Alliance Fiber Optic Products 10Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
____________________

FORM 10-Q

(Mark One)

|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

Commission File Number 0-31857

ALLIANCE FIBER OPTIC PRODUCTS, INC.
(Exact name of registrant as specified in its charter)

Delaware	77-0554122
(State or other jurisdiction of	(I.R.S. employer
Incorporation or organization)	identification number)

275 Gibraltar Drive, Sunnyvale, California 94089
(Address of Principal Executive Offices)

(408) 736-6900
(Registrant’s telephone number including area code)

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 the 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer”, ”large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated Filer o Non-accelerated filer o Smaller reporting company þ
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

On October 31, 2008, 41,776,011 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008

INDEX

	Page

PART I: FINANCIAL INFORMATION	1

ITEM 1: FINANCIAL STATEMENTS	1

Condensed Consolidated Balance Sheets at September 30, 2008 (unaudited)
and December 31, 2007	1

Condensed Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2008 and 2007 (unaudited)	2

Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2008 and 2007 (unaudited)	3

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS	4

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	17

ITEM 4T: CONTROLS AND PROCEDURES	17

PART II: OTHER INFORMATION	18

ITEM 1A: RISK FACTORS	18

ITEM 6: EXHIBITS	28

SIGNATURE	29

PART I:

FINANCIAL INFORMATION

ITEM 1:

FINANCIAL STATEMENTS

ALLIANCE FIBER OPTIC PRODUCTS, INC.

Condensed Consolidated Balance Sheets
(In thousands, except share data)

	September 30, 2008			December 31, 2007
Assets		(Unaudited)
Current assets:
Cash and cash equivalents	$	21,241		$	4,945
Short-term investments		1,990			31,535
Accounts receivable, net		5,568			5,393
Inventories, net		6,366			5,003
Prepaid expense and other current assets		517			481

Total current assets		35,682			47,357

Long-term investments		14,990			-
Property and equipment, net		4,584			4,373
Other assets		238			226


Total assets	$	55,494		$	51,956


Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	5,354		$	4,523
Accrued expenses		3,316			3,388
Current portion of bank loans		136			132

Total current liabilities		8,806			8,043

Long-term liabilities
Bank loans		457			557
Other long-term liabilities		480			449


Total long term liabilities		937			1,006


Total liabilities		9,743			9,049


Commitments and contingencies (Note 8)
Stockholders' equity:
Common stock, $0.001 par value: 250,000,000 shares authorized;
41,776,011 and 41,366,545 shares issued and outstanding at
September 30, 2008 and December 31, 2007, respectively		42			41
Additional paid-in-capital		111,484			111,006
Accumulated deficit		(65,200	)		(68,446	)
Accumulated other comprehensive income (loss)		(575	)		306


Stockholders' equity		45,751			42,907


Total liabilities and stockholders' equity	$	55,494		$	51,956

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share data)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Revenues	$	10,829	$	9,170	$	30,553	$	24,572
Cost of revenues		7,403		6,291		20,927		16,822

Gross profit		3,426		2,879		9,626		7,750


Operating expenses:
Research and development		884		876		2,677		2,413
Sales and marketing		608		556		1,921		1,759
General and administrative		888		817		2,675		2,593

Total operating expenses		2,380		2,249		7,273		6,765

Income from operations		1,046		630		2,353		985
Interest and other income, net		319		435		996		1,333

Net income before tax		1,365	$	1,065	$	3,349	$	2,318
Income tax		20		-		103		-

Net income	$	1,345	$	1,065	$	3,246	$	2,318

Net income per share:
Basic	$	0.03	$	0.03	$	0.08	$	0.06

Diluted	$	0.03	$	0.02	$	0.08	$	0.05

Shares used in computing net income per share:
Basic		41,641		40,980		41,536		40,799

Diluted		42,542		44,929		42,621		44,747

Included in costs and expenses above:
Stock based compensation charges
Cost of revenue	$	17	$	29	$	59	$	121
Research and development		7		13		26		50
Sales and marketing		5		9		18		33
General and administrative		5		40		28		114

Total	$	34	$	91	$	131	$	318

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)

	Nine Months Ended September 30,
	2008			2007
Cash flows from operating activities:
Net Income	$	3,246		$	2,318
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization		769			868
Loss on disposal of property and equipment		-			53
Amortization of stock-based compensation		131			318
Provision (credit) for doubtful accounts and sales returns		-			(59	)
Provision for inventory		(236	)		(352	)
Changes in assets and liabilities:
Accounts receivable		(175	)		(1,140	)
Inventories		(1,127	)		310
Prepaid expenses and other current assets		(36	)		(211	)
Other assets		(12	)		(106	)
Accounts payable		831			715
Accrued expenses		(72	)		526
Other long-term liabilities		31			44

Net cash provided by operating activities		3,377			3,284

Cash flows from investing activities:
Purchase of short-term investments		(26,690	)		(15,803	)
Proceeds from sales and maturities of short-term investments		39,911			13,486
Purchase of of property and equipment		(802	)		(728	)

Net cash provided by (used in) investing activities		12,419			(3,045	)

Cash flows from financing activities:
Proceeds from issuance of common stock under ESPP		207			276
Proceeds from the exercise of common stock options		142			162
Proceeds of bank borrowings		-			150
Repayment of bank borrowings		(109	)		(78	)

Net cash provided by financing activities		240			510

Effect of exchange rate changes on cash and cash equivalents		260			186

Net increase in cash and cash equivalents		16,296			935
Cash and cash equivalents at beginning of period		4,945			4,321

Cash and cash equivalents at end of period	$	21,241		$	5,256

Supplemental disclosure of cash flow information:
Unrealized (loss) gain on investments	$	(1,334	)	$	10
Cash paid for income taxes	$	(50	)	$	-

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENT

(Unaudited)

1. Summary of Significant Accounting Policies

The Company

Alliance Fiber Optic Products, Inc. (the “Company”) was incorporated in California on December 12, 1995 and reincorporated in Delaware on October 19, 2000. The Company designs, manufactures and markets fiber optic components for communications equipment manufacturers. The Company’s headquarters are located in Sunnyvale, California, and it has operations in Taiwan and China.

Basis of Presentation

The condensed consolidated financial information as of September 30, 2008 included herein is unaudited, has been prepared by the Company in accordance with generally accepted accounting principles in the United States of America, and reflects all adjustments, consisting only of normal recurring adjustments, which in the opinion of management are necessary to state fairly the Company's consolidated financial position, results of its consolidated operations, and consolidated cash flows for the periods presented.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates, and such differences may be material to the financial statements.

These financial statements should be read in conjunction with the Company's audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2007. The results of operations for the three and nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for any future periods.

Revenue Recognition

The Company recognizes revenue upon shipment of its products to its customers, provided that the Company has received a purchase order, the price is fixed, collection of the resulting receivable is reasonably assured and transfer of title and risk of loss has occurred. Subsequent to the sale of its products, the Company has no obligation to provide any modification or customization upgrades, enhancements or post contract customer support.

Allowances are provided for estimated returns. A provision for estimated sales return allowances is recorded at the time revenue is recognized based on historical returns, current economic trends and changes in customer demand. Such allowances are adjusted periodically to reflect actual and anticipated experience. Such adjustments, which are recorded against revenue in the period, could be material.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist primarily of market rate accounts, municipal bonds, and highly rated commercial paper that are stated at cost, which approximates fair value.

Concentrations of Risk

Our connectivity products (formerly named optical path multiplexing solution) contributed 64.4% and 67.4% of our revenues for the three months ended September 30, 2008 and 2007, respectively. Our optical passive products (formerly named dense wavelength division multiplexing) contributed 35.6% and 32.6% of our revenues for the three months ended September 30, 2008 and 2007, respectively.

Our connectivity products contributed 64.3% and 66.8% of our revenues for the nine months ended September 30, 2008 and 2007, respectively. Our optical passive products contributed 35.7% and 33.2% of our revenues for the nine months ended September 30, 2008 and 2007, respectively.

In the quarters ended September 30, 2008 and 2007, our top 10 customers comprised 62.3% and 51.8% of our revenues, respectively. For the quarters ended September 30, 2008 and 2007, one customer accounted for 14.1% and 13.3% of our total revenues, respectively.

In the nine months ended September 30, 2008 and 2007, our top 10 customers comprised 64.1% and 54.5% of our revenues, respectively. For the nine months ended September 30, 2008, two customers accounted for 15.9% and 10.3% of our total revenues, respectively. For the nine months ended September 30, 2007, one customer accounted for 18.2% of our total revenues.

2. Recent Accounting Pronouncements

In June 2007, the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities (“EITF 07-3”). EITF 07-3 addresses the diversity that exists with respect to the accounting for the non-refundable portion of a payment made by a research and development entity for future research and development activities. Under EITF 07-3, an entity would defer and capitalize non-refundable advance payments made for research and development activities until the related goods or services are delivered or the related services are performed. EITF 07-3 is effective for fiscal years beginning after December 15, 2007. On January 1, 2008, the Company adopted the provisions of EITF 07-3, which did not have an impact on the Company’s unaudited condensed consolidated results of operations and financial condition for the three and nine months ended September 30, 2008.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company has elected not to account for any of its financial assets or liabilities using the provisions of SFAS 159. As such, the adoption of SFAS 159, on January 1, 2008, did not have an impact on the Company’s unaudited condensed consolidated results of operations or financial condition for the three and nine months ended September 30, 2008.

In September 2006, FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. On January 1, 2008, the Company adopted the provisions of SFAS 157.

In October 2008, the FASB issued Staff Position (“FSP”) FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is N ot Active”. The Company has adopted the application specified in FAS 157-3 to assess the relevance of observable and unobservable inputs available to measure fair market value. See Note 11 for further details on the impact of the adoption of SFAS 157 on the Company’s unaudited condensed consolidated results of operations and financial condition for the three and nine months ended September 30, 2008.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“FAS 160”). FAS 160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. FAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The Company is currently evaluating the potential impact upon the adoption of FAS 160 may have on its financial statements.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants (“AICPA”) and the SEC did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

3. Stock-based Compensation

Effective January 1, 2006, the Company adopted the provisions of FASB Statement No. 123 (revised 2004), “Share-Based Payment” and the Securities and Exchange Commission Staff Accounting Bulletin No. 107 (collectively, “Statement No. 123(R)”), which establish accounting for share-based payment (“SBP”) awards exchanged for employee services and requires companies to expense the estimated fair value of these awards over the requisite employee service period.

Statement No. 123(R) requires companies to record compensation expense for stock options measured at fair value, on the date of grant, using an option-pricing model. The fair value of stock options is determined using the Binomial Lattice Model instead of the Black-Scholes Model previously utilized under Statement No. 123. The Company believes that the revised model represents a more likely projection of actual outcomes.

Statement No. 123(R) requires that the realized tax benefit related to the excess of the deductible amount over the compensation expense recognized be reported as a financing cash flow rather than as an operating cash flow, as required under previous accounting guidance. The Company does not recognize any tax benefit related to this based on the Company’s historical operating performance, lack of taxable income and the accumulated deficit.

As of September 30, 2008, there was three thousand dollars of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s various option plans; that cost is expected to be recognized over a period of 1.25 years. As of September 30, 2007, there was $0.8 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s various option plans; that cost is expected to be recognized over a period of 2.25 years.

For the three and nine months ended September 30, 2008 and 2007, the fair value of SBP awards were estimated using the Binomial Lattice valuation model, with the following weighted-average assumptions and fair values as follows:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2008	2007	2008	2007
Volatility (percent)*	36.4	52.0	36.4	52.0
Expected term (in years)**	4	4	4	4
Risk-free interest rate (percent)***	2.84	4.30	2.71	4.57
Expected dividend rate (percent)	--	--	--	--
Forfeiture rate (percent)****	10	11	10	11
Weighted-average fair value per option granted	N/A	$ 2.20	$ 1.81	$ 2.13

* Volatility is projected using Industry Analysts’ forecasts for earnings, earnings per share, and stock price, and the Company’s earning forecast.

** The expected term represents the weighted average period the option is expected to be outstanding and is based primarily on the historical exercise behavior of employees.

*** The risk free interest rate is based on the U.S. Treasury zero-coupon yield with a maturity that approximates the expected life of the option.

**** Forfeiture rate is the estimated percentage of options forfeited by employees by leaving or being terminated before vesting.

N/A: No options were granted during the period.

Cash received from option exercises during the nine months ended September 30, 2008 and 2007 was $142,000 and $162,000, respectively, and is included within the financing activities section in the accompanying consolidated statements of cash flows.

4. Inventories, net (in thousands)

	September 30, 2008	December 31, 2007

Inventories
Finished goods	$ 2,330	$ 1,599
Work-in-process	1,921	1,877
Raw materials	2,115	1,527

	$ 6,366	$ 5,003

5. Net Income Per Share

Basic net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed using the weighted-average number of shares of common stock outstanding plus the effect of all dilutive securities representing potential shares of common stock outstanding during the period.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated (in thousands, except per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Numerator:
Net income	$	1,345	$	1,065	$	3,246	$	2,318

Denominator:
Shares used in computing net income per share:

Basic		41,641		40,980		41,536		40,799

Diluted		42,542		44,929		42,621		44,747

Net income per share:
Basic	$	0.03	$	0.03	$	0.08	$	0.06

Diluted	$	0.03	$	0.02	$	0.08	$	0.05

Total stock options outstanding of 0.9 million and 1.1 million for the three and nine months ended September 30, 2008, respectively, and total stock options outstanding of 3.9 million for each of the three and nine months ended September 30, 2007, were excluded from the computation, as their inclusion would be antidilutive.

6. Comprehensive Income

Comprehensive income is defined as the change in equity of a company during a period resulting from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The difference between net income and comprehensive income for the Company is due to foreign exchange translations adjustments and unrealized gain on available-for-sale securities.

The components of comprehensive income are as follows (in thousands):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008			2007		2008			2007
Net income	$	1,345		$	1,065	$	3,246		$	2,318
Cumulative translation adjustments		(68	)		189		453			248
Unrealized gain (loss) on short-term investments		(387	)		11		(1,334	)		21

Total comprehensive income	$	890		$	1,265	$	2,365		$	2,587

7. Income Taxes

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” on January 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company has determined the impact of the adoption of FIN 48 is insignificant to the Company’s consolidated financial position, results of operations and cash flows.

8. Commitments and Contingencies

Litigation:

From time to time, the Company may be involved in litigation in the normal course of business. As of the date of these financial statements, the Company is not aware of any material legal proceedings pending or threatened against the Company.

Indemnification and Product Warranty:

The Company indemnifies certain customers, suppliers and subcontractors for attorney fees and damages and costs awarded against these parties in certain circumstances in which products are alleged to infringe third party intellectual property rights, including patents, trade secrets, trademarks or copyrights. In all cases, there are limits on and exceptions to the potential liability for indemnification relating to intellectual property infringement claims. The Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. To date, the Company has not paid any claim or been required to defend any action related to indemnification obligations, and accordingly, the Company has not accrued any amounts for such indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations.

The Company generally warrants products against defects in materials and workmanship and non-conformance to specifications for varying lengths of time. If there is a material increase in customer claims compared with historical experience, or if costs of servicing warranty claims are greater than expected, the Company may record a charge against cost of revenues.

Operating Leases:

The Company leases certain office space under long-term operating leases expiring at various dates through 2012.

The Company’s aggregate future minimum facility lease payments are as follows (in thousands):

Three months ending December 31, 2008	$	222
Years ending December 31:
2009		595
2010		383
2011		106
2012		45

Total	$	1,351

Letter of Credit:

The Company had a letter of credit of $0.4 million outstanding as of September 30, 2008. The letter of credit is collateralized by short-term investments of $0.4 million.

9. Bank Loans

In November 2004, the Company entered into a ten-year loan of $0.5 million in Taiwan with an interest rate of 2.3% for the first two years and 3.6% for the following years. In November 2006, the Company entered into a seven-year loan of $0.2 million in Taiwan with an interest rate of 2.8%. Both loans are secured by the Company’s building in Taiwan. The net book value of the building was $0.6 million as of September 30, 2008.

In April 2005, the Company entered into a five-year equipment loan of $0.2 million in Taiwan with an interest rate of 2.9% for the first year and 3.7% for the following years. In September 2007, the Company entered into a three-year equipment loan of $0.04 million and a five-year equipment loan of $0.1 million with an interest rate of 3.68% for the first year for both loans.

Payments due under the bank loans as of September 30, 2008 are as follows (in thousands):


Years ending December 31,
2008	$	39
2009		154
2010		126
2011		103
2012		97
2013 and after		127

Total payment		646
Less: Amounts representing interest		(53	)

Present value of net remaining payments		593
Less: current portion		(136	)

Long-term portion	$	457

10. Related Party Transactions

As of September 30, 2008, Foxconn Holding Limited was a holder of 19.15% of the Company’s common stock, based on share ownership information set forth in a Schedule 13G filed by Foxconn Holding Limited on January 4, 2002. The Company sells products and purchases raw materials from Hon Hai Precision Company Limited, who is the parent company of Foxconn Holding Limited, in the normal course of business. These transactions were made at prices and terms consistent with those with unrelated third parties. Sales of products to Hon Hai Precision Industry Company Limited were $0.2 million and $1.1 million for the three and nine months ended September 30, 2008. Purchases of raw materials from Hon Hai Precision Company Limited were $1.1 million and $3.6 million for the three and nine months ended September 30, 2008. Amounts due from Hon Hai Precision Company Limited were $0.1 million at September 30, 2008. Amounts due to Hon Hai Precision Company Limited were $1.1 million at September 30, 2008.

11. Fair Value of Financial instruments

Effective January 1, 2008, the Company adopted SFAS 157. SFAS 157 provides a definition of fair value, establishes a hierarchy for measuring fair value under generally accepted accounting principles, and requires certain disclosures about fair values used in the financial statements. SFAS 157 does not extend the use of fair value beyond what is currently required by other pronouncements, and it does not pertain to stock-based compensation under SFAS No. 123R, Share-Based Payments (“SFAS 123R”) or to leases under SFAS No. 13, Accounting for Leases.

In February 2008, FASB Staff Position (“FSP”) FAS 157-2, Effective Date of FASB Statement No. 157, was issued. This FSP provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect to financial assets and liabilities only.

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

In October 2008, the FASB issued FSP SFAS 157-3, which provides guidance on how management's internal cash flow and discount rate assumptions should be considered when measuring fair value when relevant observable data does not exist, how observable market information in a market that is not active should be considered when measuring fair value and how the use of market quotes should be considered when assessing the relevance of observable and unobservable data available to measure fair value. The Company incorporated the considerations of FSP SFAS 157-3 in its assessment of the fair value of its auction rate securities (“ARS”) as of September 30, 2008.

The Company measures the following financial assets at fair value on a recurring basis. The fair value of these financial assets at September 30, 2008 (in thousands) were as follows:

	Fair Value measurements at Reporting Date Using

		Balance at September 30, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs(Level 2)		Significant Unobservable Input (Level 3)

Cash and cash equivalents	$	12,631	$	12,631	$	-	$	-
Short-term investments		1,990		1,990		-		-
Long-term investments		14,990		-		-		14,990

Total	$	29,611	$	14,621	$	-	$	14,990

Cash and cash equivalents are comprised of short-term, highly liquid investments with maturities of 90 days or less from the date of purchase. Short-term investments are comprised of available-for-sale securities primarily invested in United States government agencies and commercial paper which are recorded at the estimated fair value based on level 1 inputs. Unrealized gains and losses associated with the Company’s investments, if any, are reported in stockholders’ equity in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. For the three and nine months ended September 30, 2008, the Company recognized $0.4 million and $1.3 million, respectively in unrealized loss associated with its short-term and long-term investments.

The Company’s investments in ARS are required to be measured at fair value on a recurring basis. Since mid-February 2008, all ARS investments in the Company’s portfolio have experienced failed auctions. Due to the lack of liquidity, the Company reclassified its ARS portfolio from short-term available-for-sale to long-term available-for-sale investment securities as of March 31, 2008, and determined that the market for its ARS was not active at September 30, 2008. Consequently, the Company’s ARS investments have been classified within level 3 as their valuation requires substantial judgment and estimation of factors that are not currently observable in the market due to the lack of trading. This valuation may be revised in future periods as market conditions evolve. The Company estimated the fair value of its auction rate securities based on estimates contained in broker statements that were compiled utilizing level 3 inputs including, but not limited to factors such as tax status, credit quality, duration, insurance wraps and the portfolio composition of The Federal Family Education Loan Program loans.

The Company measured its ARS assets for the nine months ended September 30, 2008 (in thousands) as follows:

		Significant Unobservable Inputs (Level 3)

Fair value January 1, 2008	$	16,150
Purchase, January 2008		250
Sales, February 2008		(100)
Unrealized losses for nine months ended September 30, 2008		(1,310)

Fair value September 30, 2008	$	14,990

In October 2008, the Company received an offer from UBS AG to purchase its ARS at par value (approximately $16.3 million) in accordance with the terms of the offer. The offer is non-transferable and expires on November 14, 2008. The Company is in the process of evaluating the offer and its impact on the Company.

12. Geographic Segment Information

The Company operates in a single industry segment. This industry segment is characterized by rapid technological change and significant competition.

The following is a summary of the Company’s revenues generated from geographic segments, revenues generated by product lines and identifiable assets located in these segments (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Revenues
North America	$	6,403	$	5,536	$	17,108	$	14,900
Europe		1,935		733		4,554		1,883
Asia		2,491		2,901		8,891		7,789

Total	$	10,829	$	9,170	$	30,553	$	24,572

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Revenues
Connectivity products	$	6,977	$	6,180	$	19,648	$	16,413
Optical passive products		3,852		2,990		10,905		8,159

Total	$	10,829	$	9,170	$	30,553	$	24,572

	September 30, 2008		December 31, 2007
Property and Equipment
United States	$	119	$	93
Taiwan		2,770		2,800
China		1,695		1,480

Total	$	4,584	$	4,373

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

When used in this Report, the words “expects,” “anticipates,” “believes”, “estimates,” “plans,” “intends,” “could,” “will,” “may” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include statements as to our operating results, revenues, sources of revenues, cost of revenues, gross profit, profitability, the amount and mix of anticipated investments, expenditures and expenses, our liquidity and the adequacy and availability of our capital resources, exposure to interest rate or currency fluctuations, anticipated working capital and capital expenditures, reliance on our connectivity products, our cash flow, trends in average selling prices, our reliance on the commercial success of our optical passive products, plans for future products and enhancements of existing products, features, benefits and uses of our products, demand for our products, our success being tied to relationships with key customers, industry trends and market demand, our efforts to protect our intellectual property, the potential benefit of indemnification agreements, increases in the number of possible license offers and patent infringement claims, our competitive position, sources of competition, consolidation in our industry, our international strategy, inventory management, our employee relations, the adequacy of our internal controls, the value of our investments, and the effect of recent and changing accounting pronouncements and our critical accounting policies, estimates, models, judgments and assumptions on our financial results. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, those risks discussed elsewhere in this report, as well as risks related to the development of the metropolitan, last mile access, and enterprise networks, customer acceptance of our products, our ability to retain and obtain customers, industry-wide overcapacity and shifts in supply and demand for optical components and modules, our ability to meet customer demand and manage inventory, fluctuations in demand for our products, declines in average selling prices, development of new products by us and our competitors, increased competition, inability to obtain sufficient quantities of a raw material component, loss of a key supplier, integration of acquired businesses or technologies, financial stability in foreign markets, foreign currency exchange rates, interest rates, costs associated with being a public company, failure to meet customer requirements, our ability to license intellectual property on commercially reasonable terms, economic stability, the impact and extent of the economic and financial crisis, and the risks set forth below under Part II, Item 1A, “Risk Factors.” These forward-looking statements speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K, its Consolidated Financial Statement and the notes thereto, for the year ended December 31, 2007.

The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes included elsewhere in this Report.

Critical Accounting Policies and Estimates

Stock-based Compensation Expense

Stock-based compensation expense recognized under SFAS 123(R) for the three and nine months ended September 30, 2008 was $34,000 and $131,000, respectively, determined by the Binomial Lattice valuation model, and represents stock-based compensation expense related to employee stock options. As of September 30, 2008, total unrecognized compensation costs related to unnvested stock options was three thousand dollars, which is expected to be recognized as an expense over a weighted average period of approximately 1.25 years.

Management’s discussion and analysis of financial condition and results of operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, asset impairments, income taxes, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values for assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K, for the year ended December 31, 2007.

Overview

We were founded in December 1995 and commenced operations to design, manufacture and market fiber optic interconnect products, which we call our connectivity products. We started selling our optical passive products in July 2000. Since introduction, sales of optical passive products have fluctuated with the overall market for these products.

Our optical passive products contributed revenues of $3.9 million and $3.0 million for the three months ended September 30, 2008 and 2007, respectively. In the three months ended September 30, 2008 and 2007, our top 10 customers comprised 62.3% and 51.8% of our revenues, respectively. One customer accounted for 14.1% and 13.3% of our total revenues for the three months ended September 30, 2008 and 2007, respectively. In the nine months ended September 30, 2008 and 2007, our top 10 customers comprised 64.1% and 54.5% of our revenues, respectively. Two customers accounted for 15.9% and 10.3% of our total revenues for the nine months ended September 30, 2008, respectively. One customer accounted for 18.2% of our total revenues for the nine months ended September 30, 2007. We market and sell our products predominantly through our direct sales force.

Our cost of revenues consists of raw materials, components, direct labor, manufacturing overhead and production start-up costs. We expect that our cost of revenues as a percentage of revenues will fluctuate from period to period based on a number of factors including:

changes in manufacturing volume;

costs incurred in establishing additional manufacturing lines and facilities;

inventory write-downs and impairment charges related to manufacturing assets;

mix of products sold;

changes in our pricing and pricing from our competitors;

mix of sales channels through which our products are sold; and

mix of domestic and international sales.

Research and development expenses consist primarily of salaries and related personnel expenses, fees paid to outside service providers, materials costs, test units, facilities, overhead and other expenses related to the design, development, testing and enhancement of our products. We expense our research and development costs as they are incurred. We believe that a significant level of investment for product research and development is required to remain competitive.

Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as costs associated with trade shows, promotional activities and travel expenses. We intend to continue to invest in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. However, we cannot be certain that our expenditures will result in higher revenues. In addition, we believe that our future success depends upon establishing successful relationships with a variety of key customers.

General and administrative expenses consist primarily of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting support.

Results of Operations

The following table sets forth the relationship between various components of operations, stated as a percentage of revenues for the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Revenues		100.0%		100.0%		100.0%		100.0%
Cost of revenues		68.4		68.6		68.5		68.5

Gross profit		31.6		31.4		31.5		31.5

Operating expenses:
Research and development		8.2		9.5		8.7		9.8
Sales and marketing		5.6		6.1		6.3		7.2
General and administrative		8.2		8.9		8.8		10.5

Total operating expenses		22.0		24.5		23.8		27.5

Income from operations		9.6		6.9		7.7		4.0
Interest and other income, net		3.0		4.7		3.2		5.4

Net income before tax		12.6%		11.6%		10.9%		9.4%
Inome tax		0.2		-		0.3		-

Net income		12.4%		11.6%		10.6%		9.4%

Revenues. Revenues were $10.8 million and $9.2 million for the three months ended September 30, 2008 and 2007, respectively. Revenues increased 18.1% in the quarter ended September 30, 2008 from the same period in 2007, as a result of a broadbased increase in demand from our customers, especially for our Multi-fiber Data Center product lines. Revenues were $30.6 million and $24.6 million for the nine months ended September 30, 2008 and 2007, respectively. Revenues increased 24.3% in the nine months ended September 30, 2008 from the same period in 2007, mainly due to a large telecom product contract for our optical passive and connectivity products and increased volume shipments of our optical passive and connectivity products for telecom and cable television applications.

Cost of Revenues. Cost of revenues was $7.4 million and $6.3 million for the three months ended September 30, 2008 and 2007, respectively. Cost of revenues as a percentage of revenues decreased slightly to 68.4% for the three months ended September 30, 2008 from 68.6% for the three months ended September 30, 2007. Cost of revenues was $20.9 million and $16.8 million for the nine months ended September 30, 2008 and 2007, respectively. Cost of revenues as a percentage of revenues remained the same at 68.5% for the nine months ended September 30, 2008 and 2007, respectively, and reflect increased sales of optical passive products, which have lower gross margins.

Gross Profit. Gross profit increased to $3.4 million, or 31.6% of revenues, for the three months ended September 30, 2008 from $2.9 million, or 31.4% of revenues, for the same period in 2007. Gross profit increased in dollars to $9.6 million, or 31.5% of revenues, for the nine months ended September 30, 2008 from $7.8 million, or 31.5% of revenues, for the same period in 2007. For the period ended September 30, 2008, the utilization of our factories as a result of increased volume shipments of our products were offset to some extent by increased sales of optical passive products which have lower gross margins.

Research and Development Expenses. Research and development expenses remained at $0.9 million for the three months ended September 30, 2008 and for the same period in 2007. Research and development expenses increased to $2.7 million for the nine months ended September 30, 2008 from $2.4 million for the same period in 2007. The increase was primarily due to costs associated with new product development. As a percentage of revenues, research and development expenses decreased to 8.2% in the three months ended September 30, 2008 from 9.5% for the same period in 2007. As a percentage of revenues, research and development expenses decreased to 8.7% in the nine months ended September 30, 2008 from 9.8% for the same period in 2007. We expect research and development expenses on our product development efforts to increase in the near term as we intend to continue to invest in our research and product development efforts.

Sales and Marketing Expenses. Sales and marketing expenses remained at $0.6 million for the three months ended September 30, 2008 and 2007. Sales and marketing expenses increased to $1.9 million for the nine months ended September 30, 2008 from $1.8 million for the same period in 2007. As a percentage of revenues, sales and marketing expenses decreased to 5.6% in the three months ended September 30, 2008 from 6.1% for the same period in 2007. As a percentage of revenues, sales and marketing expenses decreased to 6.3% in the nine months ended September 30, 2008 from 7.2% for the same period in 2007. We expect sales and marketing expenses will remain relatively flat in the next quarter as a result of no trade show activities.

General and Administrative Expenses. General and administrative expenses increased to $0.9 million for the three months ended September 30, 2008 from $0.8 million for the same period in 2007. General and administrative expenses increased to $2.7 million for the nine months ended September 30, 2008 from $2.6 million for the same period in 2007. As a percentage of revenues, general and administrative expenses decreased to 8.2% in the three months ended September 30, 2008 from 8.9% for the same period in 2007. As a percentage of revenues, general and administrative expenses decreased to 8.8% in the nine months ended September 30, 2008 from 10.5% for the same period in 2007. We expect general and administrative expenses will remain relatively flat in the next quarter.

Stock-Based Compensation. Total stock based compensation decreased to $34,000 for the three months ended September 30, 2008 from $91,000 for the same period in 2007. Total stock based compensation decreased to $131,000 for the nine months ended September 30, 2008 from $318,000 for the same period in 2007. These decreases were due to the lower market price of our common stock.

Interest and Other Income, Net. Interest and other income, net, was $0.3 million and $0.4 million for the three months ended September 30, 2008 and 2007, respectively. Interest and other income, net, was $1.0 million and $1.3 million for the nine months ended September 30, 2008 and 2007, respectively. The decrease in interest and other income is due to lower interest rates on our investments.

Liquidity and Capital Resources

At September 30, 2008, we had cash and cash equivalents of $21.2 million and short-term investments of $2.0 million. On March 31, 2008, we reclassified $15.6 million of auction rate securities collateralized by student loans and substantially guaranteed by the U.S. Department of Education from short-term investments into long-term investments. During the three months ended September 30, 2008, the Company recorded an unrealized loss of $0.4 million on these securities. At September 30, 2008, we had long-term investments of $15.0 million. Continued auction failures could adversely impact our liquidity as we may not be able to sell these securities when we want to and may have to hold them until maturity between 2032 and 2046. In October 2008, we received an offer from UBS AG to purchase our ARS at par value (approximately $16.3 million) in accordance with the terms of the offer. The offer is non-transferable and expires on November 14, 2008. We are in the process of evaluating the offer and its impact on the Company.

Net cash provided by operating activities was $3.4 million for the nine months ended September 30, 2008. The cash provided was primarily due to net income of $3.2 million, an increase in accounts payable of $0.8 million, and total depreciation and amortization expenses of $0.9 million, which was offset by $0.2 million inventory provision and $1.1 million increase in inventory. Net cash provided by operating activities was $3.3 million for the nine months ended September 30, 2007. Net cash provided by operating activities was primarily due to net income of $2.3 million, an increase in accounts payable of $0.7 million, an increase in accrued expenses of $0.5 million, and total depreciation and amortization expenses of $1.2 million, which was offset by a $1.1 million increase in accounts receivable, a $0.4 million decreased in inventory provision and a $0.3 million decrease in inventory.

Net cash provided by investing activities was $12.4 million for the nine months ended September 30, 2008. This resulted from $13.2 million in net proceeds from sales of short-term investments offset by $0.8 million spent on equipment. Cash used in investing activities was $3.0 million for the nine months ended September 30, 2007. In the nine months ended September 30, 2007, we spent a net $2.3 million for the purchase of short-term securities, and we used $0.7 million to acquire property and equipment.

Cash provided by financing activities was $0.2 million and $0.5 million for the nine months ended September 30, 2008 and 2007, respectively, and was comprised of proceeds from exercise of options to purchase common stock and common stock issued through our Employee Stock Purchase Plan. Cash provided for the nine months ended September 30, 2007 also included net proceeds from borrowings under an equipment loan of $0.2 million, offset by repayment of bank borrowings.

We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, our future growth, including any potential acquisitions, may require additional funding. If cash generated from operations is insufficient to satisfy our long-term liquidity requirements or we are not able to access our long-term investments, we may need to raise capital through additional equity or debt financings, additional credit facilities, strategic relationships or other arrangements. If additional funds are raised through the issuance of securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of any debt facility could impose restrictions on our operations. The sale of additional equity or debt securities could result in additional dilution to our stockholders, and additional financing, particularly in light of the current economic environment, may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of our planned product development and marketing efforts. Strategic arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies or products. Our failure to raise capital when needed could harm our business, financial condition and operating results.

Contractual Obligations

Our corporate headquarters are in Sunnyvale, California where we lease a 34,800 square foot facility for a current monthly rent of approximately $33,000. The lease has a six-year term commencing on July 22, 2004.

In December 2000, we purchased approximately 8,200 square feet of space immediately adjacent to our leased facility in Tu-Cheng City, Taiwan for $0.8 million. Additionally, in February 2006, we entered into a lease for a total of 21,600 square feet in a facility located in Hu-Kou, Taiwan. This lease expires in January 2009 and has been terminated by the Company as of November 6, 2008.

In July 2007, we renewed the lease for our 62,000 square feet facility in the Shenzhen area of China, which will expire in July 2012. Additionally, in February 2007, we entered into a lease for an 8,200 square feet dormitory in Shenzhen, which lease will expire in January 2012.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

Recent Accounting Pronouncements

See Note 2 of our Notes to Unaudited Condensed Consolidated Financial Statements included with this Quarterly Report on Form 10-Q for information on recent accounting pronouncements.

ITEM 4T: CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Acting Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

(b) Changes in internal controls. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described in Item 4(a) above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II:

OTHER INFORMATION

ITEM 1A: RISK FACTORS

We have a history of losses, may experience future losses and may not be able to generate sufficient revenues in the future to achieve and sustain profitability.

We had net income of approximately $1.3 million and $1.1 million in the third quarters of fiscal 2008 and 2007, respectively. Although we generated a profit in the third quarter of fiscal 2008 and 2007, we may not be able to sustain profitability in the future. Although our cash and cash equivalents increased slightly in the third quarter of fiscal 2008, our cash flows may be negative again in the future as we continue to invest in our business. As of September 30, 2008, we had an accumulated deficit of approximately $65.2 million.

We continue to experience fluctuating demand for our products. If demand for our products increases in the future, we expect to incur significant and increasing expenses for expansion of our manufacturing operations, research and development, sales and marketing, and administration, and in expanding direct sales and distribution channels. Given the rate at which competition in our industry intensifies and the fluctuations in demand for our products, we may not be able to adequately control our costs and expenses or achieve or maintain adequate operating margins. As a result, to maintain profitability, we will need to generate and sustain substantially higher revenues while maintaining reasonable cost and expense levels. We may not be able to sustain profitability on a quarterly or an annual basis.

Our connectivity products have historically represented a significant part of our revenues, and if we are unsuccessful in commercially selling our optical passive products, our business will be seriously harmed.

Sales of our connectivity products accounted for over 64.4% of our revenues in the quarter ended September 30, 2008 and majority of our historical revenues. We expect to substantially depend on these products for the majority of our near-term revenues. Any significant decline in the price of, or demand for, these products, or failure to increase their market acceptance, would seriously harm our business. In addition, we believe that our future growth and a significant portion of our future revenues will depend on the commercial success of our optical passive products, which we began shipping commercially in July 2000. Demand for these products has fluctuated over the past few years, declining sharply starting in mid fiscal 2001 and then increasing beginning in 2003. If demand for these products does not continue to increase and our target customers do not continue to adopt and purchase our optical passive products, our revenues may decline and we may have to write-off additional inventory that is currently on our books.

We depend on a small number of customers for a significant portion of our total revenues and the loss of, or a significant reduction in orders from, any of these customers, would significantly reduce our revenues and harm our operating results.

In the quarters ended September 30, 2008 and 2007, our top 10 customers comprised 62.3% and 51.8% of our revenues, respectively. One customer accounted for 14.1% and 13.3% of our total revenues for the three months ended September 30, 2008 and 2007, respectively.

We derive a significant portion of our revenues from a small number of customers, and we anticipate that we will continue to do so in the foreseeable future. These customers may decide not to purchase our products at all, to purchase fewer products than they did in the past, or to alter their purchasing patterns in some other way. The loss of any significant customer, a significant reduction in sales we make to them, or any problems collecting receivables from them would likely harm our financial condition and results of operations.

Our quarterly and annual financial results have historically fluctuated due primarily to introduction of, demand for, and sales of our products, and future fluctuations may cause our stock price to decline.

We believe that period-to-period comparisons of our operating results are not a good indication of our future performance. Our quarterly operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a number of factors. For example, the timing and expenses associated with product introductions and establishing additional manufacturing lines and facilities, changes in manufacturing volume, declining average selling prices of our products, the timing and extent of product sales, the mix of domestic and international sales, the mix of sales channels through which our products are sold, the mix of products sold and significant fluctuations in the demand for our products have caused our operating results to fluctuate in the past. Because we incur operating expenses based on anticipated revenue trends, and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing revenues or any decrease in revenues could significantly harm our quarterly results of operations. Other factors, many of which are more fully discussed in other risk factors below, may also cause our results to fluctuate. Many of the factors that may cause our results to fluctuate are outside of our control. If our quarterly or annual operating results do not meet the expectations of investors and securities analysts, the trading price of our common stock could significantly decline.

Uncertainty in the credit markets has and may continue to impact the value and liquidity of our auction-rate securities.

Credit concerns in the capital markets have significantly reduced our ability to liquidate $16.3 million in auction-rate securities that we classify as long-term investments on our balance sheet. All auction-rate securities we hold have failed to sell at auction since February 2008 due to an insufficient number of bidders. We may not be able to liquidate these securities and use the cash to finance our business. In addition, we reviewed the value of these securities for impairment as of September 30, 2008 and concluded they were temporarily impaired for liquidity issues. We have recorded an unrealized loss of $0.4 million and $1.3 million for the three and nine months ended September 30, 2008, respectively. In future periods, the estimated fair value of our auction-rate securities could decline further based on market conditions, which could result in additional impairment.

If we cannot attract more optical communications equipment manufacturers to purchase our products, we may not be able to increase or sustain our revenues.

Our future success will depend on our ability to migrate existing customers to our new products and our ability to attract additional customers. Some of our present customers are relatively new companies. The growth of our customer base could be adversely affected by:

customer unwillingness to implement our products;

any delays or difficulties that we may incur in completing the development and introduction of our planned products or product enhancements;

the success of our customers;

excess inventory in the telecommunications industry;

new product introductions by our competitors;

any failure of our products to perform as expected; or

any difficulty we may incur in meeting customers’ delivery requirements or product specifications.

The fluctuations in the economy have affected the telecommunications industry. Telecommunications companies have cut back on their capital expenditure budgets, which has and may continue to further decrease demand for equipment and parts, including our products. This decrease has had and may continue to have an adverse effect on the demand for fiber optic products and negatively impact the growth of our customer base.

We are exposed to risks and increased expenses and business risk as a result of Restriction on Hazardous Substances, or RoHS, directives.

Following the lead of the European Union, or EU, various governmental agencies have either already put into place or are planning to introduce regulations that regulate the permissible levels of hazardous substances in products sold in various regions of the world. For example, the RoHS directive for EU took effect on July 1, 2006. The labeling provisions of similar legislation in China went into effect on March 1, 2007. Consequently, many suppliers of products sold into the EU have required their suppliers to be compliant with the new directive. Many of our customers have adopted this approach and have required our full compliance. Though we have devoted a significant amount of resources and effort planning and executing our RoHS program, it is possible that some of our products might be incompatible with such regulations. In such event, we could experience the following consequences: loss of revenue, damaged reputation, diversion of resources, monetary penalties, and legal action.

The market for fiber optic components is increasingly competitive, and if we are unable to compete successfully our revenues could decline.

The market for fiber optic components is intensely competitive. We believe that our principal competitors are the major manufacturers of optical components and integrated modules, including vendors selling to third parties and business divisions within communications equipment suppliers. Our principal competitors in the components market include Avanex Corp., DiCon Fiberoptics, Inc., JDS Uniphase Corp., Oplink Communications Inc., Stratos International, Inc. and Tyco Electronics Corporation. We believe that we primarily compete with diversified suppliers for the majority of our product line and to a lesser extent with niche companies that offer a more limited product line. Competitors in any portion of our business may also rapidly become competitors in other portions of our business.

Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing, manufacturing and other resources than we do. As a result, these competitors may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, to devote more resources to the development, promotion and sale of products, to negotiate lower prices on raw materials and components, or to deliver competitive products at lower prices.

Several of our existing and potential customers are also current and potential competitors of ours. These companies may develop or acquire additional competitive products or technologies in the future and subsequently reduce or cease their purchases from us. In light of the consolidation in the optical networking industry, we also believe that the size of suppliers will be an increasingly important part of a purchaser’s decision-making criteria in the future. We may not be able to compete successfully with existing or new competitors, and we cannot ensure that the competitive pressures we face will not result in lower prices for our products, loss of market share, or reduced gross margins, any of which could harm our business.

New and competing technologies are emerging due to increased competition and customer demand. The introduction of products incorporating new or competing technologies or the emergence of new industry standards could make our existing products noncompetitive. For example, there are technologies for the design of wavelength division multiplexers that compete with the technology that we incorporate in our products. If our products do not incorporate technologies demanded by customers, we could lose market share causing our business to suffer.

If we fail to effectively manage our operations, specifically given the past history of sudden and dramatic downturn in demand for our products, our operating results could be harmed.

As of September 30, 2008, we had a total of 41 full-time employees in Sunnyvale, California, 319 full-time employees in Taiwan, and 489 full-time employees in China. Matching the scale of our operations with demand fluctuations, combined with the challenges of expanding and managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management and resources. To manage the expected fluctuations in our operations and personnel, we will be required to:

improve existing and implement new operational, financial and management controls, reporting systems and procedures;

hire, train, motivate and manage additional qualified personnel, especially if we experience a significant increase in demand for our products;

effectively expand or reduce our manufacturing capacity, attempting to adjust it to customer demand; and

effectively manage relationships with our customers, suppliers, representatives and other third parties.

In addition, we will need to coordinate our domestic and international operations and establish the necessary infrastructure to implement our international strategy. If we are not able to manage our operations in an efficient and timely manner, our business will be severely harmed.

Our success also depends, to a large degree, on the efficient and uninterrupted operation of our facilities. We have expanded our manufacturing facilities in Taiwan and manufacture many of our products there. Our facility in China also houses a substantial portion of our manufacturing operations. There is significant political tension between Taiwan and China. If there is an outbreak of hostilities between Taiwan and China, our manufacturing operations may be disrupted or we may have to relocate our manufacturing operations. Tensions between Taiwan and China may also affect our facility in China. Relocating a portion of our employees could cause temporary disruptions in our operations and divert management’s attention.

Because of the time it takes to develop fiber optic components, we incur substantial expenses for which we may not earn associated revenues.

The development of new or enhanced fiber optic products is a complex and uncertain process. We may experience design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements. Development costs and expenses are incurred before we generate revenues from sales of products resulting from these efforts. Our total research and development expenses were approximately $0.9 million for the three months ended September 30, 2008 and 2007, respectively. Our total research and development expenses were approximately $2.7 million and $2.4 million for the nine months ended September 30, 2008 and 2007, respectively. We expect that our research and development expense may increase in the last quarter of 2008 as we intend to continue to invest in our research and product development efforts. Any such increase could have a negative impact on our earnings in future periods.

If we are unable to develop new products and product enhancements that achieve market acceptance, sales of our fiber optic components could decline, which could reduce our revenues.

The communications industry is characterized by rapidly changing technology, frequent new product introductions, changes in customer requirements, evolving industry standards and, more recently, significant variations in customer demand. Our future success depends on our ability to anticipate market needs and develop products that address those needs. As a result, our products could quickly become obsolete if we fail to predict market needs accurately or develop new products or product enhancements in a timely manner. Our failure to predict market needs accurately or to develop new products or product enhancements in a timely manner will harm market acceptance and sales of our products. If the development or enhancement of these products or any other future products takes longer than we anticipate, or if we are unable to introduce these products to market, our sales will not increase. Even if we are able to develop and commercially introduce them, these new products may not achieve the widespread market acceptance necessary to provide an adequate return on our investment.

Current and future demand for our products depends on the continued growth of the Internet and the communications industry, which is experiencing rapid consolidation, realignment, oversupply of product inventory and fluctuating demand for fiber optic products.

Our future success depends on the continued growth of the Internet as a widely used medium for communications and commerce, and the growth of optical networks to meet the increased demand for capacity to transmit data, or bandwidth. If the Internet does not continue to expand as a medium for communications and commerce, the need to significantly increase bandwidth across networks and the market for fiber optic components may not continue to develop. If this growth does not continue, sales of our products may decline, which would adversely affect our revenues. Our customers have experienced an oversupply of inventory due to fluctuating demand for their products that has resulted in inconsistent demand for our products. Future demand for our products is uncertain and will depend heavily on the continued growth and upgrading of optical networks, especially in the metropolitan, last mile, and enterprise access segments of the networks.

Inconsistent spending by telecommunication companies over the past several years has resulted in fluctuating demand for our products. The rate at which communication service providers and other fiber optic network users have built new fiber optic networks or installed new systems in their existing fiber optic networks has fluctuated in the past and these fluctuations may continue in the future. These fluctuations may result in reduced demand for new or upgraded fiber optic systems that utilize our products and therefore, may result in reduced demand for our products. Declines in the development of new networks and installation of new systems have resulted in the past in a decrease in demand for our products, an increase in our inventory, and erosion in the average selling prices of our products.

The communications industry is experiencing consolidation and realignment, as industry participants seek to capitalize on the rapidly changing competitive landscape developing around the Internet and new communications technologies such as fiber optic networks. As the communications industry consolidates and realigns to accommodate technological and other developments, our customers may consolidate or align with other entities in a manner that results in a decrease in demand for our products.

We are experiencing fluctuations in market demand due to overcapacity in our industry and an economy that is stymied by the current financial and economic crisis, international terrorism, war and political instability.

The United States economy has experienced and continues to experience significant fluctuations in consumption and demand. During the past several years, telecommunication companies have mostly decreased their spending, which has resulted in excess inventory, overcapacity and a decrease in demand for our products. We may experience further decreases in the demand for our products due to a weak domestic and international economy and the impact of the current financial and economic crisis as the fiber optics industry copes with the effects of oversupply of products, international terrorism, war and political and economic instability. Even if the general economy experiences a recovery, the activity of the United States telecommunications industry may lag behind the recovery of the overall United States economy.

The optical networking component industry has in the past, is now, and may in the future experience declining average selling prices, which could cause our gross margins to decline.

The optical networking component industry has in the past experienced declining average selling prices as a result of increasing competition and greater unit volumes as communication service providers continue to deploy fiber optic networks. Average selling prices are currently decreasing and may continue to decrease in the future in response to product introductions by competitors, price pressures from significant customers, greater manufacturing efficiencies achieved through increased automation in the manufacturing process and inventory build-up due to decreased demand. Average selling price declines may contribute to a decline in our gross margins, which could harm our results of operations.

We will not attract new orders for our fiber optic components unless we can deliver sufficient quantities of our products to optical communications equipment manufacturers.

Communications service providers and optical systems manufacturers typically require that suppliers commit to provide specified quantities of products over a given period of time. If we are unable to commit to deliver quantities of our products to satisfy a customer’s anticipated needs, we will lose the order and the opportunity for significant sales to that customer for a lengthy period of time. In addition, we would be unable to fill large orders if we do not have sufficient manufacturing capacity to enable us to commit to provide customers with specified quantities of products. However, if we build our manufacturing capacity and inventory in excess of demand, as we have done in the past, we may produce excess inventory that may have to be reserved or written off.

We depend on a limited number of third parties to supply key materials, components and equipment, such as ferrules, optical filters and lenses, and if we are not able to obtain sufficient quantities of these items at acceptable prices, our ability to fill orders would be limited and our operating results could be harmed.

We depend on third parties to supply the raw materials and components we use to manufacture our products. To be competitive, we must obtain from our suppliers, on a timely basis, sufficient quantities of raw materials and components at acceptable prices. We obtain most of our critical raw materials and components from a single or limited number of suppliers and generally do not have long-term supply contracts with them. As a result, our suppliers could terminate the supply of a particular material or component at any time without penalty. Finding alternative sources may involve significant expense and delay, if these sources can be found at all. One component, GRIN lenses, is only available from one supplier. Difficulties in obtaining raw materials or components in the future may delay or limit our product shipments, which could result in lost orders, increase our costs, reduce our control over quality and delivery schedules and require us to redesign our products. If a supplier became unable or unwilling to continue to manufacture or ship materials or components in required volumes, we would have to identify and qualify an acceptable replacement. A delay or reduction in shipments or any need to identify and qualify replacement suppliers would harm our business.

Because we experience long lead times for materials and components, we may not be able to effectively manage our inventory levels, which could harm our operating results.

Because we experience long lead times for materials and components and are often required to purchase significant amounts of materials and components far in advance of product shipments, we may not effectively manage our inventory levels, which could harm our operating results. Alternatively, if we underestimate our raw material requirements, we may have inadequate inventory, which could result in delays in shipments and loss of customers. If we purchase raw materials and increase production in anticipation of orders that do not materialize or that shift to another quarter, we will, as we have in the past, have to carry or write off excess inventory and our gross margins will decline. Both situations 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. The time our customers require to incorporate our products into their own can vary significantly and generally exceeds several months, which further complicates our planning processes and reduces the predictability of our forecasts. Even if we receive these orders, the additional manufacturing capacity that we add to meet our customer’s requirements may be underutilized in a subsequent quarter.

We are exposed to risks and increased expenses as a result of laws requiring companies to evaluate internal controls over financial reporting.

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to perform an assessment of our internal controls as of December 31, 2007, and our independent auditors to attest to the effectiveness of our internal controls over financial reporting beginning with our year ending December 31, 2009. We have implemented an ongoing program to perform the system and process evaluation and testing we believe to be necessary to comply with these requirements, however, we cannot assure you that we will be successful in our efforts. In the event that our chief executive officer, acting chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be negatively affected and this could cause a decline in our stock price.

We depend on key personnel to operate our business effectively in the rapidly changing fiber optic components market, and if we are unable to hire and retain appropriate management and technical personnel, our ability to develop our business could be harmed.

Our success depends to a significant degree upon the continued contributions of the principal members of our technical sales, marketing, engineering and management personnel, many of whom perform important management functions and would be difficult to replace. We particularly depend upon the continued services of our executive officers, particularly Peter Chang, our President and Chief Executive Officer; David Hubbard, our Vice President, Sales and Marketing; Wei-shin Tsay, our senior Vice President of Product Development; Anita Ho, our Acting Chief Financial Officer and Corporate Controller; and other key engineering, sales, marketing, finance, manufacturing and support personnel. In addition, we depend upon the continued services of key management personnel at our Taiwanese subsidiary and at our facility in China. None of our officers or key employees is bound by an employment agreement for any specific term, and may terminate their employment at any time. In addition, 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. We may have difficulty hiring skilled engineers at our manufacturing facilities in the United States, Taiwan, and China. If we are not successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs, our business may be harmed.

If we are not able to achieve acceptable manufacturing yields and sufficient product reliability in the production of our fiber optic components, we may incur increased costs and delays in shipping products to our customers, which could impair our operating results.

Complex and precise processes are required for the manufacture of our products. Changes in our manufacturing processes or those of our suppliers, or the inadvertent use of defective materials, 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 production yields could delay product shipments and impair our operating results. We may not obtain acceptable yields in the future.

In some cases, existing manufacturing techniques, which involve substantial manual labor, may not allow us to cost-effectively meet our production goals so that we maintain acceptable gross margins while meeting the cost targets of our customers. We may not achieve adequate manufacturing cost efficiencies.

Because we plan to introduce new products and product enhancements, we must effectively transfer production information from our product development department to our manufacturing group and coordinate our efforts with our suppliers to rapidly achieve volume production. In our experience, our yields have been lower during the early stages of introducing new product to manufacturing. 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.

Because the qualification and sales cycle associated with fiber optic components is lengthy and varied, it is difficult to predict the timing of a sale or whether a sale will be made, which may cause us to have excess manufacturing capacity or inventory and negatively impact our operating results.

In the communications 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. This process may range from three to nine months and sometimes longer. 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 customer until at least the adoption of a future redesigned system. Even then, many customers may be reluctant to incorporate entirely new products into their new systems, as this could involve significant additional redesign efforts. If we fail to achieve design-in wins in our potential customers’ qualification processes, we will lose the opportunity for significant sales to those customers for a lengthy period of time.

In addition, some of our customers require that our products be subjected to standards-based qualification testing, which can take up to nine months or more. While our customers are evaluating our products and 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. Even after the evaluation process, it is possible a potential customer will not purchase our products. In addition, product purchases are frequently subject to unplanned processing and other delays, particularly with respect to larger customers for which our products represent a very small percentage of their overall purchase activity. Accordingly, our revenues and operating results may vary significantly and unexpectedly from quarter to quarter.

If our customers do not qualify our manufacturing lines for volume shipments, our optical networking components may be dropped from supply programs and our revenues may decline.

Customers generally will not purchase any of our products, other than limited numbers of evaluation units, before they qualify our products, approve our manufacturing process and approve our quality assurance system. Our existing manufacturing lines, as well as each new manufacturing line, must pass through various levels of approval with our customers. For example, customers may require that we be registered under international quality standards. Our products may also have to be qualified to specific customer requirements. This customer approval process determines whether the manufacturing line achieves the customers’ quality, performance and reliability standards. Delays in product qualification may cause a product to be dropped from a long-term supply program and result in significant lost revenue opportunity over the term of that program.

Our fiber optic components are deployed in large and complex communications networks and may contain defects that are not detected until after our products have been installed, which could damage our reputation and cause us to lose customers.

Our products are designed for deployment in large and complex optical networks. Because of the nature of these products, they can only be fully tested for reliability when deployed in networks for long periods of time. Our fiber optic products may contain undetected defects when first introduced or as new versions are released, and our customers may discover defects in our products only after they have been fully deployed and operated under peak stress conditions. In addition, our products are combined with products from other vendors. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:

loss of customers;

damage to our reputation;

failure to attract new customers or achieve market acceptance;

diversion of development and engineering resources; and

legal actions by our customers.

The occurrence of any one or more of the foregoing factors could negatively impact our revenues.

The market for fiber optic components is new and unpredictable, characterized by rapid technological changes, evolving industry standards, and significant changes in customer demand, which could result in decreased demand for our products, erosion of average selling prices, and could negatively impact our revenues.

The market for fiber optic components is new and characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. Because this market is new, it is difficult to predict its potential size or future growth rate. Widespread adoption of optical networks, especially in the metropolitan, last mile, and enterprise access segments of the networks, is critical to our future success. Potential end-user customers who have invested substantial resources in their existing copper lines or other systems may be reluctant or slow to adopt a new approach, such as optical networks. Our success in generating revenues in this market will depend on:

the education of potential end-user customers and network service providers about the benefits of optical networks; and

the continued growth of the metropolitan, last mile, and enterprise access segments of the communications network.

If we fail to address changing market conditions, sales of our products may decline, which would adversely impact our revenues.

We may be unable to successfully integrate acquired businesses or assets with our business, which may disrupt our business, divert management’s attention and slow our ability to expand the range of our proprietary technologies and products.

To expand the range of our proprietary technologies and products, we may acquire complementary businesses, technologies or products, if appropriate opportunities arise. We may be unable to identify other suitable acquisitions at reasonable prices or on reasonable terms, or consummate future acquisitions or other investments, any of which could slow our growth strategy. We may have difficulty integrating the acquired products, personnel or technologies of any company or acquisition that we may make. Similarly, we may not be able to attract or retain key management, technical or sales personnel of any other companies that we acquire or from which we acquire assets. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses.

If our common stock is not relisted on the Nasdaq Global Market, we may be subject to certain provisions of the California General Corporation Law that may affect our charter documents and result in additional expenses.

Beginning at the commencement of trading on November 8, 2002, the listing of our common stock was transferred from the Nasdaq Global Market to the Nasdaq Capital Market. As a result, we may become subject to certain sections of the California General Corporation Law that will affect our charter documents if our common stock is not returned to being listed on the Nasdaq Global Market. A recent Delaware decision has called into question the applicability of the California General Corporation Law to Delaware corporations. However, if the California General Corporation Law applies to our Company, we will not be able to continue to have a classified board or continue to eliminate cumulative voting by our stockholders. In addition, certain provisions of our Certificate of Incorporation that call for supermajority voting may need to be approved by stockholders every two years or be eliminated. Also, in the event of a reorganization, stockholders will have dissenting stockholder rights under both California and Delaware law. Any of these changes will result in additional expense as we will have to comply with certain provisions of the California General Corporation Law as well as the Delaware General Corporation Law. We included these provisions in our charter documents in order to delay or discourage a change of control or changes in our management. Because of the California General Corporation Law, we may not be able to avail ourselves of these provisions.

If we are unable to maintain our listing on the Nasdaq Capital Market, the price and liquidity of our common stock may decline.

There can be no assurance that we will be able to satisfy all of the quantitative maintenance criteria for continued listing on the Nasdaq Capital Market, including a requirement that we maintain a continued minimum bid price of $1.00 per share. Although the minimum bid price requirement has been temporarily suspended beginning on October 16, 2008, the requirement will be reinstated in early 2009. Accordingly, beginning on January 19, 2009, if the closing bid price of our common stock falls and remains below $1.00 for 30 consecutive trading days as it has for significant periods of time in the past, our common stock may not remain listed on the Nasdaq Capital Market. If we fail to maintain continued listing on the Nasdaq Capital Market and must move to a market with less liquidity, our financial condition could be harmed and our stock price would likely decline. If we are delisted, it could have a material adverse effect on the market price of our common stock as well as the liquidity of the trading market for our common stock.

Many companies that face delisting as a result of closing bid prices that are below the Nasdaq Capital Market’s continued listing standards seek to maintain the listing of their securities by effecting reverse stock splits. However, reverse stock splits do not always result in a sustained closing bid price per share. We may consider the merits of implementing a reverse split and evaluate other courses of action as we believe may be appropriate.

If we fail to protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenues or increase our costs.

The fiber optic component market is a highly competitive industry in which we, and most other participants, rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and licensing arrangements to establish and protect proprietary rights. The competitive nature of our industry, rapidly changing technology, frequent new product introductions, changes in customer requirements and evolving industry standards heighten the importance of protecting proprietary technology rights. Since the United States Patent and Trademark Office keeps patent applications confidential until a patent is issued, our pending patent applications may attempt to protect proprietary technology claimed in a third party patent application. Our existing and future patents may not be sufficiently broad to protect our proprietary technologies as it is difficult to police the unauthorized use of our products and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully as United States laws. Our competitors and suppliers may independently develop similar technology, duplicate our products, or design around any of our patents or other intellectual property. If we are unable to adequately protect our proprietary technology rights, others may be able to use our proprietary technology without having to compensate us, which could reduce our revenues and negatively impact our ability to compete effectively.

Litigation may be necessary to enforce our intellectual property rights or to determine the validity or scope of the proprietary rights of others. As a result of any such litigation, we could lose our proprietary rights and incur substantial unexpected operating costs. Any action we take to protect our intellectual property rights could be costly and could absorb significant management time and attention. In addition, failure to adequately protect our trademark rights could impair our brand identity and our ability to compete effectively.

We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use some technologies in the future.

Our industry is very competitive and is characterized by frequent intellectual property litigation based on allegations of infringement of intellectual property rights. Numerous patents in our industry have already been issued, and as the market further develops and participants in our industry obtain additional intellectual property protection, litigation is likely to become more frequent. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business. In addition, we have and we may continue to enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. Any litigation arising from claims asserting that our products infringe or may infringe the proprietary rights of third parties, whether the litigation is with or without merit, could be time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel. We do not have insurance against our alleged or actual infringement of intellectual property of others. These claims could cause us to stop selling our products, which incorporate the challenged intellectual property, and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements. These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all.

Although we are not aware of any intellectual property lawsuits filed against us, we may be a party to litigation regarding intellectual property in the future. We may not prevail in any such actions, given their complex technical issues and inherent uncertainties. Insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely basis, our business could be harmed.

If we fail to increase sales of our products to optical communications equipment manufacturers outside of North America, growth of our business may be harmed.

For the three and nine months ended September 30, 2008, sales to customers located outside of North America were 40.9% and 44.0% of our revenues, respectively. In order to expand our business, we must increase our sales to customers located outside of North America. We have limited experience in marketing and distributing our products internationally and in developing versions of our products that comply with local standards. Our international sales will be limited if we cannot establish relationships with international distributors, establish additional foreign operations, expand international sales channels, hire additional personnel and develop relationships with international communications equipment manufacturers. Even if we are able to successfully continue international operations, we may not be able to maintain or increase international market demand for our products.

Because our manufacturing operations are located in active earthquake fault zones in Taiwan, and our Taiwan location is susceptible to the effects of a typhoon, we face the risk that a natural disaster could limit our ability to supply products.

Two of our primary manufacturing operations are located in Tu-Cheng City, Taiwan, and Hu-Kou City, Taiwan, each, an active earthquake fault zone. These regions have experienced large earthquakes in the past and may likely experience them in the future. In September 2001, a typhoon hit Taiwan causing businesses, including our manufacturing facility, and the financial markets to close for two days. Because the majority of our manufacturing operations are located in Taiwan, a large earthquake or typhoon in Taiwan could disrupt our manufacturing operations for an extended period of time, which would limit our ability to supply our products to our customers in sufficient quantities on a timely basis, harming our customer relationships.

ITEM 6: EXHIBITS

Exhibits

Exhibit
Number		Title

31.1		Rule 13a-14(a) certification of Chief Executive Officer
31.2		Rule 13a-14(a) certification of Acting Chief Financial Officer
32.1*		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
32.2*		Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).

___________________

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No 34-47986, Final Rule: Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 12, 2008

ALLIANCE FIBER OPTIC PRODUCTS, INC.
By /s/ Anita K. Ho
Anita K. Ho
Acting Chief Financial Officer
(Principal Financial and Accounting Officer and Duly
Authorized Signatory)

Exhibit 31.1

Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period Ended September 30, 2008

CERTIFICATION

I, Peter C. Chang, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Alliance Fiber Optic Products, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 12, 2008
By /s/Peter C. Chang
Peter C. Chang
Chief Executive Officer
(Principal Executive Officer)

Exhibit 31.2

Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period Ended September 30, 2008

CERTIFICATION

I, Anita K. Ho, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Alliance Fiber Optic Products, Inc.;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 12, 2008

By /s/Anita K. Ho
Anita K. Ho
Acting Chief Financial Officer
(Principal Accounting Officer)

Exhibit 32.1

Statement of Chief EXECUTIVE Officer under 18 U.S.C. § 1350

I, Peter C. Chang, the chief executive officer of Alliance Fiber Optic Products, Inc. (the “Company”), certify for the purposes of section 1350 of chapter 63 of title 18 of the United States Code that, to the best of my knowledge,

(i) the Quarterly Report of the Company on Form 10-Q for the period ended September 30, 2008 (the “Report”), fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934, and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

          /s/ Peter C. Chang
            Peter C. Chang
          November 12, 2008

Exhibit 32.2

Statement of Acting Chief FINANCIAL Officer under 18 U.S.C. § 1350

I, Anita K. Ho, the acting chief financial officer of Alliance Fiber Optic Products, Inc. (the “Company”), certify for the purposes of section 1350 of chapter 63 of title 18 of the United States Code that, to the best of my knowledge,

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

          /s/Anita K. Ho
          Anita K. Ho
          November 12, 2008

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Good

Alliance Fiber Optic Products (AFOP) Inactive 10-Q2008 Q3 Quarterly report

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