****UNITED        STATES SECURITIES AND EXCHANGE COMMISSION****

**Washington, D.C. 20549**

        _______________

**FORM 10-K**

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

**For the fiscal year ended December 31,        2007**

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)**                              |                                                         |

| **275 Gibraltar Drive, Sunnyvale, CA                        94089** |
|---------------------------------------------------------------------|
| **(Address of principal                        executive offices)** |
| Issuer's telephone                        number: (408) 736-6900    |

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

                                **                               Title of each        class                          **                       **                 Name of each exchange on which        registered      **

**Common Stock, par value $0.001 per        share****                              ****The Nasdaq Stock Market        LLC**

Series A Participating Preferred Stock        Purchase Rights                                            The Nasdaq Stock Market LLC

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

** **

| Indicate by check mark                        if the registrant is a well-known seasoned issuer, as defined in Rule 405                        of the Securities Act.Yes [ ]      No                        [X]

Indicate by check mark if the registrant is not                        required to file reports pursuant to Section 13 or Section 15(d) of the                        Exchange Act.

Yes [                        ]     No [X]

                         

Indicate by check mark                        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 [   ]

                         

Indicate by check mark                        if there is no disclosure of delinquent filers in response to Item 405 of                        Regulation S-K 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-K or any amendment to this Form                        10-K. [   ]

                         

Indicate by check mark                        whether the registrant is a large accelerated filer, an accelerated filer,                        a non-accelerated filer, or a smaller reporting company. See the                        definitions of "large

accelerated filer",                        "accelerated filer", and "smaller reporting company" in Rule 12b-2 of the                        Exchange Act. (Check one):

     

Large accelerated                        filer[                        ]                                                                          Accelerated filer [                        ]                                                                                                      Non-accelerated filer []                                                                     Smaller reporting company [X]

                                                                                                                               (Do not check if a                        smaller reporting company)

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

                         

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 Capital Market on June 29,                        2007) was

approximately                        $55,575,208

                         

As of March 7, 2008                        there were41,428,420shares of Common Stock,                        $0.001 per share par value, outstanding.

**DOCUMENTS                        INCORPORATED BY REFERENCE**

Items 10 (as to directors and                        Section 16(a) Beneficial Ownership Reporting Compliance), 11,12 (as to                        Security Ownership of Certain Beneficial Owners) 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 2008 Annual Meeting of                        Stockholders to be held on May 16, 2008. |  |
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        

         

ALLIANCE FIBER OPTIC PRODUCTS,        INC.

# TABLE OF        CONTENTS

# 2007 FORM        10-K

|   |                             |                                                                                                                                                       |   |
|--------|----------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                             |                                                                                                                                                       | Page   |
|   | PART I                           |                                                                                                                                                       | 1      |
|   |                             | Item 1.                    Business                                                                                                                        | 1      |
|   |                             | Item 1A.                    Risk Factors                                                                                                                   | 7      |
|   |                             | Item 1B.                    Unresolved Staff Comments                                                                                                      | 17     |
|   |                             | Item 2.                    Properties                                                                                                                      | 17     |
|   |                             | Item 3.                    Legal Proceedings                                                                                                               | 17     |
|   |                             | Item 4.                    Submission of Matters to a Vote of Security Holders                                                                             | 17     |
|   |                             | Executive                    Officers of the Registrant                                                                                                    | 17     |
|   | PART II                          |                                                                                                                                                       | 19     |
|   |                             | Item 5.                    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer                    Purchases of Equity Securities | 19     |
|   |                             | Item 6.                    Selected Financial Data                                                                                                         | 19     |
|   |                             | Item 7.                    Management's Discussion and Analysis of Financial Condition and Results of                    Operations                        | 19     |
|   |                             | Item 7A.                    Quantitative and Qualitative Disclosures About Market Risk                                                                     | 26     |
|   |                             | Item 8.                    Financial Statements and Supplementary Data                                                                                     | 27     |
|   |                             | Item 9.                    Changes In and Disagreements With Accountants on Accounting and Financial                    Disclosure                         | 49     |
|   |                             | Item 9A(T).                    Controls and Procedures                                                                                                     | 49     |
|   |                             | Item 9B.                    Other Information                                                                                                              | 50     |
|   | PART III                         |                                                                                                                                                       | 51     |
|   |                             | Item 10.                    Directors Executive Officers and Corporate Governance                                                                          | 51     |
|   |                             | Item 11.                    Executive Compensation                                                                                                         | 51     |
|   |                             | Item 12.                    Security Ownership of Certain Beneficial Owners and Management and Related                    Stockholder Matters              | 51     |
|   |                             | Item 13.                    Certain Relationships and Related Transactions, and Director                    Independence                                   | 52     |
|   |                             | Item 14.                    Principal Accounting Fees and Services                                                                                         | 52     |
|   | PART IV                          |                                                                                                                                                       | 53     |
|   |                             | Item 15.                    Exhibits and Financial Statement Schedules                                                                                     | 53     |
|   | SIGNATURES                       |                                                                                                                                                       | 54     |
|   | EXHIBIT                    INDEX |                                                                                                                                                       | 55     |

         

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PART I

         

**Item 1. Business**

*When used in this Report, the words "expects,"        "anticipates," "believes", "estimates," "plans," "intends," "could," "will," "may" and        similar expressions are intended to identify forward-looking statements. These are        statements that relate to future periods and include statements as to our operating        results, revenues, sources of revenues, cost of revenues, gross margins, net and operating        losses, profitability, the amount and mix of anticipated investments, exposure to interest        or exchange rate**changes**, expenditures and expenses, our liquidity and the adequacy of our capital resources,        anticipated working capital and capital expenditures, reliance on our**c**onnectivity        products, our cash flow, trends in average selling prices, our reliance on the commercial        success of our**o**ptical**p**assive        products, plans for future products and enhancements of existing products, features,        benefits and uses of our products, demand for our products, our expectations regarding the        impact of accounting changes,**our success        being tied to relationships with key customers, industry trends and market demand,        acquisitions of complementary businesses, products or technologies, our efforts to protect        our intellectual property, potential indemnification agreements, increases in the number of        possible license offers and patent infringement claims, our competitive position, sources        of competition, consolidation in our industry, our international strategy, our employee        relations, the adequacy of our internal controls, the potential effect of recent accounting        pronouncements and our critical accounting policies and estimates. Forward-looking        statements are subject to risks and uncertainties that could cause actual results to differ        materially from those**expected**. These risks and uncertainties include, but are not limited to, those risks        discussed**in Item 1A - Risk        Factors**,        below**,        a**s well as risks related to the        development of the metropolitan, last mile access, and enterprise networks, customer        acceptance of our products, our ability to retain and obtain customers, industry-wide        overcapacity and shifts in supply and demand for optical components and modules, our        ability to meet customer demand and manage inventory, fluctuations in demand for our        products, declines in average selling prices, development of new products by us and our        competitors, increased competition, inability to obtain sufficient quantities of a raw        material**s**, loss of a key supplier, integration of acquired businesses or technologies, financial        stability in foreign markets, foreign currency exchange rates, costs associated with being        a public company, delisting from the Nasdaq Capital Market, failure to meet customer        requirements, our ability to license intellectual property on commercially reasonable        terms, economic stability, and the**state        of the capital markets.**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.*

*A**ll        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.*

AFOP, OPIS and SPECTRAMUX are our trademarks. 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 and service providers. 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, with high quality, 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.

**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.

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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.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.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 demultiplexer, 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 componentsconnect,        guide, mix, filter, route, adjust and stabilize optical signals transmitted through an        optical network.

**Market Conditions**

In periods prior to 2004, 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 continue to 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.

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Over the past two years, the optical components industry        has experienced a slight increase and resumption in business levels. Recent orders for our        products have been utilized both for upgrades of existing networks and new network builds.        In addition, certain large telecommunications service providers have recently announced        that they plan to deploy new broadband access networks based on fiber optic technologies        for residential users. These fiber-to-the-home networks, or FTTH, are expected to        significantly increase the capacity and expand the types of services that can be utilized        by residential users. It remains difficult, however, to predict the timing or extent of a        full industry recovery and the potential impact to our business from this or any other        deployment initiatives.

**Products**

Our lines of optical products support the needs of        current and next generation optical network systems applications. Ourconnectivity (formerly named Optical Path Management        Solutions, or OPMS) product family provides a comprehensive line of optical interconnect        devices, couplers and splitters, PLC (planar lightwave circuits) and related optical        products, as well as customized integrated modules incorporating these devices. Ouropticalpassive products (formerly named Wavelength Management        Solutions, or WMS) include WDM and DWDM components and modules that utilize thin film        filter technologies to separate optical signals, variable attenuators, optical switches and        other optical devices utilizing micro optic lensing technology including integrated        electro-optical modules incorporating these products.

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

**Connectivity        Products.**In nearly all fiber optic networks,        the optical fiber, passive optical components and active optical devices must be joined        using optical interconnection systems. Ourconnectivity 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 ourconnectivityproducts described below are in production and are        shipping to customers.

*Connectivity 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 components to provide superior integrated Connectivity        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 vertically 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 and Planar Fiber Optical Splitters and        Couplers*. Fused and planar 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 fidelity 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.

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*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 attenuating 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.

*Planar Lightwave Circuit        Splitters*. Our optical splitters reduce        insertion loss, or the power loss incurred when inserting components into an optical path,        and deliver high performance. We believe these devices enable more effective monitoring and        management of optical networks.

**Optical Passive Products.**As the capacity and complexity of optical networks        increases, future systems face significant challenges. Performance characteristics such as        stability, wavelength isolation, channel balance and power loss due to polarization become        important to optimize, and product solutions which enhance these characteristics provide        competitive advantage. In recent years,WDMhas 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. These particularOpticalPassive 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.

Our Optical PassiveProducts devices serve many system OEM customers needs        for current and next generation network equipment. All ofourOpticalPassive 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 signal power 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. We believe that 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 nanometers, orspacing 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 coversfourchannel,eightchannel,        andsixteenchannel mux and demux applications, and upgradeability        for bothfourchannel andeightchannel        types. We also offer optical add-drop modules, orOADMs,for        CWDM networks, with the capability of adding or dropping from one tofifteenchannels. 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.

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*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.OurTelcordia        1209/1221-qualified CCWDM builds on AFOP's proprietary optical bench platform, and we        believe 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.

*Optical Isolators*These devices use polarization rotation to block return        signals from the forward optical path. They limit distortions in devices and signals caused        by reflected lights in the fiber.

*Optical Bypass Switches*As the name suggests, these devices utilize beam        shifting optics or mirror to switch optical signals from one fiber to another in response        to a control signal provided electronically. Optical switches are used in test equipment        for basic functionality and in networks to provide protection and redundancy.

*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, 2007, we had 55        United States patents issued or assigned to us and had 31 United States patent applications        pending. Our 55 U.S. patents expire between January 2011 and June 2025. We also have 31        foreign patents issued, and 1 foreign patent application pending. Our foreign patents        issued will expire between October 2008 and August 2022. 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, 2007, there were 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, 2007, we sold our products to more than 200 customers. One customer        accounted for 17.4% of our revenues in the year ended December 31, 2007. Two customers        accounted for 15.1% and 10.0%, respectively, of our revenues in the year ended December 31,        2006. One customer accounted for 10.2% of our revenues in the year ended December 31,        2005.

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      The        following is a summary of our revenues generated by geographic segments (in        thousands):

|                                                             | **Years Ended December                    31,** |
|-------------------------------------------------------------|-------------------------------------------------|
|                                                        | **2007**                                        | **2006** | **2005** |
| **Revenues**                                                |                                            |  |  |  |  |  |  |  |  |  |  |
|                      North America |                                            |   | $ | 20,204 |   | $ | 18,594 |   | $ | 15,677 |   |
|                      Europe        |                                            |   |   | 2,707 |   |   | 1,930 |   |   | 867 |   |
|                      Asia          |                                            |   |   | 10,875 |   |   | 6,268 |   |   | 4,419 |   |
|                                                             |                                                 |  |  |  |  |  |
|                          |                                            |   | $ | 33,786 |   | $ | 26,792 |   | $ | 20,963 |   |
|                                                             |                                                 |  |  |  |  |  |
|                                                             |                                                 |  |  |

**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.

*Technical Support and Product        Management*. We maintain a technically        knowledgeable support staff that we believe 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 you that they will        continue to do so.

Our principal competitors in the components market        include Avanex Corporation, DiCon Fiberoptics, Inc., JDS Uniphase Corp., Oplink        Communications, Inc., Corning Cable Systems Inc. and Tyco Electronics Corporation. We        estimate that we had approximately 20 competitors in the components market as of December        31, 2007. 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 continued to experience 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, 2007, we had a total of 58        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.

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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 $3.2 million, $3.1 million and $3.4 million for the years ended        December 31, 2007, 2006 and 2005, 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 ourconnectivityproducts at our facility in Tu-Cheng City, Taiwan and        our fiber array products at our facility in Hu-Kou 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.

We have established a quality management system which is        designed to ensure that the products we provide to our customers meet or exceed their        requirements. All of our four facilities are ISO 9001-2000 certified. Among them, both        Taiwan facilities are also TL-9000 certified.

**Employees**

As of December 31, 2007, we had 691 full-time        employees, including 43 located in the United States, 377 in Taiwan and 271 in China. Of        our 691 full-time employees, 58 are engaged in product development, 544 are engaged in        manufacturing production, 21 are engaged in sales, marketing, application support and        customer service, and 68 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.

**Additional****Information**

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.Our internet        address is www.afop.com. We make available free of charge through a hyperlink on our        website our annual reports on Form 10-K, quarterly reports on Form 10-Q, 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 t>his Annual Report on Form 10-K.

**Item 1A.Risk Factors**

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

        We had net income of approximately $3.4 million and $0.7 million in fiscal year 2007 and        2006, respectively. We incurred net losses of approximately $2.6 million in fiscal year        2005. Although we generated a profit in the 2007 and 2006 fiscal years, we may not be able        to sustain profitability in the future. Although our cash and cash equivalents increased in        2007, we could find our cash flows to be negative again in the future as we continue to        invest in our business. As of December 31, 2007, we had an accumulated deficit of        approximately $68.4 million.

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

**Ourconnectivity products have historically represented a        significant part of our revenues, and if we are unsuccessful in commercially selling our        Optical Passive products, our business will be seriously harmed.**

Sales of ourconnectivity products accounted for 66.5%, 61.3%, and        67.2% of our revenues in the fiscal years ended December 31, 2007, 2006, and 2005,        respectively and substantially all of our historical revenues. We expect to depend on        ourconnectivity products forthe majority ofour 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 2007 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 ouropticalpassive related products, which we began shipping        commercially in July 2000. Demand for these products has fluctuated over the past few        years, declining sharply starting in mid fiscal 2001 and then increasing beginning in 2003.        If demand does not continue to increase and our target customers do not continue to adopt        and purchase our Optical Passive related products, our revenues may decline and we may have        to write-off additional inventory that is currently on our books.

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

         

**In the years ended December 31, 2007        and 2006, our top 10 customers comprised 58.1% and 61.1% of our revenues, respectively. One        customer accounted for 17.4% of our total revenues for the year ended December 31, 2007.        Two customers accounted for 15.1% and 10.0%, respectively, of our total revenues for the        year ended December 31, 2006.**

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

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

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

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

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

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

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

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

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

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

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

As of December 31, 2007, we had a total of 43 full-time        employees in Sunnyvale, California, 377 full-time employees in Taiwan, and 271 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 our operations in an efficient and        timely manner, our business will be severely harmed.

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

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

The development of new or enhanced fiber optic products        is a complex and uncertain process. We may experience design, manufacturing, marketing and        other difficulties that could delay or prevent the development, introduction or marketing        of new products and enhancements. Development costs and expenses are incurred before we        generate revenues from sales of products resulting from these efforts. Our total research        and development expenses were approximately $3.2 million, $3.1 million and $3.4 million for        the fiscal years 2007, 2006 and 2005, respectively. We intend to continue to invest in our        research and product development efforts, which could have a negative impact on our        earnings in future periods if we do not earn associated revenue from such        efforts.

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

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

**Current and future demand for our products depends on        the continued growth of the Internet and the communications industry, which is experiencing        consolidation, realignment, fluctuations of product inventory and 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, which would adversely affect our revenues. Our customers        have experienced an oversupply of inventory due to fluctuating demand for their products        that has resulted in inconsistent demand for our products. Future demand for our products        is uncertain and will depend heavily on the continued growth and upgrading of optical        networks, especially in the metropolitan, last mile, and enterprise access segments of the        networks.

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

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

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

     Since 2001, the United States        economy has experienced and continues to experience significant fluctuations in consumption        and demand. During the past several years, telecommunication companies have mostly        decreased their spending, which has resulted in excess inventory, overcapacity and a        decrease in demand for our products. We may experience further decreases in the demand for        our products due to a weak domestic and international economy 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.

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

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

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**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 within their desired lead times.**

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

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

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

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

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

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

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

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**Changes to financial accounting standards may affect        our results of operations and cause us to change our business practices.**

**We prepare our financial statements        to conform with generally accepted accounting principles, or GAAP, in the United States.        These accounting principles are subject to interpretation by the American Institute of        Certified Public Accountants, the Securities and Exchange Commission and various bodies        formed to interpret and create appropriate accounting policies. A change in those policies        can have a significant effect on our reported results and may affect our reporting of        transactions completed before a change is announced. Changes to those rules or the        questioning of current practices may adversely affect our reported financial results or the        way we conduct our business. For example,accounting policies affecting many        aspects of our business, including rules relating to employee stock option grants, have        recently been revised. The Financial Accounting Standards Board and other agencies have        finalized changes to U.S. generally accepted accounting principles that required us,        starting in our first quarter of 2006, to record a charge to earnings for employee stock        option grants and other equity incentives. As a result of adopting Statement        No. 123(R), on January 1, 2006, the Company's income before income tax and net income        for the year ended December 31, 2007 was $3.4 million, or $0.4 million lower than if it had        continued to account for share-based compensation under APB Opinion 25. The adoption of        Statement No. 123(R) did not impact basic and diluted income and loss per share for the        year ended December 31, 2007. In addition, since we historically have used equity-related        compensation as a component of our total employee compensation program, the accounting        change could make the use of equity-related compensation less attractive to us and        therefore make it more difficult to attract and retain employees.**

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

Our success depends to a significant degree upon the        continued contributions of the principal members of our technical sales, marketing,        engineering and management personnel, many of whom perform important management functions        and would be difficult to replace. We particularly depend upon the continued services of        our executive officers, particularly Peter Chang, our President and Chief Executive        Officer; David Hubbard, our Vice President, Sales and Marketing; Wei-shin Tsay, our senior        Vice President of Product Development; Anita Ho, our Acting Chief Financial Officer and        Corporate Controller; and other key engineering, sales, marketing, finance, manufacturing        and support personnel. In addition, we depend upon the continued services of key management        personnel at our Taiwanese and Chinese subsidiaries. None of our officers or key employees        is bound by an employment agreement for any specific term, and may terminate their        employment at any time. In addition, we do not have "key person" life insurance policies        covering any of our employees.

Our ability to continue to attract and retain highly        skilled personnel will be a critical factor in determining whether we will be successful in        the future. We may have difficulty hiring skilled engineers at our manufacturing facilities        in the United States, Taiwan, and China. If we are not successful in attracting,        assimilating or retaining qualified personnel to fulfill our current or future needs, our        business may be harmed.

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

Complex and precise processes are required for the        manufacture of our products. Changes in our manufacturing processes or those of our        suppliers, or the inadvertent use of defective materials, could significantly reduce our        manufacturing yields and product reliability. Because the majority of our manufacturing        costs are relatively fixed, manufacturing yields are critical to our results of operations.        Lower than expected production yields could delay product shipments and impair our        operating results. We may not obtain acceptable yields in the future.

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

Because we plan to introduce new products and product        enhancements, we must effectively transfer production information from our product        development department to our manufacturing group and coordinate our efforts with 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.

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**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.

**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     | financial penalties or legal actions by our customers. |
|--|---------------------------|--------------------------------------------------------|

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

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

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

|  | 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 with our business, which may disrupt our business, divert management's        attention and slow our ability to expand the range of our proprietary technologies and        products.

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

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

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

15

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**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.

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

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

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

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

For the years ended December 31, 2007, 2006 and 2005,        sales to customers located outside of North America were 40.2%, 30.6%, and 25.2% of our        revenues, respectively. In order to expand our business, we must increase our sales to        customers located outside of North America. We have limited experience in marketing and        distributing our products internationally and in developing versions of our products that        comply with local standards. Our international sales will be limited if we cannot establish        relationships with international distributors, establish additional foreign operations,        expand international sales channels, hire additional personnel and develop relationships        with international communications equipment manufacturers. Even if we are able to        successfully continue international operations, we may not be able to maintain or increase        international market demand for our products.

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

Two of our primary manufacturing operations in Taiwan        and our headquarters in California are located in 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.

**Item 1B. Unresolved Staff Comments**

None

**Item 2. Properties**

In the United States, we lease a total of approximately        34,800 square feet of administrative, sales, marketing, product development and        manufacturing space in one building located in Sunnyvale, California pursuant to a lease        that expires in July 2010.

In Taiwan, we lease a total of approximately 38,800        square feet in one facility located in Tu-Cheng City, Taiwan. Thislease expiresat various times fromDecember2008        toJanuary2009. We intend to renew this lease prior to its        expiration date. 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.

Additionally, in February 2006, we entered into a lease        for a total of 21,600 square feet facility located in Hu-Kou, Taiwan. This lease will        expire in January 2009.

In July 2007, we renewed the lease for our 62,000 square        foot facility in the Shenzhen area of China, which will expire in July 2012. In February        2007, we entered into a lease for an 8,200 square foot facilityin Shenzhen, which lease will expire in January 2012.        Additionally, in October 2007, we entered into a new lease for a 72,000 square foot        facility near the current facility in the Shenzhen area of China. This new facility is        under construction andourleaseis        expected tobegin in August 2008 and expire in        July 2013.

**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-K, 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**

None

**Executive Officers of the Registrant**

Our executive officers as of December 31, 2007 are as        follows:

*Peter C.        Chang*, 50, 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.

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*David A.        Hubbard*, 48, 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.        From 1985 to 1995 Mr.Hubbardheld severalproductline        andbusinessmanagement positions at Tyco Electronics/ AMP inc.        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.*, 56, 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*, 61, has served as our Acting Chief        Financial Officer since July 2002. From October 2000 toJuly 2007, Ms. Ho hasalsoserved 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.

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**PART II**

         

Item 5. Market for Registrant's Common Equity,        Related Stockholder Mattersand Issuer        Purchases of Equity Securities

The Company's common stock, par value $0.001, was traded        on the Nasdaq Global Market under the ticker symbol "AFOP" until November 8, 2002, when it        began to trade on the Nasdaq Capital 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 Capital Market.

|   | **High**                                  |   | **Low** |   |
|--------|-------------------------------------------|--------|---------|--------|
|   |                                           |   |         |   |
|   | **2007**                                  |   |    |   |   |
|   |   First                Quarter  | $2.19  |    | $1.89  |   |
|   |   Second                Quarter | $2.10  |    | $1.69  |   |
|   |   Third                Quarter  | $2.43  |    | $1.75  |   |
|   |   Fourth                Quarter | $2.21  |    | $1.71  |   |
|   | **2006**                                  |   |    |   |   |
|   |   First                Quarter  | $2.30  |    | $1.18  |   |
|   |   Second                Quarter | $2.69  |    | $1.34  |   |
|   |   Third                Quarter  | $1.79  |    | $1.31  |   |
|   |   Fourth                Quarter | $2.17  |    | $1.52  |   |

As of March 7, 2008, the Company's common stock was held        by67stockholders 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 12 of this Annual Report on        Form 10-K.

**Item 6. Selected Financial Data**

Not required.

**Item 7. Management's Discussion and Analysis of        Financial Condition and Results of Operations**

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

**Recent Accounting Pronouncements**

See Note 1 to the Consolidated        Financial Statements for a full description of recent accounting pronouncements, including        the expected dates of adoption and estimated effects on results of operations and financial        condition, which is incorporated herein by reference.

**Critical Accounting Policies and        Estimates**

*General*

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.

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

*Revenue Recognition*

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, the collection of the resulting receivable        is reasonably assured and transfer of title and risk of loss has occurred. Subsequent to        the sale of our products, we have no obligation to provide any modification or        customization, upgrades, enhancements, or post-contract customer support.

*Stock-based Compensation        Expense*

         

On January 1, 2006, we adopted        Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based        Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation        expense for all share-based payment awards made to our employees and directors including        stock options and purchases under our Employee Stock Purchase Plan based on estimated fair        values. We adopted SFAS 123(R) using the modified prospective transition method, which        requires the application of the accounting standard as of January 1, 2006, the first        day of our fiscal year. Our Consolidated Financial Statements for the year ended December        31, 2007 and 2006 reflect the impact of SFAS 123(R). In accordance with the modified        prospective transition method, our Consolidated Financial Statements for prior periods have        not been restated to reflect, and do not include, the impact of SFAS 123(R). The value of        the portion of the award that is ultimately expected to vest is recognized as expense over        the requisite service periods in our Consolidated Statement of Operations. Prior to the        adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors        using the intrinsic value method in accordance with APB 25 as allowed under Statement of        Financial Accounting Standards No. 123,*Accounting for Stock-Based        Compensation*(SFAS 123). As        stock-based compensation expense recognized in the Consolidated Statement of Operations for        the fiscal year 2007 and 2006 is based on awards ultimately expected to vest, it has been        reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the        time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ        from those estimates. The estimated average forfeiture rates for the years ended December        31, 2007 and 2006, of approximately 6% and 10%, respectively, were based on historical        forfeiture experience. In our pro forma information required under SFAS 123 for the periods        prior to fiscal 2006, we accounted for forfeitures as they occurred. See Note 2 to the        Consolidated Financial Statement for a further discussion on stock-based        compensation.

*Allowance for Doubtful Accounts*

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.

*Inventory*

Inventories are stated at the lower of cost or market,        with cost being determined using standard cost, which approximates actual cost on a        first-in, first-out basis. Market value is determined as the lower of replacement cost or        net realizable value. Provisions are made for excess and obsolete inventory based on        historical usage and management's estimates of future demand. Inventory reserves, once        established, are only reversed upon sale or disposition of related inventory.

*Valuation of Long-Lived Assets*

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. We did not record any asset impairment charge        for the years ended December 31, 2007, 2006, and 2005, respectively.

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*Taxes on Earnings*

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 as we believe it is more likely than not that such benefit will not be        realized.

**Overview**

We were founded in December 1995 and commenced        operations to design, manufacture and market fiber optic interconnect products, which we        call ourconnectivityproducts, orwhat wepreviouslycalledourOPMS        products. We have broadened ourconnectivity        product linetoinclude attenuators, PLC, and fused fiber products. In        early 1999, we started forming a new product line based in part on our proprietary        technology. We started selling ouropticalpassive products, orwhat wepreviouslycalledourDWDMproducts,        and other wavelength management products in July 2000. Since introduction, sales of Optical        Passive products have fluctuated with the overall market for these products.

We market and sell our products predominantly through        our direct sales force.From our inception        through December 31, 2007, we derived a substantial portion of our revenues from        ourconnectivity product line. Ouropticalpassive products contributed as a percentage of revenue        34%, 39% and 33% for the years ended December 31, 2007, 2006 and 2005, respectively. In the        years ended December 31, 2007, 2006 and 2005, our top 10 customers comprised 58%, 61%,        and 57% of our revenues, respectively. One customer accounted for 17% of our revenues in        2007. Two customers accounted for 15% and 10% of our revenue in 2006. One customer        accounted for 10% of our revenues in 2005.

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 by our competitors; |
|--|---------------------------|--------------------------------------------------------|

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

|  | o     | mix of domestic and international sales. |
|--|---------------------------|------------------------------------------|

Research and development expenses consist primarily of        salaries and related personnel expenses, fees paid to outside service providers, materials        costs, test units, facilities, overhead and other expenses related to the design,        development, testing and enhancement of our products. We expense our research and        development costs as they are incurred. We believe that a significant level of investment        for product research and development is required to remain competitive. We expect research        and development expenses may increase as we intend to continue to invest in our research        and product development efforts during 2008.

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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 2007 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 general and administrative expenses will increase in absolute dollar to support our        revenue growth, higher insurance premiums, and costs associated with compliance with new        laws and regulations.

In December 2005, we accelerated options to purchase up        to 1.9 million shares of our common stock held by employees at the director level and        above, including executive officers.  The purpose of the accelerated vesting was to        enable the Company to avoid recognizing any non-cash compensation expense associated with        these options in future periods.  As a result of the acceleration, we expect to avoid        recognition of up to approximately $1.5 million of compensation expense over the course of        the original vesting periods, including approximately $0.7 million and $0.4 million in 2007        and 2006, respectively.

        Stock-based compensation expenses recognized under SFAS 123(R) were $0.4 million and $0.3        million for the year ended December 31, 2007 and 2006, respectively. These expenses were        determined by the Binomial Lattice valuation model, and they are related to employee stock        options and stock purchases through our employee stock purchase plan. As of December 31,        2007, total unrecognized compensation costs related to unvested stock options was $0.6        million, which is expected to be recognized as an expense over a weighted average period of        approximately 2 years. Subsequent to the adoption of SFAS 123(R), we have not made any        changes in the type of incentive equity instruments or added any performance conditions to        the incentive options.

We own 98.5% of the outstanding common stock of Alliance        Fiber Optic Products, Ltd (formally named Transian Technology Ltd. Co.), a Taiwan        corporation. This majority owned subsidiary is engaged in design and manufacturing of our        products.

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.

**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.

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|                                                                                               | Years Ended December                    31,        |   |
|-----------------------------------------------------------------------------------------------|----------------------------------------------------|--------|
|                                                                                               | **       2007** |   | **       2006** |   | **       2005** |   |
| Revenues                                                                                      |                                               | 100.0% |   | 100.0% | .  | 100.0% |   |
|                                                                                          |                                               |   |   |   |   |   |   |
| Cost of                revenues                                                               |                                               | 68.5   |   | 72.3 |   | 78.1 |   |
|                                                                                          |                                                    |   |  |   |  |   |
|     Gross                profit                                           |                                               | 31.5   |   | 27.7 |   | 21.9 |   |
|                                                                                          |                                               |   |   |   |   |   |   |
| Operating                expenses:                                                            |                                               |   |   |   |   |   |   |
|      Research                and development                         |                                               | 9.5    |   | 11.5 |   | 16.4 |   |
|      Sales                and marketing                              |                                               | 7.0    |   | 8.4 |   | 10.4 |   |
|      General                and administrative                       |                                               | 10.2   |   | 11.5 |   | 14.3 |   |
|                                                                                          |                                                    |   |  |   |  |   |
|          Total                operating expenses |                                               | 26.7   |   | 31.4 |   | 41.1 |   |
|                                                                                          |                                               |   |   |   |   |   |   |
| Income                (loss) from operations                                             |                                               | 4.8    |   | (3.7) |   | (19.2) |   |
| Interest and                other income, net                                                 |                                               | 5.2    |   | 6.2 |   | 6.7 |   |
|                                                                                          |                                                    |   |  |   |  |   |
| Net income                (loss)                                                              |                                               | 10.0%  |   | 2.5% |   | (12.5%) |   |
|                                                                                          |                                                    |   |  |   |  |   |

        Results of Operations

        Comparison of Fiscal Year 2007 and Fiscal Year 2006

*Revenues.*Revenues were $33.8 million and $26.8 million for the        years ended December 31, 2007 and 2006, respectively. Connectivity products revenue        increased to $22.5 million in 2007 from $16.4 million in 2006 primarily due to increased        volume shipments of our products. Opticalpassive        products revenue increased to $11.3 million in 2007 from $10.4 million in 2006, primarily        due to the increased acceptance of our products by our customers which resulted in higher        volume shipments partially offset by lower average selling prices.

*Cost of Revenues.*Cost of revenues in fiscal year 2007 increased to $23.2        million from $19.4 million in fiscal year 2006. Cost of revenues as a percentage of net        revenues decreased to 68.5% in fiscal year 2007 from 72.3% in fiscal year 2006. The        increase of cost of revenues in 2007 was due to increased volume of products        sold.

*Gross        Profit*.Our2007 gross        profit was $10.6 million, or 31.5% of revenues, compared with a 2006 gross profit of $7.4        million, or 27.7% of revenues. The gross profit in 2007 forconnectivity products increased to $8.0million from $4.9million in 2006. The gross profit in 2007 foropticalpassive products increased to $2.8million from $2.5 million in 2006. Higher utilization of        our factories as a result of increased volume shipments of our products resulted in an        improved gross margin for the year ended December 31, 2007. We expect our gross profit as a        percentage of revenuestocontinue to improve with higher production volumes,        which we anticipate will result in improved absorption of overhead expenses. However, our        average selling prices are declining, which will negatively impact our gross profit and may        offset any benefits from improved absorption.

*Research and Development        Expenses*. Research and        development expenses increased to $3.2 million infiscal year2007 from $3.1 million infiscal year2006. As a percentage of revenues,        research and development expenses decreased to 9.5% in 2007 from 11.5% in 2006and the decrease was a result of        increased revenue.The        increasein absolute        dollarswas primarily due to        increased headcount in Taiwan and increased material expenses. We expect research and        development expenses on our product development efforts may increase as we intend to        continue to invest in our research and product development efforts.

*Sales and Marketing        Expenses*. Sales and marketing expenses        remained flat at $2.3 million infiscal        years2007 and 2006. As a percentage of revenues,        sales and marketing expenses decreased to 7.0% in 2007 from 8.4% in 2006. We expect sales        and marketing expenses will remain relatively flat due in part to continued emphasis on        expense control.

*General and Administrative        Expenses*. General and administrative expenses        increased to $3.5 million infiscal year2007 from $3.1 million infiscal year2006. The increase was primarily due to an increase in        compensation andemployeebenefits resulting fromourgrowth. As        a percentage of revenues, general and administrative expenses decreased to 10.2% in 2007        from 11.5% in 2006. We expect general and administrative expenses will increase due to        higher costs associated with compliance with laws and regulations such as the        Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder.

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*Stock-Based Compensation.*Total stock-based compensation was $0.4 million and $0.3        million for the years ended December 31, 2007 and 2006, respectively. Effective        January 1,2006, we adopted the fair value recognition provisions of SFAS 123(R), determined        by the Binomial Lattice valuation model as comparison, and these amounts represent        stock-based compensation expenses related to employee stock options.

*Interest and Other Income, Net.*Interest and other income, net, was $1.8 million and        $1.7 million for the years ended December 31, 2007 and 2006, respectively. These        amounts consisted primarily of interest income, which fluctuated based on cash balances and        changes in interest rates. The increase in 2007 was due to higher interest        income.

*Income        Taxes*. There was no income tax benefit in the        years ended December 31, 2007 and 2006.

As of December 31, 2007, we hadapproximately $38.5million and $20.4 million of net operatingloss carryforwards for federal and state tax purposes,        respectively, which will expire in2021 for        federal and in 2011for 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 due to our history of        losses.

***Comparison of Fiscal Year 2006 and Fiscal Year 2005***

*Revenues.*Revenues were $26.8 million and $21.0 million for the        years ended December 31, 2006 and 2005, respectively. Connectivity products revenue        increased to $16.4 million in 2006 from $14.1 million in 2005 primarily due to increased        volume shipments of our products. Opticalpassive        products revenue increased to $10.4 million in 2006 from $6.9 million in 2005 primarily due        to the increased acceptance of our products by our customers which resulted in higher        volume shipments partially offset by lower average selling prices.

*Cost of Revenues.*Cost of revenues in fiscal year 2006 increased to $19.4        million from $16.4 million in fiscal year 2005. Cost of revenues as a percentage of net        revenues decreased to 72.3% in fiscal year 2006 from 78.1% in fiscal year 2005. The        increase of cost of revenues in 2006 was due to increased volume of products        sold.

*Gross        Profit*.Our2006 gross        profit was $7.4 million, or 27.7% of revenues, compared with a 2005 gross profit of $4.6        million, or 21.9% of revenues. The gross profit infiscal year2006 forconnectivity products increased to $4.9 million from        $4.5 million in 2005 and was also due to higher revenue. The gross profit infiscal year2006 foropticalpassive products increased to $2.5 million from $0.1        million in 2005 due to higher revenue from increased volume of shipments.

*Research and Development        Expenses*. Research and        development expenses decreased to $3.1 million in 2006 from $3.4 million in 2005. As a        percentage of revenues, research and development expenses decreased to 11.5% in 2006 from        16.4% in 2005. The decrease was primarily due to reduced headcount in the United States and        reduced material expenses.

*Sales and Marketing        Expenses*. Sales and marketing expenses        increased to $2.3 million in 2006 from $2.2 million in 2005. As a percentage of revenues,        sales and marketing expenses decreased to 8.4% in 2006 from 10.4% in 2005. The increase in        absolute dollars was due to higher commissions and professional fees as result of higher        revenue

*General and Administrative        Expenses*. General and administrative expenses        increased to $3.1 million in 2006 from $3.0 million in 2005. As a percentage of revenues,        general and administrative expenses decreased to 11.5% in 2006 from 14.3% in 2005. The        increase in absolute dollars was primarily due to stock-based compensation expense        resulting from the adoption of FAS 123R and other costs associated with being a public        company.

*Stock-Based Compensation.*Total stock-based compensation was $0.3 million in the        year ended December 31, 2006. Effective January 1, 2006, we adopted the fair value        recognition provisions of SFAS 123(R), determined by the Binomial Lattice valuation model        as comparison, and this amount represents stock-based compensation expense related to        employee stock options. There was no stock-based compensation expense in fiscal 2005        because the deferred compensation balance was fully amortized as of December 31,        2004.

24

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*Interest and Other Income, Net.*Interest and other income, net, was $1.7 million and        $1.4 million for the years ended December 31, 2006 and 2005, respectively. These        amounts consisted primarily of interest income, which fluctuated based on cash balances and        changes in interest rates. The increase in 2006 was due to higher interest        income.

*Income        Taxes*. There was no income tax benefit in the        years ended December 31, 2006 and 2005, respectively.

As of December 31, 2006, we had approximately $40.7        million and $22.4 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.

**Liquidity and Capital Resources**

***Comparison of Fiscal Year 2007 and Fiscal Year        2006***

Net cash provided by operating activities was        $5.3 million and $2.1 million in 2007 and 2006, respectively. The increase in our cash        provided by operations in 2007 was primarily due to our net income of $3.4 million, an        increase in accounts payable of $1.6 million, and an increase in accrued liabilities        of$0.6 million which was offset by increase in        accounts receivable of $1.3 million. The increase in our cash provided by operations in        2006 was primarily due to our net income of$0.7        million, an increase in accounts payable of $0.6 million, and an increase in accrued        liabilities of$0.5 million which was offset by        increase in accounts receivable of $0.5 million and increase in inventory of $0.8        million.

Cash used in investing activities was $5.8 million in        2007 and $1.1 million in 2006. In 2007, we spent $1.2 million to acquire property and        equipment and $4.6 million was invested in short-term securities. In 2006, we spent $1.0        million to acquire property and equipment and $0.1 million was invested in short-term        securities.

Cash generated by financing activities was        $0.8 million in 2007, compared with $0.7 million in 2006. Cash generated by financing        activities in 2007 and 2006 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 borrowings under mortgage and equipment loans.

AtDecember        31, 2007, we had a letter of credit with a financial institution for $0.4 million. We        pledged $0.4 million of our short-term investments as collateral for the letter of credit.        Between November 2004 and September 2007, we entered into two mortgage loans of $0.7        million total with an interest rate of 3.20% and three equipment loans of $0.7 million        total with an interest rate of 3.68% in Taiwan. The loans are secured by the building and        equipment we own in Taiwan.

Our principal source of liquidity as of December        31, 2007 consisted of $36.5 million in cash and cash equivalents and interest bearing        marketable securities.Of this amount, $16.4        million was held in auction rate securities collateralized by student loans and        substantially guaranteed by the U.S. Department of Education. Subsequent to year end, six        auctions have failed to totaling $8.1million        related to these securities.Continued auction        failures could adversely impact our liquidity as we may not be able to sell these        securities when we want to and may have to hold them until maturity between 2032 and        2046.

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, additional credit        facilities, strategic relationships or other arrangements. If additional funds are raised        through the issuance of securities, these securities could have rights, preferences and        privileges senior to holders of common stock, and the terms of any debt facility could        impose restrictions on our operations. The sale of additional equity or debt securities        could result in additional dilution to our stockholders, and additional financing 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 our research and development and        marketing expenses. Strategic arrangements, if necessary to raise additional funds, may        require us to relinquish our rights to certain of our technologies or products. Our failure        to raise capital when needed could harm our business, financial condition and operating        results.

25

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***Comparison of Fiscal Year 2006 and Fiscal Year        2005***

Net cash provided by operating activities was        $2.1 million in 2006 and net cash used in operating activities was $1.8 million in        2005. The increase in our cash provided by operations in 2006 was primarily due to        recording net income in 2006 versus a net loss in 2005, which was partially offset by        higher accounts receivable and inventories. The higher accounts receivable and inventories        were due to increase in sales in 2006.

Cash used in investing activities was $1.1 million in        2006 and $3.4 million in 2005. In 2006, we spent $1.0 million to acquire property and        equipment and $0.1 million was invested in short-term securities. In 2005, we spent $0.7        million to acquire property and equipment and $2.7 million was invested in short-term        securities.

Cash generated by financing activities was        $0.7 million in 2006compared with $0.6        million in 2005. Cash generated by financing activities in 2006 and 2005 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 borrowings under mortgage and        equipment.

**Contractual Obligations**

Our long-term debt obligations are for principal and        interest on mortgage and equipment loansfrom        financial instrumentsin Taiwan.

In July 2004, we moved into our corporate headquarters        in Sunnyvale, California. The lease has a six-year term commencing on July 22,        2004.

In Taiwan, we lease a total of approximately        38,800 square feet in one facility located in Tu-Cheng City, Taiwan.        Thislease        expiresat various times fromDecember2008to        January2009.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.

Additionally, in February 2006, we entered into a lease        for a total of 21,600 square feet facility located in Hu-Kou, Taiwan. This lease will        expire in January 2009.

In July 2007, we renewed the lease for our 62,000 square        foot facility in the Shenzhen area of China, which will expire in July 2012. In February        2007, we entered into a lease for an 8,200 square feet facilityin Shenzhen, which lease will expire in January 2012.        Additionally, in October 2007, we entered into a new lease for a 72,000 square foot        facility near the current facility in the Shenzhen area of China. This new facility is        under construction andourleaseis        expected tobegin in August 2008 and expire in        July 2013.     

The following summarizes our contractual obligations at        December 31, 2007 (in thousands):

|                                       | Payments Due by                    Period |
|--------------------------------------------|-------------------------------------------|
||
| **Contractual                Obligations** |
| Long-Term Debt                Obligations  |                                      | $      756 |   | $      153 |   | $    278 |   | $   200 |   | $   125 |   |
| Operating                Lease Obligations |                                      | 2,388 |   | 960 |   | 1,063 |   | 314 |  | 51 |  |
|                                            |                                           |  |  |  |  |  |  |  |  |  |  |
| Total                                      |                                      | $    3,144 |   | $   1,113 |   | $    1,341 |   | $    514 |   | $   176 |   |
|                                            |                                           |  |  |  |  |  |  |  |  |  |  |

**Off-Balance Sheet Arrangements**

We do not have any off-balance sheet arrangements, as        such term is defined in rules promulgated by the Securities and Exchange Commission, that        have or are reasonably likely to have a current or future effect on our financial        condition, changes in financial condition, revenues or expenses, results of operations,        liquidity, capital expenditures or capital resources that are material to        investors.

**Item 7A. Quantitative and Qualitative Disclosures        About Market Risk**

Not required.

26

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**Item 8. Financial Statements and Supplementary        Data**

**INDEX TO CONSOLIDATED FINANCIAL        STATEMENTS**

|                                                                                                                                                                                                              | **Page** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| **Consolidated Financial                    Statements**

Report of Stonefield                    Josephson, Inc., Independent Registered Public Accounting                    Firm      | 28       |
| Consolidated Balance Sheets as of                    December 31, 2007 and 2006                                                                                                     | 29       |
| Consolidated Statements of                    Operations                                                                                                                                 | 30       |
| Consolidated Statements of                    Cash Flows                                                                                                                                 | 31       |
| Consolidated Statements of                    Stockholders' Equity                                                                                                                       | 32       |
| Notes to Consolidated                    Financial Statements                                                                                                                            | 33       |

27

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING        FIRM**

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

We have audited the accompanying        consolidatedbalance sheets of        Alliance Fiber Optic Products, Inc. as of December 31, 2007 and 2006, and the        relatedconsolidatedstatements of operations, stockholders'        equity, and cash flows for each of thethreeyears in the period ended December 31,        2007. 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 in accordance with the standards of the Public Company Accounting        Oversight Board (United States). Those standards require that we plan and perform the audit        to obtain reasonable assurance about whether the financial statements are free of material        misstatement. We were not engaged to perform an audit of the Company's internal control        over financial reporting. Our audit included consideration of internal control over        financial reporting as a basis for designing audit procedures that are appropriate in the        circumstances, but not for the purpose of expressing an opinion on the effectiveness of the        Company's internal control over financial reporting. Accordingly, we express no such        opinion. An audit also 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, as well as evaluating the overall financial        statement presentation. We believe that our audits provide a reasonable basis for our        opinion.

In our opinion, theconsolidatedfinancial statements referred to above        present fairly, in all material respects, the financial position of Alliance Fiber Optic        Products, Inc. as of December 31, 2007 and 2006, and the results oftheiroperations andtheircash flows for each of thethreeyears in the period ended December 31,        2007 in conformity with accounting principles generally accepted in the United States of        America.

/s/Stonefield Josephson, Inc.                  Stonefield Josephson, Inc.        San Francisco, California        March 20, 2008

28

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

|                                                                                                                                 |                                         |          |
|---------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------|----------|
|                                                                                                                            | **December                        31,** |
| ** **                                                                                                                      | **2007**                                | **2006** |
| **Assets**                                                                                                                      |                                    |     |   |  |   |   |  |   |
| Current                    assets:                                                                                              |                                    |     |  |  |  |  |  |  |
|       Cash                    and cash equivalents                                                |                                    |     | $ | 4,945 |   | $ | 4,321 |   |
|       Short-term                    investments                                                   |                                    |     |   | 31,535 |   |   | 26,857 |   |
|       Accounts                    receivable, net                                                 |                                    |     |   | 5,393 |   |   | 4,009 |   |
|       Inventories                                                                                 |                                    |     |   | 5,003 |   |   | 4,465 |   |
|       Prepaid                    expense and other current assets                                 |                                    |     |   | 481 |   |   | 601 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    current assets                       |                                    |     |   | 47,357 |   |   | 40,253 |   |
| Property                    and equipment, net                                                                                  |                                    |     |   | 4,373 |   |   | 4,264 |   |
| Other                    assets                                                                                                 |                                    |     |   | 226 |   |   | 176 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    assets                               |                                    |     | $ | 51,956 |   | $ | 44,693 |   |
|                                                                                                                                 |                                         |          |  |  |
|                                                                                                                                 |                                         |          |
| **Liabilities and                    Stockholders' Equity**                                                                     |                                    |     |  |  |  |  |  |  |
| Current                    liabilities:                                                                                         |                                    |     |  |  |  |  |  |  |
|       Accounts                    payable                                                         |                                    |     | $ | 4,523 |   | $ | 2,950 |   |
|       Accrued                    expenses                                                         |                                    |     |   | 3,388 |   |   | 2,815 |   |
|       Current                    portion of bank loan                                             |                                    |     |   | 132 |   |   | 94 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    current liabilities                  |                                    |     |   | 8,043 |   |   | 5,859 |   |
| Long-term                    liabilities:                                                                                       |                                    |     |  |  |  |  |  |  |
|       Bank                    loan                                                                |                                    |     |   | 557 |   |   | 545 |   |
|       Other                    long-term liabilities                                              |                                    |     |   | 449 |   |   | 385 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    long term liabilities                |                                    |     |   | 1,006 |   |   | 930 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    liabilities                          |                                    |     |   | 9,049 |   |   | 6,789 |   |
|                                                                                                                                 |                                         |          |  |  |
| Commitments and                    contingencies (Note 10)                                                                      |                                    |     |   |  - |   |   |  - |   |
| Stockholders'                    equity                                                                                         |                                    |     |  |  |  |  |  |  |
|       Common                    stock, $0.001 par value: 250,000,000 shares authorized;           |                                    |     |   |   |   |   |   |   |
|       41,366,545                    and 40,540,128 shares issued and outstanding at               |                                    |     |  |  |  |  |  |  |
|        December                    31, 2007 and 2006, respectively                           |                                    |     |   | 41 |   |   | 41 |   |
|       Additional                    paid-in-capital                                               |                                    |     |   | 111,006 |   |   | 109,793 |   |
|       Accumulated                    deficit                                                      |                                    |     |   | (68,446 | ) |   | (71,809 | ) |
|       Accumulated                    other comprehensive income (loss)                            |                                    |     |   | 306 |  |   | (121 | ) |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    stockholders' equity                 |                                    |     |   | 42,907 |   |   | 37,904 |   |
|                                                                                                                                 |                                         |          |  |  |
|            Total                    liabilities and stockholders' equity |                                    |     | $ | 51,956 |   | $ | 44,693 |   |
|                                                                                                                                 |                                         |          |  |  |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

29

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

|                                                                                       |                                                     |          |          |
|---------------------------------------------------------------------------------------|-----------------------------------------------------|----------|----------|
| ** **                                                                            | **Years Ended                        December 31,** |
|                                                                                  | **2007**                                            | **2006** | **2005** |
| Revenues                                                                              |                                                |     | $        | 33,786 |   | $ | 26,792 |   | $ | 20,963 |   |
| Cost of                    revenues                                                   |                                                |     |     | 23,158 |   |   | 19,380 |   |   | 16,363 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
|                      Gross profit                                                |                                                |     |     | 10,628 |   |   | 7,412 |   |   | 4,600 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Operating                    expenses:                                                |                                                |     |          |  |  |  |  |  |  |  |  |
|   Research and                    development                               |                                                |     |     | 3,217 |   |   | 3,080 |   |   | 3,434 |   |
|   Sales and                    marketing                                    |                                                |     |     | 2,349 |   |   | 2,255 |   |   | 2,177 |   |
|   General and                    administrative                             |                                                |     |     | 3,457 |   |   | 3,077 |   |   | 3,009 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|        Total                    operating expenses |                                                |     |     | 9,023 |   |   | 8,412 |   |   | 8,620 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Income                    (loss) from operations                                      |                                                |     |     | 1,605 |  |   | (1,000 | ) |   | (4,020 | ) |
| Interest                    and other income, net                                     |                                                |     |     | 1,758 |   |   | 1,657 |   |   | 1,403 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Net income                    (loss)                                                  |                                                |     |     | 3.363 |  |   | 657 |  |   | (2,617 | ) |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Net income                    (loss) per share:                                       |                                                |     |          |  |  |  |  |  |  |  |  |
|    Basic                                                               |                                                |     | $        | 0.08 |  | $ | 0.02 |  | $ | (0.07 | ) |
|    Diluted                                                             |                                                |     | $        | 0.08 |  | $ | 0.01 |  | $ | (0.07 | ) |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Shares                    used in computing net income (loss) per share:              |                                                |     |          |  |  |  |  |  |  |  |  |
|    Basic                                                               |                                                |     |     | 40,897 |   |   | 40,118 |   |   | 39,330 |   |
|    Diluted                                                             |                                                |     |     | 44,720 |   |   | 44,914 |   |   | 39,330 |   |
|                                                                                       |                                                     |          |          |  |  |  |
|                                                                                       |                                                     |          |          |
| Included                    in costs and expenses above-                              |                                                |     |          |  |  |  |  |  |  |  |  |
| Stock                    based compensation charges:                                  |                                                |     |     |   |   |   |   |   |   |   |   |
|   Cost of                    revenues                                       |                                                |     | $        | 149 |   | $ | 109 |  | $ | - |  |
|   Research and                    development                               |                                                |     |     | 63 |   |   | 57 |   |   | - |   |
|   Sales and                    marketing                                    |                                                |     |     | 42 |   |   | 32 |   |   | - |   |
|   General and                    administrative                             |                                                |     |     | 144 |   |   | 100 |   |   | - |   |
|                                                                                       |                                                     |          |     |   |  |   |   |  |   |   |  |
|                                                                                       |                                                     |          | $        | 398 |  | $ | 298 |  | $ | - |  |
|                                                                                       |                                                     |          |     |   |  |   |   |  |   |   |  |
|                                                                                       |                                                     |          |          |

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

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

|                                                                                                                                                                        |                                                     |          |          |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|----------|----------|
|                                                                                                                                                                   | **Years Ended                        December 31,** |
|                                                                                                                                                                   | **2007**                                            | **2006** | **2005** |
|  **Cash flows                    from operating activities:**                                                                                                     |                                                |     |     |  |   |   |  |   |   |  |   |
|    Net                    income (loss)                                                                                                                 |                                                |     | $        | 3,363 |  | $ | 657 |  | $ | (2,617 | ) |
|    Adjustments                    to reconcile net income (loss) to net cash used                                                                       |                                                |     |          |  |  |  |  |  |  |  |  |
|       in                    operating activities:                                                                                        |                                                |     |          |  |  |  |  |  |  |  |  |
|       Depreciation                                                                                                                       |                                                |     |     | 1,157 |   |   | 1,288 |   |   | 1,599 |   |
|       Amortization                    of stock based compensation                                                                        |                                                |     |     | 398 |   |   | 298 |   |   | - |   |
|       Loss                    on disposal of property and equipment                                                                      |                                                |     |     | 54 |   |   | 72 |   |   | 77 |   |
|       Provision                    for inventory valuation                                                                               |                                                |     |     | (344 | ) |   | 698 |  |   | (140 | ) |
|       Credit                    (provision) for doubtful accounts and sales returns                                                      |                                                |     |     | (59 | ) |   | 83 |  |   | 30 |  |
|       Changes                    in assets and liabilities:                                                                              |                                                |     |          |  |  |  |  |  |  |  |  |
|          Accounts                    receivable                                                                           |                                                |     |     | (1,325 | ) |   | (522 | ) |   | (1,278 | ) |
|          Inventories                                                                                                      |                                                |     |     | (194 | ) |   | (1,493 | ) |   | 468 |  |
|          Prepaid                    expenses and other current assets                                                |                                                |     |     | 120 |  |   | 33 |   |   | 19 |   |
|          Other                    assets                                                                                  |                                                     |          |          | (50 | ) |  | (70 | ) |  | 15 |  |
|          Accounts                    payable                                                                              |                                                |     |     | 1,573 |   |   | 608 |   |   | 137 |   |
|          Accrued                    expense                                                                               |                                                |     |     | 573 |  |   | 460 |  |   | (82 | ) |
|          Other                    long-term liabilities                                                                   |                                                |     |     | 64 |  |   | 5 |  |   | (24 | ) |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|                 Net                    cash provided by (used in) operating activities |                                                |     |     | 5,330 |  |   | 2,117 |  |   | (1,796 | ) |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|  **Cash flows                    from investing activities:**                                                                                                     |                                                |     |          |  |  |  |  |  |  |  |  |
|    Purchase                    of short-term investments                                                                                                |                                                |     |     | (15,803 | ) |   | (10,693 | ) |   | (39,163 | ) |
|    Proceeds                    from sales and maturities of short-term investments                                                                      |                                                |     |     | 11,159 |   |   | 10,537 |   |   | 36,460 |   |
|    Purchase                    of property and equipment                                                                                                |                                                |     |     | (1,164 | ) |   | (964 | ) |   | (703 | ) |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|                                                                                                                                                                        |                                                     |          |          |
|                 Net                    cash used in investing activities               |                                                |     |     | (5,808 | ) |   | (1,120 | ) |   | (3,406 | )  |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|  **Cash flows                    from financing activities:**                                                                                                     |                                                |     |          |  |  |  |  |  |  |  |  |
|    Proceeds                    from issuance of common stock under ESPP                                                                                 |                                                |     |     | 543 |   |   | 423 |   |   | 378 |   |
|    Proceeds                    from the exercise of common stock options                                                                                |                                                |     |     | 272 |   |   | 206 |   |   | 84 |   |
|    Proceeds                    from bank borrowings                                                                                                     |                                                |     |     | 150 |   |   | 150 |   |   | 172 |   |
|    Repayment                    of bank borrowings                                                                                                      |                                                |     |     | (117 | ) |   | (72 | ) |   | (51 | )  |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|                 Net                    cash provided by financing activities           |                                                |     |     | 848 |   |   | 707 |   |   | 583 |   |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|  Effect of exchange                    rate changes on cash and cash equivalents                                                                                  |                                                |     |     | 254 |  |   | (97 | ) |   | (166 | ) |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|  Net                    increase (decrease) in cash and cash equivalents                                                                                          |                                                |     |     | 624 |  |   | 1,607 |  |   | (4,785 | ) |
|  Cash                    and cash equivalents at beginning of year                                                                                                |                                                |     |     | 4,321 |   |   | 2,714 |   |   | 7,499 |   |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |
|  Cash                    and cash equivalents at end of year                                                                                                      |                                                |     | $        | 4,945 |   | $ | 4,321 |   | $ | 2,714 |   |
|                                                                                                                                                                        |                                                     |          |          |  |  |  |

 

**        **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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        Stockholder' Equity(in thousands)

|                                                              | Common Stock                    Shares          Amount | Additional                    Paid-in                    Capital | Receivables                    From                    Stockholders | Deferred                    Stock-based                    Compensation | Accumulated                    Deficit | Accumulated                    Other                    Comprehensive                    income (loss) | Total  | Comprehensive                    Income/(Loss) |
|-------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|------------------------------------------------------------------|---------------------------------------------------------------------|-------------------------------------------------------------------------|----------------------------------------|--------------------------------------------------------------------------------------------------------|--------|------------------------------------------------|
| **Balance at December                    31, 2004**               |                                                                                                     |                                                             |                                                                | 38,999                                                                  |                                   | $                                                                                                      | 39     |                                           | $ | 108,406 |   | $ |   |   | $ |   |   | $ | (69,849 | ) | $ | 46 |   | $ | 38,642 |   |   |   |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |
| Issuance of common                    stock                       |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   upon exercise                    of options           |                                                                                                     |                                                             |                                                                | 159                                                                     |                                   |                                                                                                   | --     |                                           |   | 84 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 84 |   |   |
| Issuance of                    common stock upon                  |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|   purchase of                    ESPP                   |                                                                                                     |                                                             |                                                                | 561                                                                     |                                   |                                                                                                   | 1      |                                           |   | 377 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 378 |   |   |   |   |
| Comprehensive                    loss:                            |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   Net loss for                    the year              |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | (2,617 | ) |   | -- |   |   | (2,617 | ) | $ | (2,617 | ) |
|   Unrealized gain                    on            |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|     short-term                    investments |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 33 |   |   | 33 |   |   | 33 |   |
|  Currency translation                    adjustments         |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | (199 | ) |   | (199 | ) |   | (199 | ) |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|    Comprehensive                    loss           |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   | $ | (2,783 | ) |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |
| **Balance at December                    31, 2005**               |                                                                                                     |                                                             |                                                                | 39,719                                                                  |                                   | $                                                                                                      | 40     |                                           | $ | 108,867 |   | $ | -- |   | $ | -- |   | $ | (72,466 | ) | $ | (120 | ) | $ | 36,321 |   |   |   |   |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |
| Issuance of                    common stock                       |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   upon exercise                    of options           |                                                                                                     |                                                             |                                                                | 287                                                                     |                                   |                                                                                                   | --     |                                           |   | 206 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 206 |   |   |
| Issuance of                    common stock upon                  |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    purchase                    of ESPP             |                                                                                                     |                                                             |                                                                | 534                                                                     |                                   |                                                                                                   | 1      |                                           |   | 422 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 423 |   |   |   |   |
| Deferred stock-based compensation                                 |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | 298 |   |   | -- |   |   | -- |   |   | 298 |   |   |   |   |
| Comprehensive                    loss:                            |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   Net loss for                    the year              |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | 657 |   |   | -- |   |   | 657 |   | $ | 657 |   |
|   Unrealized gain                    on                 |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|     short-term                    investments |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 8 |   |   | 8 |   |   | 8 |   |
|  Currency translation                    adjustments         |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | (9 | ) |   | (9 | ) |   | (9 | ) |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|    Comprehensive                    income         |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   | $ | 656 |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |
| **Balance at December                    31, 2006**               |                                                                                                     |                                                             |                                                                | 40,540                                                                  |                                   | $                                                                                                      | 41     |                                           | $ | 109,495 |   | $ | - |   | $ | 298 |   | $ | (71,809 | ) | $ | (121 | ) | $ | 37,904 |   |   |   |   |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
| Issuance of                    common stock                       |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   upon exercise                    of options           |                                                                                                     |                                                             |                                                                | 382                                                                     |                                   |                                                                                                   | --     |                                           |   | 272 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 272 |   |   |
| Issuance of                    common stock upon                  |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|    purchase                    of ESPP             |                                                                                                     |                                                             |                                                                | 445                                                                     |                                   |                                                                                                   | --     |                                           |   | 543 |   |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 543 |   |   |   |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |
| Deferred                    stock-based compensation              |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | 398 |   |   | -- |   |   | -- |   |   | 398 |   |   |   |   |
| Comprehensive income                    :                         |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|   Net income for                    the year            |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | 3,363 |   |   | -- |   |   | 3,363 |   | $ | 3,363 |   |
|   Unrealized gain                    on                 |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |   |
|     short-term                    investments |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 34 |   |   | 34 |   |   | 34 |   |
|  Currency translation                    adjustments         |                                                                                                     |                                                             |                                                                | --                                                                      |                                   |                                                                                                   | --     |                                           |   | -- |   |   | -- |   |   | -- |   |   | -- |   |   | 393 |   |   | 393 |   |   | 393 |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|    Comprehensive                    income         |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   | $ | 3,790 |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |  |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |
| **Balance at December                    31, 2007**               |                                                                                                     |                                                             |                                                                | 41,367                                                                  |                                   | $                                                                                                      | 41     |                                           | $ | 110,310 |   | $ | -- |   | $ | 696 |   | $ | (68,446 | ) | $ | 306 |   | $ | 42,907 |   |   |   |   |
|                                                              |                                                                                                          |                                                                  |                                                                     |                                                                         |                                        |                                                                                                        |        |                                                |   |
|                                                              |                                                                                                     |                                                             |                                                                |                                                                    |                                   |                                                                                                   |   |                                           |   |   |

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

32

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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. Significant estimates involve those required in the assessment of allowance for        sales returns, doubtful accounts and/or potential excess obsolete inventory. 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 through 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 short-term investments**

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, 2007 and 2006, 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.

**Fair****v****alue        of****f****inancial****i****nstruments**

The carrying value of the Company's cash and cash        equivalents, accounts receivable, accounts payable,debt and foreign exchange contractsapproximate fair value due to the relatively short        period of time to maturity.

33

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**Allowance for****d****oubtful****a****ccounts**

The Company performs credit evaluations of customers'        financial condition. The Company maintains allowances for doubtful accounts for estimated        losses resulting from the inability or unwillingness of customers to make required        payments. When the Company becomes aware that a specific customer is unable to meet its        financial obligations, for example, as a result of bankruptcy or deterioration in the        customer's operating results or financial position, the Company records a specific        allowance to reflect the level of credit risk in the customer's outstanding receivable        balance. In addition, the Company records additional allowances based on certain        percentages of aged receivable balances. These percentages are determined by a variety of        factors including, but not limited to, current economic trends, historical payment and bad        debt write-off experience. The Company is not able to predict changes in the financial        condition of customers, and if circumstances related to customers deteriorate, estimates of        the recoverability of trade receivables could be materially affected and the Company may be        required to record additional allowances. Alternatively, if the Company provides more        allowances than the Company needs, the Company may reverse a portion of such provisions in        future periods based on actual collection experience.

**Inventories**

Inventories are stated at the lower of cost or market,        with cost being determined using standard cost, which approximates actual cost on a        first-in, first-out basis. Market value is determined as the lower of replacement cost or        net realizable value. Provisions are made for excess and obsolete inventory based on        historical usage and management's estimates of future demand. Inventory reserves, once        established, are only reversed upon sale or disposition of related inventory.

**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. Depreciation and amortization        expense was $1.2 million in 2007, $1.3 million in 2006 and $1.6 million in 2005.

**Revenue recognition**

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

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

**Shipping and handling expenses**

Shipping and handling expenses are included in        cost of revenue.

**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.

34

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**Sales taxes**

The Companyaccountsfor        taxes charged to our customers and collected on behalf of the taxing authorities and        recognizerevenue on the saleson a net basis.

**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 files income tax returns in the U.S. federal jurisdiction, and various state        and foreign jurisdictions. The Company is no longer subject to U.S. federal, state and        local, or non-U.S. income tax examinations by tax authorities for years before 2003. The        Company is currently not under any examinations by nor has received notices of examination        from tax authorities.

The Company adopted the provisions of FASB        Interpretation No. 48,"Accounting for        Uncertainty inIncome Taxes" ("FIN48"),on        January 1, 2007. As a result of the implementation ofFIN48, the        Company recognized no increase in the liability for unrecognized tax benefits. A        reconciliation of the beginning and ending amount of unrecognized tax benefit is as        follows:

|                                                                         |        |
|-------------------------------------------------------------------------|--------|
|                                                                         |        |  |  | (thousands) |  |
| Balance at January 1,                2007                               |   |   | $ | - |   |
| Additions                based on tax positions related to current year |   |   |   | - |   |
| Additions for                tax positions of prior years               |   |   |   | - |   |
| Reductions for tax                positions of prior years         |   |   |   | - |   |
| PenSettlements                                                          |   |   |   | - |  |
|                                                                         |        |  |
| Balance at                December 31, 2007                             |   |   | $ | - |   |
|                                                                         |        |

**Stock-based compensation**

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

Prior to January 1, 2006, the Company accounted for        stock-based compensation arrangements in accordance with the provisions of Accounting        Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees".        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 andthe Emerging Issue Task Force ("EITF")Issue No. 96-18, which require the award to be recorded        at its fair value. See Note 2 to the Consolidated Financial Statement for a further        discussion on stock-based compensation.

**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) consists of cumulative translation adjustments and unrealized        gain (loss) on short-term investments and is disclosed in the consolidated statements of        stockholders' equity.

35

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**Recent****a****ccounting****p****ronouncements**

In June 2007, theFinancial Accounting Standards Board        ("FASB")ratified EITF Issue No.        07-3,"Accounting for        Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and        Development Activities"(EITF        07-3).EITF 07-3 requires        non-refundable advance payments for goods and services to be used in future research and        development (R&D) activities to be recorded as assets and the payments to be expensed        when the R&D activities are performed. EITF 07-3 applies prospectively for new        contractual arrangements entered into beginning in the first quarter of fiscal year 2008.        The Company is currently evaluating the impact of EITF 07-3, but does not expect the        adoption of EITF 07-3 to have a material impact on its consolidated financial        position, results of operations or cash flows.

         

In February 2007, the FASB issued SFAS No. 159, "The        Fair Value Option for Financial Assets and Financial Liabilities(SFAS159)".        SFAS159 permits entities to elect to measure        many financial instruments and certain other items at fair value that are not currently        required to be measured at fair value. This election is irrevocable. SFAS 159 will be        effective for the Company on January 1, 2008. The Company is currently assessing the        potential impact that the adoption of SFAS 159 will have on its financial        statements.

In September 2006, the FASB issued SFAS No. 157, "Fair        Value Measurements" (SFAS 157), which defines fair value, establishes guidelines for        measuring fair value and expands disclosures regarding fair value measurements. SFAS 157        does not require any new fair value measurements but rather eliminates inconsistencies in        guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal        years beginning after November 15, 2007. Earlier adoption is permitted, provided the        Company has not yet issued financial statements, including for interim periods, for that        fiscal year. The Company is currently evaluating the impact of SFAS 157, but does not        expect the adoption of SFAS 157 to have a material impact on its consolidated financial        position, results of operations or cash flows.

In July 2006, the FASB issued FIN 48 ¡X an        interpretation of FASB No. 109, "Accounting for Income Taxes." FIN 48 prescribes a        comprehensive model for recognizing, measuring, presenting and disclosing in the financial        statements tax positions taken or expected to be taken on a tax return, including a        decision on whether or not to file in a particular jurisdiction. FIN 48 clarifies the        accounting for uncertainty in income taxes recognized in an enterprise's financial        statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." The        provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this        standard. Only tax positions that meet a "more-likely-than-not" recognition threshold at        the effective date may be recognized orcontinue to be recognized upon adoption        of FIN 48.The Company adopted the        provisions ofFIN48on January        1, 2007. As a result of the implementation of Interpretation 48, the Company recognized no        increase in the liability for unrecognized tax benefits.

In June 2006, EITF        issued EITF issue No.06-03, "How Taxes Collected from Customers and Remitted to        Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus        Net Presentation)" (EITF 06-03). EITF 06-03 provides guidance regarding accounting for        certain taxes assessed by a governmental authority that are imposed on a revenue-producing        transactions between a seller and a customer. These taxes may include, but are not limited        to, sales, use, value added, and some excise taxes. The Company has historically presented        and plans to continue to present on a net basis in the accompanying Consolidated Statement        of Operations and record as a liability until amounts are remitted to the respective taxing        authority. EITF 06-3 is effective for interim and annual reporting periods beginning after        December 15, 2006, with earlier application permitted. The Company adopted EITF 06-3        effective January 1, 2007. Adoption of this issue had no effect on the consolidated        financial statements and related disclosures.

         

**2. Stock-based compensation**

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

36

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

The Company adopted the modified        prospective transition method provided for under Statement No. 123(R) and, accordingly, has        not restated prior period amounts. Under this transition method, compensation expense for        the year ended December 31, 2007 includes compensation expense for all SBP awards granted        prior to, but not yet vested as of, January 1, 2006 based on the grant date fair value        estimated in accordance with the original provisions of Statement No. 123. Stock-based        compensation expense for all SBP awards granted after January 1, 2006 is based on the        grant date fair value estimated in accordance with the provisions of Statement        No. 123(R). Stock-based compensation expense includes an estimate for forfeitures and        is recognized over the expected term of the award on a straight-line basis. The Company        evaluated the need to record a cumulative effect adjustment relating to estimated        forfeitures for unvested previously issued awards, and the impact was not deemed to be        material.

**As a result of adopting Statement        No. 123(R), on January 1, 2006, the Company's income before income tax and net income        for the year ended December 31, 2007 was $3.4 million, or $0.4 million lower than if it had        continued to account for share-based compensation under APB Opinion 25. The adoption of        Statement No. 123(R) did not impact basic and diluted income and loss per share for the        year ended December 31, 2007.**

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

As of December 31, 2007, there was $0.6        million of total unrecognized compensation cost related to non-vested share-based        compensation arrangements granted under the Company's various option plans. The cost is        expected to be recognized over a period of 2 years.

The following table presents the        Company's pro forma net income and basic and diluted net income per share for the year        ended December 31, 2005 had compensation expense been determined in accordance with the        fair value method of accounting at the grant dates for awards under the Company's various        stock-based compensation plans:

         

|                                                                                                                      |                                                     |        |
|----------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|--------|
|                                                                                                                      | ** **                                          |        |  |
|                                                                                                                      | **Year Ended December 31,                    2005** |        |  |
| Net loss as                reported                                                                                  |                                                |   | $ | (2,617 | ) |  |  |  |  |
|                                                                                                                      |                                                     |        |  |
| Add:                Stock-based employee compensation expense included                                               |                                                |   |  |  |  |  |  |  |  |
|     in                reported net loss                                                          |                                                |   |   | - |   |   |  |   |  |
| Deduct: Total                stock-based employee compensation expense                                               |                                                |   |  |  |  |  |  |  |  |
|     determined                under fair value based method for all awards, net of related taxes |                                                |   |   | (796 | ) |   |  |  |  |
|                                                                                                                      |                                                     |        |  |  |
| Pro forma net                loss                                                                                    |                                                |   | $ | (3,413 | ) |  |  |  |  |
|                                                                                                                      |                                                     |        |  |  |
| Net loss per                share                                                                                    |                                                |   |  |  |  |  |  |  |  |
|      Basic                and Diluted - as reported                                         |                                                |   | $ | (0.07 | ) |  |  |  |  |
|      Basic                and Diluted - pro forma                                           |                                                |   | $ | (0.09 | ) |  |  |  |  |
| Shares used in                EPS calculation (basic and diluted)                                                    |                                                |   |   | 39,330 |   |   |

37

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**For the year ended December 31, 2005,        the fair value ofstock-basedplanawards was estimated using the        Black-Scholes valuation model, with the following weighted-average assumptions and fair        values as follows:**

|                                                               | **Year Ended December 31,                    2005** |        |
|---------------------------------------------------------------|-----------------------------------------------------|--------|
| Volatility                (percent)*                          |                                                |   |  |  | 46.2 |  |  |  |
|                                                               |                                                     |        |
| Expected term                (in years)**                     |                                                |   |   |  |  4 |   |  |   |
|                                                               |                                                     |        |
| Risk-free                interest rate (precent)***           |                                                |   |   |  |  4.40 |   |  |   |
|                                                               |                                                     |        |
| Expected                dividend rate (precent)               |                                                |   |   |  |  - |   |  |   |
|                                                               |                                                     |        |
| Weighted-average fair value per                option granted |                                                |   | $ |  |  0.90 |

         

         

         

         

         

         

         

         

         

         

         

         

         

*Volatility is measured using historical        daily price changes of the Company's common stock over the expected life of the option                  ** The expected term represents the weighted average period the option is expected to be        outstanding and is based primarily on the historical exercise behavior of employees.                  *** The risk free interest rate is based on the U.S. Treasury zero-coupon yield with a        maturity that approximates the expected life of the option.         

For the year ended December 31, 2007        and 2006, the fair value ofstock-basedplanawards was estimated using the Binomial        Lattice valuation model, with the following weighted-average assumptions and fair values as        follows:

|                                                               |                                                 |          |        |
|---------------------------------------------------------------|-------------------------------------------------|----------|--------|
|                                                               | **Years Ended December                    31,** |
|                                                               | **2007**                                        | **2006** |
| Volatility                (percent)*                          |                                            |     | $      | 37.7 |  | $ |  | 36.7 |
|                                                               |                                                 |          |
| Expected term                (in years)**                     |                                            |     |   | 4 |   |   |  |  4 |
|                                                               |                                                 |          |
| Risk-free                interest rate (precent)***           |                                            |     |   | 3.52 |   |   |  |  4.60 |
|                                                               |                                                 |          |
| Expected                dividend rate (precent)               |                                            |     |   | - |   |   |  | - |
|                                                               |                                                 |          |
| Forfeiture rate (percent)****                                 |                                                 |          |        | 6 |  |  |  | 10 |
|                                                               |                                                 |          |        |  |  |  |  |  |
| Weighted-average fair value per                option granted |                                            |     | $      | 1.34 |   | $ |  | 1.28 |

         

* Volatility is projected using        Industry Analysis forecasts for earnings, earnings per share, and stock price, and the        Company's earning forecast.                  ** The expected term represents the weighted average period the option is expected to be        outstanding and is based primarily on the historical exercise behavior of employees.                  *** The risk free interest rate is based on the U.S. Treasury zero-coupon yield with a        maturity that approximates the expected life of the option.                  **** Forfeiture rate is the estimated percentage of options forfeited by employees by        leaving or being terminated before vesting.         

        At December 31, 2007, the Company had two stock-based compensation plans. They are: (a)        1997 Stock Option Plan and (b) 2000 Stock Incentive Plan, which are described below.

38

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

(a) 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.**

(b) 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. 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.        The Board of Directors determined not to increase the number of shares available under the        Plan on January 1, 2007 and 2006, respectively. Incentive stock options and nonstatutory        stock options are granted at 100% of the fair market value of the Company's common stock on        the date of grant.

Options granted under the 2000 Stock        Incentive Plan generally vest over four years and are exercisable for not more than ten        years.

The following information relates to        the stock option activity for the year ended December 31, 2007:

|                                                                             |        |        |
|-----------------------------------------------------------------------------|--------|--------|
||
||
|   Outstanding at                December 31, 2006                 |   |   | 5,046,083 | $ | 1.24 |   |   |   |   |
|   Granted                                                         |   |   | 375,500 |   | 2.13 |   |   |   |   |
|   Exercised                                                       |   |   | (381,625) |   | 0.71 |   |   |   |   |
|   Forfeited                                                       |   |   | (72,500) |   | 1.54 |   |   |   |   |
|   Outstanding at                December 31, 2007                 |   |   | 4,967,458  | $ | 1.34 |   | 6.5 Years | $ | 3,884,493  |
|   Vested and expected                to vest at December 31, 2007 |   |   | 4,894,338  | $ | 1.34 |   | 6.5 Years | $ | 3,832,260  |
|   Exercisable at                December 31, 2007                 |   |   | 4,465,772 | $ | 1.34 |   | 6.3 Years | $ | 3,562,414  |

39

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

The following information relates to        the stock option activity for the year ended December 31, 2006:

|                                                                             | Year Ended                    December 31, 2006 |
|-----------------------------------------------------------------------------|-------------------------------------------------|
||
|   Outstanding at                December 31, 2005                 |                                            |   | 4,840,383 | $ | 1.12 |   |   |   |   |
|   Granted                                                         |                                            |   | 640,000 |   | 1.91 |   |   |   |   |
|   Exercised                                                       |                                            |   | (286,600) |   | 0.72 |   |   |   |   |
|   Forfeited                                                       |                                            |   | (147,700) |   | 1.14 |   |   |   |   |
|   Outstanding at                December 31, 2006                 |                                            |   | 5,046,083 | $ | 1.24 |   | 7.2 Years | $ | 4,033,478 |
|   Vested and expected                to vest at December 31, 2006 |                                            |   | 4,989,357 | $ | 1.24 |   | 7.2 Years | $ | 3,971,513 |
|   Exercisable at                December 31, 2006                 |                                            |   | 4,478,825 | $ | 1.28 |   | 7.0 Years | $ | 3,413,824 |

**The aggregate intrinsic value in the        table above represents the total pre-tax intrinsic value (the difference between the        Company's closing stock price on the last trading day of the fourth quarter of fiscal 2007        and 2006 and the exercise price, multiplied by the number of in-the-money options) that        would have been received by the option holders had all option holders exercised their        options on December 31, 2007 and 2006. This amount changes based on the fair market value        of the Company's stock. The total intrinsic value of options exercised for the year ended        December 31, 2007 and 2006 was $470,000 and $348,000, respectively.**

        The expected dividend rate is 0% for years ended December 31, 2007 and 2006,        respectively.

**Cash received from option exercises        during the year ended December 31, 2007 and 2006 was $272,000 and $206,000, respectively,        and is included within the financing activities section in the accompanying consolidated        statements of cash flows.**

Information relating to stock options outstanding at        December 31, 2007 is as follows:

| Options Outstanding                   |                   | Options Exercisable                       |        |
|---------------------------------------|-------------------|-------------------------------------------|--------|
| **Exercise                    Price** |                   | **Number                    Outstanding** |        | **Weighted                    Average                    Remaining                    Contractual                    Life (in Years)** |  | **Weighted                    Average                    Exercise                    Price** |  | **Number                    Exercisable** |  | **Weighted                    Average                    Exercise                    Price** |  |
| $                                     | 0.20 - $0.86      |                                      |   | 1,027,025 |   |   | 4.29 |  | $ | 0.75 |   |   | 1,002,725 |   | $ | 0.75 |   |
| $                                     | 0.90 - $0.90      |                                      |   | 964,050 |   |   | 7.83 |  | $ | 0.90 |   |   | 791,850 |   | $ | 0.90 |   |
| $                                     | 0.91 - $0.96 |                                      |   | 1,083,800 |   |   | 6.44 |  | $ | 0.94 |   |   | 1,006,200 |   | $ | 0.94 |   |
| $                                     | 1.00 - $2.02      |                                      |   | 1,388,250 |   |   | 7.35 |  | $ | 1.78 |   |   | 1,255,666 |   | $ | 1.77 |   |
| $                                     | 2.10 - $5.75 |                                      |   | 476,333 |   |   | 6.52 |  | $ | 2.87 |   |   | 381,331 |   | $ | 3.02 |   |
| $                                     | 6.38 - $6.38 |                                      |        | 28,000  |   |   | 3.03  |  | $ | 6.38 |   |  | 28,000 |   | $ | 6.38 |   |
|                                       |                   |                                           |        |   |  |  |  |  |  |  |  |  |   |  |  |  |  |
|                                  |              |                                           |        | 4,967,458  |   |   | 6.51  |  | $ | 1.34 |   |  | 4,465,772 |   | $ | 1.34 |   |
|                                       |                   |                                           |        |   |  |  |  |  |  |  |  |  |   |  |  |  |  |

Options exercisable as of December 31, 2007, 2006, and        2005 were 4,465,772, 4,478,825, and4,338,221 at        an average exercise price of $1.34, $1.28, and $1.14 per share, respectively.

40

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**Accelerated Vesting of Options**

On December 30, 2005, the Board of Directors of the        Company approved accelerating the vesting of all the currently unvested stock options        awarded to employees at the director level and above, including executive officers. The        unvested options to purchase up to approximately 1.9 million additional shares became        immediately exercisable as a result of the vesting acceleration. Typically, stock options        granted by the Company vest over a four year period. The number of shares and exercise        prices of the options subject to the acceleration remain unchanged. No additional        compensation expense was taken based on historical employee turnover rates and        forfeitures.

The purpose of the accelerated vesting was to enable the        Company to avoid recognizing in its statement of operations non-cash compensation expense        associated with these options in future periods, upon the expected implementation of FASB        Statement of Financial Accounting Standards No. 123 (Revised 2004), "Share-Based Payment"        in January 2006. As a result of the acceleration, the Company expects to avoid recognition        of up to approximately $1.5 million of compensation expense over the course of the original        vesting periods. Approximately $0.7 million and $0.4 million of such compensation expenses        were avoided in 2007 and 2006, respectively.

**Restrictions have been imposed upon the sale of any        shares received through the exercise of acceleration options, which restrictions will        prevent the sale of any shares received from the exercise of an accelerated option prior to        the original vesting date of the option. This restriction does not affect the fair value of        the options at the grant date.**

        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 444,792,534,177 and 560,780 shares were issued under the Plan in        2007, 2006, and 2005, respectively.

The following information relates to the        Plan:

|                                                                                                               |        |
|---------------------------------------------------------------------------------------------------------------|--------|
|                     Weighted average fair value per share of shares purchased             |   |   | $ | 1.22 |   |
|      Total                compensatin expense for ESPP                               |   |   | $ | 202,140 |   |
|      Total                amount of cash received from the purchase of stock through ESPP |   |   | $ | 543,648 |   |
|      Total                intrinsic value of ESPP stock purchased as December 31, 2007    |   |   | $ | 426,089 |   |

There were 355,529 shares available for future        issuance under the Employee Stock Purchase Plan as of December 31, 2007.

41

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**3. Net income/(loss) per share**

Basic net income/(loss) per share is computed by        dividing net income/(loss) for the period by the weighted average number of shares of        common stock outstanding during the period. Diluted net income/(loss) per share is computed        by dividing the net loss for the period by the combination of dilutive common share        equivalents, comprised of shares issuable under the Company's stock-based compensation        plans, and the weighted average number of common shares outstanding during the period.        There were no incremental dilutive common share equivalents in the periods        presented.

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

|                                                                                                        | Years Ended December                    31, |        |
|--------------------------------------------------------------------------------------------------------|---------------------------------------------|--------|
|                                                                                                        | **2007**                                    |        | **2006** |  | **2005** |  |
| Numerator:                                                                                             |                                        |   |   |  |   |   |  |   |   |  |   |
|   Net income (loss)                attributable to common stockholders                       |                                        |   | $ | 3,363 |  | $ | 657 |  | $ | (2,617 | ) |
|                                                                                                        |                                             |        |  |  |  |  |
| Denominator:                                                                                           |                                        |   |  |  |  |  |  |  |  |  |  |
|   Shares used in                computing net income (loss) per share:             |                                        |   |  |  |  |  |  |  |  |  |  |
|        Weighted                average of common shares outstanding |                                        |   |   |  |   |   |  |   |   |  |   |
|        Basic                                                        |                                             |        |  | 40,897 |  |  | 40,118 |  |  | 39,330 |  |
|                                                                                                        |                                        |        |   |  |   |  |
|        Diluted                                                      |                                        |   |   | 44,720 |   |   | 44,914 |   |   | 39,330 |   |
|                                                                                                        |                                             |        |  |  |  |  |
|                                                                                                        |                                             |        |  |
| Net income                (loss) per share attributable to common stockholders:                        |                                        |   |  |  |  |  |  |  |  |  |  |
|        Basic                                                        |                                        |   | $ | 0.08 |  | $ | 0.02 |  | $ | (0.07 | ) |
|                                                                                                        |                                             |        |   |   |  |   |   |  |   |   |  |
|        Diluted                                                      |                                        |   | $ | 0.08 |  | $ | 0.01 |  | $ | (0.07 | ) |
|                                                                                                        |                                             |        |  |  |  |  |
|                                                                                                        |                                             |        |  |

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

|                                                              | Years Ended December                    31, |        |
|--------------------------------------------------------------|---------------------------------------------|--------|
|                                                              | **2007**                                    |        | **2006** |  | **2005** |  |
| Options to purchase common                stock and shares   |                                        |   |   |  |   |   |  |   |   |  |   |
|     subject                to repurchase |                                        |   |   | 3,823 |   |   | 4,796 |   |   | 4,840 |   |
|                                                              |                                             |        |  |  |  |  |
|                                                              |                                             |        |  |

42

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**4. Balance Sheet Components****(in thousands)**

|                                                                                     | December 31, |
|------------------------------------------------------------------------------------------|--------------|
|                                                                                     | **2007**     | **2006** |
| **Cash and cash                equivalents:**                                            |         |   |   |  |   |   |  |   |
|    Cash                                                                   |         |   | $ | 4,042 |   | $ | 3,276 |   |
|    Money market                instruments and funds                      |         |   |   | 903 |   |   | 1,045 |   |
|                                                                                          |              |  |  |  |
|                                                                                     |         |   | $ | 4,945 |   | $ | 4,321 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Accounts                receivable, net:**                                             |         |   |
|    Accounts                receivable                                     |         |   | $ | 5,556 |   | $ | 4,231 |   |
|    Less:                Allowance for doubtful accounts and sales returns |         |   |   | (163 | ) |   | (222 | ) |
|                                                                                          |              |  |  |  |
|                                                                                     |         |   | $ | 5,393 |   | $ | 4,009 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Allowance                for doubtful accounts and sales returns:**                    |         |   |
|    Balance at                beginning of year                            |         |   | $ | 222 |   | $ | 146 |   |
|    Change                                                                 |         |   |   | (42 | ) |   | 83 |  |
|    Utilized                                                               |         |   |   | (17 | ) |   | (7 | ) |
|                                                                                          |              |  |  |  |
|    Balance at                end of year                                  |         |   | $ | 163 |   | $ | 222 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Inventories:**                                                                         |         |   |
|    Finished                goods                                          |         |   | $ | 1,599 |   | $ | 1,415 |   |
|    Work-in-process                                                        |         |   |   | 1,877 |   |   | 1,751 |   |
|    Raw                materials                                           |         |   |   | 1,527 |   |   | 1,299 |   |
|                                                                                          |              |  |  |  |
|                                                                                     |         |   | $ | 5,003 |   | $ | 4,465 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Accrued                expenses:**                                                     |         |   |
|    Compensation                costs                                      |         |   | $ | 1,872 |   | $ | 1,483 |   |
|    Professional                fees                                       |         |   |   | 622 |   |   | 421 |   |
|    Outside                commission                                      |         |   |   | 90 |   |   | 79 |   |
|    Royalties                                                              |         |   |   | 127 |   |   | 57 |   |
|    ESPP                                                                   |         |   |   | 106 |   |   | 124 |   |
|    Deferred                rent                                           |         |   |   | 130 |   |   | 158 |   |
|    Warranty                                                               |         |   |   | 48 |   |   | 57 |   |
|    Operating                related (Taiwan and China)                    |         |   |   | 275 |   |   | 229 |   |
|    Others                                                                 |         |   |   | 118 |   |   | 207 |   |
|                                                                                          |              |  |  |  |
|                                                                                     |         |   | $ | 3,388 |   | $ | 2,815 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Other                long-term liabilities:**                                          |         |   |
|    Accrued                pension liability (Taiwan)                      |         |   | $ | 411 |   | $ | 369 |   |
|    Other                liabilities                                       |         |   |   | 38 |   |   | 16 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
|                                                                                     |         |   | $ | 449 |   | $ | 385 |   |
|                                                                                          |              |  |  |  |
|                                                                                          |              |  |
| **Accumulated                other comprehensive income/(loss):**                        |         |   |
|    Cumulative                translation adjustments                      |         |   | $ | 292 |  | $ | (101 | ) |
|    Unrealized                gain (loss) on short-term investments        |         |   |   | 14 |  |   | (20 | ) |
|                                                                                          |              |  |  |  |
|                                                                                     |         |   | $ | 306 |  | $ | (121 | ) |
|                                                                                          |              |  |  |

43

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

**5. Marketable        Securities**

|                                                            | **December 31,                2007**             | **December 31,                2006**                              |
|------------------------------------------------------------|--------------------------------------------------|-------------------------------------------------------------------|
|                                                            |                                                  |                                                                   |
|                                                            | **Available-for-Sale                Securities** | **Available-for-Sale                Securities**                  |
|                                                            |                                                  |                                                                   |
| (in thousands)                                             | **Cost**                                         | **Gross                    Unrealized                    Losses** | **Fair Value** | **Cost** | **Gross                    Unrealized                    Losses** | **Fair Value** |
| Money market funds                                         |                                             |                                                              | $ | 903 |   | $ | -- |   | $ | 903 |   | $ | 1,045 |   | $ | -- |   | $ | 1.045 |   |
| Auction rate                securities                     |                                             |                                                              |   | 16,150 |   |   | -- |   |   | 16,150 |   |   | 7,800 |   |   | -- |   |   | 7,800 |   |
| US Treasury                and Federal                     |                                             |                                                              |  |  |
|    Agency                Securities         |                                             |                                                              |   | - |   |   |  |  |   | - |   |   | 500 |   |   | - |  |   | 500 |   |
| Corporate                bonds                             |                                             |                                                              |   | 15,371 |   |   | 14 |  |   | 15,385 |   |   | 18,577 |   |   | (20 | ) |   | 18,557 |   |
|                                                            |                                                  |                                                                   |  |  |  |  |  |  |  |  |  |  |
| Total                available-for-sale securities         |                                             |                                                              | $ | 32,424 |   | $ | 14 |  | $ | 32,438 |   | $ | 27,922 |   | $ | (20 | ) | $ | 27,902 |   |
|                                                       |                                             |                                                              |  |  |  |  |  |  |  |  |  |  |  |  |
| Included                in:                                |                                             |                                                              |
|    Cash and cash                equivalents |                                             |                                                              |  |  | $ | 903 |   |  |  | $ | 1,045 |   |
|    Short-term                investments    |                                             |                                                              |  |  |   | 31,535 |   |  |  |   | 26,857 |   |
|                                                            |                                                  |                                                                   |  |  |  |  |  |  |
|    Total                                    |                                             |                                                              |  |  | $ | 32,438 |   |  |  | $ | 27,902 |   |
|                                                            |                                                  |                                                                   |  |  |  |  |  |

Approximately $0.4 million of the short term investments        above are pledged as collateral for a stand-by letter of credit issued by a commercial        bank.

**6. Property and Equipment,        Net**

|                                              | December 31, |
|---------------------------------------------------|--------------|
| (in thousands)                                    | **2007**     | **2006** |
| Machinery and                equipment            |         |   | $ | 9,116 |   | $ | 8,964 |   |
| Furniture and                fixtures             |         |   |   | 469 |   |   | 447 |   |
| Leasehold                improvements             |         |   |   | 811 |   |   | 767 |   |
| Building and                equipment prepayments |         |   |   | 972 |   |   | 1,214 |   |
|                                                   |              |  |  |  |
|                                              |         |   | $ | 11,368 |   | $ | 11,392 |   |
| Less:                Accumulated depreciation     |         |   |   | (6,995 | ) |   | (7,128 | ) |
|                                                   |              |  |  |  |
| Total property                and equipment, net  |         |   | $ | 4,373 |   | $ | 4,264 |   |
|                                                   |              |  |  |  |
|                                                   |              |  |

**7. Income Taxes**

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

|                                                                    | Years Ended December                    31, |        |
|--------------------------------------------------------------------|---------------------------------------------|--------|
| (in thousands)                                                     | **2007**                                    |        | **2006** |  | **2005** |  |
| Income (loss) subject to                domestic income taxes only |                                        |   | $ | 1,953 |  | $ | 987 |  | $ | (1,493 | ) |
| Income (loss)                subject to foreign income taxes only  |                                        |   |   | 1,410 |  |   | (330 | ) |   | (1,124 | ) |
|                                                                    |                                             |        |  |  |  |  |
|                                                                    |                                             |        |  |
|                                                               |                                        |   | $ | 3,363 |  | $ | 657 |  | $ | (2,617 | ) |
|                                                                    |                                             |        |  |  |  |  |

44

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

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

|                                                       | Years Ended December                    31, |        |
|-------------------------------------------------------|---------------------------------------------|--------|
|                                                       | **2007**                                    |        | **2006** |  | **2005** |  |
| Statutory federal income tax                rate      |                                        |   |   | (34.0 | )% |   | (34.0 | )% |   | (34.0 | )% |
| State income                tax                       |                                        |   |   | (5.9 | ) |   | (5.9 | ) |   | (6.2 | ) |
| Stock                compensation                     |                                        |   |   | (4.7 | ) |   | (18.0 | )  |   | - |   |
| Net operating                loss carryforward        |                                        |   |   | 44.4 |   |   | 14.0 |   |   | - |   |
| Research                expenses excluded from income |                                        |   |   | - |   |   | - |   |   | 1.0 |   |
| Research and                development credits       |                                        |   |   | - |  |   | - |  |   | (2.8 | ) |
| Valuation                allowance                    |                                        |   |   | 1.6 |   |   | 41.5 |   |   | 41.0 |   |
| Other                                                 |                                        |   |   | (1.4 | ) |   | 2.4 |   |   | 1.0 |   |
|                                                       |                                             |        |  |  |  |  |
| Effective tax                rate                     |                                        |   |   | 0.0 | % |   | 0.0 | % |   | 0.0 |  % |
|                                                       |                                             |        |  |  |  |  |
|                                                       |                                             |        |  |

 

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

|                                                                         | December 31, |        |
|-------------------------------------------------------------------------|--------------|--------|
| (in thousands)                                                          | **2007**     |        | **2006** |  | **2005** |  |
| Deferred tax                assets:                                     |         |   |   |  |  |   |  |  |   |   |  |
|     Net                operating loss carryforwards |         |   | $  | 15,335 |  | $  | 16,677 |  | $  | 17,100 |  |
|     Credit                carryforwards             |         |   |   | 1,803 |  |   | 1,803 |   |   | 2,140 |   |
|     Depreciation                                    |         |   |   | 2 |   |   | 10 |   |   | 401 |   |
|     Stock                compensation               |         |   |   | 274 |   |   | 118 |   |   | - |   |
|     Accruals                and allowances          |         |   |   | 769 |  |   | 849 |  |   | 1,057 |  |
|                                                                         |              |        |  |  |  |  |
|                                                                         |         |   |   | 18,210 |  |   | 19,457 |  |   | 20,698 |   |
| Less: valuation                allowances                               |              |        |  | (18,210) |  |  | (19,457) |  |  | (20,698) |  |
|                                                                         |              |        |   |   |  |   |   |  |   |   |  |
|                                                                         |              |        | $ | - |  | $ | - |  | $ | - |  |
|                                                                         |              |        |  |  |  |  |
|                                                                         |              |        |  |

 

|                                                                           | December 31, |        |
|---------------------------------------------------------------------------|--------------|--------|
| (in thousands)                                                            | **2007**     |        | **2006** |  | **2005** |  |
| Valuation allowances on                deferred tax assets:               |         |   |   |  |  |   |  |  |   |   |  |
|      Balance                at beginning of year |         |   | $  | 19,457 |  | $  | 20,698 |  | $  | 19,499 |  |
|     Addition                                          |         |   |   | - |  |   | - |   |   | 1,199 |   |
|     Utilized                                          |         |   |   | (1,247) |   |   | (1,241) |   |   | - |   |
|                                                                           |              |        |  |  |  |  |
| Balance at end of                year                                     |              |        | $ | 18,210 |  | $ | 19,457 |  | $ | 20,698 |  |
|                                                                           |              |        |  |  |  |  |
|                                                                           |              |        |  |

 

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

As of December 31, 2007, the Company had net        operating loss carryforwards ofapproximately        $38.5million forfederal and $20.4 millionfor state tax purposes. If not utilized, these        carryforwards will begin to expirein 2021 for        federal and in 2011 forstate        purposes.

As of December 31, 2007, the Company had research credit        carryforwards of approximately $1.2millionand        $0.9millionfor federal and state income tax purposes, respectively.        If not utilized, the federal carryforward will expire in various amounts beginning        in2021.The California tax credit can be carried forward        indefinitely.

45

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements

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.

**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, 2007, one customer accounted for        20.0% of the Company's accounts receivable. At December 31, 2006, two customers accounted        for 14.6% and 12.3% of the Company's accounts receivable, respectively.

One customer accounted for 17.4% of revenues in the year        ended December 31, 2007. At December 31, 2006, two customers accounted for 15.1% and 10.0%        of revenue, respectively. At December 31, 2005, one customer accounted for 10.2% of        revenue. 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.

**9. Geographic Segment Information**

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

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

|                                       | **Years Ended December                    31,** |
|--------------------------------------------|-------------------------------------------------|
|                                       | **2007**                                        | **2006** | **2005** |
| **Revenues**                               |                                            |
| North America                              |                                            |   | $ | 20,204 |   | $ | 18,594 |   | $ | 15,677 |   |
| Europe                                     |                                            |   |   | 2,707 |   |   | 1,930 |   |   | 867 |   |
| Asia                                       |                                            |   |   | 10,875 |   |   | 6,268 |   |   | 4,419 |   |
|                                            |                                                 |  |  |  |  |  |
|                                            |                                                 |  |  |
|                                            |                                                 |  |  |
|         |                                            |   | $ | 33,786 |   | $ | 26,792 |   | $ | 20,963 |   |
|                                            |                                                 |  |  |  |  |  |
|                                            |                                                 |  |  |

|                                            |                                                 |          |          |
|--------------------------------------------|-------------------------------------------------|----------|----------|
|                                       | **Years Ended December                    31,** |
|                                       | **2007**                                        | **2006** | **2005** |
| **Revenues**                               |                                            |
| Connectivity                Products       |                                            |     | $        | 22,463 |   | $ | 16,413 |   | $ | 14,092 |   |
| Optical                Passive Products    |                                            |     |     | 11,323 |   |   | 10,379 |   |   | 6,871 |   |
|                                            |                                                 |          |          |  |  |  |
|                                            |                                                 |          |          |
|                                            |                                                 |          |          |
|         |                                            |     | $        | 33,787 |   | $ | 26,792 |   | $ | 20,963 |   |
|                                            |                                                 |          |          |  |  |  |
|                                            |                                                 |          |          |

|                                                       | December 31, |
|------------------------------------------------------------|--------------|
|                                                       | **2007**     | **2006** |
|                                                            |              |  |  |  |
| **Property and                Equipment**                  |         |   |   |  |   |   |  |   |
|      United                States |         |   | $ | 93 |   | $ | 144 |   |
|      Taiwan                       |         |   |   | 2,800 |   |   | 3,015 |   |
|      China                        |         |   |   | 1,480 |   |   | 1,105 |   |
|                                                            |              |  |  |  |
|                                                       |         |   | $ | 4,373 |   | $ | 4,264 |   |
|                                                            |              |  |  |  |

46

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**ALLIANCE FIBER OPTIC PRODUCTS, INC.**

        Notes to Consolidated Financial Statements

**10. Commitments and Contingencies**

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

**Off-Balance Sheet        Arrangements**: The Company had no off-balance        sheet arrangements as of December 31, 2007.

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

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

**Operating Leases:**The Company leases certain office space under long-term        operating leases expiring at various dates through 2013. Total rent expense under these        operating leases were approximately $0.9 million, $0.8 million, and $0.6 million for the        years ended December 31, 2007, 2006, and 2005, respectively.

Total future minimum lease payments under operating        leases as of December 31, 2007 are summarized below (in thousands):

| **                    Years ending December 31,** |        |
|-----------------------------------------------------------------------|--------|
|                     2008                          |   |   | $  | 960 |   |
|                     2009                          |   |   |   | 639 |   |
|                     2010                          |   |   |   | 424 |   |
|                     2011                          |   |   |   | 185 |   |
|      2012                                         |        |  |  | 129 |  |
|      2013                                         |        |  |  | 51 |  |
|                                                                       |        |  |
|                     Total                         |   |   | $ | 2,388 |   |
|                                                                       |        |  |

**Letter of Credit:**The Company had a letter of credit of $0.4 million        outstanding as of December 31, 2007. The letter of credit is collateralized by short term        investments of $0.4 million.

**11. Bank Loan**

In November 2004, the Company entered into a ten-year        loan of $0.5 million in Taiwan with an interest rate of 2.3% for the first two years and        3.6% for the following years. In November 2006, the Company entered into a seven-year loan        of $0.2 million in Taiwan with an interest rate of 2.8%.Both loans are secured by the Company's building in        Taiwan. The net book value of the building was $0.6 million as of December 31,        2007.

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

47

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements 

Payments due under bank loans as of December 31,        2007 are as follows (in thousands):

| **Years ending December                31,**           |        |
|--------------------------------------------------------|--------|
| 2008                                                   |   |   | $ | 153 |   |
| 2009                                                   |   |   |   | 153 |   |
| 2010                                                   |   |   |   | 125 |   |
| 2011                                                   |   |   |   | 103 |   |
| 2012                                                   |   |   |   | 97 |   |
| 2013and                after                           |   |   |   | 125 |   |
|                                                        |        |  |
| Total                payment                           |   |   |   | 756 |   |
| Less: Amounts                representing interest     |   |   |   | (67 | ) |
|                                                        |        |  |
| Present value                of net remaining payments |   |   |   | 689 |   |
| Less: current                portion                   |   |   |   | (132 | ) |
|                                                        |        |  |
| Long-term                portion                       |   |   | $ | 557 |   |
|                                                        |        |

**12. Related Party Transactions**

As of March 7, 2008, Foxconn Holding Limited was a        holder of 19.3% of the Company's common stock. In the normal course of business, the        Company sells products to and purchases raw materials from Hon Hai Precision Company        Limited, who is the parent company of Foxconn Holding Limited. These transactions were made        at prices and terms consistent with those of unrelated third parties. Sales of products to        Hon Hai Precision Industry Company Limited were $1.1 million, $0.5 million, and $0.8        million in the years ended December 31, 2007, 2006, and 2005 respectively. Purchases of raw        materials from Hon Hai Precision Company Limited were $3.2 million, $2.5 million, and $2.3        million in the years ended December 31, 2007, 2006, and 2005 respectively. Amounts due from        Hon Hai Precision Company Limited were $0.2 million and $0.1 million at December 31, 2007        and 2006, respectively. Amounts due to Hon Hai Precision Company Limited were $1.1 million        and $0.6 million at December 31, 2007 and 2006, respectively.

**1****3.        Subsequent Event**

At January 31, 2008, the Company's        short-term investments included $16.4 million of auction rate securities. Subsequent to        January 31, 2008,sixauctions have failed totaling$8.1millionrelated to these auction rate        securities. All of these investments are AAA/Aaa rated securities collateralized by student        loans, with approximately 92% of such collateral in the aggregate being guaranteed by the        U.S. government under the Federal Family Education Loan Program.While each failed auction will be        assessed individually,the        Companydoes notbelieve that any of the underlying        issuers of its auction rate securitieswereat risk or that these securities are        otherwise impairedas of the        date hereof. If the issuers are unable to successfully close future auctions,their credit ratings        deteriorate,the U.S. government        fails to support its guaranteesof the obligations or there is        continued uncertainty in the credit markets,the Company may be required to record        an impairment charge on these investments in the future. The Company maynot be able to liquidate any of these        securities in the short term and may insteadhave to wait until the maturity of the        underlying notes (between2032and2046) to redeem them.

48

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**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements 

 

**Item 9. Changes In and Disagreements With Accountants        on Accounting and Financial Disclosure**

**     **None

**Item 9A(T). Controls and Procedures**

*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, or 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        ourChiefExecutive        Of        ficerandActing ChiefFinancialOfficer, as        appropriate, to allow timely decisions regarding required disclosure. In designing and        evaluating our disclosure controls and procedures, management recognized that disclosure        controls and procedures, no matter how well conceived and operated, can provide only        reasonable, not absolute, assurance that the objectives of the disclosure controls and        procedures are met. Our disclosure controls and procedures have been designed to meet        reasonable assurance standards. Additionally, in designing disclosure controls and        procedures, our management necessarily was required to apply its judgment in evaluating the        cost-benefit relationship of possible disclosure controls and procedures. The design of any        disclosure controls and procedures also is based in part upon certain assumptions about the        likelihood of future events, and there can be no assurance that any design will succeed in        achieving its stated goals under all potential future conditions.

         

Based on their        evaluation as of the end of the period covered by this Annual Report on Form 10-K,        ourChiefExecutiveOfficerandActing ChiefFinancialOfficer have concluded        that, as of such date, our disclosure controls and procedures were effective at the        reasonable assurance level.

             

*Management's Annual Report on        Internal Control over Financial Reporting.*Our management is responsible for        establishing and maintaining internal control over our financial reporting. Because of its        inherent limitations, internal control over financial reporting may not prevent or detect        misstatements. Projections of any evaluation of the effectiveness of internal control to        future periods are subject to the risk that controls may become inadequate because of        changes in conditions, or that the degree of compliance with policies or procedures may        deteriorate.

As of the end of thefiscal year, an evaluation was        performed under the supervision and with the participation of our management, including the        Chief Executive Officer andActingChief Financial Officer, of the        effectiveness of our internal control over financial reporting (as defined in        Section 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended,        and sections 302 and 404 of the Sarbanes-Oxley Act)based on the framework inInternal Control - Integrated        Frameworkissued by the        Committee of Sponsoring Organizations of the Treadway Commission.

As part of this evaluation, we analyzed        and tested our processes for control effectiveness (controls which reasonably assure        accurate and complete financial information in accordance with GAAP), prevention of acts of        fraud and transactions being approved by management. When necessary, we confirmed that        appropriate corrective action (including process improvements) had been        undertaken.

Based on the evaluation as of the end        of the fiscal year 2007, the Company's Chief Executive Officer andActingChief Financial Officer have concluded        that our internal controls over financialreportingwere effective.

This annual report does not include an        attestation report of our registered public accounting firm regarding internal control over        financial reporting. Management's report was not subject to attestation by our registered        public accounting firm pursuant to temporary rules of the Securities and Exchange        Commission that permit us to provide only management's report in this annual        report.

49

----

**ALLIANCE        FIBER OPTIC PRODUCTS, INC.**

Notes to        Consolidated Financial Statements 

**Item 9B. Other Information**

Not Applicable.

50

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**PART III**

         

**Item 10. Directors, Executive Officers and Corporate        Governance**

The information required by this item 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 2008 Annual Meeting of        Stockholders to be held on May 16, 2008 (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-K 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 Richard Black (Chairperson), James C. Yeh 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 Richard        Black, James Yeh 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 24, 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 11. Executive Compensation**

The information required by this item is incorporated by        reference from the information under the captions "Election of Directors - Director        Compensation,"and"Executive Compensation," contained in the Proxy        Statement.

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

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

51

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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, 2007:

|                                         |                                                                                                                                                                                                                                                                                                       |        |
|----------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Plan                category                 | Number of securities                    to be issued upon                    exercise of                    outstanding options,                    warrants and rights                                      (a) |        | Weighted-average                    exercise price of                    outstanding options,                    warrants and rights                                      (b) |  | Number of securities                    remaining available for                    future issuance under                    equity compensation                    plans (excluding                    securities reflected in                    column (a))                                      (c) |  |
| Equity                compensation plans     |                                                                                                                                                                                                                                                                                                       |   |   |   |   |   |   |   |   |   |   |
| approved by security                holders  |                                                                                                                                                                                                                                                                                                       |   |   | 4,967,458 |  (1) | $ | 1.34 |   |   | 4,591,770 |  (2) |
|                                              |                                                                                                                                                                                                                                                                                                            |        |  |  |  |  |  |  |  |  |  |
| Equity                compensation plans not |                                                                                                                                                                                                                                                                                                       |   |   |   |   |   |   |   |   |   |   |
| approved by                security holders  |                                                                                                                                                                                                                                                                                                       |   |   | - |   |   | - |   |   | - |   |
|                                              |                                                                                                                                                                                                                                                                                                            |        |  |  |  |  |
| Total                                        |                                                                                                                                                                                                                                                                                                       |   |   | 4,967,458 |   | $ | 1.34 |   |   | 4,591,770 |   |
|                                              |                                                                                                                                                                                                                                                                                                            |        |  |  |  |  |

(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:

(i)4,236,241        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. There was no increase on        January 1, 2007 because the Board determined there were enough shares available for        issuance in 2008 pursuant to the Plan. Stock options, restricted stock, restricted stock        units or stock appreciation rights may be awarded under the 2000 Stock Incentive        Plan.

(ii)355,529        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 13. Certain Relationships and Related        Transactions, and Director Independence**

The information required by this item is incorporated by        reference from the information contained under the caption "Certain Relationships and        Related Party Transactions", and "Election of Directors - Director Independence" contained        in the Proxy Statement.

**Item 14. Principal Accounting Fees and        Services**

The information required by this item is incorporated by        reference from the information set forth under the caption "Ratification of the Appointment        of Independent Registered Public Accounting Firm¡XPrincipal Accountant Fees and        Services" and "Pre-Approval Policies and Procedures" in the Proxy Statement.

52

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**PART IV**

         

**Item 15. Exhibits and Financial Statement        Schedules**

         

(a) The following documents are filed as part of this        report:

(1) Financial Statements

Reference is made to the index to Consolidated Financial        Statements under Item 8 of Part II hereof.         

(2) Financial Statement Schedules

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

(3) Exhibits

See the List of Exhibits, which follows the signature        pages of this report and is incorporated herein by reference.

53

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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 24, 2008

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-K 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     

Peter C.                    Chang              | President, Chief Executive                    Officer                    (Principal Executive Officer) and Chairman | March 21, 2008 |
|      /s/                    Anita K. Ho     

Anita K. Ho                                            | Acting Chief Financial                    Officer                    (Principal Financial and Accounting Officer)   | March 21, 2008 |
|      /s/                    Richard                    Black                         

Richard Black | Director                                                                                                            | March 21, 2008 |
|      /s/                    Gwong-Yih                    Lee                         

Gwong-Yih Lee | Director                                                                                                            | March 21, 2008 |
|      /s/                    Ray                    Sun                         

Ray Sun             | Director                                                                                                            | March 21, 2008 |
|      /s/                    James C.                    Yeh                         

James C. Yeh   | Director                                                                                                            | March 21, 2008 |

54

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        EXHIBIT INDEX

| **Exhibit****Number** | **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 Company's 10-K for 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#                 | 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)).                                                                                                    |
| 10.4#                 | Alliance Fiber Optic                    Products, Inc. Amended and Restated 2000 Employee Stock Purchase                    Plan.                                                                                                                                                                                                                                                      |
| 10.5#                 | 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)). |
| 10.6#                 | Lease Agreement dated April                    5, 2004 by and between Moffett Office Park Investors LLC and Alliance Fiber                    Optic Products, Inc. (incorporated by reference to Exhibit 10.13 to Company's                    Quarterly Report on Form 10-QSB for period ended June 30, 2004).                                                                        |
| 10.7#                 | Form of 2000 Stock                    Incentive Plan Option Agreement                                                                                                                                                                                                                                                                                                                  |
| 21.1                  | Subsidiaries of the Company                    (incorporated by reference to Exhibit 21.1 to the Company's Annual Report                    on Form 10-K for the year ended December 31, 2000).                                                                                                                                                                              |
| 23.1                  | Consent of Stonefield                    Josephson, Inc., Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                               |
| 24.1                  | Power of Attorney (see page                    57 of this Form 10-K)                                                                                                                                                                                                                                                                                                                   |
| 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

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hereto are deemed to accompany this Form 10-K 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.

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Exhibit        23.1

   

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING        FIRM

We hereby consent to the incorporation by reference in        the Registration Statements on Form S-8 (Nos. 333-141656, 333-50998, 333-50926,        333-54864, 333-54874, 333-119710, 333-119711,333-123648, 333-123649 and 333-132801) of Alliance Fiber        Optic Products, Inc. of our report dated March 20, 2008, relating to the consolidated        financial statements which appear in this Form 10-K.                  /s/Stonefield Josephson, Inc.

San Francisco, California        March 20, 2008

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Exhibit 31.1

**Certification of the Chief Executive        Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period Ended        December 31, 2007**

         

**CERTIFICATION**

         

I, Peter C. Chang, certify        that:

         

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

         

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

         

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

         

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

         

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

         

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

         

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

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

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

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

         

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

   Date: March 24,        2008

By/s/Peter C. Chang

Peter C. Chang        Chief Executive Officer

   (Principal Executive        Officer)

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        Exhibit 31.2

**Certification of the****Acting****Chief Financial Officer Pursuant to        Section 302 of the Sarbanes-Oxley Act of 2002 for the Period Ended December 31,        2007**

         

**CERTIFICATION**

         

I, Anita K. Ho, certify        that:

         

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

         

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

         

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

         

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

         

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

         

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

         

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

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

         

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

         

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

         

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

> 
                                   Date: March                                    24, 2008

By/s/Anita K. Ho

Anita K. Ho        Acting Chief Financial Officer

   (Principal Accounting        Officer)

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**Exhibit 32.1**

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

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

(i)     the Annual Report of        the Company on Form 10-K for the period ended December 31, 2007 (the "Report"),        fully complies with the requirements of section 13(a) or section 15 (d) of the Securities        Exchange Act of 1934, and

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

     /s/ Peter C.        Chang                    

     Peter C. Chang

         

     March 24, 2008

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        Exhibit 32.2

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

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

(i)     the Annual Report of        the Company on Form 10-K for the period ended December 31, 2007 (the "Report"),        fully complies with the requirements of section 13(a) or section 15(d) of the Securities        Exchange Act of 1934, and

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

     /s/ Anita K.        Ho                    

     Anita K.        Ho

         

     March        24, 2008

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