---

UNITED STATES SECURITIES
AND EXCHANGE COMMISSIONWashington, D.C. 20549
_________________

# FORM 10-KSB

[X]       
          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
          OF 1934

# For the fiscal year
ended December 31, 2003

# OR

[  ]       
          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
          OF 1934

# For the transition
period from to

# 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 incorporation | (IRS Employer Identification No.)
|or organization)                              |                                  

735 North Pastoria
Avenue, Sunnyvale, CA 94085(Address of principal
executive offices)

Issuers telephone
number: (408) 736-6900

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

# Securities registered pursuant
to Section 12(g) of the Act:Common Stock, par
value $0.001 per shareSeries A Participating
Preferred Stock Purchase Rights

Check
whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the past 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 [X] No [   ]

Check
if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.
[   ]

The
issuers revenues for its fiscal year ending December 31, 2003: $11,469,860

The aggregate
market value of the voting and non-voting common equity held by non-affiliates (based upon
the closing sale price on the Nasdaq SmallCap Market on March 3, 2004) was approximately
$44,178,389.

As
of March 3, 2004 there were 38,278,573 shares of Common Stock, $0.001 per share par
value, outstanding.

# DOCUMENTS INCORPORATED
BY REFERENCE

Items 9
(as to directors and Section 16(a) Beneficial Ownership Reporting Compliance), 10, 11
(as to Beneficial Ownership), 12 and 13 of Part III incorporate by reference
information from the registrants proxy statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for the
registrants 2004 Annual Meeting of Stockholders to be held on May 14, 2004.

---

# ALLIANCE FIBER OPTIC
PRODUCTS, INC.

# TABLE OF CONTENTS

# 2003 FORM 10-KSB

| |               |                                                                                                                                   |     
| | ------------- | --------------------------------------------------------------------------------------------------------------------------------- | ----
| |               |                                                                                                                                   | Page
| |               |                                                                                                                                   |     
| | PART I        |                                                                                                                                   |     
| |               | Item 1. Description of Business                                                                                                   | 1   
| |               | Item 2. Description of Property                                                                                                   | 7   
| |               | Item 3. Legal Proceedings                                                                                                         | 7   
| |               | Item 4. Submission of Matters to a Vote of Security Holders                                                                       | 7   
| |               |                                                                                                                                   |     
| | PART II       |                                                                                                                                   | 9   
| |               | Item 5. Market for Registrant's Common Equity and Related Stockholder Matters                                                     | 9   
| |               | Item 6. Management's Discussion and Analysis or Plan of Operations                                                                | 10  
| |               | Item 7. Financial Statements                                                                                                      | 28  
| |               | Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure                                      | 47  
| |               | Item 8A. Controls and Procedures                                                                                                  | 47  
| |               |                                                                                                                                   |     
| | PART III      |                                                                                                                                   | 48  
| |               |                                                                                                                                   |     
| |               | Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange           Act | 48  
| |               | Item 10. Executive Compensation                                                                                                   | 48  
| |               | Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                           | 48  
| |               | Item 12. Certain Relationships and Related Transactions                                                                           | 49  
| |               | Item 13. Exhibits and Reports on Form 8-K                                                                                         | 49  
| |               | Item 14. Principal Accountant Fees and Services                                                                                   | 52  
| |               |                                                                                                                                   |     
| | SIGNATURES    |                                                                                                                                   | 53  
| |               |                                                                                                                                   |     
| | EXHIBIT INDEX |                                                                                                                                   | 54  

i

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# PART I

# Item 1. Description of
Business

When
used in this Report, the words expects, anticipates,
believes, estimates, plans, and similar expressions
are intended to identify forward-looking statements. These are statements that relate to
future periods and include statements as to sources of revenues, net and operating losses,
the amount and mix of anticipated expenditures and expenses, reliance on our OPMS
products, our net cash flow, our reliance on the commercial success of our DWDM-related
products, our marketing and commercialization of products under development, plans for
enhancements of existing products, plans for future products, features and uses of our
products, our patent applications and intellectual property, increases in the number of
possible license offers and patent infringement claims, recognition of revenues,
differentiating factors in the fiber optic market, our competitive advantages, our ability
to compete, the source of our competition, consolidation in our industry, effects of
competition on our operating results, increased pricing pressure, the number of our
competitors, and our anticipated investments and expenditures. 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 below, as well as risks related to the development of
the metropolitan, last mile access, and enterprise networks, acceptance of our products by
our customers, industry wide shifts in supply and demand for optical components and
modules, overcapacity in our industry, development of new products by us and our
competitors, our ability to ramp new products into volume production, decreased demand for
our products, our ability to retain and obtain customers, increased competition in our
markets, delisting from the Nasdaq SmallCap Market, inability to obtain sufficient
quantities of a raw material product, not meeting customer requirements and our ability to
license intellectual property on commercially reasonable terms; and the risks set forth
below under Item 6, Managements Discussion and Analysis or Plan of
Operation. 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.

In
the sections of this report entitled Business and Managements
Discussion and Analysis of Financial Condition and Results of Operations  Factors
That May Affect Results, all references to Alliance Fiber Optic
Products, AFOP, we, us, our or the
Company mean Alliance Fiber Optic Products, Inc. and its subsidiaries, except
where it is made clear that the term means only the parent company.

OPIS
is our trademark. We may also refer to trademarks of other corporations and organizations
in this document.

# Overview

Alliance
Fiber Optic Products designs, manufactures and markets a broad range of high performance
fiber optic components, and integrated modules incorporating these components, for leading
and emerging communications equipment manufacturers. We offer a broad range of products
including interconnect devices that are used to connect optical fibers and components,
couplers and splitters that are used to divide and combine optical power, and dense
wavelength division multiplexing, or DWDM, devices that separate and combine multiple
specific wavelengths. Our emphasis on design for manufacturing and our comprehensive
manufacturing expertise enable us to produce our products efficiently and in volume
quantities. Our product scope and ability to integrate our components into optical modules
enable us to satisfy a wide range of customer requirements throughout the optical
networking market. Our customers deploy our products in long-haul networks that connect
cities, metropolitan networks that connect areas within cities, last mile access networks
that connect to individual businesses and homes, and enterprise networks within
businesses.

We
were incorporated in California in December 1995. In October 2000, prior to our initial
public offering, we reincorporated in Delaware as Alliance Fiber Optic Products, Inc.

# Industry Background

The
popularity of the Internet and the growing number of data intensive Internet-based
applications and services has fueled a significant increase in the volume of data traffic.
This traffic growth has increased the demands on communication networks originally
developed to primarily transport voice traffic. To meet this demand, many communications
service providers have and are designing and installing new networks based on fiber optic
technology, which provides greater data-carrying capacity, or bandwidth, and increased
transmission speeds compared to existing communications networks. Until recently, most of
the fiber deployed had been dedicated to long-haul networks. However, the demands for
high-speed network access and bandwidth are shifting the focus towards more complex
metropolitan networks and last mile access networks, which require an increasing number of
connections and components.

1

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Optical
fiber is currently being deployed across the following segments of communications
networks: long-haul, metropolitan, last mile access, and enterprise.

Long-haul
networks.Long-haul networks connect the communications networks of cities around the
world and transport large amounts of data and voice traffic. To solve congestion problems,
service providers have invested significant resources in the deployment of optical
infrastructure. As a result, current long-haul networks provide high bandwidth for
transmitting data over very long distances. The build-out of long-haul networks represents
an important step in improving network infrastructure to support increased demand for new
services and greater traffic volumes.

Metropolitan
networks. Metropolitan networks connect long-haul networks to last mile access
networks within urban areas. Due to the increase in data traffic and the demand for
enhanced services, the existing metropolitan network infrastructure has become a
bottleneck for the provision of communications services to business and residential end
users. As a result, service providers are making investments in infrastructure to reduce
capacity constraints in metropolitan networks.

Last
mile access networks. Last mile access networks connect business and residential end
users to their service provider in order to provide increased bandwidth to the end user.
Traditional access networks use the existing copper wire based infrastructure, which is
slow compared to the high-speed networks commonly used within businesses. Established and
new service providers are beginning to deploy fiber technologies in the last mile access
network in order to provide high bandwidth connectivity to the end user.

Enterprise
networks.Local area networks serving the business community have utilized fiber optic
links for over a decade. Historically these links have connected vertical backbone
requirements between various floors of copper-based networks within office buildings. Over
the last several years, as the bandwidth of local networks has increased, optical fiber
has become a pervasive medium for horizontal network links especially in the storage
network environment.

Service
providers are seeking to maximize the performance and capacity of both new and existing
optical networks through advances in optical technology. Wavelength division multiplexing,
or WDM, has been used for several years to increase system capacity by combining different
light signals at different wavelengths, on a single optical fiber. Each wavelength
represents a separate high-bandwidth channel that can carry data. Multiplexing devices
combine, or multiplex, these different wavelengths at one end of the optical network, and
demultiplexing devices, or demultiplex, separate them at the other end. WDM technology has
been enhanced with the introduction of dense wavelength division multiplexing, or DWDM,
which permits the wavelengths to be spaced more closely together. The tighter spacing
allows even more wavelengths to be transmitted on one optical fiber. The use of WDM and
DWDM technology is well established in the long-haul market and is increasingly utilized
in the metropolitan and last mile access markets.

Fiber
optic components are used within optical networks to create, combine, isolate, amplify,
split, direct and perform various other functions on the optical signals. Fiber optic
components are divided into two broad categories, active and passive components. Active
components require power to operate and use electrical signals to create, modulate or
amplify optical signals. Passive optical components guide, mix, filter, route, adjust and
stabilize optical signals transmitted through an optical network.

# Market Conditions

During
the last fiscal year, the demand for optical transport systems and related devices has
declined. In previous periods, communication equipment manufacturers purchased optical
transport systems and related devices in anticipation of an extremely rapid increase in
demand for bandwidth. While demand for bandwidth continues to increase, this demand has
grown at a far slower pace than previously anticipated. As a result, communication
equipment manufacturers ended up with excess inventories of optical systems and devices
that now create a barrier to new sales opportunities.

This
situation has created challenges for suppliers in the optical communication industry. Due
to decreased unit shipments as a result of overcapacity in the industry and the resulting
competition for fewer sales opportunities, average selling prices have declined as
companies compete for significantly smaller market opportunities.

2

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# Products

Our
passive optical products support the needs of current and next generation optical network
systems applications. Our Optical Path Management Solution, or OPMS, product family
provides a comprehensive line of optical interconnect devices, couplers and splitters and
related optical products, as well as customized integrated modules incorporating these
devices. Our Wavelength Management Solutions, or WMS, include WDM and DWDM components and
modules that utilize thin film filter technologies to separate optical signals. Our
advanced optical devices include our all-fiber optical depolarizer, which reduces the
degree of polarization of a light source, our automatic variable optical attenuator, which
controls the amount of power in an optical fiber, and our switchable optical drop/add
module, which inserts or extracts specific wavelengths in a DWDM system.

The
following is a discussion of our current product offerings and the products that we are
developing.

OPMS
Products.In nearly all fiber optic networks, the optical fiber, passive
optical components and active optical devices must be joined using optical interconnection
systems. Our OPMS platform provides fundamental component support for these applications
as well as standard and custom value added integrated solutions that address the need for
higher functionality and modularity. All of the OPMS products described below are in
production and are shipping to customers.

OPMS
Modules.The evolution of optical components is driven by the increasing need for
packaging density, module performance and overall cost effectiveness. We design and
package our various OPMS components to provide integrated modules for our customers. Our
integrated modules are designed to reduce our customers system design requirements
and ease implementation.

Optical
Connectors, Adapters and Cable Assemblies. Optical connectors and adapters are
precision devices that connect fibers together. Optical cable assemblies are used to
bridge relatively short distances with optical paths. We offer a broad range of industry
standard connection products that support a wide range of fiber and fiber cable types.
Further, with our integrated design and manufacturing capability, we are able to customize
these products to meet our customers needs for compact size and special features. We
specialize in providing our customers with high performance custom cable assemblies to
serve in conjunction with our optical interconnection solutions at all interface points in
the optical communications network.

Fused
Fiber Optical Splitters and Couplers. Fused fiber optical splitters and couplers are
branching devices that are used to split optical power from a single fiber, or set of
fibers, into a different set of fibers. They are often used to distribute optical signals
to multiple locations for processing. These devices utilize signal and power sharing
features to reduce the total cost of delivering bandwidth to end-users. Our optical
splitters and couplers reduce insertion loss, or the power loss incurred when inserting
components into an optical path, and deliver high performance, including uniform optical
wavelength splitting.

Optical
Tap Couplers and Ultra Low Polarization Dependent Loss Tap Couplers. Optical tap
couplers are fused fiber branching devices that split off a portion of light to allow for
optical monitoring and feedback. These devices are used extensively in fiber amplifier
power control. They are also utilized in transmission equipment for performance monitoring
and control. Our ultra low polarization dependent loss devices offer low levels of
sensitivity to polarization, which is a characteristic of light that can cause a reduction
in the power of optical signals. These devices enable more effective monitoring and
management of optical networks.

Amplifier
WDM Couplers. Amplifier WDM couplers are used with specialized fibers to combine or
separate specific wavelengths of light associated with standard telecommunications optical
amplifier requirements. Our amplifier WDM couplers are stable low power loss components
with high power handling capability.

Optical
Fixed Attenuators. Optical fixed attenuators diminish the optical power within a given
optical path without interference or reduction in optical signal quality. Typically this
function is embedded in an optical connector or adapter element to simplify optical
network installation. We utilize attenuated fiber that reduces power while preserving
performance characteristics, including optical signal quality and reliability.

Fused
Fiber WDM Couplers. Fused fiber WDM couplers are used to combine and separate optical
signals transmitted on different wavelengths. This function provides the first level of
bandwidth expansion for a network by increasing a fibers signal carrying capacity.
Fused fiber WDM couplers may also be used to add additional functionality to the network
such as network status monitoring. Our fused fiber WDM couplers provide a cost effective
way to minimize loss and maximize wavelength isolation.

3

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Filter-Based
Wavelength Management Products. In recent years, wavelength division multiplexing has
become the preferred method of increasing bandwidth throughout optical networks. Our
filter-based products serve WDM and DWDM systems as core passive elements that direct and
manage larger numbers of optical signal channels. Our wavelength management products also
enable network DWDM systems to manage and monitor a large number of optical signals by
separating these signals into different paths that can be processed individually. All of
the Filter-Based Wavelength Management Products described below are in production and are
shipping to customers.

Filter
WDMs. Our thin film filter based WDMs are used to combine and separate optical
signals. Our filter-based products allow for higher isolation and narrower wavelength
separations than fused fiber technology. Our filter WDMs are designed for a range of
network applications including combining active and passive components and wavelength
monitoring, splitting and separating tasks.

Amplifier
Filter WDMs. Amplifier filter WDMs utilize thin film filter technology to maintain
wavelength separation in demanding applications. In addition, filter technology allows for
narrow wavelength separation. Our amplifier filter WDMs are designed for a range of
applications, such as splitting wavelengths and connecting lasers used in wavelength
amplification.

DWDMs.
          Dense wave division multiplexers, or DWDMs, are integrated optical modules that
          combine, or multiplex, and separate, or demultiplex, multiple optical signals of
          different wavelengths on a single fiber. The separation of wavelengths are so
          narrow, or dense, that a large number of channels (greater than 10) can be
          combined within the band of usable wavelengths of the fiber itself. We utilize
          proprietary thin film technology in the development and manufacture of our DWDM
          products. This technology delivers excellent performance characteristics,
          including narrow channel separation and wide channel bandpass, which is the
          range of frequencies that will pass through a filter. Thin film filter
          technology allows for a range of solutions for 200 GHz, 100 GHz and 50 GHz
          International Telecom Union wavelength spacing applications, which permit 40
          channels, 80 channels, and 160 channels, respectively, to be transmitted across
          a single fiber. Our DWDMs directly address the scalable channel plans found in
          metropolitan and last mile access network applications.

CWDMs.
          Coarse wavelength division multiplexers, or CWDMs, are integrated optical
          modules that multiplex or demultiplex multiple optical signals of different
          wavelengths on a single fiber. Our CWDM product separate wavelength into 20 nm
          spacing to cover the complete fiber optical communication spectrum from 1270 nm
          to 1610 nm. With the unique low insertion loss and flat band-pass profile, CWDMs
          provide the most economic and efficient wavelength division multiplexing
          solutions for metropolitan and access networks. Our CWDM product covers 4
          channel, 8 channel, and 16 channel mux and demux applications, and upgradability
          for both 4 channel and 8 channel type. We also offer optical add-drop modules
          (OADMs) for CWDM networks, with the capability of adding or dropping from one to
          15 channels. In addition to the CWDM mux, demux and optical add/drop modules, we
          also offer complete rackmount CWDM solutions to customers so they can easily
          mount our CWDM products directly on their system rack. We believe CWDM products
          directly address the metropolitan and access markets competitive
          wavelength management needs.

CCWDMs.
          Compact coarse wavelength division multiplexers, or CCWDMs, are integrated
          optical modules that are designed to significantly improve optical performance,
          while reducing manufacturing costs, in a package less than 1/4 the size of
          conventional CWDM modules. It features high wavelength accuracy and stability,
          low insertion loss, high isolation, low polarization dependent loss and an
          epoxy-free optical path. The Telcordia 1209/1221-qualified CCWDM builds on
          AFOPs proprietary optical bench platform, and the Company believes it has
          the smallest footprint of any comparable CWDMs. With a channel spacing of 20 nm
          and wide bandpass characteristics it allows for datacom or telecom network
          applications with low-cost uncooled lasers. These CCWDM Mux/Demuxes are
          available in four or eight channels and include an expansion port for 16 channel
          systems.

Add/Drop
DWDM Filters.Add/drop DWDM filter products are used to insert or extract specific
wavelengths in a DWDM system. While a large number of channels can be transmitted through
a single fiber network, often only selected channels of information are required at a
particular location. Our 200 GHz, 100 GHz and 50 GHz add/drop components use high
performance filter technology and operate with very little optical power loss in order to
provide high channel separation and high stability.

Advanced
Optical Devices.As the capacity and complexity of optical networks increases, future
systems face significant challenges. Performance characteristics such as stability,
channel balance and power loss due to polarization become difficult to manage without the
addition of optical control devices. Our advanced optical devices serve to add further
control in next generation networks and network measurement equipment. All of the Advanced
Optical Devices described below are in production and are shipping to customers.

4

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All-Fiber
Depolarizers. Depolarizers are devices that reduce the degree of polarization of a
light source. As polarization effects become a more significant limiting factor in next
generation network performance, depolarization becomes an increasingly important tool in
developing solutions to design constraints. We have developed and patented an all-fiber
depolarizer, which can significantly depolarize light from a range of sources, including
those used in communications networks and fiber optic test and measurement equipment.

Automatic
Variable Optical Attenuators. Automatic variable optical attenuators are designed to
control the optical power in a fiber. They are often combined with an active system
component to maintain optical power on a network even if the input signal is changing
power. Our automatic variable optical attenuators are specifically designed for
application in DWDM networks for use with individual channel source elements such as
add/drop transmitters. The cost and performance characteristics of our automatic variable
optical attenuators are specifically targeted to allow for the use of these devices in
volume as principal DWDM channel stabilization components.

# Intellectual Property

We
rely on a combination of patent, copyright, trademark and trade secret laws, as well as
confidentiality agreements and licensing arrangements, to establish and protect our
proprietary rights. As of December 31, 2003, we had 26 U.S. patents issued or
assigned to us and had 27 U.S. patent applications pending. The 26 U.S. patents expire
between September 2013 and October 2023. We also had 19 foreign patents issued, and 12
foreign patent applications pending. Our foreign patents issued will expire between
September 2009 and March 2013. We also utilize unpatented proprietary know-how and trade
secrets and employ various methods to protect them.

From
time to time, third parties, including our competitors, may assert patent, copyright and
other intellectual property rights to technologies that are important to us. We expect we
will increasingly be subject to license offers and infringement claims as the number of
products and competitors in our market grows and the functions of products overlap.
Patents of third parties may be determined to be valid, or some of our products may
ultimately be determined to infringe them. Other companies may pursue litigation with
respect to those or other claims. The results of any litigation are inherently uncertain.
In the event of an adverse result in any litigation with respect to intellectual property
rights relevant to our products that could arise in the future, we could be required to
obtain licenses to the infringing technology, to pay substantial damages under applicable
law, to cease the manufacture, use and sale of infringing products or to expend
significant resources to develop non-infringing technology. Licenses may not be available
from third parties either on commercially reasonable terms or at all. In addition,
litigation frequently involves substantial expenditures and can require significant
management attention, even if we ultimately prevail. Accordingly, any infringement claim
or litigation against us could significantly harm our business, operating results,
financial condition, or cash flows. As of December 31, 2003, there are no infringement
claims or litigation pending against us.

# Customers

We
sell our products to communications equipment manufacturers that incorporate our products
into their systems that they in turn sell to network service providers. In certain cases,
we sell our products to other component manufacturers for resale or inclusion in their
products. In the year ended December 31, 2003, we sold our products to more than 200
customers. No individual customer accounted for 10% or more of our revenues in either of
the years ended December 31, 2001 or 2002. One customer, Scientific Atlanta, accounted for
10.8% of our revenues in the year ended December 31, 2003.

# Sales, Marketing and
Technical Support and Product Management

Sales.
          Our direct sales force markets and sells our products primarily in the United
          States. We also maintain a sales support staff in Taiwan to service customers
          based in the Asia Pacific region. Our direct sales force and technical marketing
          personnel maintain close contact with our customers and provide technical
          support.

Marketing.We have a number of marketing programs to support the sale and distribution
          of our products and to inform existing and potential customers about the
          capabilities and benefits of our products. Our marketing efforts include
          participating in industry trade shows and technical conferences, advertising in
          trade journals and communicating through our corporate website and direct mail.

5

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Technical
Support and Product Management. We maintain a technically knowledgeable support staff
that is critical to our development of long-term customer relationships. Our technical
support and product management staff works closely with our customers to understand their
product requirements, to assist customers with utilizing our product line, and to develop
customized product solutions.

# Competition

The
fiber optic component industry is highly competitive and subject to rapid technological
change. We believe that the principal differentiating factors in the fiber optic component
market are support for multiple optical interfaces, high optical power, wavelength
selection, manufacturing capacity, reliable and compact packaging, price, product
innovation and reliability of product performance. Based on our assessment of the
performance and price of similar competitive product offerings, we believe that our
products compare favorably, although we cannot assure that they will continue to do so.

Our
principal competitors in the components market include Avanex Corporation, DiCon
Fiberoptics, Inc., Gould Electronics Inc., JDS Uniphase, Luminent, Inc., a subsidiary of
MRV Communications, Inc., Oplink, Inc., Stratos Lightwave, Inc. and Tyco Electronics
Corporation. We estimate that we have approximately 25 competitors in the components
market as of December 31, 2003. We believe that we primarily compete with diversified
suppliers for the majority of our product line and to a lesser extent with a large number
of niche companies that offer a more limited product line. Competitors throughout the
optical component industry, including those who sell active components, may rapidly become
competitors in portions of our business. Competitors who provide both active and passive
components may have a competitive advantage because they provide a more complete product
solution than we provide. In addition, our industry has recently experienced significant
consolidation, and we anticipate that further consolidation will occur. This consolidation
has further increased and we believe will further increase competition. We expect
significant pricing pressure from our competitors that may negatively affect our margins.
We cannot assure you that we will be able to compete successfully with existing or future
competitors or that competitive pressures will not seriously harm our business, operating
results and financial condition.

# Product Development

As
of December 31, 2003, we had a total of 40 engineers and technicians that are
directly involved in research and development of our products located in the United
States, Taiwan and China. Our engineering team has extensive design, packaging, processing
and software experience in optical components, interfaces and systems.

Our
primary product development center is located in Sunnyvale, California, where we opened
our Photonics Technology Center in March 2001. Our Taiwanese subsidiary also engages in
product development. Our research and development expenses were $10.4 million,
$7.3 million and $5.6 million for the years ended December 31, 2001, 2002 and
2003, respectively. We spend a substantial proportion of our financial resources to
develop new technologies and products to serve the next generation communication markets.

# Sources and Availability
of Raw Materials

We
make significant purchases of key materials, components and equipment, including ferrules,
graded index lenses, or GRIN lenses, filters and other components from third party
suppliers. We obtain most of our critical raw materials and components from a single or
limited number of suppliers. When possible, we also develop and maintain alternative
sources for essential materials and components. However, there is only one supplier of
GRIN lenses. The inability to obtain sufficient quantities of these materials or
components may result in delays, increased costs, and reductions in our product shipments.

# Manufacturing

We
currently manufacture the majority of our OPMS and optical amplifier products at our
facility in Tu-Cheng City, Taiwan. We manufacture our filter-based and advanced products
at our headquarters in Sunnyvale, California and at our facility near Shenzhen, China.

Each
of our facilities maintains comprehensive in-house manufacturing processes, including
component and integrated module design, integration, production, and testing. We plan to
continue to invest resources in manufacturing management, engineering and quality control.

6

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We
have established a quality management system, or QMS, which is designed to ensure that the
products we provide to our customers meet or exceed their requirements. The QMS system is
based on international standard ISO 9000. Our Taiwan facility and our United States
facility are both ISO 9001-2000 certified in manufacturing.

# Employees

As
of December 31, 2003, we had 387 full-time employees, including 79 located in the
United States, 168 in Taiwan and 140 in mainland China. Of our 387 full-time employees, 40
are engaged in product development, 284 are engaged in manufacturing production, 15 are
engaged in sales, marketing, application support and customer service, and 48 are engaged
in general and administration. None of our employees are represented by a labor union. We
have not experienced any work stoppages and we consider our relations with our employees
to be good.

# Available Information

AFOPs
internet address is www.afop.com. AFOP makes available free of charge through a
hyperlink on our website our annual reports on Form 10-KSB, quarterly reports on Form
10-QSB, current reports on Form 8-K, and amendments to those reports filed or furnished
pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after the
material is furnished to the SEC. Our website and the information contained therein or
connected thereto is not intended to be incorporated into this Annual Report on Form
10-KSB.

# Item 2. Description of
Property

In
the United States, we lease a total of approximately 32,800 square feet in three buildings
located in Sunnyvale, California. Of the 32,800 square feet:

|  |                                                                                                                                                                                                                                                                                                                          
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|o | we lease  11,700 square feet of administrative,  sales,  marketing,  product development and manufacturing space pursuant to a
         lease that expires in May 2004; and                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                          
|o | we lease a 10,500 square foot
manufacturing and product development facility pursuant to a lease that expires in
July 2004.                                                                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                          
|o | we lease an additional 10,600 square feet of space near our current headquarters in
Sunnyvale, California in December 2000 pursuant to a lease that commenced in February 2001
and expires in July 2004. In September of 2002, we consolidated our operations in
California into two buildings and vacated this facility.

We
are currently in the process of evaluating our future facility requirements in California,
and we have begun lease negotiations on specific properties.

In
Taiwan, we lease a total of approximately 38,800 square feet in one facility located in
Tu-Cheng City, Taiwan. These leases expire at various times from 2003 to 2004.
Additionally, in December 2000, the Company purchased approximately 8,200 square feet of
space immediately adjacent to the leased facility for $0.8 million, bringing the total
square footage to approximately 47,000 square feet. Of this total, 33,400 square feet is
used for manufacturing and 13,600 square feet is used for administration and product
development.

In
August 2002, we entered into a lease for a 62,000 square foot facility near the Shenzhen
area which will expire in July 2007.

# Item 3. Legal Proceedings

From
time to time we may be involved in litigation relating to claims arising in the ordinary
course of business. As of the date of this Form 10-KSB, there are no material legal
proceedings pending against us or, to the best of our knowledge, threatened against us.

# Item 4. Submission of
Matters to a Vote of Security Holders

No
matters were submitted to a vote of security holders during the fourth quarter of the year
covered by this report.

7

---

# Executive Officers of
the Registrant

Our
executive officers as of December 31, 2003 are as follows:

Peter C. Chang, 46, has served as our Chairman of the Board, Chief Executive Officer,
          President and Secretary since our formation in December 1995. From 1990 through
          1995, Mr. Chang was Division Manager at Hon Hai Holding. From 1984 through
          1988, he was an engineer at AlliedSignal Inc. and from 1988 through 1990 was a
          member of the technology staff at Lucent Bell Labs. Mr. Chang received a
          B.S. in Mechanical Engineering from the National Taiwan University and an M.S.
          in Mechanical Engineering from Notre Dame University.

David A. Hubbard, 44, has served as our Vice President, Sales and Marketing since
          October 1996. From February 1995 to September 1996, Mr. Hubbard was
          Director of Marketing/Business Development at Tracor/AEL Industries.
          Mr. Hubbard received his M.S. from University of Connecticut and his B.S.
          from State University of New York.

Wei-Shin
Tsay, Ph.D., 52, has served as our Senior Vice President, Product Development
since August 2000. From 1996 through August 2000, Dr. Tsay held various management
positions in engineering, operations, and marketing at JDS Uniphase. From 1994 through
1996, Dr. Tsay held various product management positions at Lucent
Microelectronics/Optoelectronics Strategic Business Unit. From 1982 through 1994, Dr. Tsay
held various engineering and technical management positions at Bell Labs. Dr. Tsay
received an M.S. in Manufacturing Systems Engineering from Lehigh University, a Ph.D. in
physics from the University of Rochester and a B.S. in Physics at the National Tsing-Hua
University in Hsin-Chu, Taiwan.

Anita
K. Ho, 57, has served as our Acting Chief Financial Officer since July 2002. From
October 2000 to the present, Ms. Ho has served as our Corporate Controller. From 1998 to
2000, Ms. Ho was a Finance Manager at 3Com Corporation. From 1995 through 1998, Ms. Ho was
a member of the finance staff at 3Com Corporation. Ms. Ho received a B.S. in Accounting
from Soochow University in Taipei, Taiwan.

8

---

# PART II

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

The
Companys common stock, par value $0.001, was traded on the Nasdaq National Market
under the ticker symbol AFOP until November 8, 2002, when it began to trade on
the Nasdaq SmallCap Market under the same ticker symbol. The following table summarizes
the high and low closing prices for our common stock as reported on the Nasdaq National
Market and SmallCap Market, as applicable.

| | High                |       | Low |      
| | ------------------- | ----- | --- | -----
| |                     |       |     |      
| | 2002                |       |     |      
| | First Quarter 2002  | $1.92 |     | $0.99
| | Second Quarter 2002 | $1.10 |     | $0.70
| | Third Quarter 2002  | $0.98 |     | $0.41
| | Fourth Quarter 2002 | $0.67 |     | $0.36
| |                     |       |     |      
| | 2003                |       |     |      
| | First Quarter 2003  | $0.62 |     | $0.45
| | Second Quarter 2003 | $0.83 |     | $0.48
| | Third Quarter 2003  | $1.85 |     | $0.81
| | Fourth Quarter 2003 | $2.70 |     | $1.60

As
of March 1, 2004, the Companys common stock was held by 89 stockholders of record
(not including beneficial holders of common stock held in street name). The Company has
never declared or paid dividends on its capital stock and does not anticipate paying any
dividends in the foreseeable future.

# Securities Authorized
for Issuance Under Equity Compensation Plans

Information
regarding securities authorized for issuance under our equity compensation plans can be
found under Item 11 of this Annual Report on Form 10-KSB.

9

---

# Item 6.
Managements Discussion and Analysis or Plan of Operations

When
used in this discussion, the words expects, anticipates,
believes, estimates, plans, and similar expressions
are intended to identify forward-looking statements. These statements, which include
statements as to critical accounting policies, our sources of revenue, anticipated revenue
levels, our profitability, the fluctuation of our cost of revenues as a percentage of
revenues, our net and operating losses, our net cash flow, the amount and mix of our
anticipated expenditures and expenses, expenditures required to remain competitive,
increase or decrease of our expenses in absolute dollars or as a percentage of revenue,
market conditions, the need for additional inventory reserves or provisions, gross margin
as a percentage of revenue, our reliance on our OPMS products sales levels, reliance
on the commercial success of our DWDM-related products, our success being tied to
relationships with key customers, our deferred stock-based compensation, the adequacy of
our capital resources, the impact of recent accounting pronouncements, period-to-period
comparisons of our operating results, our ability to obtain raw materials and components
and maintain and develop supplier relationships, our ability to establish and maintain
relationships with key customers, our anticipated use of resources, our ability to
maintain appropriate inventory, factors that affect a customers decision to choose a
supplier, our competitors, competition in our industry, our competitive advantage,
consolidation in our industry, our need for additional financing and investments of our
existing cash 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 below, further decreased demand for our products,
continued economic instability, as well as competition including the impact of competitive
products and pricing, timely design acceptance by our customers, our success attracting
new customers, loss of a key customer, our customers adopting our new products, timely
introduction of new technologies, our ability to ramp new products into volume production,
our ability to attract and retain highly skilled personnel, loss of a key supplier,
industry wide shifts in supply and demand for optical components and modules, industry
overcapacity, being delisted from the Nasdaq SmallCap Market, integration of acquired
businesses, financial stability in foreign markets and the matters discussed in
Factors That May Affect Results. 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.

The
following discussion should be read in conjunction with our Consolidated Financial
Statements and Notes thereto.

# Critical Accounting
Policies and Estimates

Managements
discussion and analysis of our financial condition and results of operations are based on
our 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.

We
believe the following critical accounting policies affect managements more
significant judgments and estimates used in the preparation of the Companys
Consolidated Financial Statements:

We
follow SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements for recognizing revenue. Specifically, we recognize revenues upon the
shipment of our products to our customers provided that we have received a purchase order,
the price is fixed, and the collection of the resulting receivable is probable. Subsequent
to the sale of our products, we have no obligation to provide any modification or
customization, upgrades, enhancements, or post-contract customer support.

Allowances
are provided for estimated returns. Provisions for return allowances are recorded at the
time revenue is recognized based on our historical returns, current economic trends and
changes in customer demand. Such allowances are adjusted periodically to reflect actual
and anticipated experience. Material differences may result in the amount and timing of
our revenue for any period if management made different judgments or utilized different
estimates.

10

---

Our
inventory provision for estimated losses to be incurred on sale or disposal of inventory
is based on assumptions about future demand and market conditions. If actual demand or
market conditions are less favorable than those projected by management, additional
inventory provisions may be required. We utilized $0.1 million of previously reserved
excess inventory for our DWDM-related products in the year ended December 31, 2003. We
recorded provisions of $0.1 million and $2.6 million for excess DWDM-related inventory in
the years ended December 31, 2003 and December 31, 2002. We recorded provisions of $0.1
million and $1.9 million for excess OPMS-related inventory in the years ended December 31,
2003 and December 31, 2002.

We
review the valuation of long-lived assets and assess the impairment of the assets whenever
events or changes in circumstances indicate that the carrying value may not be recoverable
due to: significant underperformance relative to expected historical or projected future
operating results; significant changes in the manner of our use of the assets or the
strategy for the overall business; and significant negative industry or economic trends.
When we determine that the carrying value of long-lived assets may not be recoverable
based on the existence of one or more of the above indicators of impairment, we measure
any impairment based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our current
business model. In the quarter ended June 30, 2002, we wrote off approximately $1.0
million for non-functional or damaged equipment and machinery in Taiwan which were used
for the production of fused fiber products. We did not record any impairments for the year
ended December 31, 2003.

We
estimate our income taxes in each of the jurisdictions in which we operate. This process
involves us estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting purposes.
These differences result in deferred tax assets and liabilities, which are included in our
Consolidated Balance Sheets. We must then assess the likelihood that our deferred tax
assets will be recovered from future taxable income and to the extent we believe that
recovery is not likely, we must establish a valuation allowance. To the extent we
establish a valuation allowance or increase this allowance in a period, we must include an
expense within the tax provision in our Statements of Operations. To date, we have
recorded a full allowance against our deferred tax assets.

# Overview

We
were founded in December 1995 and commenced operations to design, manufacture and market
fiber optic interconnect products, which we call our Optical Path Management Solution, or
OPMS, products. We have broadened our OPMS product line which now includes attenuators and
fused fiber products. In early 1999, we started forming a new product line based in part
on our proprietary technology. We started selling our dense wavelength division
multiplexing, or DWDM, and other wavelength management products in July 2000. Since
introduction, sales of DWDM-related products have fluctuated with the overall market for
these products.

We
market and sell our products predominantly through our direct sales force, which we began
building in early 1998. From our inception through December 31, 2003, we derived a
substantial portion all of our revenues from our OPMS product line. Our DWDM-related
products contributed as a percentage of revenue 8.8%, 8.4% and 20.9% for the years ended
December 31, 2001, 2002 and 2003, respectively. In the years ended December 31, 2001,
2002 and 2003, our top 10 customers comprised 35.5%, 49.8%, and 48.9% of our revenues,
respectively. No individual customer accounted for 10% or more of our revenues in 2001 or
2002; one customer, Scientific Atlanta, accounted for 10.8% of our revenues in 2003.

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:

|  |                                                                              
|- | -----------------------------------------------------------------------------
|o | changes in manufacturing volume;                                             
|  |                                                                              
|o | costs incurred in establishing additional manufacturing lines and facilities;
|  |                                                                              
|o | inventory write-downs and impairment charges related to manufacturing assets;
|  |                                                                              
|o | mix of products sold;                                                        
|  |                                                                              
|o | changes in our pricing and pricing from our competitors;                     
|  |                                                                              
|o | mix of sales channels through which our products are sold; and               
|  |                                                                              
|o | mix of domestic and international sales.                                     

11

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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, so accordingly we plan to continue to invest amounts similar to our
spending levels in 2003 in our product development efforts.

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 the
costs associated with trade shows, promotional activities and travel expenses. We intend
to continue to invest amounts similar to our spending levels in 2003 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 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. We expect most of these expenses
to remain flat in absolute dollars with the exception of professional and legal services
we expect will increase due to increased rates and fees and costs associated with
compliance with new laws.

In
connection with the grant of stock options to employees and consultants, we recorded
deferred stock-based compensation of approximately $26.8 million in
stockholders equity prior to our initial public offering, representing the
difference between the estimated fair market value of our common stock and the exercise
price of these options at the date of grant. Deferred stock-based compensation is being
amortized using the graded vesting method, under which each option grant is separated into
portions based on its vesting terms which results in acceleration of amortization expense
for the overall award. We expect non-cash compensation expense, which was
$0.9 million in the year ended December 31, 2003, to decrease in future periods.

In
July 2000, we issued 4,700,000 shares of Series C convertible preferred stock at a price
of $5.50 per share. The difference between the issuance price and the deemed fair value of
the preferred stock on the date of the transaction resulted in a deemed preferred stock
dividend of $14.8 million, which was fully recognized in the quarter ended
September 30, 2000.

In
November 2000, we completed our initial public offering by issuing 4,500,000 shares of
common stock at a price of $11.00 per share. The proceeds of the offering, net of costs
associated with the registration and issuance of the shares, totaled $44.4 million.

In
October 1997, we acquired 97% of the outstanding common stock of Transian Technology Ltd.
Co. (Transian), a Taiwan corporation, for $512,000 to expand our design and
manufacturing capacity. In April 1998, we invested an additional $152,000 in cash,
increasing our ownership of Transian to 98.5%.

In
December 2000, we established a subsidiary, Alliance Fiber Optic Products, in the
Peoples Republic of China, which we have developed as a manufacturing facility. We
commenced production at this facility in the third quarter of 2003.

In
January 2004, we completed the purchase of Taiwan-based Ritek Corporations photonic
business. Under the terms of the agreement, AFOP acquired substantially all of the assets
of Riteks photonics business in exchange for 1.7 million shares of AFOP common
stock for total consideration of $4.1 million.  Additionally AFOP received $1.5 million in cash from Ritek. Riteks photonics
business is located in Hsin Chu Industrial Park, Taiwan, and we may continue to operate
the business at this facility rent-free for two years after the closing.

12

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# 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.

|                               | Years Ended December 31, |         
|------------------------------ | ------------------------ | --------
|                               | 2001                     |         
|Revenues                       |                          | 100.0%  
|                               |                          |         
|Cost of revenues:              |                          | 133.7   
|                               |                          |         
|Gross profit (loss)            |                          | (33.7)  
|Operating expenses:            |                         
|Research and development       |                          | 50.9    
|Sales and marketing            |                          | 16.6    
|General and administrative     |                          | 27.4    
|Excess Facility Charges        |                          | --      
|                               |                          |         
|Total operating expenses       |                          | 94.9    
|                               |                          |         
|Loss from operations           |                          | (128.5) 
|Interest and other income, net |                          | 11.3    
|                               |                          |         
|Loss before income taxes       |                          | (117.3) 
|Income tax provision (benefit) |                          | 1.1     
|                               |                          |         
|Net loss                       |                          | (118.4%)
|                               |                          |         

# Results of Operations

# Comparison of Fiscal
Year 2002 and Fiscal Year 2003

Revenues.Revenues were $13.1 million and $11.5 million for the years ended
          December 31, 2002 and 2003, respectively. OPMS revenues decreased from
          $12.0 million in 2002 to $9.1 million in 2003 primarily due to decreased volume
          shipments of our products as a result of continued poor market conditions. DWDM
          revenues increased from $1.1 million in 2002 to $2.4 million in 2003 primarily
          due to the increased acceptance of our products by our customers which resulted
          in higher volume shipments partially offset by lower ASPs.

Cost
of Revenues.Cost of revenues in fiscal year 2003 decreased to $9.7 million from
approximately $16.2 million in fiscal year 2002. Cost of revenues as a percentage of net
revenues decreased to 84.7% in fiscal year 2003 from 123.4% compared to fiscal year 2002.
Cost of revenues in 2002 were primarily impacted by write-offs for excess and obsolete
inventory resulting from the slowdown in telecommunications capital spending, the general
downturn in the U.S. economy, and the allocation of our fixed costs over decreased
production volume. Cost of revenues in 2003 benefited from the allocation of our fixed
costs over increased DWDM production volume and much lower write-offs for excess and
obsolete inventory. Management continues to closely monitor the Companys inventory
levels. Any decline in demand for our products would result in reduced sales, increased
operating losses and additional inventory provisions.

Gross
Profit (Loss). 2003 gross profit was $1.7 million, or 15.3% of revenues, compared with
a 2002 gross loss of $3.1 million, or (23.4%) of revenues. The gross profit in 2003 was
mainly due to lower losses for our DWDM products as a result of the allocation of fixed
costs over increased DWDM production volume and lower inventory write-offs. The gross loss
in 2002 was due to losses related to our DWDM products and decreasing profits on our OPMS
products.

13

---

The
gross loss in 2002 for DWDM products of $5.1 million was primarily caused by reduced
revenue in 2002 and an inventory provision of $2.6 million for excess inventory which was
recorded in accordance with the Companys policy of reserving against inventory
levels in excess of expected future demand. The gross loss in 2003 for DWDM products of
$1.4 million was primarily caused by reduced average selling prices as the market
environment remained very price competitive.

Gross
profit for OPMS products increased from $2.1 million in 2002 to $3.1 million in 2003
primarily as a result of a higher inventory provision charge of $1.9 million for excess
OPMS inventory that was taken in 2002 as compared to the inventory provision charge of
$0.1 million that was taken in 2003.

We
expect our gross margin as a percentage of revenues to be negatively impacted in the near
term due to low OPMS production volumes and selling price competition for our DWDM
products. We had approximately $1.4 million in DWDM-related net inventory and $2.0 million
in OPMS-related net inventory on hand at December 31, 2003. Although we continue to take
steps to attempt to manage future inventory levels, we may have to record inventory
provisions in future periods if a decrease in demand for our products occurs.

Research
and Development Expenses. Research and development expenses decreased from
$7.3 million in 2002 to $5.6 million in 2003. The decrease in 2003 was primarily
due to lower general expenditures, as well as tighter controls over discretionary
spending. As a percentage of revenues, research and development expenses decreased from
55.7% in 2002 to 48.5% in 2003. We expect research and development expenses to remain
relatively flat due to the uncertainty about customer demand for our products in the
current economic environment.

Sales
and Marketing Expenses. Sales and marketing expenses decreased from $2.9 million in
2002 to $2.0 million in 2003. The decrease in 2003 was primarily due to lower sales
forces expenses resulting from tighter controls over discretionary spending. As a
percentage of revenues, sales and marketing expenses decreased from 21.9% in 2002 to 17.4%
in 2003. We expect sales and marketing expenses will remain relatively flat due to
uncertainty about customer demand for our products in the current economic environment.

General
and Administrative Expenses. General and administrative expenses decreased from $4.5
million in 2002 to $3.4 million in 2003. The decrease in 2003 was primarily due to
reduced general expenditures as well as tighter controls over discretionary spending. As a
percentage of revenues, general and administrative expenses decreased from 34.3% in 2002
to 29.7% in 2003. We expect to maintain general and administrative expenses at the same
level with the exception of professional and legal services we expect will increase due to
higher fees and costs associated with compliance with new laws.

Excess
Facility Charge. Due to the decline in business conditions and reduced headcount in
the United States, the Company consolidated its operations in the United States from three
buildings to two buildings in Sunnyvale, California in September 2002. As a consequence,
the Company recorded an excess facility charge of $1.8 million in the year ended December
31, 2002 comprising of $1.0 million of non-cancelable lease payments which were paid in
2003 and $0.6 million of future non-cancelable lease payments, which are expected to be
paid in 2004, and $0.2 million of fixed assets that were written-off.

Stock-Based
Compensation.Total stock-based compensation decreased from $1.1 million, or 8.2% of
revenues, in the year ended December 31, 2002 to $0.9 million, or 7.9% of revenues, in the
year ended December 31, 2003. This decrease was partially due to our accounting policy
which requires the amortization of a larger proportion of deferred compensation expense
during the early vesting periods of the option grants, and partially due to the reversal
of compensation expense for unvested stock options of employees whose employment was
terminated during the year ended December 31, 2003.

Interest
and Other Income, Net.Interest and other income, net, was $1.1 million and $0.7
million for the years ended December 31, 2002 and 2003, respectively. These amounts
consisted primarily of interest income, which fluctuated based on cash balances. The
decrease from 2002 to 2003 was due to lower cash balances and lower interest rates.

Income
Taxes. There was no income tax benefit in the year ended December 31, 2003, and
there was a benefit of $0.2 million in the year ended December 31, 2002. The income tax
benefit in 2002 was primarily due to a federal income tax refund.

As
of December 31, 2003, we had approximately $32.8 million and $14.9 million of net
operating loss carryforwards for federal and state tax purposes, respectively, which will
expire in 2021 for federal and in 2011 for state purposes, if not utilized.

We
have provided a full valuation allowance against our net deferred tax assets because
realization of our deferred tax assets is uncertain.

14

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# Comparison of Fiscal
Year 2001 and Fiscal Year 2002

Revenues.Revenues were $20.4 million and $13.1 million for the years ended
          December 31, 2001 and 2002, respectively. OPMS revenues decreased from
          $18.5 million in 2001 to $12.0 million in 2002 primarily due to decreased volume
          shipments of our products as a result of poor market conditions. DWDM revenues
          decreased from $1.9 million in 2001 to $1.1 million in 2002 primarily due to the
          continued slowdown in the telecommunications industry and decreased average
          selling prices of our products due to increased competition.

Cost
of Revenues.Cost of revenues in fiscal year 2002 decreased to $16.2 million from
approximately $27.3 million in fiscal year 2001. Cost of revenues as a percentage of net
revenues decreased to 123.4% in fiscal year 2002 from 133.7% compared to fiscal year 2001.
Cost of revenues in 2002 and 2001 were primarily impacted by write-offs for excess and
obsolete inventory resulting from the slowdown in telecommunications capital spending, the
general downturn in the U.S. economy, and the allocation of our fixed costs over decreased
production volume.

Gross
Profit (Loss). Gross loss decreased from $6.9 million, or 33.7% of revenue, in 2001 to
$3.1 million, or 23.4% of revenue, in 2002. The gross loss in both years was due to losses
related to our DWDM products and decreasing profits on our OPMS products.

The
gross loss in 2001 for DWDM products of $14.8 million was primarily caused by an inventory
provision charge of $6.5 million for excess DWDM inventory and a $5.2 million impairment
charge for the property and equipment used to manufacture our DWDM-related products. The
gross loss in 2002 for DWDM products of $5.1 million was primarily caused by reduced
revenue in 2002 and an inventory provision of $2.6 million for excess inventory which was
recorded in accordance with the Companys policy of reserving against inventory
levels in excess of expected future demand.

Gross
profit for OPMS products decreased from $7.9 million in 2001 to $2.1 million in 2002
primarily as a result of reduced revenues in 2002 due to poor market conditions and an
inventory provision charge of $1.9 million for excess OPMS inventory that was taken in
2002.

Research
and Development Expenses. Research and development expenses decreased from
$10.4 million in 2001 to $7.3 million in 2002. The decrease in 2002 was
primarily due to lower personnel levels and related expenditures, as well as tighter
controls over discretionary spending.

Sales
and Marketing Expenses. Sales and marketing expenses decreased from $3.4 million in
2001 to $2.9 million in 2002. The decrease in 2002 was primarily due to lower sales
forces expenses resulting from a reduction in headcount

General
and Administrative Expenses. General and administrative expenses decreased from $5.6
million in 2001 to $4.5 million in 2002. The decrease in 2002 was primarily due to
lower personnel levels and reduced expenditures as well as tighter controls over
discretionary spending.

Excess
Facility Charge. Due to the decline in business conditions and reduced headcount in
the United States, the Company consolidated its operations in the United States from three
buildings to two buildings in Sunnyvale, California in September 2002. As a consequence,
the Company recorded an excess facility charge of $1.8 million in the year ended December
31, 2002 comprising of $1.0 million of non-cancelable lease payments which were paid in
2003 and $0.6 million of future non-cancelable lease payments, which are expected to be
paid in 2004, and $0.2 million of fixed assets that were written-off. There was no excess
facility charge recorded in the year ended December 31, 2001.

Stock-Based
Compensation.Total stock-based compensation decreased from $7.1 million, or 34.6% of
revenues, in the year ended December 31, 2001 to $1.1 million, or 8.2% of revenues, in the
year ended December 31, 2002. This decrease was partially due to our accounting policy
which requires the amortization of a larger proportion of deferred compensation expense
during the early vesting periods of the option grants, and partially due to the reversal
of compensation expense for unvested stock options of employees whose employment was
terminated during the year ended December 31, 2002.

Interest
and Other Income, Net.Interest and other income, net, was $2.3 million and $1.1
million for the years ended December 31, 2001 and 2002, respectively. These amounts
consisted primarily of interest income, which fluctuated based on cash balances. The
decrease from 2001 to 2002 was due to a lower cash balance and lower interest rates.

Income
Taxes. Income taxes included expenses $0.2 million in the year ended December 31,
2001 and a benefit of $0.2 million in the year ended December 31, 2002. The income tax
expense in 2001 was primarily the result of non-cash compensation charges that are not
deductible for income tax purposes resulting in taxable income. The income tax benefit in
2002 was primarily due to a federal income tax refund.

15

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# Liquidity and Capital
Resources

Since
inception, we have financed our operations primarily through private sales of convertible
preferred stock and bank debt. Additionally, in November 2000, we completed our initial
public offering of common stock, raising $44.4 million, net of costs and expenses. As
of December 31, 2003, we had cash and cash equivalents of $5.0 million and
short-term investments of $30.9 million.

Net
cash used in operating activities was $11.1 million in 2001, $6.7 million in
2002, and $7.9 million in 2003. Net cash used in 2001 was primarily the result of our net
loss, which was partially offset by non-cash charges, and an increase in working capital
requirements caused by the expansion of our operations in anticipation of increased
revenues, which did not materialize. In 2002, our net loss of $18.3 million included
non-cash charges of $10.1 million, primarily related to non-cash compensation expenses of
$1.1 million, depreciation of $1.7 million, impairment write-off of property and equipment
of $1.0 million, an excess facility charge of $1.8 million, and an inventory provision of
$4.5 million. In 2003, our net loss of $8.5 million included non-cash charges of $2.0
million, primarily related to non-cash compensation expenses of $0.9 million and
depreciation of $1.1 million. Accounts receivable increased by $1.0 million and inventory
increased $0.8 million from 2002 to 2003 primarily due to an upturn in business in the
fourth quarter of 2003. Accrued expenses decreased $0.2 million offset by increase in
payables by $0.8 million. Net cash used in operating activities in 2003 totaled $7.9
million, $1.2 million more than cash used in 2002 in operating activities.

Cash
used in investing activities was $14.9 million in 2001. Cash generated by investing
activities was $1.0 million and $30,000 in 2002 and 2003, respectively. In 2001, $6.1
million was used for property and equipment and net $8.8 million was used to purchase
short-term securities. In 2002, we spent $0.8 million on property and equipment and we
received net $1.9 million from the sale of short-term securities. In 2003, we spent $0.3
million on property and equipment and we received net $0.3 million from the sale of short-term securities.

Cash
generated by financing activities was $0.5 million in 2001, $0.4 million in 2002 and
$1.1 million in 2003. Cash generated by financing activities in 2001, 2002 and 2003 was
comprised of proceeds from the exercise of options to purchase shares of our common stock,
common stock issued through our Employee Stock Purchase Plan, and repayment of notes
receivable.

We
entered into loan facilities in July 1999 and January 2000 with a financial institution
for a maximum of $0.8 million, which were drawn down during the course of fiscal years
1999 and 2000. We repaid these loans with a portion of the proceeds of our initial public
offering. These facilities were closed as of December 31, 2001. In July 2000, we arranged
an additional facility with the same financial institution in the form of a $0.6 million
letter of credit to secure a building lease. During 2001, the financial institution letter
of credit was replaced by a letter of credit issued by another financial institution for
the same amount. We pledged $0.6 million of our short-term investment as collateral for
the letter of credit.

In
July and December 2000, we entered into leases for 10,500 and 10,600 square feet of space,
respectively, near our existing facility in Sunnyvale, California. In September of 2002,
we consolidated our operations in California into two buildings and vacated the facility
with 10,600 square feet. As a result of the consolidation, we recorded an excess facility
charge of $1.6 million and wrote off fixed assets of $0.2 million in the year ended
December 31, 2002. We are currently in the process of evaluating our future facility
requirements in California, and we have begun lease negotiations on specific properties.
Additionally, in December 2000, the Company purchased approximately 8,200 square feet of
space immediately adjacent to our leased facility in Tu-Cheng City, Taiwan for $0.8
million. In April 2001 we entered into a lease in mainland China but cancelled it, without
penalty, in the third quarter of 2001. We had a lease for a facility near the Shenzhen
area totaling approximately 12,000 square feet which expired in December 2002. In August,
2002 we entered into a new lease for a 62,000 square foot facility near the same Shenzhen
area which will expire in July 2007. The future minimum lease payments under our operating
leases, excluding one building in Sunnyvale no longer used by the Company, are as follows
(in thousands):

| |                           |               
| | ------------------------- | --------------
| | Years ending December 31, |               
| | 2004                      | $          740
| | 2005                      | 66            
| | 2006                      | 55            
| | 2007                      | 32            
| | 2008                      | -             
| |                           |               
| | Total                     | $          893
| |                           |               

We
had no other significant commitments as of December 31, 2003.

16

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Our
principal source of liquidity as of December 31, 2003 consisted of $35.9 million in cash
and cash equivalents and interest bearing marketable securities.

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 potential
acquisitions, may require additional funding. If cash generated from operations is
insufficient to satisfy our long-term liquidity requirements, we may need to raise capital
through additional equity or debt financings or additional credit facilities. 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 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, which could harm our
business, financial condition and operating results.

# Supplementary Data
 Quarterly Results

The
following table contains selected unaudited quarterly results of operations data for each
of the eight quarters in the period ended December 31, 2003. We believe that the
historical quarterly information has been prepared substantially on the same basis as the
audited financial statements, and all necessary adjustments, consisting only of normal
recurring adjustments, have been included in the amounts below to present fairly the
unaudited quarterly results of operation data (in thousands, except per share data):

|                           | Three Months Ended
|-------------------------- | ------------------
|                           |                   
|                           | March 31, 2002    
|                           |                   
|Revenues                   |                   
|Gross profit (loss)        |                   
|Net loss attributable to   |                   
|common stockholders (1)    |                   
|Basic and diluted net loss |                   
|per share attributable to  |                   
|common stockholders(2)     |                   

|(1) |  | Net loss attributable to common stockholders in the quarters ended March 31,
               2002, June 30, 2002 and September 30, 2002 include charges for inventory
               provisions of $2.2 million, $0.8 million and $1.2 million, respectively. Net
               loss attributable to common stockholders in the quarter ended June 30, 2002
               includes charges for asset impairments of $1.0 million.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Net loss per share is computed independently for each quarter presented.
               Therefore, the aggregate of the quarterly per share information may not equal
               the annual net loss per share.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

17

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# FACTORS THAT MAY
AFFECT RESULTS

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

We
incurred net losses of approximately $26.2 million, $19.6 million and $9.2 million in
fiscal year 2001, 2002 and 2003, respectively, and expect that our net losses and negative
cash flows will continue for the foreseeable future. As of December 31, 2003, we had an
accumulated deficit of approximately $60.5 million.

Although
we continue to experience fluctuating demand for our products, we are hopeful that demand
for our products will increase in the future. If this happens, we expect to incur
significant and increasing expenses for expansion of our manufacturing operations,
research and development, sales and marketing, and administration, and in developing
direct sales and distribution channels. Given our early stage of development, our
potential need to increase our operating expenses, the rate at which competition in our
industry intensifies, and the significant 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 achieve and 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 achieve and sustain profitability on a quarterly or
an annual basis.

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, the
timing and extent of product sales, 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.

Our Optical Path Management
Solution (OPMS) products have historically represented a substantial portion of our
revenues, and if we are unsuccessful in commercially selling our DWDM-related products,
our business will be seriously harmed.

Sales
of our OPMS products accounted for over 79% of our revenues in the fiscal year ended
December 31, 2003 and substantially all of our historical revenues. We expect to
substantially depend on these products for our near-term revenues. Any significant decline
in the demand for these products, or failure to increase their market acceptance, would
seriously harm our business. Declining average selling prices of our products during 2003
have negatively impacted our revenues. We believe that our future growth and a significant
portion of our future revenues will depend on the commercial success of our DWDM-related
products, which we began shipping in July 2000. Demand for these products have fluctuated
over the past few years as demand declined sharply starting in mid fiscal 2001 and then
increased beginning in 2003. If demand does not continue to increase and our target
customers do not continue to adopt and purchase our DWDM-related products, our revenues
may decline and we may have to write-off additional inventory currently on our books.

We are experiencing a decrease in
market demand due to overcapacity in our industry and an economy that is stymied by
international terrorism, war and political instability.

Since
2001, the United States economy has experienced and continues to experience a significant
slowdown in consumption and demand. During the past few years, telecommunication companies
have 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 as the fiber optics industry
copes with the effects of oversupply of products, international terrorism, war and
political 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.

18

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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:

|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|o | customer unwillingness to implement our products;                                                                                                            
|  |                                                                                                                                                              
|o | any delays or  difficulties  that we may incur in completing  the  development  and  introduction  of our planned  products or
         product enhancements;
|  |                                                                                                                                                              
|o | the success of our customers;                                                                                                                                
|  |                                                                                                                                                              
|o | excess inventory in the telecommunications industry;                                                                                                         
|  |                                                                                                                                                              
|o | new product introductions by our competitors;                                                                                                                
|  |                                                                                                                                                              
|o | any failure of our products to perform as expected; or                                                                                                       
|  |                                                                                                                                                              
|o | any difficulty we may incur in meeting customers' delivery requirements or product specifications.                                                           

The
downturn in the economy has 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.

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,
DiCon Fiberoptics, Gould, JDS Uniphase, Lucent, Luminent (a subsidiary of MRV
Communications, Inc.), Oplink, Stratos Lightwave and Tyco Electronics. 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. In addition, our industry has recently experienced significant consolidation,
and we anticipate that further consolidation will occur. This consolidation has further
increased competition.

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 greater 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.

19

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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.

We
rapidly expanded our operations domestically and internationally in the final two quarters
of 2000. We had to carefully manage and re-evaluate this expansion given the sudden and
dramatic downturn in demand for our products experienced in 2001 and 2002. Additionally,
we implemented a reduction in force to reduce employees during the second, third and
fourth quarters of 2002 to match our operations to this decreased demand for our products.
As of December 31, 2003, we had a total of 79 full-time employees in Sunnyvale,
California, 168 full-time employees in Taiwan, and 140 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:

|  |                                                                                                                                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|o | improve existing and implement new operational, financial and management controls, reporting systems and procedures;                                            
|  |                                                                                                                                                                 
|o | hire,  train,  motivate and manage  additional  qualified  personnel,  especially if we  experience a significant  increase in
         demand for our products;
|  |                                                                                                                                                                 
|o | effectively expand or reduce our manufacturing capacity, attempting to adjust it to customer demand; and                                                        
|  |                                                                                                                                                                 
|o | 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 fluctuations in our growth 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. During the third quarter of 2002, we entered into a lease for
a new facility in China, which continues through July 2007. 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 training
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 $10.4 million, $7.3 million and $5.6 million for the fiscal years 2001, 2002
and 2003, respectively. We intend to continue to invest a substantial amount of funds,
comparable to our investment levels in 2003, in our research and product development
efforts, which 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.

20

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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 reduction in 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 continue to decline
and would adversely affect our revenues. Our customers have experienced an oversupply of
inventory due to lower demand for their products that has resulted in a decrease of orders
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.

Decreased
spending by telecommunication companies over the past three years has resulted in
decreased demand for some of 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 a decrease in demand for our
products, an increase in our inventory, and erosion in the average selling prices.

The
communications industry is experiencing rapid 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 and
reacts to the economic environment. 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.

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
have contributed to a decline in our gross margins and may continue to decline in the
future, 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.

21

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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. 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. All of our graded
index, or GRIN, lenses, which are incorporated into substantially all of our filter-based
DWDM products, are obtained from one supplier, Nippon Sheet Glass. Nippon Sheet Glass is
the only known supplier of GRIN lenses.

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. We recorded significant charges for excess and obsolete inventory in
the year ended December 31, 2002. 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. Either situation could cause our results of operations to be below the
expectations of investors and public market analysts, which could, in turn, cause the
price of our common stock to decline. 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 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, 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. 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.

22

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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 regularly, we must effectively
transfer production information from our product development department to our
manufacturing group and coordinate our efforts with those of 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 six 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.

23

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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:

|  |                                                               
|- | --------------------------------------------------------------
|o | loss of customers;                                            
|  |                                                               
|o | damage to our reputation;                                     
|  |                                                               
|o | failure to attract new customers or achieve market acceptance;
|  |                                                               
|o | diversion of development and engineering resources; and       
|  |                                                               
|o | legal actions by our customers.                               

The
occurrence of any one or more of the foregoing factors could cause our net loss to
increase.

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 emerging
market will depend on:

|  |                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------
|o | the education of potential end-user customers and network service providers about the benefits of optical networks; and
|  |                                                                                                                        
|o | 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, including our acquisition of the photonics
division of Ritek Corporation, 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.
For example, we recently acquired the photonics division of Ritek Corporation. 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 the photonics division of Ritek Corporation or of any other 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.

24

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If our common stock is not
relisted on the Nasdaq National 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
National Market to the Nasdaq SmallCap Market.  As a result, we may become subject to certain sections of the California General
Corporation Law that would affect our charter documents if our common stock is not returned to being listed on the Nasdaq National
Market.  For example, we would 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 would have
dissenting stockholder rights under both California and Delaware law.  Any of these changes would result in additional expense as
we would 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 SmallCap Market,
the price and liquidity of our common stock may decline.

Beginning at the commencement of trading on November 8, 2002, our common stock was listed on the Nasdaq SmallCap Market.  There
can be no assurance that we will be able to satisfy all of the quantitative maintenance criteria for continued listing on the
Nasdaq SmallCap Market including a continued minimum bid price of $1.00 per share.  If we fail to maintain continued listing on
the Nasdaq SmallCap 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, and the liquidity
of the trading market for our common stock.

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 policing unauthorized use of
our products is difficult 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.

25

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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 may in the future 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 years ended December 31, 2001, 2002 and 2003, sales to customers located outside of
North America were 17.8%, 9.6%, and 10.0% of our revenues, respectively. The percentage
decrease in sales to customers outside North America in the past year was mainly caused by
decreased sales to five customers outside of North America which was partially offset by
increased sales to one customer outside of North America. 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.

The outbreaks of Severe Acute
Respiratory Syndrome, or SARS, and of the Bird flu pose a risk to the Companys
business.

The
outbreaks of SARS and of the bird flu have developed into an international health concern,
especially in Asia. We have manufacturing facilities located in Taiwan and China. An
outbreak of SARS or the bird flu among our employees in Asia could disrupt our Asian
manufacturing operations for an extended period of time, which could limit our ability to
supply our products to our customers in sufficient quantities on a timely basis. A
shutdown of our Asian facilities due to fear of spread of infection or because of a
quarantine could result in our inability to supply our customers. If we are unable to
fulfill demand for our products, our relationships with our customers would be harmed and
our revenues could be impacted. We also rely on companies in Asia for many of the
components necessary to manufacture our products. If our suppliers experience a
significant disruption in their businesses as a result of SARS or the bird flu, we may not
be able to obtain the parts necessary to make our products which could negatively impact
our revenues. In addition, if any of our customers experiences a significant disruption in
their business as a result of SARS or the bird flu, they may delay or cancel purchases of
our products which could harm our business. Also, certain of our key employees travel to
Asia to oversee our Asian operations and to meet with our suppliers and customers. If any
of our key employees are infected with SARS or the bird flu on such a trip or if these
employees are quarantined when they return to the United States, our business could be
negatively impacted. These conditions and uncertainties make it difficult for us, our
suppliers and our customers to accurately forecast and plan future business activities.

26

---

Because our manufacturing
operations are located in active earthquake fault zones in California and 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.

Our
primary manufacturing operations are located in Sunnyvale, California and Tu-Cheng City,
Taiwan, both active earthquake fault zones. 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.

27

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# Item 7. Financial
Statements

# INDEX TO CONSOLIDATED
FINANCIAL STATEMENTS

| |                                                                                                                   | Page
| | ----------------------------------------------------------------------------------------------------------------- | ----
| | Consolidated Financial Statements                                                                                 |     
| | Report of Independent Auditors                                                                                    | 29  
| | Consolidated Balance Sheet as of December 31, 2002 and 2003                                                       | 30  
| | Consolidated Statements of Operations for each of the three years in the period ended December 31, 2003           | 31  
| | Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003           | 32  
| | Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2003 | 33  
| | Notes to Consolidated Financial Statements                                                                        | 34  
| | Financial Statement Schedules                                                                                     |     
| | Controls and Procedures                                                                                           | 46  

28

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# REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and
Stockholders of Alliance Fiber Optic Products, Inc.

In our opinion, the accompanying
consolidated balance sheets and the related consolidated statements of operations,
stockholders equity and cash flows present fairly, in all material respects, the
financial position of Alliance Fiber Optic Products, Inc. and its subsidiaries at December
31, 2003 and 2002, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2003 in conformity with accounting
principles generally accepted in the United States of America. These financial statements
are the responsibility of the Companys management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the United
States of America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant
estimates made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLPSan Jose, California
February 13, 2004

29

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# ALLIANCE FIBER OPTIC
PRODUCTS, INC.Consolidated Balance
Sheets(in thousands, except
share data)

|                                                               |              |     
|-------------------------------------------------------------- | ------------ | ----
|                                                               | December 31,
|                                                               | 2002         | 2003
|Assets                                                         |              |     
|Current assets:                                                |              |     
|Cash and cash equivalents                                      |              |     
|Short-term investments                                         |              |     
|Accounts receivable, net                                       |              |     
|Inventories, Net                                               |              |     
|Prepaid expense and other current assets                       |              |     
|                                                               |              |     
|                                                               |              |     
|Total current assets                                           |              |     
|Property and equipment, net                                    |              |     
|Other assets                                                   |              |     
|                                                               |              |     
|                                                               |              |     
|Total assets                                                   |              |     
|                                                               |              |     
|                                                               |              |     
|Liabilities and Stockholders' Equity                           |              |     
|Current liabilities:                                           |              |     
|Accounts payable                                               |              |     
|Income tax payable                                             |              |     
|Accrued expenses                                               |              |     
|Accrued excess facility charge - short term                    |              |     
|                                                               |              |     
|                                                               |              |     
|Total current liabilities                                      |              |     
|Long-term liabilities:                                         |              |     
|Accrued excess facility charge - long term                     |              |     
|Other long-term liabilities                                    |              |     
|                                                               |              |     
|                                                               |              |     
|Total liabilities                                              |              |     
|                                                               |              |     
|                                                               |              |     
|Commitments and contingencies (Note 9)                         |              |     
|Stockholders' equity                                           |              |     
|Common stock, $0.001 par value: 250,000,000 shares authorized; |              |     
|35,580,871 and 36,504,356 shares issued and outstanding at     |              |     
|December 31, 2002 and 2003, respectively                       |              |     
|Additional paid-in-capital                                     |              |     
|Receivables from stockholders                                  |              |     
|Deferred stock-based compensation                              |              |     
|Accumulated deficit                                            |              |     
|Accumulated other comprehensive loss                           |              |     
|                                                               |              |     
|                                                               |              |     
|Stockholders' equity                                           |              |     
|                                                               |              |     
|                                                               |              |     
|Total liabilities and stockholders' equity                     |              |     
|                                                               |              |     

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

30

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# ALLIANCE FIBER OPTIC
PRODUCTS, INC.Consolidated
Statements of Operations(in thousands, except
share data)

|                                             |                          |      |     
|-------------------------------------------- | ------------------------ | ---- | ----
|                                             | Years Ended December 31,
|                                             | 2001                     | 2002 | 2003
|Revenues                                     |                          |      | $   
|Cost of revenues                             |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Gross profit (loss)                          |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Operating expenses:                          |                          |     
|Research and development                     |                          |      |     
|Sales and marketing                          |                          |      |     
|General and administrative                   |                          |      |     
|Excess facility charges                      |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Total operating expenses                     |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Loss from operations                         |                          |      |     
|Interest and other income, net               |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Loss before income taxes                     |                          |      |     
|Income tax provision (benefit)               |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Net loss                                     |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Net loss per share:                          |                          |     
|Basic and diluted                            |                          |      | $   
|                                             |                          |      |     
|                                             |                          |      |     
|Shares used in computing net loss per share: |                          |     
|Basic and diluted                            |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Included in costs and expenses above:        |                          |     
|Stock based compensation charges             |                          |     
|Cost of revenue                              |                          |      | $   
|Research and development                     |                          |      |     
|Sales and marketing                          |                          |      |     
|General and administrative                   |                          |      |     
|                                             |                          |      |     
|                                             |                          |      |     
|Total                                        |                          |      | $   
|                                             |                          |      |     

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

31

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# ALLIANCE FIBER OPTIC
PRODUCTS, INC.Consolidated
Statements of Cash Flows(in
thousands)

|For the following years ended December 31                    | 2001 |  | 2002 |         | 2003 |  
|------------------------------------------------------------ | ---- |  | ---- | ------- | ---- | -
|Cash flows from operating activities:                        |      |  |      |         |      |  
|Net loss                                                     |      |  | $    | (24,133 | )    | $
|Adjustments to reconcile net loss to net cash used           |      | 
|in operating activities:                                     |      | 
|Depreciation                                                 |      |  |      | 2,109   |      |  
|Amortization of stock based compensation                     |      |  |      | 7,057   |      |  
|Impairment in property and equipment                         |      |  |      | 5,200   |      |  
|Provision for accounts receivable                            |      |  |      | --      |      |  
|Provision for inventory                                      |      |  |      | 6,543   |      |  
|Excess facility charge                                       |      |  |      | --      |      |  
|Interest income receivable                                   |      |  |      | --      |      |  
|Changes in assets and liabilities:                           |      | 
|Accounts receivable                                          |      |  |      | 2,648   |      |  
|Inventories                                                  |      |  |      | (7,213  | )    |  
|Prepaid expenses and other assets                            |      |  |      | (709    | )    |  
|Accounts payable                                             |      |  |      | (1,818  | )    |  
|Income tax payable                                           |      |  |      | (248    | )    |  
|Accrued expenses                                             |      |  |      | (552    | )    |  
|Other long-term liabilities                                  |      |  |      | 10      |      |  
|Minority interest                                            |      |  |      | (9      | )    |  
|                                                             |      |  |      |         |      |  
|Net cash used in operating activities                        |      |  |      | (11,115 | )    |  
|                                                             |      |  |      |         |      |  
|Cash flows from investing activities:                        |      | 
|Purchase of short-term investments                           |      |  |      | (70,938 | )    |  
|Proceeds from sales and maturities of short-term investments |      |  |      | 62,106  |      |  
|Purchase of property and equipment                           |      |  |      | (6,100  | )    |  
|                                                             |      |  |      |         |      |  
|Net cash used in investing activities                        |      |  |      | (14,932 | )    |  
|                                                             |      |  |      |         |      |  
|                                                             |      |  |     
|Cash flows from financing activities:                        |      | 
|Proceeds from issuance of common stock under ESPP            |      |  |      | 342     |      |  
|Proceeds from the exercise of common stock options           |      |  |      | 123     |      |  
|Proceeds from repayment of notes receivable                  |      |  |      | 2       |      |  
|                                                             |      |  |      |         |      |  
|                                                             |      |  |     
|Net cash provided by financing activities                    |      |  |      | 467     |      |  
|                                                             |      |  |      |         |      |  
|                                                             |      |  |     
|Effect of exchange rate changes on cash and cash equivalents |      |  |      | (21     | )    |  
|                                                             |      |  |      |         |      |  
|                                                             |      |  |     
|Net increase (decrease) in cash and cash equivalents         |      |  |      | (25,601 | )    |  
|Cash and cash equivalents at beginning of year               |      |  |      | 42,548  |      |  
|                                                             |      |  |      |         |      |  
|                                                             |      |  |     
|Cash and cash equivalents at end of year                     |      |  | $    | 16,947  |      | $
|                                                             |      |  |      |         |      |  

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

32

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# ALLIANCE FIBER OPTIC
PRODUCTS, INC.Consolidated
Statements of Stockholders Equity(in
thousands)

|                                     | Common StockShares          Amount | AdditionalPaid-inCapital | ReceivablesFromStockholders | DeferredStock-basedCompensation | AccumulatedDeficit | AccumulatedOtherComprehensiveLoss | Total | ComprehensiveIncome/(Loss)
|------------------------------------ | ---------------------------------- | ------------------------ | --------------------------- | ------------------------------- | ------------------ | --------------------------------- | ----- | --------------------------
|Balance at December 31, 2000         |                                    |                          |                             | 34,644                          |                    | $                                 | 35    |                           
|Issuance of Common Stock             |                                    |                         
|upon exercise of options             |                                    |                          |                             | 782                             |                    |                                   | --    |                           
|Issuance of Common Stock upon        |                                    |                         
|purchase of ESPP                     |                                    |                          |                             | 182                             |                    |                                   | --    |                           
|Interest of notes receivable         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Repayment of notes receivable        |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Stock repurchased                    |                                    |                          |                             | (199                            | )                  |                                   | --    |                           
|Deferred stock-based compensation    |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Amortization of deferred stock-based |                                    |                         
|compensation                         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Comprehensive Loss:                  |                                    |                         
|Net loss for the year                |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Unrealized loss on short-term        |                                    |                         
|investments                          |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Currency translation adjustments     |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Comprehensive Loss                   |                                    | $                        | (24,073                     | )                              
|                                     |                                    |                          |                             |                                 |                    |                                   |       |                           
|Balance at December 31, 2001         |                                    |                          |                             | 34,644                          |                    | $                                 | 35    |                           
|Issuance of Common Stock             |                                    |                         
|upon exercise of options             |                                    |                          |                             | 80                              |                    |                                   | --    |                           
|Issuance of Common Stock upon        |                                    |                         
|purchase of ESPP                     |                                    |                          |                             | 254                             |                    |                                   | --    |                           
|Interest of notes receivable         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Repayment of notes receivable        |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Stock repurchased                    |                                    |                          |                             | (163                            | )                  |                                   | --    |                           
|Deferred stock-based compensation    |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Amortization of deferred stock-based |                                    |                         
|compensation                         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Comprehensive Loss:                  |                                    |                         
|Net loss for the year                |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Unrealized loss on short-term        |                                    |                         
|investments                          |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Currency translation adjustments     |                                    |                          |                             | --                              |                    |                                   | --    |                           
|                                     |                                    |                          |                             |                                 |                    |                                   |       |                           
|Comprehensive Loss                   |                                    | $                        | (18,239                     | )                              
|                                     |                                    |                          |                             |                                 |                    |                                   |       |                           
|Balance at December 31, 2002         |                                    |                          |                             | 35,580                          |                    | $                                 | 35    |                           
|Issuance of Common Stock             |                                    |                         
|upon exercise of options             |                                    |                          |                             | 218                             |                    |                                   | --    |                           
|Issuance of Common Stock upon        |                                    |                         
|purchase of ESPP                     |                                    |                          |                             | 706                             |                    |                                   | 1     |                           
|Interest of notes receivable         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Repayment of notes receivable        |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Deferred stock-based compensation    |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Amortization of deferred stock-based |                                    |                         
|compensation                         |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Comprehensive Loss:                  |                                    |                         
|Net loss for the year                |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Unrealized loss on short-term        |                                    |                         
|investments                          |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Currency translation adjustments     |                                    |                          |                             | --                              |                    |                                   | --    |                           
|Comprehensive Loss                   |                                    | $                        | (8,584                      | )                              
|                                     |                                    |                          |                             |                                 |                    |                                   |       |                           
|Balance at December 31, 2003         |                                    |                          |                             | 36,504                          |                    | $                                 | 36    |                           

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

33

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# Notes to Consolidated
Financial Statements

# 1. The Company and
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.

# Use of estimates

The
preparation of financial statements in accordance with generally accepted accounting
principles in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates.

# Basis of presentation

The
Consolidated Financial Statements include the accounts of the Company and its
subsidiaries. All material intercompany accounts and transactions have been eliminated in
consolidation.

# Foreign currency
translation

The
Companys operations in foreign subsidiaries use the local currency as their
functional currency. All assets and liabilities of the subsidiaries are translated at
rates of exchange on the balance sheet date. Revenues and expenses are translated at the
average rate of exchange for the period. Gains and losses resulting from foreign currency
translation are recorded as a separate component of other comprehensive income (loss) in
stockholders equity. Foreign currency transaction gains and losses are recorded in
interest and other income and have not been material.

# Cash, cash equivalents
and marketable securities

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. Investments include high-grade corporate debt obligations
that have maturities greater than three months but less than one year. As of December 31,
2002 and 2003, all investments are classified as short-term investments. Short-term
investments are classified as available-for-sale and are reported at fair value, with
unrealized gains and losses recorded in stockholders equity as a component of other
comprehensive income/loss. Realized gains and losses on sales of all investments are
reported in results of operations and computed using the specific identification method.

The
Companys financial instruments also include accounts receivable, accounts payable
and debts, and are carried at cost, which approximates their fair value because of the
short-term maturity of these instruments.

34

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# Inventories

Inventories
are stated at the lower of cost or market, with cost being determined on a first-in,
first-out basis. Provisions are made for excess and obsolete inventory based on historical
usage and managements estimates of future demand.

# Property and equipment

Property
and equipment are stated at cost less accumulated depreciation and impairment charges.
Depreciation is computed using the straight-line method using estimated useful lives of
two to five years for machinery and equipment and five years for furniture and fixtures.
Amortization of leasehold improvements is computed using the straight-line method over the
shorter of the estimated life of the assets, generally two to four years, or the lease
term.

# Impairment of long-lived
assets

The
Company reviews long-lived assets for impairment whenever events or changes in
circumstances indicate the carrying amount of the assets may not be fully recoverable.
When such an event occurs, the Company estimates the future cash flows expected to result
from the use of the asset and its eventual disposition. If the undiscounted expected
future cash flows are less than the carrying amount of the asset, an impairment loss is
recognized to the extent the carrying amount of such assets exceeds its fair value, which
is determined based on discounted cash flows or appraised value, depending on the nature
of the asset.

# 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, title has passed and
collection of the resulting receivable is probable. Subsequent to the sale of its
products, the Company has no obligation to provide any modification or customization
upgrades, enhancements or postcontract 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 could be material which are
recorded against revenue in the period.

# Research and development
expenses

Research
and development costs are expensed as incurred.

# Advertising expenses

Advertising
costs are expensed as incurred and have not been material.

# Income taxes

The
Company accounts for deferred income taxes under the liability approach whereby the
expected future tax consequences of temporary differences between the book and tax basis
of assets and liabilities are recognized as deferred tax assets and liabilities. A
valuation allowance is established for any deferred tax assets for which realization is
uncertain. The Company does not record a deferred tax provision on unremitted earnings of
its subsidiaries to the extent that such earnings are considered permanently invested.

35

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# Stock-based compensation

The
Company accounts for stock-based compensation arrangements in accordance with the
provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and Financial Accounting Standards
Board (FASB) issued Interpretations (FIN) No. 44 Accounting
for Certain Transactions Involving Stock Compensation  An Interpretation of APB No.
25. Under APB Opinion No. 25 and FIN No. 44, compensation cost is, in general,
recognized based on the excess, if any, of the fair market value of the Companys
stock on the date of grant over the amount an employee must pay to acquire the stock. In
addition, the Company complies with the disclosure provisions of SFAS No. 123,
Accounting for Stock-Based Compensation and SFAS No. 148, Accounting for
Stock-Based Compensation, Transition and Disclosure. Equity instruments issued to
non-employees are accounted for in accordance with the provisions of SFAS No. 123,
SFAS 148 and Emerging Issues Task Force (EITF) Issue No. 96-18, which require
the award to be recorded at its fair value.

# Pro Forma Disclosure
Under SFAS No. 123

Pro
forma information regarding net loss and net loss per share is required by SFAS
No. 123, which also requires that the information be determined as if the Company had
accounted for its stock based awards under the fair value method. The fair value of these
stock based awards was estimated using the Black-Scholes model. The Company calculated the
fair value of each stock based award on the date of grant using the Black-Scholes model,
as prescribed by SFAS No. 123, using the following assumptions:

|     | Options      | ESPP        
|---- | ------------ | ------------
|     | InterestRate | Term        
|2003 |              | 1.91 - 2.77%
|2002 |              | 2.40 - 3.73%
|2001 |              | 3.91 - 4.86%

The
weighted average fair value on the grant date of options in the years ended
December 31, 2001, 2002 and 2003 was $0.82, $0.39, and $0.65 respectively. The
weighted average fair value of the employee stock purchase rights granted under the 2000
ESPP plan during 2001 and 2002 was $2.06 and $0.28, respectively. No employee stock
purchase rights were granted in 2000.

36

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

Had
compensation cost been determined based upon the fair value on the grant date, consistent
with the methodology prescribed under SFAS No. 123, the Companys pro forma net
loss and pro forma basic and diluted net loss per share under SFAS No. 123 would have
been as follows (in thousands, except per share data):

|                                                        | Years Ended December 31,
|------------------------------------------------------- | ------------------------
|                                                        | 2001                    
|Net loss, as reported:                                  |                         
|Add: Stock-based employee compensation expense included |                         
|in reported net income                                  |                         
|Deduct: Total stock-based employee compensation expense |                         
|determined under fair value based method for all awards |                         
|                                                        |                         
|Pro forma net loss:                                     |                         
|                                                        |                         
|Net loss per share basic and diluted:                   |                         
|As reported                                             |                         
|Pro forma                                               |                         

# Net loss per share

Basic
net loss per share is computed by dividing net loss for the period by the weighted average
number of shares of common stock outstanding during the period. Diluted net loss per share
is computed by dividing the net loss for the period by the weighted average number of
common shares outstanding during the period. The calculation of diluted net loss per share
excludes potential common shares if the effect is anti-dilutive.

# Comprehensive income
(loss)

Comprehensive
income (loss) is defined as the change in equity of a company from transactions and other
events and circumstances excluding transactions resulting from investments from owners and
distributions to owners. Comprehensive income (loss) is disclosed in the consolidated
statements of stockholders equity.

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# 2.    
          Balance Sheet Components (in thousands)

|                                                        | December 31,
|------------------------------------------------------- | ------------
|                                                        | 2002        
|Cash and cash equivalents:                              |             
|Cash                                                    |             
|Municipal bonds                                         |             
|Money Market instruments and funds                      |             
|                                                        |             
|                                                        |             
|                                                        |             
|                                                        |             
|Accounts receivable, net:                               |             
|Accounts receivable                                     |             
|Less: Allowance for doubtful accounts and sales returns |             
|                                                        |             
|                                                        |             
|                                                        |             
|                                                        |             
|Allowance for doubtful accounts and sales returns:      |             
|Balance at beginning of year                            |             
|Addition                                                |             
|Utilized                                                |             
|                                                        |             
|Balance at end of year                                  |             
|                                                        |             
|                                                        |             
|Inventories:                                            |             
|Finished goods                                          |             
|Work-in-process                                         |             
|Raw materials                                           |             
|                                                        |             
|                                                        |             
|                                                        |             
|Property and equipment, net:                            |             
|Machinery and equipment                                 |             
|Furniture and fixtures                                  |             
|Leasehold improvements                                  |             
|Building and equipment prepayments                      |             
|                                                        |             
|                                                        |             
|Less: Accumulated depreciation                          |             
|                                                        |             
|                                                        |             
|                                                        |             
|Accrued expenses:                                       |             
|Accrued compensation costs                              |             
|Accrued professional fees                               |             
|Other accruals                                          |             
|                                                        |             
|                                                        |             
|                                                        |             
|Accumulated other comprehensive loss:                   |             
|Cumulative translation adjustments                      |             
|Unrealized gain (loss) on short-term investments        |             
|                                                        |             
|                                                        |             
|                                                        |             

38

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# 3. Short-term Investments

|                           | December 31, 2003      | 
|-------------------------- | ---------------------- | 
|                           | PurchaseAmortized Cost | 
|Corporate Debt Obligations |                        | 
|Municipal Bonds            |                        | 
|Government Agencies        |                        | 
|                           |                        | 
|                           |                        | 
|                           |                        | 

|                           | December 31, 2002      | 
|-------------------------- | ---------------------- | 
|                           | PurchaseAmortized Cost | 
|Corporate Debt Obligations |                        | 
|Municipal Bonds            |                        | 
|Government Agencies        |                        | 
|                           |                        | 
|                           |                        | 
|                           |                        | 

Approximately
$0.6 million of the short term investments above are pledged as collateral for a stand-by
letter of credit issued by a commercial bank.

# 4. Impairment of
Property and Equipment

Certain
of the Companys equipment and machinery located in Taiwan for the production of its
fused fiber products were determined to be non-functional or damaged. Accordingly, the
Company wrote off $1.0 million in the year ended December 31, 2002 for this equipment and
machinery.

As
a result of the business decline and reduced headcount in the United States, the Company
consolidated its operations in the United States from three buildings to two buildings in
Sunnyvale, California. As a consequence, the Company recorded excess facility charges of
$1.8 million during 2002, comprised of $1.6 million of non-cancelable lease payments and
$0.2 million of fixed assets written-off. Cash payments in 2003 amounted to $1.0 million
and $0.6 million remains on the consolidated balance sheet in accrued facility charges at
December 31, 2003 which is expected to be fully paid in 2004.

# 5. Income Taxes

The components of loss before income
taxes are as follows (in thousands):

|                                                   | Years Ended December 31, | 
|-------------------------------------------------- | ------------------------ | 
|                                                   | 2001                     | 
|Loss subject to domestic income taxes only         |                          | 
|Income (loss) subject to foreign income taxes only |                          | 
|                                                   |                          | 
|                                                   |                          | 
|                                                   |                          | 

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

The income tax provision (benefit) is
composed of the following (in thousands):

|                          | Years Ended December 31, | 
|------------------------- | ------------------------ | 
|                          | 2001                     | 
|Current                   |                          | 
|Federal                   |                          | 
|State                     |                          | 
|Foreign                   |                          | 
|                          |                          | 
|                          |                          | 
|Deferred                  |                          | 
|                          |                          | 
|Total provision (benefit) |                          | 
|                          |                          | 

The following is a reconciliation of
the effective tax rates and the United States statutory federal income tax rate

|                                  | Years Ended December 31, | 
|--------------------------------- | ------------------------ | 
|                                  | 2001                     | 
|Statutory federal income tax rate |                          | 
|State income tax                  |                          | 
|Foreign taxes                     |                          | 
|Stock compensation                |                          | 
|Research and development credits  |                          | 
|Valuation allowance               |                          | 
|Other                             |                          | 
|                                  |                          | 
|Effective tax rate                |                          | 
|                                  |                          | 

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

Deferred tax assets consisted of the
following (in thousands):

|                                 | Years Ended December 31, | 
|-------------------------------- | ------------------------ | 
|                                 | 2001                     | 
|Deferred tax assets:             |                          | 
|Net operating loss carryforwards |                          | 
|Credit carryforwards             |                          | 
|Depreciation                     |                          | 
|Accruals and allowances          |                          | 
|                                 |                          | 
|                                 |                          | 
|Less: valuation allowances       |                          | 
|                                 |                          | 
|Net deferred tax assets          |                          | 
|                                 |                          | 

|                                             | Years Ended December 31, | 
|-------------------------------------------- | ------------------------ | 
|                                             | 2001                     | 
|Valuation allowances on deferred tax assets: |                          | 
|Balance at beginning of year                 |                          | 
|Addition                                     |                          | 
|Utilized                                     |                          | 
|                                             |                          | 
|Balance at end of year                       |                          | 
|                                             |                          | 

Based
upon the weight of available evidence, which includes the Companys historical
operating performance, lack of taxable income and the accumulated deficit, the Company
provided a full valuation allowance against the net deferred tax assets.

As
of December 31, 2003, the Company had net operating losses carryforward of
approximately $32.8 million for federal and $14.9 million for state tax purposes. If not
utilized, these carryforwards will begin to expire in 2021 for federal and in 2011 for
state purposes.

As
of December 31, 2003, the Company had research credit carryforwards of approximately $1.0
million and $0.8 million for federal and state income tax purposes, respectively. If not
utilized, the federal carryforward will expire in various amounts beginning in 2021. The
California tax credit can be carried forward indefinitely.

Internal
Revenue Code Section 382 limits the use of net operating loss and tax credit carryforwards
in certain situations where changes occur in the stock ownership of a company. In the
event the Company has had a change in ownership, utilization of the carryforwards could be
restricted.

41

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# 6. Net Loss Per Share

The
following table sets forth the computation of basic and diluted net loss per share for the
years indicated (in thousands, except per share amounts):

|                                                             | Years Ended December 31, | 
|------------------------------------------------------------ | ------------------------ | 
|                                                             | 2001                     | 
|Numerator:                                                   |                          | 
|Net loss attributable to common stockholders                 |                          | 
|                                                             |                          | 
|                                                             |                          | 
|Denominator:                                                 |                          | 
|Shares used in computing net loss per share:                 |                          | 
|Weighted average of common shares outstanding                |                          | 
|Less: Weighted average of shares subject to repurchase right |                          | 
|                                                             |                          | 
|Basic and diluted                                            |                          | 
|                                                             |                          | 
|                                                             |                          | 
|Net loss per share attributable to common stockholders:      |                          | 
|Basic and diluted                                            |                          | 
|                                                             |                          | 

The
following outstanding options were excluded from the computation of diluted net loss per
share (in thousands) as the effect would have been anti-dilutive:

|                                            | Years Ended December 31,
|------------------------------------------- | ------------------------
|                                            | 2001                    
|Options to purchase common stock and shares |                         
|subject to repurchase                       | 5,398                   
|                                            |                         
|                                            |                         
|                                            | 5,398                   
|                                            |                         

# 7. Stock-based
Compensation Plans

# 1997 Stock Option Plan

In
May 1997, the Company adopted its 1997 Stock Plan under which 3,000,000 shares of common
stock were reserved for issuance to eligible employees, directors and consultants upon
exercise of stock options and stock purchase rights. During the year ended
December 31, 2000, an additional 5,200,000 shares were reserved for issuance under
the 1997 Stock Plan. Incentive stock options are granted at a price not less than 100% of
the fair market value of the Companys common stock and at a price of not less than
110% of the fair market value for grants to any person who owned more than 10% of the
voting power of all classes of stock on the date of grant. Nonstatutory stock options are
granted at a price not less than 85% of the fair market value of the common stock and at a
price not less than 110% of the fair market value for grants to a person who owned more
than 10% of the voting power of all classes of stock on the date of the grant. Options
granted under the 1997 Stock Plan generally vest over four years and are exercisable for
not more than ten years (five years for grants to any person who owned more than 10% of
the voting power of all classes of stock on the date of the grant). In November 2000, the
1997 Stock Plan was replaced by the 2000 Stock Incentive Plan and all shares available for
grant under the 1997 Stock Plan were transferred to the 2000 Stock Incentive Plan.

42

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# 2000 Stock Incentive Plan

In
November 2000, the Company adopted its 2000 Stock Incentive Plan under which 1,500,000
shares of common stock were reserved for issuance to eligible employees, directors and
consultants upon exercise of stock options and stock purchase rights. In addition,
1,397,867 shares available for grant under the 1997 Stock Plan at the time of its
termination were transferred to and became reserved for issuance under the 2000 Stock
Incentive Plan. On January 1 of each year, beginning on January 1, 2001, the number
of shares available for grant will automatically increase by the lesser of:
(i) 1,700,000 shares; (ii) 5% of the fully diluted outstanding shares of stock
on that date; or (iii) a lesser amount as may be determined by the Board of
Directors. Incentive stock options are granted at a price not less than 100% of the fair
market value of the Companys common stock and at a price of not less than 110% of
the fair market value for grants to any person who owned more than 10% of the voting power
of all classes of stock on the date of grant. Nonstatutory stock options are granted at a
price not less than 85% of the fair market value of the common stock and at a price not
less than 110% of the fair market value for grants to a person who owned more than 10% of
the voting power of all classes of stock on the date of the grant. Options granted under
the 2000 Stock Incentive Plan generally vest over four years and are exercisable for not
more than ten years (five years for grants to any person who owned more than 10% of the
voting power of all classes of stock on the date of the grant).

The following table summarizes option
activity under the Plans:

|                             |                    | Options Outstanding |                 | Weighted
Average |              
|---------------------------- | ------------------ | ------------------- | --------------- | ---------------- | -------------
|                             | Availablefor Grant |                     | Number ofShares |                  | ExercisePrice
|Balance at December 31, 2000 |                    |                     |                 | 2,718,867        |              
|                             |                    |                     |                 |                 
|Addition of the 2000 Plan    |                    |                     |                 | 1,459,333        |              
|Granted                      |                    |                     |                 | (1,922,300       | )            
|Canceled                     |                    |                     |                 | 104,150          |              
|Exercised                    |                    |                     |                 | --               |              
|Balance at December 31, 2001 |                    |                     |                 | 2,360,050        |              
|                             |                    |                     |                 |                 
|Addition of the 2000 Plan    |                    |                     |                 | --               |              
|Granted                      |                    |                     |                 | (632,900         | )            
|Canceled                     |                    |                     |                 | 733,350          |              
|Exercised                    |                    |                     |                 | --               |              
|Balance at December 31, 2002 |                    |                     |                 | 2,460,500        |              
|                             |                    |                     |                 |                 
|Addition of the 2000 Plan    |                    |                     |                 | 1,700,000        |              
|Granted                      |                    |                     |                 | (1,356,300       | )            
|Canceled                     |                    |                     |                 | 290,850          |              
|Exercised                    |                    |                     |                 | --               |              
|Balance at December 31, 2003 |                    |                     |                 | 3,095,050        |              

43

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

Information relating to stock options outstanding
at December 31, 2003 is as follows:

|Options Outstanding |             | Options Exercisable | 
|------------------- | ----------- | ------------------- | 
|ExercisePrice       |             | NumberOutstanding   | 
|$                   | 0.05        |                     | 
|$                   | 0.20        |                     | 
|$                   | 0.42 $0.63 |                     | 
|$                   | 0.70 $1.00 |                     | 
|$                   | 1.56 $2.50 |                     | 
|$                   | 4.00 $5.75 |                     | 
|$                   | 6.38        |                     | 
|                    |             |                     | 

# Receivables from
Stockholders

On
various dates during the year ended December 31, 2000, 2,935,000 options were exercised
prior to being vested by certain officers of the Company for a total of $1.95 million in
notes payable to the Company. These exercised shares are subject to rights of repurchase
by the Company until such shares are vested. The notes are full recourse, have a four-year
term, and bear interest ranging from 6.5% to 7.0% per annum. The number of shares of
common stock subject to repurchase was 570,833 and 170,833 as of December 31, 2002 and
2003, respectively.

# Employee Stock Purchase
Plan

In
November 2000, the Company adopted its 2000 Employee Stock Purchase Plan (the
Plan). The Company reserved 1,500,000 shares of common stock for issuance
under the Plan. On the first day of January each year beginning January 1, 2001,
additional shares of common stock are reserved for issuance under the Plan as determined
by the Board of Directors. The plan limits the annual increase to the lesser of 1% of the
Companys issued and outstanding common stock or 1,000,000 shares. The Plan provides
eligible employees with the opportunity to acquire shares of common stock at a price of
85% of the lower of the fair market value of the common stock on the first day of the
offering period or the last day of the offering period, whichever is lower. The Plan is
structured as a qualified employee stock purchase plan under Section 423 of the amended
Internal Revenue Code of 1986. However, the Plan is not intended to be a qualified
pension, profit sharing or stock bonus plan under Section 401(a) of the 1986 Code and is
not subject to the provisions of the Employee Retirement Security Act of 1974. The Board
may amend, suspend, or terminate the Plan at any time without notice. A total of 253,647
and 705,185 shares were purchased under the Plan in 2002 and 2003, respectively.

# Stock-based Compensation
under APB Opinion No. 25

During
the years ended December 31, 2001, 2002 and 2003, the Company recorded stock base
compensation expense of $7.0 million, $1.1 million and $0.9 million respectively. This
compensation expense represents the difference between the exercise price of common stock
options and the deemed fair value for financial statement reporting purposes of the
Companys common stock on the option grant date. Deferred compensation is being
amortized using the graded vesting method, in accordance with FIN No. 28, over the
vesting period of each respective option, generally four years. Under the graded vesting
method, each option grant is separated into portions based on its vesting terms, which
results in acceleration of amortization expense for the overall award. The accelerated
amortization pattern results in expensing approximately 52% of the total award in year
one, 27% in year two, 15% in year three and 6% in year four.

44

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# SFAS No. 123
Compensation to Consultants

In
the years ended December 31, 2001, 2002 and 2003, the Company granted options to
purchase common stock of 29,000, 10,000, and 0 shares, respectively, to consultants and an
advisor. The weighted average exercise prices were approximately $3.83 and $0.40 for the
years ended December 31, 2001 and 2002 respectively. These options vest over periods of
one to four years. The Company is required to record the change in the fair value of these
options at each reporting date prior to vesting and then finally at the vesting date of
the option. Deferred stock-based compensation in accordance with SFAS No. 123 and
EITF Issue No. 96-18 related to these options totaled $0.8 million and $0.0 million at
December 31, 2001 and 2002 respectively. Amortization of the deferred stock-based
compensation balance amounted to $0.0 million and $0.2 million for the years ended
December 31, 2001 and 2002, respectively.

# 8. Concentrations of
Certain Risks

Financial
instruments that potentially subject the Company to significant concentrations of credit
risk consist primarily of cash, cash equivalents, short-term investments and accounts
receivable. The Company limits the amount of deposits in any one financial institution and
any one financial instrument. The Company invests its excess cash principally in
certificates of deposit, debt instruments issued by high-credit quality financial
institutions and corporations and money market accounts with financial institutions in the
United States.

The
Company performs ongoing credit evaluations of its customers financial condition,
and limits the amount of credit extended when deemed necessary, but generally does not
require collateral.

At
December 31, 2002, one customer accounted for 10% of the Companys accounts
receivable. At December 31, 2003, two customers accounted for 14% and 13% of the
Companys accounts receivable, respectively.

For
the years ended December 31, 2001 and 2002, no individual customer accounted for 10%
or more of the Companys revenues. For the year ended December 31, 2003, one
individual customer accounted for 10% or more of the Companys revenues.

Certain
components used in manufacturing the Companys products have relatively few
alternative sources of supply, and establishing additional or replacement suppliers for
such components cannot be accomplished quickly.

45

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# 9. Commitments and
Contingencies

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.

The
Company leases certain office space under long-term operating leases expiring at various
dates through 2007. Total lease expenses under these operating leases were approximately
$2.1 million, $1.8 million, and $1.2 million for the years ended December 31, 2001,
2002 and 2003, respectively.

Total
future minimum lease payments under operating leases as of December 31, 2003, which
exclude one building in Sunnyvale no longer used by the Company, for the years ending
December 31, are summarized below (in thousands):

| |                           |               
| | ------------------------- | --------------
| | Years ending December 31, |               
| | 2004                      | $          740
| | 2005                      | 66            
| | 2006                      | 55            
| | 2007                      | 32            
| | 2008                      | -             
| |                           |               
| | Total                     | $          893
| |                           |               

The
Company had no other significant commitments as of December 31, 2003.

# 10. Subsequent Events

In
January 2004, we completed the purchase of Taiwan-based Ritek Corporations photonic
business. Under the terms of the agreement, AFOP acquired substantially all of the assets
of Riteks photonics business in exchange for 1.7 million shares of AFOP common
stock for total consideration of $4.1 million. Additionally AFOP received $1.5 million in cash from Ritek. Riteks photonics
business is located in Hsin Chu Industrial Park, Taiwan, and we may continue to operate
the business at this facility rent-free for two years after the closing.

46

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# ALLIANCE FIBER OPTIC PRODUCTS,
INC.

# Item 8. Changes In and
Disagreements With Accountants on Accounting and Financial Disclosure

None.

# Item
8A. 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
          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, and management believes that they 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 Annual Report on Form
10-KSB, our Chief Executive Officer and Chief Financial Officer have concluded that,
subject to the limitations noted above, 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 Annual Report on Form 10-KSB 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 8A(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.

47

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# PART III

Item 9. Directors, Executive
Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act

The
information required by this item (with respect to Directors) is incorporated by reference
from the information under the caption Election of Directors contained in the
Companys Proxy Statement to be filed with the Securities and Exchange Commission in
connection with the solicitation of proxies for the Companys 2004 Annual Meeting of
Stockholders to be held on May 14, 2004 (the Proxy Statement). Certain
information required by this item concerning executive officers is set forth in Part I of
this Report under the caption Executive Officers of the Registrant.

Item 405
of Regulation S-B calls for disclosure of any known late filing or failure by an
insider to file a report required by Section 16(a) of the Exchange Act. This
disclosure is contained in the section entitled Section 16(a) Beneficial
Ownership Reporting Compliance in the Proxy Statement and is incorporated herein by
reference.

The
Company has a separately designated standing Audit Committee established in accordance
with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are James
C. Yeh (Chairperson), Richard Black and Ray Sun, all of whom meet the independence
standards established by The Nasdaq Stock Market for serving on an audit committee. The
Board of Directors has determined that each of James Yeh, Richard Black and Ray Sun is an
audit committee financial expert as defined SEC regulations.

The
Companys Board of Directors adopted a Code of Ethics for all of its directors and
officers on March 22, 2004. The Companys Code of Ethics is available on the
Companys website at http://www.afop.com.To date, there have been no waivers
under the companys Code of Ethics. The Company will post any waivers, if and when
granted, under its Code of Ethics on the Companys website at http://www.afop.com.

# Item 10. Executive
Compensation

The
information required by this item is incorporated by reference from the information under
the captions Election of Directors  Director Compensation,
Executive Compensation, and Election of Directors  Compensation
Committee Interlocks and Insider Participation contained in the Proxy Statement.

# Item 11. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The
information required by this item is incorporated by reference from the information under
the caption Security Ownership of Certain Beneficial Owners and Management
contained in the Proxy Statement.

48

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# Equity Compensation Plan
Information

Set
forth in the table below is certain information regarding the Companys equity
compensation plans as of December 31, 2003:

|                              |                                                                                                              | 
|----------------------------- | ------------------------------------------------------------------------------------------------------------ | 
|Plan category                 | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and rights                  (a) | 
|Equity compensation plans     |                                                                                                              | 
|approved by security holders  |                                                                                                              | 
|Equity compensation plans not |                                                                                                              | 
|approved by security holders  |                                                                                                              | 
|                              |                                                                                                              | 
|Total                         |                                                                                                              | 
|                              |                                                                                                              | 

(1)    
          Includes shares to be issued upon exercise of outstanding options granted under
          the 1997 Stock Plan and the 2000 Stock Incentive Plan. Options to purchase
          shares of the Companys Common Stock are no longer granted under the 1997
          Stock Plan.

(2)    
          Includes the number of shares reserved for issuance under the Companys
          2000 Stock Incentive Plan. The number of shares reserved for issuance under the
          Companys 2000 Stock Incentive Plan will be increased on the first day of
          the Companys fiscal year by the lesser of 1,700,000 shares, 5% of the
          fully diluted outstanding shares of the Companys common stock on that date
          or a lesser amount determined by the Companys Board of Directors.

(3)    
          Includes 715,177 shares reserved for issuance under the Companys 2000
          Employee Stock Purchase Plan (the ESPP). The number of shares
          reserved for issuance under the ESPP increases on the first day of the
          Companys fiscal year by an amount as may be determined by the Board of
          Directors, or, if less, the lesser of 1,000,000 shares or 1.0% of the
          outstanding common stock on that date. The ESPP permits eligible employees to
          contribute up to 20% of cash compensation toward the semi-annual purchase of the
          Companys common stock. The purchase price per share is 85% of the fair
          market value on the last trading day prior to the beginning of the six-month
          period at which an eligible employee is enrolled; or the fair market value on
          the last trading day of the month in which the six-month period expired,
          whichever is lower.

# Item 12. Certain
Relationships and Related Transactions

The
information required by this item is incorporated by reference from the information
contained under the caption Certain Relationships and Related Party
Transactions contained in the Proxy Statement.

# Item 13. Exhibits and
Reports on Form 8-K

All
financial statement schedules have been omitted because they are not applicable or not
required or because the information is included elsewhere in the Consolidated Financial
Statements or the Notes thereto.

49

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(a)
Exhibits

|ExhibitNumber | Description of Document                                                                                                                                                                                                                                                                
|------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3(i).1        | Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i).3 to
     the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                         
|3(i).2        | Certificate of Designation of Series A Participating Preferred Stock (incorporated by reference
     to Exhibit 3(i).2 to the Company's Form 10-K for the year ended December 31, 2002).                                                                                               
|3(ii).1       | Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii).3 to the Company's
     Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                                        
|4.1           | Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's
     Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002).                                                                                                     
|4.2           | Amended and Restated Rights Agreement dated as of August 31, 2000 (incorporated by reference to
     Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                            
|4.3           | Rights Agreement dated as of May 29, 2001 between the Company and Mellon Investor Services, LLC
     (incorporated by reference to Exhibit 4.1 to the Company's Form 8-A (File No. 0-31857)).                                                                                          
|10.1#         | 1997 Stock Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.1 to
     the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                           
|10.2#         | Form of Indemnification Agreement between the Company and its officers and directors
     (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                        
|10.3          | Lease Agreement dated April 6, 1999 by and between North Pastoria Partners and the Company
     (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                  
|10.4          | Lease dated June 26, 2000 by and between Renault & Handley Employees Investment Co. and the
     Company (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                         
|10.5#         | Alliance Fiber Optic Products, Inc. 2000 Stock Incentive Plan (incorporated by reference to
     Exhibit 10.5 to Amendment No. 3 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                            
|10.6#         | Alliance Fiber Optic Products, Inc. 2000 Employee Stock Purchase Plan (incorporated by reference
     to Exhibit 10.6 to Amendment No. 4 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                    
|10.7#         | Alliance Fiber Optic Products, Inc. 1997 Stock Plan Stock Option Agreement dated May 2, 2000
     between Peter C. Chang and the Company (incorporated by reference to Exhibit 10.7 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).      
|10.8#         | Alliance Fiber Optic Products, Inc. 1997 Stock Plan Stock Option Agreement dated June 15, 2000
     between R. David Dicioccio and the Company (incorporated by reference to Exhibit 10.8 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).

50

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|ExhibitNumber | Description of Document                                                                                                                                                                                                            
|------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.9#         | Form of Full Recourse Promissory Note (incorporated by reference to Exhibit 10.9 to Amendment
     No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                
|10.11#        | Agreement and Release of Claim by and between the Company and John M. Harland dated August 23,
     2001 (incorporated by reference to Exhibit 10.11 to the Company's Form 10-Q for the Quarter ended September 30, 2001).         
|10.12#        | Full Recourse Promissory Note dated May 1, 2002 between the Company and Wei-Shin Tsay
     (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarterly period ended June 30, 2002).
|21.1          | Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 to the Company's Annual
     Report on Form 10-KSB).                                                                                                        
|23.1          | Consent of PricewaterhouseCoopers LLP, independent accountants.                                                                                                                                                                    
|24.1          | Power of Attorney (see page 53 of this Form 10-KSB)                                                                                                                                                                                
|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.ss.1350).                                                                                                                  
|32.2**        | Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002
     (18 U.S.C.ss.1350).                                                                                                           

_________________ 
** In accordance with Item
601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule:
Managements Reports 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-KSB 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.# Indicates management contract or compensatory plan or arrangement.

(b)    
          Reports on Form 8-K

On
October 22, 2003, AFOP filed a current report on Form 8-K furnishing under Item 12 the Company's press release relating to its financial results for the quarter
ended September 30, 2003

On
November 3, 2003, AFOP filed a current report on Form 8-K reporting under Item 5 that it had entered into an agreement to acquire the photonics business of Ritek Corporation.

# Item 14. Principal
Accountant Fees and Services

The
information required by this item is incorporated by reference from the information under
the caption Ratification of Independent Auditors  Principal Accountant Fees
and Services and Pre-Approval Policies and Procedures contained in
the Proxy Statement.

51

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# SIGNATURES

In
accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

|                     | ALLIANCE FIBER OPTIC PRODUCTS, INC.  
|-------------------- | -------------------------------------
|                     |                                      
|Date: March 16, 2004 |                                      
|                     | By/s/ Peter C. Chang                 
|                     | Peter C. Chang                       
|                     | President and Chief Executive Officer

# POWER OF ATTORNEY

KNOW
ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and
appoints Peter C. Chang and Anita K. Ho, and each of them, his true and lawful
attorneys-in-fact, each with full power of substitution, for him or her in any and all
capacities, to sign any amendments to this report on Form 10-KSB and to file the same,
with exhibits thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue
hereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

|Name               | Title                               | Date          
|------------------ | ----------------------------------- | --------------
|                   |                                     |               
|/s/ Peter C. Chang | President, Chief Executive Officer  | March 16, 2004
|Peter C. Chang     | (Principal Executive Officer) and   |               
|                   | Chairman                            |               
|/s/ Anita K. Ho    | Acting Chief Financial Officer      | March 16, 2004
|Anita K. Ho        | (Principal Financial and Accounting |               
|                   | Officer)                            |               
|/s/ Richard Black  | Director                            | March 16, 2004
|Richard Black      |                                     |               
|                   |                                     |               
|/s/ Gwong-Yih Lee  | Director                            | March 16, 2004
|Gwong-Yih Lee      |                                     |               
|                   |                                     |               
|/s/ Ray Sun        | Director                            | March 16, 2004
|Ray Sun            |                                     |               
|                   |                                     |               
|/s/ James C. Yeh   | Director                            | March 16, 2004
|James C. Yeh       |                                     |               
|                   |                                     |               

53

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# EXHIBIT INDEX

|ExhibitNumber | Description of Document                                                                                                                                                                                                                                                                
|------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3(i).1        | Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i).3 to
     the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                         
|3(i).2        | Certificate of Designation of Series A Participating Preferred Stock (incorporated by reference
     to Exhibit 3(i).2 to the Company's Form 10-K for the year ended December 31, 2002).                                                                                               
|3(ii).1       | Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3(ii).3 to the Company's
     Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                                        
|4.1           | Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company's
     Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002).                                                                                                     
|4.2           | Amended and Restated Rights Agreement dated as of August 31, 2000 (incorporated by reference to
     Exhibit 4.2 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                            
|4.3           | Rights Agreement dated as of May 29, 2001 between the Company and Mellon Investor Services, LLC
     (incorporated by reference to Exhibit 4.1 to the Company's Form 8-A (File No. 0-31857)).                                                                                          
|10.1#         | 1997 Stock Plan and form of agreements thereunder (incorporated by reference to Exhibit 10.1 to
     the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                                                           
|10.2#         | Form of Indemnification Agreement between the Company and its officers and directors
     (incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                        
|10.3          | Lease Agreement dated April 6, 1999 by and between North Pastoria Partners and the Company
     (incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                  
|10.4          | Lease dated June 26, 2000 by and between Renault & Handley Employees Investment Co. and the
     Company (incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                         
|10.5#         | Alliance Fiber Optic Products, Inc. 2000 Stock Incentive Plan (incorporated by reference to
     Exhibit 10.5 to Amendment No. 3 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                            
|10.6#         | Alliance Fiber Optic Products, Inc. 2000 Employee Stock Purchase Plan (incorporated by reference
     to Exhibit 10.6 to Amendment No. 4 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                                    
|10.7#         | Alliance Fiber Optic Products, Inc. 1997 Stock Plan Stock Option Agreement dated May 2, 2000
     between Peter C. Chang and the Company (incorporated by reference to Exhibit 10.7 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).      
|10.8#         | Alliance Fiber Optic Products, Inc. 1997 Stock Plan Stock Option Agreement dated June 15, 2000
     between R. David Dicioccio and the Company (incorporated by reference to Exhibit 10.8 to Amendment No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).

54

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|ExhibitNumber | Description of Document                                                                                                                                                                                                            
|------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.9#         | Form of Full Recourse Promissory Note (incorporated by reference to Exhibit 10.9 to Amendment
     No. 1 to the Company's Registration Statement on Form S-1 (File No. 333-45482)).                                                
|10.11#        | Agreement and Release of Claim by and between the Company and John M. Harland dated August 23,
     2001 (incorporated by reference to Exhibit 10.11 to the Company's Form 10-Q for the Quarter ended September 30, 2001).         
|10.12#        | Full Recourse Promissory Note dated May 1, 2002 between the Company and Wei-Shin Tsay
     (incorporated by reference to Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the quarterly period ended June 30, 2002).
|21.1          | Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 to the Company's Annual
     Report on Form 10-KSB).                                                                                                        
|23.1          | Consent of PricewaterhouseCoopers LLP, independent accountants.                                                                                                                                                                    
|24.1          | Power of Attorney (see page 53 of this Form 10-KSB)                                                                                                                                                                                
|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.ss.1350).                                                                                                                  
|32.2**        | Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002
     (18 U.S.C.ss.1350).                                                                                                           

_________________ 
** In accordance with Item
601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule:
Managements Reports 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-KSB 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.# Indicates management contract or compensatory plan or arrangement.

55

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