Nine Months Ended
                                     March 31,                 March 31,
                              ------------------------- -------------------------
                                 2000         1999         2000         1999
                              ------------ ------------ ------------ ------------
Net loss attributable to
 common stockholders..........   ($29,157)     ($2,510)    ($69,002)     ($5,117)
                              ============ ============ ============ ============
Basic and diluted:
  Weighted-average shares
     of common stock
     outstanding..............     47,384       12,955       28,523       12,205
  Less: weighted-average
     shares subject to
     repurchase...............    (13,255)     (10,740)     (13,020)     (11,047)
                              ------------ ------------ ------------ ------------
Weighted-average shares
  used in computing basic
  and diluted net loss
  per common share............     34,129        2,215       15,503        1,158
                              ============ ============ ============ ============
Basic and diluted net
  loss per common
  share.......................     ($0.85)      ($1.13)      ($4.45)      ($4.42)
                              ============ ============ ============ ============

4. Segment Information

The Company has adopted the FASB's Statement of Financial Acco Segments of an Enterprise and Related Information." The Company operates in one segme processors.

5. Initial Public Offering

On February 9, 2000, the Company completed its initial public Common Stock, including 900,000 shares in connection with the exercise of the underwr share. Concurrently with the completion of the offering, the Company sold to Microsof affiliate of MCI WorldCom, Inc., an aggregate of 769,230 shares of our common stock f

Upon the closing of the offering, all the Company's outstanding pr aggregate of 35,019,134 shares of Common Stock. After the offering, the Company's aut of Common Stock, of which 64,186,491 shares were outstanding as of March 31, 2000, an which was issued or outstanding as of March 31, 2000.

6. Effect of New Accounting Statements

In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Hedging Activities" (FAS 133), which will be effective for the Company's fiscal year establishes accounting and reporting standards requiring that every derivative instru embedded in other contracts, be recorded in the balance sheet as either an asset or l statement also requires that changes in the derivative's fair value be recognized in criteria are met. The Company has not evaluated the impact of FAS 133; however, it be material effect on its consolidated financial position, results of operations, or cas derivative contracts.

In December 1999, the Securities and Exchange Commission issued Staff Accounting B Financial Statements" (SAB 101). SAB 101 summarizes certain of the SEC Staff's views principles to revenue recognition in financial statements. The Company is currently e Company determine that a change in its accounting policy is necessary, such a change result in a charge to results of operations for the cumulative effect of the change. as deferred revenue and recognized as revenue in future periods. Prior financial stat

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDI OF OPERATIONS

This report contains certain forward-looking statements (as such term is defined i Section 21E of the Securities Exchange Act of 1934) and information relating to the C management of the Company as well as assumptions made by and information currently av addition, when used in this report, the words "likely," "will," & "may," "would," "could," "anticipate," " "expect," "intend," "plan," "predict," and si relate to the Company or the management of the Company, may identify forward-looking judgment of the Company as of the date of this quarterly report on Form 10-Q with res subject to certain risks, including the factors set forth in "Risk Factors," Company's business, operating results or financial condition. Investors are cautione inherently uncertain. Should one or more of these risks or uncertainties materialize incorrect, actual results or outcomes may vary materially from those described herein reflected in the forward-looking statements are reasonable, we cannot guarantee futur achievements. Moreover, neither we nor any other person assumes responsibility for t looking statements. Avanex Corporation undertakes no obligation to update forward lo

The following discussion and analysis should be read in conjunction with the conde notes thereto included in Item 1 in this Quarterly Report and our Registration Statem Securities and Exchange Commission on February 3, 2000 (File No. 333-92097).

OVERVIEW

Avanex designs, manufactures and markets fiber optic-based pro designed to increase the performance of optical networks. We were founded in October engaged in research and development activities and in hiring additional employees. A during this period were related to the design and development of our photonic process began making volume shipments of our initial product during the quarter ended October

The revenues currently recognized are derived from sales of tw commenced shipments of our PowerFilter in April 1999. To date, we have generated most PowerFilter to a limited number of customers. While we are diversifying our customer for any given period will continue to depend on a small number of customers.

Our future success depends on our abili products that address those needs. Any failure to predict market needs accurately or enhancements in a timely manner will substantially decrease market acceptance and sal could quickly become obsolete as new technologies are introduced and incorporated int anticipate that our PowerMux product, which incorporates our PowerFilter product and PowerFilter product in most applications. We must continue to develop state-of-the-a commercial market quickly in order to be successful. If the development of any future if we are unable to develop and introduce these products to the commercial market, ou market share. Even if we are able to develop and commercially introduce new products the new products or enhancements will achieve widespread market acceptance. Any fail acceptance could significantly harm our business.

We currently purchase several key components used in our products from single or l Sheet Glass, Hoya USA, Inc., CMI Sumitomo Corporation of America, Casix, Inc. and Bro filters, lenses and specialty glass. Recent acquisitions of suppliers in these areas sources of supply. We may face difficulties in obtaining the necessary components fo trend towards consolidation of our suppliers continues. A shortage of components wou capacity and to meet expected increases in demand for our products.

New products also often initially have lower manufacturing yields and generally ar more mature products. Manufacturing yields generally improve as the product matures yields also vary depending on the complexity and uniqueness of product specifications variations in manufacturing yields may have a significant impact on gross margins.

The market for photonic processors is new and evolving and the predict. A customer's decision to purchase our products typically involves a commitme and product qualification process. This initial evaluation and product qualification includes technical evaluation, integration, testing, planning and implementation into implementation cycles for our products, as well as the practice of customers in the c large orders with short lead times, may cause our revenues, gross margins and operati unexpectedly from quarter to quarter.

RESULTS OF OPERATIONS

NET REVENUE

The quarter ended June 30, 1999 was the Company's first quarte for the three months ended March 31, 2000 and $21.4 million for the nine months ended periods in the preceding fiscal year). One customer, MCI WorldCom, Inc. (MCI), accoun three months ended March 31, 2000, and MCI accounted for approximately 89% of net rev

We currently derive our revenues primar and PowerMux. To date, we have generated most of our revenues from sales of PowerFil will account for a lower percentage of net revenues as we gain increased revenues fro including PowerMux.

COST OF REVENUE

RESEARCH AND DEVELOPMENT EXPENSES

Research and development expenses were $5.0 million for the th increase of $3.6 million or 250% over the comparable quarter of fiscal 1999, and were 31, 2000, an increase of $5.1 million or 180% over the comparable period of fiscal 19 increased personnel costs associated with increased headcount and to a lesser extent prototype expenses and non-recurring engineering costs. Research and development is e the Company expects that research and development expense will continue to increase i

SALES AND MARKETING EXPENSES

Sales and marketing expenses were $2.1 million for the three m of $1.9 million over the comparable quarter of fiscal 1999, and were $3.7 million in increase of $3.3 million over the comparable period of fiscal 1999. The increase was costs associated with additional headcount to support our customer requirements and t expenses including commissions, advertising, and trade shows. The Company expects to marketing, and customer support activities; therefore, sales and marketing expenses a future periods.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses totaled $1.5 million for t increase of $1.3 million over the comparable quarter of fiscal 1999, and totaled $3.6 2000, an increase of $3.2 million over the comparable period of fiscal 1999. The incr personnel costs associated with additional headcount to support increased levels of b professional services including legal and accounting services associated with being a general and administrative expense to continue to increase in absolute dollars in fut business activity.

STOCK COMPENSATION

INTEREST INCOME, NET

Net interest income includes income on cash investments partia obligations. Net interest income was $2.0 million in the three months ended March 31, March 31, 2000. This compares with net interest income of $21,000 in the three months months ended March 31, 1999. The increase in net interest income is a direct result o proceeds we received from our underwriters upon the closing of our initial public off

Stock accretion increased to $17.7 million and $37.7 milli 31, 2000, respectively, from zero for the three and nine months ended March 31, 1999. connection with the issuance, in September and October 1999, of 5,230,646 shares of S order to accrete the value of the preferred stock to its deemed fair value. A $17.7 m connection with the sale of 769,230 shares of common stock to Microsoft Corporation a MCI WorldCom, Inc., for $13.00 per share. The charge is equal to the difference betwe initial public offering and $13, multiplied by the number of shares issued.

LIQUIDITY AND CAPITAL RESOURCES

From inception on October 24, 1997, to our initial public offe through private sales of approximately $30.4 million of redeemable convertible prefer through bank borrowings as well as through equipment lease financing. On February 9, (including exercise of the underwriter's over-allotment option) at a price of $36.00 Proceeds to us, net of issuance costs, were approximately $228.4 million. Concurrentl to Microsoft Corporation and MCI WorldCom Venture Fund, an affiliate of MCI WorldCom, common stock for $13.00 per share. Proceeds from the sale of these shares were appro combined balance of cash, cash equivalents and short-term investments was $198.1 mill $48.6 million.

Net cash used in operating activities was $10.4 million for th million for the comparative period of fiscal 1999. The increase in cash used from the primarily the result of net operating losses and increases in inventory, accounts rec increases in accounts payable and other accrued liabilities, and non-cash charges, in

Net cash used in investing activities was $249.0 million in th million of cash used in investing activities was for the purchase of investment secur remaining cash used in investing activities was for investments in production equipme computers and facilities to support the expansion of our operations. Net cash used i comparable period of fiscal 1999.

Net cash generated from financing activities was $262.4 millio primarily from the initial public offering that closed on February 9, 2000, sales of WorldCom Venture Fund, sales of redeemable, convertible preferred stock, and borrowi generated $7.2 million in the nine months ended March 31, 1999, primarily from the is stock.

We financed capital purchases primarily through leases or equi revolving credit line from a financial institution, which allows for maximum borrowin equal to the prime rate plus 0.75%. As of March 31, 2000, we had drawn $1.7 million a requires that we comply with specified covenants.

In connection with our expansion into a new manufacturing facility California we have spent approximately $1.5 million for equipment and leasehold impro building in March 2000. As a result of our expansion into this new building, our capi future periods.

Our capital requirements depend on market acceptance of our produc introductions and delivery, and the need for us to develop, market, sell and support time, we may also consider the acquisition of, or evaluate investments in, products a Any acquisition or investment may require additional capital. Although we believe tha to fund our operations for at least the next 12 months, we cannot assure you that we or private equity financing or from other sources within this time frame or that addi terms acceptable to us, or at all.

You should carefully consider the risks described below and al Q. If any of the following risks actually occur, our business, financial condition an trading price of our common stock could decline, and you may lose all or part of your

We have incurred significant losses since inception and expect incurred net losses of $1.1 million in the period from our inception on October 24, 1 fiscal year ended June 30, 1999, $7.5 million in the quarter ended October 1, 1999, $ 1999, and $11.5 million in the quarter ended March 31, 2000. As of March 31, 2000, we To date, we have not achieved profitability on a quarterly or annual basis. Due to in have funded our operations primarily through the sale of equity securities, bank borr a large amount of fixed expenses and we expect to continue to incur significant and i product development and administrative expenses. As a result, we will need to generat containing costs and operating expenses if we are ever to achieve profitability. Alth quarter ended March 31, 1999 to $21.4 million in the nine months ended March 31, 2000 continue to grow or that we will ever achieve sufficient revenue levels to achieve pr

As a result of our limited operating history, particularly for sale, it is difficult to forecast our revenues accurately, and we have limited me to plan future operating expenses. We began operations in October 1997. Until April 1 our only activities were research and development. We began shipping our PowerFilter evaluation in April 1999. Volume shipments did not commence until the quarter ended O difficulties frequently encountered by early stage companies in a new and rapidly evo of our products and business are, and the size of our market is, unproven. Our abilit depend on, among other things, the level of demand for our products and our capacity

Our revenues and operating results are likely to vary sign factors, many of which are more fully discussed in other risk factors, are likely to

• fluctuations in demand for and sales of our products, which will depend on the speed and magnitude of the transition to an all-optical network;

• cancellations of orders and shipment rescheduling;

• our ability to significantly expand our manufacturing capacity at our facility in Fremont, California, which commenced operations in November 1999;

• the ability of Concord Micro-Optics, Inc., or CMI, to timely produce and deliver subcomponents from its facility in China in the quantity and of the quality we require;

• the practice of companies in the communications industry to sporadically place large orders with short lead times;

• competitive factors, including introductions of new products and product enhancements by potential competitors, entry of new competitors into the photonic processor market, including Lucent Technologies, Nortel Networks and Fujitsu, and pricing pressures;

• our ability to develop, introduce, manufacture and ship new and enhanced fiber optic products in a timely manner without defects;

• our ability to control expenses, particularly in light of our limited operating history;

• availability of components for our products and increases in the price of these components;

• mix of our products sold; and

• economic conditions specific to the communications and related industries.

A high percentage of our expenses, including those related to marketing, research and development and general and administrative functions, are ess if we experience delays in generating and recognizing revenue, our quarterly operatin we expand our manufacturing capacity, we will incur expenses in one quarter relating may not result in off-setting revenue until a subsequent quarter. New product introdu research and development expenses and sales and marketing expenses that are incurred recognized until a subsequent quarter. If growth in our revenues does not outpace the operations could be seriously harmed.

Due to these and other factors, we believe that quarter-to-qua not be meaningful. You should not rely on our results for one quarter as any indicati in future quarters our operating results may be below the expectations of public mark price of our common stock would likely decrease.

OUR POWERFILTER PRODUCT CURRENTLY REPRESENTS MOST OF OUR REVENU COMMERCIALLY SELLING OUR POWERMUX PRODUCT, OUR REVENUES WILL NOT GROW SIGNIFIC

We currently offer only two products on a commercial basis, Po PowerFilter product accounted for 95% of our net revenue in the quarter ended June 30 the quarters ended October 1, 1999 and December 31, 1999, and 100% of our net revenue substantially depend on this product for our near-term revenue. Any decline in the pr or its failure to achieve broad market acceptance, would seriously harm our business. and a significant portion of our future revenue will depend on the commercial success customers do not widely adopt, purchase and successfully deploy our products, our rev business will be seriously harmed.

WE RELY ON A LIMITED NUMBER OF CUSTOMERS, AND ANY DECREASE IN R CUSTOMERS WITHOUT A CORRESPONDING INCREASE IN REVENUES FROM OTHER CUSTOMERS WO