# UNITED        STATES

# SECURITIES AND        EXCHANGE COMMISSION

WASHINGTON, D.C.        20549

_________________

# FORM        10-Q

|   |       |
|--------|------------|
|   | (Mark One) |

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

|   |                                                                  |
|--------|-----------------------------------------------------------------------|
|   | For the quarterly period ended September 30,                2007 |

|       |   |                                                             |
|------------|--------|------------------------------------------------------------------|
| ** ** | o      | 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 |   | (I.R.S. employer       |   |
|   | Incorporation or organization)  |   | identification number) |   |

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

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

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

Indicate by check mark whether the        registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.        See definition of “accelerated filer and large accelerated filer” in Rule 12b-2        of the Exchange Act). Large Accelerated Filer         o Accelerated Filer         o Non-Accelerated Filer         þ

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

On November 2, 2007, 41,092,335        shares of the registrant’s Common Stock, $0.001 par value per share, were        outstanding.

----

# ALLIANCE FIBER OPTIC        PRODUCTS, INC.

# FORM 10-Q

# QUARTERLY PERIOD        ENDED SEPTEMBER 30, 2007

# INDEX

|                                                                                                                                                      | Page   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                      |   |
| PART I:                FINANCIAL INFORMATION                                                                                                              | 1      |
|                                                                                                                                                      |   |
|      ITEM                1: FINANCIAL STATEMENTS                                                                                 | 1      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Balance Sheets at September 30, 2007 (unaudited)        |   |
|           and                December 31, 2006                                                          | 1      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Statements of Operations for the                        |   |
|           Three                and Nine Months Ended September 30, 2007 and 2006 (unaudited)            | 2      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Statements of Cash Flows for the                        |   |
|           Nine                Months Ended September 30, 2007 and 2006 (unaudited)                      | 3      |
|                                                                                                                                                      |   |
|           NOTES                TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                           | 4      |
|                                                                                                                                                      |   |
|      ITEM                2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF                OPERATIONS | 11     |
|                                                                                                                                                      |   |
|      ITEM                3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                           | 17     |
|                                                                                                                                                      |   |
|      ITEM                4: CONTROLS AND PROCEDURES                                                                              | 17     |
|                                                                                                                                                      |   |
| PART II: OTHER                INFORMATION                                                                                                                 | 19     |
|                                                                                                                                                      |   |
|      ITEM                1A: RISK FACTORS                                                                                        | 19     |
|                                                                                                                                                      |   |
|      ITEM                6: EXHIBITS                                                                                             | 29     |
|                                                                                                                                                      |   |
| SIGNATURE                                                                                                                                                 | 31     |

i

----

# PART I: FINANCIAL        INFORMATION

# ITEM 1: FINANCIAL        STATEMENTS

**ALLIANCE FIBER        OPTIC PRODUCTS, INC.        Condensed Consolidated Balance Sheets        (In thousands, except share data)**

|                                                                                                   | September 30,                    2007 | December 31,                    2006 |
|--------------------------------------------------------------------------------------------------------|---------------------------------------|--------------------------------------|
| **Assets**                                                                                             |                                  |                                 |   | **(Unaudited)** |   |   |  |   |
| Current                assets:                                                                         |                                  |                                 |
|  Cash and                cash equivalents                                                         |                                  |                                 | $ | 5,256 |   | $ | 4,321 |   |
|  Short-term                investments                                                            |                                  |                                 |   | 29,195 |   |   | 26,857 |   |
|  Accounts                receivable, net                                                          |                                  |                                 |   | 5,208 |   |   | 4,009 |   |
|  Inventories,                net                                                                  |                                  |                                 |   | 4,507 |   |   | 4,465 |   |
|  Prepaid                expense and other current assets                                          |                                  |                                 |   | 812 |   |   | 601 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                current assets                                |                                  |                                 |   | 44,978 |   |   | 40,253 |   |
|                                                                                                        |                                       |                                      |
| Property and                equipment, net                                                             |                                  |                                 |   | 4,141 |   |   | 4,264 |   |
| Other                assets                                                                            |                                  |                                 |   | 282 |   |   | 176 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                assets                                        |                                  |                                 | $ | 49,401 |   | $ | 44,693 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
| **Liabilities                and Stockholders' Equity**                                                |                                  |                                 |
| Current                liabilities:                                                                    |                                  |                                 |
|  Accounts                payable                                                                  |                                  |                                 | $ | 3,665 |   | $ | 2,950 |   |
|  Accrued                expenses                                                                  |                                  |                                 |   | 3,341 |   |   | 2,815 |   |
|  Current                portion of bank loans                                                     |                                  |                                 |   | 130 |   |   | 94 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                current liabilities                           |                                  |                                 |   | 7,136 |   |   | 5,859 |   |
| Other                long-term liabilities                                                             |                                  |                                 |
|  Bank                loans                                                                        |                                  |                                 |   | 587 |   |   | 545 |   |
|  Other                long-term liabilities                                                       |                                  |                                 |   | 431 |   |   | 385 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                long term liabilities                         |                                  |                                 |   | 1,018 |   |   | 930 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                liabilities                                   |                                  |                                 |   | 8,154 |   |   | 6,789 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
| Commitments                and contingencies (Note 8)                                                  |                                  |                                 |   |  |   |   |  |   |
| Stockholders'                equity:                                                                   |                                  |                                 |
|  Common                stock, $0.001 par value: 250,000,000 shares authorized;                    |                                  |                                 |
|     41,011,006                and 40,540,128 shares issued and outstanding at |                                  |                                 |
|     September                30, 2007 and December 31, 2006, respectively          |                                  |                                 |   | 41 |   |   | 41 |   |
|  Additional                paid-in-capital                                                        |                                  |                                 |   | 110,549 |   |   | 109,793 |   |
|  Accumulated                deficit                                                               |                                  |                                 |   | (69,491 | ) |   | (71,809 | ) |
|  Accumulated other                comprehensive income (loss)                                     |                                  |                                 |   | 148 |  |   | (121 | ) |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|  Stockholders'                equity                                                              |                                  |                                 |   | 41,247 |   |   | 37,904 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |
|       Total                liabilities and stockholders' equity          |                                  |                                 | $ | 49,401 |   | $ | 44,693 |   |
|                                                                                                        |                                       |                                      |  |  |
|                                                                                                        |                                       |                                      |

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

1

----

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

|                                                                        | Three Months Ended                    September 30, |        | Nine Months Ended September                    30, |        |
|-----------------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                        | **2007**                                            |        | **2006**                                           |        | **2007** |  | **2006** |  |
| Revenues                                                                    |                                                |   | $                                                  | 9,170  |   | $ | 7,573 |   | $ | 24,572 |   | $ | 19,046 |   |
| Cost of                revenues                                             |                                                |   |                                               | 6,291  |   |   | 5,402 |   |   | 16,822 |   |   | 13,907 |   |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|  Gross                profit                                           |                                                |   |                                               | 2,879  |   |   | 2,171 |   |   | 7,750 |   |   | 5,139 |  |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|                                                                             |                                                     |        |                                                    |        |
| Operating                expenses:                                          |                                                |   |                                                    |        |  |  |  |  |  |  |  |  |  |  |
|  Research                and development                               |                                                |   |                                               | 876    |   |   | 815 |   |   | 2,413 |   |   | 2,282 |   |
|  Sales                and marketing                                    |                                                |   |                                               | 556    |   |   | 543 |   |   | 1,759 |   |   | 1,684 |   |
|  General                and administrative                             |                                                |   |                                               | 817    |   |   | 789 |   |   | 2,593 |   |   | 2,272 |   |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|       Total                operating expenses |                                                |   |                                               | 2,249  |   |   | 2,147 |   |   | 6,765 |   |   | 6,238 |   |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
| Income                (loss) from operations                           |                                                |   |                                               | 630    |  |   | 24 |  |   | 985 |  |   | (1,099 | ) |
| Interest and                other income, net                               |                                                |   |                                               | 435    |   |   | 334 |   |   | 1,333 |   |   | 1,103 |   |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
| Net                income                                                   |                                                |   | $                                                  | 1,065  |  | $ | 358 |  | $ | 2,318 |  | $ | 4 |  |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
| Net income per                share:                                        |                                                |   |                                                    |        |  |  |  |  |  |  |  |  |  |  |
|       Basic                                   |                                                |   | $                                                  | 0.03   |  | $ | 0.01 |  | $ | 0.06 |  | $ | 0.00 |  |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|       Diluted                                 |                                                |   | $                                                  | 0.02   |  | $ | 0.01 |  | $ | 0.05 |  | $ | 0.00 |  |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
| Shares used in                computing net income  per share:         |                                                |   |                                                    |        |  |  |  |  |  |  |  |  |  |  |
|       Basic                                   |                                                |   |                                                    |        |  |  |  |  |  |  |  |  |  |  |
|                                                                        |                                                |   |                                               | 40,980 |   |   | 40,205 |   |   | 40,799 |   |   | 40,023 |   |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|       Diluted                                 |                                                |   |                                                    | 44,929 |  |  | 43,728 |  |  | 44,747 |  |  | 43,545 |  |
|                                                                        |                                                |   |                                          |   |                        |   |   |   |    |   |
| Included in costs and expenses above:                                       |                                                     |        |                                                    |        |  |  |  |  |  |  |  |  |  |  |
| Stock based compensation charges                                            |                                                     |        |                                                    |        |  |  |  |  |  |  |  |  |  |  |
|   Cost of revenue                                                      |                                                     |        | $                                                  | 29     |  | $ | 33 |  | $ | 121 |  | $ | 65 |  |
|   Research and development                                        |                                                     |        |                                                    | 13     |  |  | 17 |  |  | 50 |  |  | 38 |  |
|   Sales and marketing                                             |                                                     |        |                                                    | 9      |  |  | 6 |  |  | 33 |  |  | 22 |  |
|   General and administrative                                      |                                                     |        |                                                    | 40     |  |  | 27 |  |  | 114 |  |  | 67 |  |
|                                                              |                                                     |        |                                               |        |   |  |   |  |   |  |
|     Total                                                    |                                                     |        | $                                                  | 91     |  | $ | 83 |  | $ | 318 |  | $ | 192 |  |
|                                                                             |                                                     |        |                                                    |        |  |  |  |  |
|                                                                             |                                                     |        |                                                    |        |

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

2

----

**ALLIANCE FIBER        OPTIC PRODUCTS, INC.        Condensed Consolidated Statements of Cash Flows        (Unaudited, in thousands, excpet share data)**

|                                                                                                                    | Nine Months Ended September 30, |
|-------------------------------------------------------------------------------------------------------------------------|---------------------------------|
||
| **Cash flows from operating                activities:**                                                                |                            |   |   |  |   |   |  |   |
|  Net                Income                                                                                         |                            |   | $ | 2,318 |  | $ | 4 |  |
|  Adjustments to reconcile                net income to net cash used                                          |                            |   |  |  |  |  |  |  |
|   in                operating activities:                                                                     |                            |   |  |  |  |  |  |  |
|   Depreciation and                amortization                                                                |                            |   |   | 868 |   |   | 993 |   |
|   Loss on disposal of                property and equipment                                                   |                            |   |   | 53 |   |   | 34 |   |
|   Amortization of                stock-based compensation                                                     |                            |   |   | 318 |   |   | 192 |      |
|   Provision for doubtful accounts and                sales returns                                            |                                 |  |  | (59 | ) |  | 67 |  |
|   Provision for                inventory obsolescence                                                         |                            |   |   | (352 | ) |   | 384 |  |
|   Changes in assets                and liabilities:                                                           |                            |   |  |  |  |  |  |  |
|      Accounts                receivable                                                        |                            |   |   | (1,140 | ) |   | (369 | ) |
|      Inventories                                                                               |                            |   |   | 310 |  |   | (1,526 | ) |
|      Prepaid                expenses                                                           |                            |   |   | (211 | ) |   | (166 | ) |
|      Accounts                payable                                                           |                            |   |   | 715 |  |   | 817 |  |
|      Accrued                expenses                                                           |                            |   |   | 526 |  |   | 177 |  |
|      Other assets                                                                                   |                                 |  |  | (106 | ) |  | (46 | ) |
|      Other                long-term liabilities                                                |                            |   |   | 44 |  |   | 3 |  |
|                                                                                                                         |                                 |  |  |  |
|         Net                cash provided by operating activities                |                            |   |   | 3,284 |  |   | 564 |  |
|                                                                                                                         |                                 |  |  |  |
| **Cash flows                from investing activities:**                                                                |                            |   |  |  |  |  |  |  |
|  Purchase                of short-term investments                                                                 |                            |   |   | (15,803 | ) |   | (10,693 | ) |
|  Proceeds                from sales and maturities of short-term investments                                       |                            |   |   | 13,486 |   |   | 11,465 |   |
|  Purchase                of of property and equipment                                                              |                            |   |   | (728 | ) |   | (496 | ) |
|                                                                                                                         |                                 |  |  |  |
|         Net                cash (used in) provided by investing activities |                            |   |   | (3,045 | ) |   | 276 |  |
|                                                                                                                         |                                 |  |  |  |
| **Cash flows                from financing activities:**                                                                |                            |   |  |  |  |  |  |  |
|  Proceeds                from issuance of common stock under ESPP                                                  |                            |   |   | 276 |   |   | 200 |   |
|  Proceeds                from the exercise of common stock options                                                 |                            |   |   | 162 |   |   | 194 |   |
|  Proceeds                of bank borrowings                                                                        |                            |   |   | 150 |  |   | -- |  |
|  Repayment of bank                borrowings                                                                       |                            |   |   | (78 | ) |   | (54 | ) |
|                                                                                                                         |                                 |  |  |  |
|         Net                cash provided by financing activities                |                            |   |   | 510 |   |   | 340 |   |
|                                                                                                                         |                                 |  |  |  |
| Effect of                exchange rate changes on cash and cash equivalents                                             |                            |   |   | 186 |  |   | (10 | ) |
|                                                                                                                         |                                 |  |  |  |
| Net increase                in cash and cash equivalents                                                                |                            |   |   | 935 |  |   | 1,170 |  |
| Cash and cash                equivalents at beginning of period                                                         |                            |   |   | 4,321 |   |   | 2,714 |   |
|                                                                                                                         |                                 |  |  |  |
| Cash and cash                equivalents at end of period                                                               |                            |   | $ | 5,256 |   | $ | 3,884 |   |
|                                                                                                                         |                                 |  |  |  |

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

3

----

**ALLIANCE FIBER OPTIC PRODUCTS,        INC.**

**NOTES        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**1. Summary of Significant Accounting        Policies         **

***The Company***

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

***Basis of        presentation***

The condensed consolidated financial        information as of September 30,2007included herein is unaudited, has been        prepared by the Company in accordance with generally accepted accounting principles in the        United States of America, and reflects all adjustments, consisting only of normal recurring        adjustments, which in the opinion of management are necessary to state fairly the Company's        consolidated financial position, results of its consolidated operations, and consolidated        cash flows for the periods presented.

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

These financial statements should be        read in conjunction with the Company's audited consolidated financial statements included        in the Company's Annual Report on Form 10-K for the year ended December 31, 2006. The        results of operations for the three and nine months ended September 30,2007are not necessarily indicative of the        results to be expected for any future periods.

***Revenue        Recognition***

The Company recognizes revenue upon        shipment of its products to its customers, provided that the Company has received a        purchase order, the price is fixed, collection of the resulting receivable is reasonably        assured and transfer of title and risk of loss has occurred. Subsequent to the sale of its        products, the Company has no obligation to provide any modification or customization        upgrades, enhancements or post contract customer support.                  Allowances are provided for estimated returns. A provision for estimated sales return        allowances is recorded at the time revenue is recognized based on historical returns,        current economic trends and changes in customer demand. Such allowances are adjusted        periodically to reflect actual and anticipated experience. Such adjustments, which are        recorded against revenue in the period, could be material.

***Cash and Cash Equivalents         ***

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

4

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***Concentrations of        Risk***

        The Company's dense wavelength division multiplexing ("DWDM") related products contributed        revenues of $3.0 million and $8.2 million for the three and nine months ended September 30,        2007, respectively and $2.9 million and $7.0 million for the three and nine months ended        September 30, 2006, respectively. In the nine months ended September 30, 2007 and September        30, 2006, the Company's top 10 customers comprised 54.5% and 58.1% of its revenues,        respectively. For the nine months ended September 30, 2007 and September 30, 2006, one        customer accounted for 18.2% and 13.4% of revenues, respectively.

**2. Recent Accounting        Pronouncements**

        In February 2007, the Financial Accounting Standards Board ("FASB") issued SFAS No. 159,        "The Fair Value Option for Financial Assets and Financial Liabilities". SFAS No. 159        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 No. 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 FASB        Interpretation 48, "Accounting for Uncertainty in Income Taxes" (FIN 48) - 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 cumulative effect of applying the provisions        of FIN 48 is reported as an adjustment to the opening balance of retained earnings.        FIN 48 is effective for years beginning after December 15, 2006; therefore, the        Company has adoptedFIN 48 as of        January 1, 2007. The Company expects the adoption of this accounting standard will        increase the level of disclosure that the Company provides regarding its tax positions. The        adoption of FIN 48 is not expected to have a material impact on the Company's        consolidated financial position and results of operations.

In June 2006, the        Emerging Issues Task Force ("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 plansto continue to present        on a net basis in the accompanyingCondensedConsolidated 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.

5

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**3. Stock-based        Compensation**

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)")on January        1,2006. This statementestablishsaccounting for share-based payment        ("SBP") awards exchanged for employee services and requires companies to expense the        estimated fair value of these awards over the requisite employee service period.

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

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

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

For the three andninemonths endedSeptember30, 2007, the fair value of SBP awards        were estimated using the Binomial-Lattice valuation model, with the following        weighted-average assumptions and fair values as follows:

|                                                                    | Three                    Months EndedSeptember 30, |                                                                                                | **Nine Months                    Ended****September                    30,**                              |
|-------------------------------------------------------------------------|----------------------------------------------------|-----------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------|
|                                                                         |                                                    | **2007**                                                                                            | **2006**                                                                                                  |  | **2007** | **2006** |  |
|    Volatility                (percent)*                  |                                               |  52.0                                                                                          |  36.7                                                                                                |  | 52.0 |       36.7 |   |
|    Expected term                (in years)**             |                                               |    4                                                                                 |  4                                                                                                   |  | 4 |       4 |   |
|    Risk-free                interest rate (percent)***   |                                               |    4.30                                                                              |  4.74                                                                                                |  | 4.57 |       4.80 |   |
|    Expected                dividend rate (percent)       |                                               |    --                                                                                |  --                                                                                                  |  | -- |       -- |   |
|    Forfeiture                rate (percent)****          |                                               |    11                                                                                |  10                                                                                                  |  | 11 |       10 |   |
|    Weighted-average                fair value per option |                                               |                                                                                 |                                                                                                           |  |  |        |   |
|                  granted                                           |                                                    | $                             2.20 |  $                             0.71 |  | $                             2.13 |  $                             0.71 |  |
|                                                                         |                                               |                                                                                      |                                                                                                           |  |   |   |   |

* 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 September 30, 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.

(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.

6

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(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, 2006 and 2007, 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 nine months ended September 30, 2007:         

|                                                                              | Nine Months Ended                    September 30, 2007 |
|------------------------------------------------------------------------------|---------------------------------------------------------|
||
|   Outstanding at                December 31, 2006                  |                                                    |   | 5,046,083 | $ | 1.24 |   |   |   |   |
|   Granted                                                          |                                                    |   | 375,500 | $ | 2.13 |   |   |   |   |
|   Exercised                                                        |                                                    |   | (230,125) | $ | 0.71 |   |   |   |   |
|   Forfeited                                                        |                                                    |   | (65,500) | $ | 1.55 |   |   |   |   |
|   Outstanding at                September 30, 2007                      |                                                         |  | 5,125,958 | $ | 1.33 |  | 6.7 Years | $ | 2,839,458 |
|   Vested and expected                to vest at September 30, 2007 |                                                    |   | 5,069,398 | $ | 1.32 |   | 6.7 Years | $ | 2,814,495  |
|   Exercisable at                September 30, 2007                 |                                                    |   | 6,057,621 | $ | 1.31 |   | 6.5 Years | $ | 2,612,515 |

 

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 third quarter of fiscal 2007 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 September        30, 2007. This amount changes based on the fair market value of the Company's stock. The        total intrinsic value of options exercised for the three months ended September 30, 2007        and 2006 was $75,000 and $25,000, respectively. The total intrinsic value of options        exercised for the nine months ended September 30, 2007 and 2006 was $286,000 and $327,000,        respectively.

7

----

The weighted average grant date fair        value of options granted during the quarter ended September 30, 2007 was $419,000.No options were granted during the        quarter ended September 30, 2006.The weighted average grant date fair        value of options granted during the nine months ended September 30, 2007 was        $801,000.The weighted average        grant date fair value of options granted during the nine months ended September 30, 2006        was $133,000.         The expected dividend rate is 0%        forall periods.         

        Cash received from option exercises during the three and nine months ended September 30,        2007 was $63,000 and $162,000, respectively, and is included within the financing        activities section in the accompanying condensed consolidated statements of cash flows.

**4. Inventories, net (in        thousands)**

|                                            | September 30, 2007 | December 31, 2006        |
|-------------------------------------------------|--------------------|--------------------------|
|                                            |               |                          |   |  |   |
| **Inventories**                                 |               |                          |   |  |   |
|    Finished                goods |               | $   1,553 |   | $      1,415 |   |
|    Work-in-process               |               | 1,872                    |   | 1,751 |   |
|    Raw                materials  |               | 1,082                    |   | 1,299 |   |
|                                                 |                    |                          |  |  |
|  Total                                     |               | $   4,507 |   | $   4,465 |   |
|                                                 |                    |                          |  |  |
|                                                 |                    |                          |

**5. NetIncomePer        Share**

        Basic net income per share is computed by dividing net income for the period by the        weighted average number of shares of common stock outstanding during the period. Diluted        net income per share is computed by dividing the net income 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 per share for the periods indicated (in        thousands, except per share data):         

|                                                                                              | Three Months                    Ended September 30, |        | Nine Months                    Ended September 30, |        |
|---------------------------------------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                                              | **2007**                                            |        | **2006**                                           |        | **2007** |  | **2006** |  |
| Numerator:                                                                                        |                                                |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
|    Net                income                                                       |                                                |   | $                                                  | 1,065  |  | $ | 358 |   | $ | 2,318 |   | $ | 4 |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |
| Denominator:                                                                                      |                                                |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
|       Shares                used in computing net income per share: |                                                |   |                                                    |        |  |  |  |   |  |  |   |  |  |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |
|       Basic                                                         |                                                |   |                                                    | 40,980 |  |  | 40,205 |   |  | 40,799 |   |  | 40,023 |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |
|       Diluted                                                       |                                                |   |                                                    | 44,929 |  |  | 43,728 |   |  | 44,747 |   |  | 43,545 |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |
| Net income per                share:                                                              |                                                |   |                                                    |        |  |  |  |   |  |  |   |  |  |   |
|       Basic                                                         |                                                |   | $                                                  | 0.03   |  | $ | 0.01 |   | $ | 0.06 |   | $ | 0.00 |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |
|       Diluted                                                       |                                                |   | $                                                  | 0.02   |  | $ | 0.01 |   | $ | 0.05 |   | $ | 0.00 |   |
|                                                                                                   |                                                     |        |                                                    |        |  |  |  |  |

All outstanding stock options and shares subject to repurchase by the Company have been        excluded from the calculation of diluted net income per share as all such securities were        anti-dilutive for all periods presented. The total number of shares excluded from the        calculation of diluted net income share is as follows (in thousands):

8

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|                                                | Nine Months                    Ended September 30, |        |        |
|-----------------------------------------------------|----------------------------------------------------|--------|--------|
|                                                     |                                                    |
| Options to                purchase common stock and |                                               |   |   | 3,949 |   |   | 1,002 |   |  |  |
|                                                     |                                                    |        |        |  |
|                                                     |                                                    |        |        |  |

**6.****Comprehensive Income         **

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

|                                                                          | Three Months                    Ended September 30, |        | Nine Months                    Ended September 30, |       |
|-------------------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|-------|
|                                                                          | **2007**                                            |        | **2006**                                           |       | **2007** |  | **2006** |  |
| Net income                                                                    |                                                |   | $                                                  | 1,065 |   | $ | 358 |   | $ | 2,318 |   | $ | 4 |   |
| Cumulative translation                adjustments                             |                                                |   |                                                    | 189   |   |  | 42 |   |  | 248 |   |  | 18 |   |
| Unrealized gain on short-term                investments                      |                                                |   |                                                    | 11    |   |  | 9 |   |  | 21 |   |  | 22 |   |
|                                                                               |                                                     |        |                                                    |       |  |  |  |  |
|       Total                comprehensive income |                                                |   | $                                                  | 1,265 |   | $ | 409 |   | $ | 2,587 |   | $ | 44 |   |
|                                                                               |                                                     |        |                                                    |       |  |  |  |  |

 

**7. Income Taxes**

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

**8****. Commitments and Contingencies**

**Litigation:**         

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

**Indemnification and Product        Warranty:         **

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

9

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

**Operating Leases:         **

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

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

|                                                                                                                                                                                                      |        |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Three months ending December                31, 2007                                                                                                                                                 |   |   | $ | 238 |   |
| Years ending                December 31:                                                                                                                                                             |   |   |  |  |  |
|                                 2008 |   |   |   | 918 |   |
|                                 2009 |   |   |   | 550 |   |
|                                 2010 |   |   |   | 335 |   |
|                                 2011 |   |   |   | 95 |   |
|                                        2012                                       |        |  |  | 41 |  |
|                                                                                                                                                                                                      |        |  |
|  Total                                                                                                                                                                                          |   |   | $ | 2,177 |   |
|                                                                                                                                                                                                      |        |  |
|                                                                                                                                                                                                      |        |
|                                                                                                                                                                                                      |        |

**Letter of Credit:         **

The Company had a letter of credit of        $0.4 million outstanding as of September 30, 2007. The letter of credit is collateralized        by short-term investments of $0.4 million.

**8. Bank Loans**

In November 2004,        the Company entered into a ten-year loan of $0.5 million with a lender in Taiwan. The loan        has a fixed interest rate of 2.3% for the first year after which the loan has a variable        interest rate equal to Taiwan's prime rate for the remaining years. The loan is secured by        the Company's building in Taiwan. The net book value of the building was $0.6 million as of        September 30,        2007.

In September 2007, the Company also        enteredintotwo additionalequipmentloansof $0.2 millionfor 3 years and 5 yearswith a lender in Taiwan. The        loanshavea fixed interest rate of        3.6%.

Payments due under the bank        loansas of September 30,        2007are as follows (in        thousands):

|                                                                                                                                                                                                                                                 |        |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Years ending                December 31,                                                                                                                                                                                                        |   |   |   |   |   |
|                                    2007                          |   |   |   | 38 |   |
|                                    2008                          |   |   |   | 151 |   |
|                                    2009                          |   |   |   | 151 |   |
|                                    2010                          |   |   |   | 124 |   |
|                                    2011                          |   |   |   | 103 |   |
|                                                   2012                |        |  |  | 96 |  |
|                                    2013                and after |   |   |   | 124 |   |
|                                                                                                                                                                                                                                                 |        |  |
|      Total                payment                                                                                                                                                                                      |   |   |   | 787 |   |
| Less: Amounts                representing interest                                                                                                                                                                                              |   |   |   | (70 | ) |
|                                                                                                                                                                                                                                                 |        |  |
| Present value                of net remaining payments                                                                                                                                                                                          |   |   |   | 717 |   |
| Less: current                portion                                                                                                                                                                                                            |   |   |   | (130 | ) |
|                                                                                                                                                                                                                                                 |        |  |
| Long-term                portion                                                                                                                                                                                                                |   |   | $ | 587 |   |
|                                                                                                                                                                                                                                                 |        |  |
|                                                                                                                                                                                                                                                 |        |

10

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**9. Related Party        Transactions**

        As of September 30, 2007, Foxconn Holding Limited was a holder of 19.5% of the Company's        common stock, based on share ownership information set forth in a Schedule 13G filed by        Foxconn Holding Limited on January 4, 2002. The Company sells products and purchases raw        materials from Hon Hai Precision Company Limited, who is the parent company of Foxconn        Holding Limited, in the normal course of business. These transactions were made at prices        and terms consistent with those with unrelated third parties. Sales of products to Hon Hai        Precision Industry Company Limited were $0.3 million and $0.7 million for the three and        nine months ended September 30, 2007. Purchases of raw materials from Hon Hai Precision        Company Limited were $0.1 million and $0.3 million for the three and nine months ended        September 30, 2007. Amounts due from Hon Hai Precision Company Limited were $0.2 million at        September 30, 2007. Amounts due to Hon Hai Precision Company Limited were $0.1 million at        September 30, 2007.

**10.****Geographic Segment        Information**

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

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

         

|                                                             | Three Months                    Ended September 30, |        | Nine Months                    Ended September 30, |       |
|------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|-------|
|                                                             | **2007**                                            |        | **2006**                                           |       | **2007** |  | **2006** |  |
| **Revenues**                                                     |                                                |   |                                                    |       |   |  |  |   |  |  |   |  |  |   |
|       North                America |                                                |   | $                                                  | 5,536 |   | $ | 5,393 |   | $ | 14,900 |   | $ | 13,613 |   |
|       Europe                       |                                                |   |                                                    | 733   |   |  | 453 |   |  | 1,883 |   |  | 1,258 |   |
|       Asia                         |                                                |   |                                                    | 2,901 |   |  | 1,727 |   |  | 7,789 |   |  | 4,175 |   |
|                                                                  |                                                     |        |                                                    |       |  |  |  |  |
|       Total                        |                                                |   | $                                                  | 9,170 |   | $ | 7,573 |   | $ | 24,572 |   | $ | 19,046 |   |
|                                                                  |                                                     |        |                                                    |       |  |  |  |  |

|                                                                                     | Three Months                    Ended September 30, |        | Nine Months                    Ended September 30, |       |
|------------------------------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|-------|
|                                                                                     | **2006**                                            |        | **2005**                                           |       | **2006** |  | **2005** |  |
| **Revenues**                                                                             |                                                |   |                                                    |       |   |  |  |   |  |  |   |  |  |   |
|       Optical                path mulitplexing solution    |                                                |   | $                                                  | 6,180 |   | $ | 4,699 |   | $ | 16,413 |   | $ | 12,010 |   |
|       Dense                wavelength division multiplexer |                                                |   |                                                    | 2,990 |   |  | 2,874 |   |  | 8,159 |   |  | 7,036 |   |
|                                                                                          |                                                     |        |                                                    |       |  |  |  |  |
|      Total                                                      |                                                |   | $                                                  | 9,170 |   | $ | 7,573 |   | $ | 24,572 |   | $ | 19,046 |   |
|                                                                                          |                                                     |        |                                                    |       |  |  |  |  |

|                                                 | September 30,                    2007 |        | December 31,                    2006 |
|------------------------------------------------------|---------------------------------------|--------|--------------------------------------|
| **Property and                Equipment**            |                                  |   |                                 |  |   |   |  |   |
|     United                States |                                  |   | $                                    | 100 |   | $ | 144 |   |
|     Taiwan                       |                                  |   |                                 | 2,753 |   |   | 3,015 |   |
|     China                        |                                  |   |                                 | 1,288 |   |   | 1,105 |   |
|                                                      |                                       |        |                                      |  |
|                     Total        |                                  |   | $                                    | 4,141 |   | $ | 4,264 |   |
|                                                      |                                       |        |                                      |  |
|                                                      |                                       |        |
|                                                      |                                       |        |

 

11

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

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

This Management's Discussion and        Analysis of Financial Condition and Results of Operations should be read in conjunction        with the section entitled "Management's Discussion and Analysis of Financial Condition and        Results of Operations" in the Company's Annual Report on Form 10-K, its Consolidated        Financial Statement and the notes thereto, for the year ended December 31, 2006.                  The following discussion shouldalsobe read in conjunction with our        Condensed Consolidated Financial Statements and Notes thereto.         

**Critical Accounting Policies and        Estimates         **

*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        employee stock options and employee stock purchases pursuant to our Employee Stock Purchase        Plan ("ESPP") 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 2006 fiscal year.

Stock-based compensation expense        recognized under SFAS 123(R) for the three and nine months ended September 30, 2007was $91,000 and $318,000, respectively,        determined by the Binomial Latticevaluation model, and represents        stock-based compensation expense related to employee stock options.As of September 30, 2007, total        unrecognized compensation costs related to unnvested stock options was $0.8million, which is expected to be        recognized as an expense over a weighted average period of approximately2.25years.

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

12

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For additional information regarding        our critical accounting policies and estimates, see the section entitled "Management's        Discussion and Analysis of Financial Condition and Results of Operations" in our Annual        Report on Form 10-K, for the year ended December 31, 2006.

**Overview         **

We were founded in December 1995 and        commenced operations to design, manufacture and market fiber optic interconnect products,        which we call our Optical Path Management Solution, or OPMS, products. We started selling        our dense wavelength division multiplexing, or DWDM, and other wavelength management        products in July 2000. Since introduction, sales of DWDM-related products have fluctuated        with the overall market for these products.                  From our inception through September 30, 2007, we derived a substantial portion of our        revenues from our OPMS product line, although revenues from our DWDM product line have        increasedin recent yearsas a percentage of totalsales.Revenues from our DWDM products        represented32.6% and38.0% of total revenues for the three        months ended September 30,        2007and 2006, respectively, and33.2% and36.9% of total revenues for the nine        months ended September 30, 2007and 2006, respectively. We market and        sell our products predominantly through our direct sales force.         

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

|  |  o | changes in manufacturing                    volume; |
|--|---------|-----------------------------------------------------|

|  |  o | costs incurred in                    establishing additional manufacturing lines and facilities; |
|--|---------|--------------------------------------------------------------------------------------------------|

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

|  |  o | mix of products                    sold; |
|--|---------|------------------------------------------|

|  |  o | changes in our pricing and                    pricing from our competitors; |
|--|---------|-----------------------------------------------------------------------------|

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

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

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

        Sales and marketing expenses consist primarily of salaries, commissions and related        expenses for personnel engaged in marketing, sales and technical support functions, as well        as costs associated with trade shows, promotional activities and travel expenses.

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.

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**Results of Operations         **

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

|                                                                                                | Three Months                    Ended September 30, |        | Nine Months                    Ended September 30, |        |
|-----------------------------------------------------------------------------------------------------|-----------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                                                | **2007**                                            |        | **2006**                                           |        | **2007** |  | **2006** |  |
| Revenues                                                                                            |                                                |   |                                                    | 100.0% |   |  | 100.0% |   |  | 100.0% |   |  | 100.0% |   |
| Cost of revenues                                                                                    |                                                |   |                                                    | 68.6   |   |  | 71.3 |   |  | 68.5 |   |  | 73.0 |   |
|                                                                                                     |                                                     |        |                                                    |        |  |  |  |  |
|       Gross                profit                                     |                                                |   |                                                    | 31.4   |   |  | 28.7 |   |  | 31.5 |   |  | 27.0 |   |
|                                                                                                     |                                                |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Operating expenses:                                                                                 |                                                |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
|       Research                and development:                        |                                                |   |                                                    | 9.5    |   |  | 10.8 |   |  | 9.8 |   |  | 12.0 |   |
|       Sales                and marketing:                             |                                                |   |                                                    | 6.1    |   |  | 7.2 |   |  | 7.2 |   |  | 8.9 |   |
|       General                and administrative                       |                                                |   |                                                    | 8.9    |   |  | 10.4 |   |  | 10.5 |   |  | 11.9 |   |
|                                                                                                     |                                                     |        |                                                    |        |  |  |  |  |
|           Total                operating expenses |                                                |   |                                                    | 24.5   |   |  | 28.4 |   |  | 27.5 |   |  | 32.8 |   |
|                                                                                                     |                                                |   |                                                    |        |   |  |  |   |  |  |   |  |  |   |
| Income (loss) from                operations                                                        |                                                |   |                                                    | 6.9    |   |  | 0.3 |   |  | 4.0 |   |  | (5.8) |   |
| Interest and other income,                net                                                       |                                                |   |                                                    | 4.7    |   |  | 4.4 |   |  | 5.4 |   |  | 5.8 |   |
|                                                                                                     |                                                     |        |                                                    |        |  |  |  |  |
| Net income                                                                                          |                                                |   |                                                    | 11.6%  |   |  | 4.7%  |   |  | 9.4% |   |  | 0.0% |   |
|                                                                                                     |                                                     |        |                                               |        |   |  |   |  |   |  |

     

*Revenues.*Revenues were $9.2million and $7.6 million for the        three months ended September 30, 2007and 2006, respectively. Revenues        increased21.1% in the quarter        ended September 30, 2007from        the same period in 2006, as a result of anincrease in demand froma broad base ofour customers, especially fordatacenter related products from        ourPremise Market        customers.Revenues were        $24.6million and        $19.0 million for the nine months ended September 30, 2007and 2006, respectively. Revenues        increased29.5% in the nine        months ended September 30, 2007from the same period in 2006,        primarilyas a result of        increases in sales for Fiber to the Home (FTTH) related products, increases indatacenter related products from our        Premise Market customers, and some general increase in demand from improved market        conditions in the overall communications market.

*Cost of Revenues.*Cost of revenues was $6.3million and $5.4million for the three months ended        September 30, 2007and 2006,        respectively. Cost of revenues as a percentage of revenues decreased to68.6% for the three months ended        September 30, 2007from71.3% for the three months ended        September 30, 2006. Cost of revenues was $16.8million and $13.9million for the nine months ended        September 30, 2007and 2006,        respectively. Cost of revenues as a percentage of revenues decreased to68.5% for the nine months ended        September 30, 2007from73.0% for the nine months ended        September 30, 2006. Cost of revenues for the period ended September 30, 2007benefited from increased factory        utilization and improved manufacturing overhead absorption as a result of increased volume        shipments of our products.

*Gross Profit.*Gross profit increased to $2.9 million,        or 31.4% of revenues, for the three months ended September 30, 2007 from $2.2 million,        or 28.7% of revenues, for the same period in 2006. Gross profit increased to $7.8 million,        or 31.5% of revenues, for the nine months ended September 30, 2007 from $5.1 million,        or 27.0% of revenues, for the same period in 2006. For the period ended September 30, 2007,        higher utilization of our factories as a result of increased volume shipments of our        products resulted in an improved gross margin. We expect our gross profit as a percentage        of revenues continue to improve with higher production volumes, which we anticipate will        result in improved absorption of overhead expenses. However,ouraverage selling pricesare declining, whichwill negatively impact our gross profit        and may offset any benefits from improved absorption.

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*Research and Development        Expenses*.Research and development expenses        increased to $0.9 million for the three months ended September 30, 2007 from        $0.8 million for the same period in 2006. The increase was primarily due to expenses        for Passive Fiber Optic Components (PFOC) related tests, shipment of new samples, and for        new product development. Research and development expensesincreased to $2.4 million for the nine        months ended September 30, 2007 from $2.3 million for the same period in 2006.As a percentage of revenues, research        and development expenses decreased to 9.5% in the three months endedSeptember30, 2007 from10.8% for the same period in 2006. As a        percentage of revenues, research and development expenses decreased to9.8% in theninemonths endedSeptember30, 2007 from12.0% for the same period in 2006. We        expect research and development expenses on our product development efforts to increase in        the near term as we intend to continue to invest in our research and product development        efforts.

*Sales and Marketing        Expenses*. Sales and        marketing expensesincreased        to$0.6million for the three months ended        September 30, 2007 from $0.5for        the same period in 2006. Sales and marketing expensesincreased to $1.8million for the nine months ended        September 30, 2007 from $1.7for        the same period in 2006. As a percentage of revenues, sales and marketing expenses        decreased to6.1% in the three        months ended September 30, 2007from7.2% for the same period in 2006. As a        percentage of revenues, sales and marketing expenses decreased to7.2% in the nine months ended September        30, 2007from8.9% for the same period in 2006. We        expect sales and marketing expenses toremain the same in the near        term.

*General and Administrative        Expenses*. General and        administrative expenses remained at $0.8 million for the three months ended September 30,        2007and for the same period in        2006. General and administrative expenses increased to $2.6million for the nine months ended        September 30, 2007from        $2.3million for the same period        in 2006. As a percentage of revenues, general and administrative expenses decreased        to8.9% in the three months        ended September 30, 2007from10.4% for the same period in 2006. As a        percentage of revenues, general and administrative expenses decreased to 10.5% in the nine        months ended September 30, 2007from 11.9% for the same period in 2006.        We expect general and administrative expenses will increase due to higher fees and costs        associated with compliance with new laws and regulations such as the Sarbanes-Oxley Act of        2002 and the regulations promulgated thereunder.

*Stock-Based        Compensation*. Total stock        based compensation increased to $91,000 for the three months ended September 30,        2007from $83,000for the same period in 2006. Total        stock based compensation increased to $318,000 for the nine months ended September 30,        2007from $192,000for the same period in 2006.These increases were due tothehigher volatility rateweprojected for the2007fiscalyear.

*Interest and Other Income,        Net.*Interest and other        income, net, was $0.4million        and $0.3million for the three        months ended September 30, 2007and 2006, respectively. Interest and        other income, net, was $1.3million and $1.1million for the nine months ended        September 30, 2007and 2006,        respectively.The increase in        interest and other income reflects the growth in interest-earning assets and partially        offset by cumulative exchange losses.

**Liquidity and Capital Resources**

At September 30, 2007, we had cash and        cash equivalents of $5.3 million and short-term investments of $29.2 million.         

Net cash provided by operating        activities was $3.3 million for the nine months ended September 30, 2007. Net cash provided        by operating activities was primarily due to net income of $2.3 million, an increase in        accounts payable of $0.7 million, an increase in accrued expense of $0.5 million, and total        depreciation and amortization expenses of $1.2 million, which was offset by a $1.1 million        increase in accounts receivable, a $0.4 million decreased in inventory provision and a $0.3        million decrease in inventory.Net cash provided by operating        activities was $0.6 millionfor        the nine months ended September 30, 2006. The cash provided was primarily due to        depreciation expenses of $1.0 million and a $0.4 million inventory provision, which was        partially offset by $1.5 million increase in inventory. Accounts receivable increased by        $0.3 million and prepaid expenses and other assets increased by $0.2 million,offset by a $0.8 million increase in        accounts payable and a $0.2 million increase in accrued        expenses.

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Cash used in investing activities was        $3.0million for theninemonths endedSeptember30, 2007. In theninemonths endedSeptember30, 2007, we spent a net $2.3million for the purchase of short-term        securities, and we used $0.7million to acquire property and        equipment.Net cash        provided by investing activities was $0.3 million for the nine        months ended September 30, 2006. This resulted from $0.8 million in net proceeds from sales        of short-term investments offset by $0.5 millionofspending on equipment.

        Cash provided by financing activities was $0.5 million and $0.3 million for the nine months        ended September 30, 2007 and 2006, respectively, and was comprised of proceeds from        exercise of options to purchase common stock and common stock issued through our Employee        Stock Purchase Plan. Cash provided for the nine months ended September 30, 2007 also        included net proceeds from borrowings under an equipment loan of $0.2 million offset by        repayment of bank borrowings.

We believe that our current cash, cash        equivalents and short-term investments will be sufficient to meet our anticipated cash        needs for working capital and capital expenditures for at least the next 12 months.        However, our future growth, including any potential acquisitions, may require additional        funding. If cash generated from operations is insufficient to satisfy our long-term        liquidity requirements, 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 the scope of our        planned product development and marketing efforts. Strategic arrangements, if necessary to        raise additional funds, may require us to relinquish our rights to certain of our        technologies or products. Our failure to raise capital when needed could harm our business,        financial condition and operating results.

**Contractual        Obligations**

Our corporate headquarters are in        Sunnyvale, California,where we        leasea 34,800 square        footfacilityfrom a third partyfor a current month rent of        approximately $32,000. The lease has a six-year term commencing on July 22,        2004.         

In December 2000, we purchased        approximately 8,200 square feet of space immediately adjacent to our leased facility in        Tu-Cheng City, Taiwan for $0.8 million.Additionally, in February 2006, we        entered into a lease for a total of 21,600 square feet 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. Additionally, in February 2007, we entered into a new lease for an 8,200 square feet        dormitory in Shenzhen, which lease will expire in January 2012.

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****

**ITEM 3: QUANTITATIVE AND        QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

**Interest Rate        Sensitivity**

        We currently maintain our funds primarily in money market funds and highly liquid        marketable securities. We do not have any derivative financial instruments. As of September        30, 2007, $2.8 million, or 8.7% of our investments, had maturities of less than three        months. We expect to continue to invest a significant portion of our existing cash in        interest bearing, investment grade securities, with maturities of less than 12 months        pending their need for other uses. We do not believe that our investments, in the        aggregate, have significant exposure to interest rate risk and we do not believe that a 10%        change in interest rates at September 30, 2007 would have a significant impact on our        investments or interest income.

**Exchange Rate        Sensitivity**

We currently have operations in the        United States, Taiwan and China. The functional currency of our subsidiaries in Taiwan and        China are the local currencies, and we are subject to foreign currency exchange rate        fluctuations associated with the translation to United States dollars. Though some expenses        are incurred by our Taiwan and China operations, substantially all of our sales are made in        United States dollars; hence, we have minimal exposure to foreign currency rate        fluctuations relating to sales transactions. We do not believe that a hypothetical change        of 10% in the foreign currency exchange ratesin effect at September 30, 2007would have a material impact on our        financial results.

        While we expect our international revenues to continue to be denominated predominately in        United States dollars, an increasing portion of our international revenues may be        denominated in foreign currencies in the future. In addition, we plan to continue to expand        our overseas operations. As a result, our operating results may become subject to        significant fluctuations based upon changes in exchange rates of certain currencies in        relation to the United States dollar. We periodically analyze our exposure to currency        fluctuations and may engage in financial hedging techniques in the future to attempt to        minimize the effect of these potential fluctuations; however, exchange rate fluctuations        may adversely affect our financial results in the future.

**ITEM        4: CONTROLS AND PROCEDURES**

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

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

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**PART II:        OTHER INFORMATION**

**ITEM        1A: RISK FACTORS**

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

We had net income of approximately $1.1        million and $0.4 million the third quarter of fiscal 2007 and 2006, respectively. Although        we generated a profit in the third quarter, we may not be able to sustain profitability in        the future. Although our cash and cash equivalents increased in the third quarter of fiscal        2007, we could find our cash flows to be negative again in the future as we continue to        invest in our business. As of September 30, 2007, we had an accumulated deficit of        approximately $69.5 million.

Although we continue to experience        fluctuating demand for our products, wehave recently experienced        increasingdemand for our        products.If thiscontinues, we expect we will incur        significant and increasing expenses for expansion of our manufacturing operations, research        and development, sales and marketing, and administration, and inexpanding ourdirect 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.

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

        Sales of our OPMS products accounted for over 67.4% of our revenues in the quarter ended        September 30, 2007 and a substantial portion of our historical revenues. We expect to        substantially depend on these products for our near-term revenues. Any significant decline        in the price of, or demand for, our OPMS products, or failure to increase their market        acceptance, would seriously harm our business. In addition, we believe that our future        growth and a significant portion of our future revenues will depend on the commercial        success of our DWDM-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 for these        products does not continue to increase and our target customers do not continue to adopt        and purchase our DWDM-related products, our revenues may decline and we may have to        write-off inventory that is currently on our books.

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

         

        In the quarters ended September 30, 2007 and 2006, our top 10 customers comprised 51.8% and        63.1% of our revenues, respectively. One customer accounted for 13.3% of our total revenues        for the three months ended September 30, 2007. Two customers accounted for 14.5% and 11.4%,        respectively, of our total revenues for the three months ended September 30, 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.

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**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.

**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 to planning and executing our RoHS program, it is possible that some of our products        might be incompatible with such regulations. In such event, we could experience the        following consequences: loss of revenue, damaged reputation, diversion of resources,        monetary penalties, and legal action.

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**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 JDS Uniphase Corp., Oplink        Communications Inc., Stratos International, Inc., Corning Incorporated, 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        recently experienced significant consolidation, and we anticipate that further        consolidation will occur. This consolidation has further increased competition.                  Many of our current and potential competitors have significantly greater financial,        technical, marketing, purchasing, manufacturing and other resources than we do. As a        result, these competitors may be able to respond more quickly to new or emerging        technologies and to changes in customer requirements, to devote greater resources to the        development, promotion and sale of products, to negotiate lower prices on raw materials and        components, or to deliver competitive products at lower prices.                  Several of our existing and potential customers are also current and potential competitors        of ours. These companies may develop or acquire additional competitive products or        technologies in the future and subsequently reduce or cease their purchases from us. In        light of the consolidation in the optical networking industry, we also believe that the        size of suppliers will be an increasingly important part of a purchaser's decision-making        criteria in the future. We may not be able to compete successfully with existing or new        competitors, and we cannot ensure that the competitive pressures we face will not result in        lower prices for our products, loss of market share, or reduced gross margins, any of which        could harm our business.                  New and competing technologies are emerging due to increased competition and customer        demand. The introduction of products incorporating new or competing technologies or the        emergence of new industry standards could make our existing products noncompetitive. For        example, there are technologies for the design of wavelength division multiplexers that        compete with the technology that we incorporate in our products. If our products do not        incorporate technologies demanded by customers, we could lose market share causing our        business to suffer.

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

        We rapidly expanded our operations domestically and internationally in the final two        quarters of 2000. We had to carefully manage and re-evaluate this expansion given the        sudden and dramatic downturn in demand for our products experienced in 2001 and 2002.        Additionally, we implemented a reduction in force to reduce employees during the second,        third and fourth quarters of 2002 to match our operations to this decreased demand for our        products. As of September 30, 2007, we had a total of 43 full-time employees in Sunnyvale,        California, 395 full-time employees in Taiwan, and 288 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:

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|  | 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 $0.9 million and $0.8 million for the three months ended September 30, 2007        and 2006, respectively. Our total research and development expenses were approximately $2.4        million and $2.3 million for the nine months ended September 30, 2007 and 2006,        respectively. We expect that our research and development expense may increase in the last        quarter of 2007 as we intend to continue to invest in our research and product development        efforts. Any such increase could have a negative impact on our earnings in future        periods.

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

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

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

Our future success depends on the        continued growth of the Internet as a widely used medium for communications and commerce,        and the growth of optical networks to meet the increased demand for capacity to transmit        data, or bandwidth. If the Internet does not continue to expand as a medium for        communications and commerce, the need to significantly increase bandwidth across networks        and the market for fiber optic components may not continue to develop. If this growth does        not continue, sales of our products may 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.

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

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

**We are experiencing fluctuations in        market demand due to overcapacity in our industry and an economy that is stymied by        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.

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

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

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

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

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

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

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

        Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to perform an        assessment of our internal controls by December 31, 2007, and our independent auditors to        attest to the effectiveness of our internal controls over financial reporting beginning        with our fiscal year ending December 31, 2008. 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 negatively affected and this could cause a        decline in our stock price.

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

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        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, 2006 was $657,000, or        $298,000 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, 2006. 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 subsidiary. None of our officers or key employees        is bound by an employment agreement for any specific term, and may terminate their        employment at any time. In addition, we do not have "key person" life insurance policies        covering any of our employees.                  Our ability to continue to attract and retain highly skilled personnel will be a critical        factor in determining whether we will be successful in the future. We may have difficulty        hiring skilled engineers at our manufacturing facilities in the United States, Taiwan, and        China. If we are not successful in attracting, assimilating or retaining qualified        personnel to fulfill our current or future needs, our business may be harmed.

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

Complex and precise processes are        required for the manufacture of our products. Changes in our manufacturing processes or        those of our suppliers, or the inadvertent use of defective materials, could significantly        reduce our manufacturing yields and product reliability. Because the majority of our        manufacturing costs are relatively fixed, manufacturing yields are critical to our results        of operations. Lower than expected production yields could delay product shipments and        impair our operating results. We may not obtain acceptable yields in the future.                  In some cases, existing manufacturing techniques, which involve substantial manual labor,        may not allow us to cost-effectively meet our production goals so that we maintain        acceptable gross margins while meeting the cost targets of our customers. We may not        achieve adequate manufacturing cost efficiencies.                  Because we plan to introduce new products and product enhancements, we must effectively        transfer production information from our product development department to our        manufacturing group and coordinate our efforts with 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 nine months and sometimes longer. Once they decide to use a particular        supplier's product or component, these potential customers design the product into their        system, which is known as a design-in win. Suppliers whose products or components are not        designed in are unlikely to make sales to that customer until at least the adoption of a        future redesigned system. Even then, many customers may be reluctant to incorporate        entirely new products into their new systems, as this could involve significant additional        redesign efforts. If we fail to achieve design-in wins in our potential customers'        qualification processes, we will lose the opportunity for significant sales to those        customers for a lengthy period of time.                  In addition, some of our customers require that our products be subjected to        standards-based qualification testing, which can take up to nine months or more. While our        customers are evaluating our products and before they place an order with us, we may incur        substantial sales and marketing and research and development expenses, expend significant        management efforts, increase manufacturing capacity and order long lead-time supplies. Even        after the evaluation process, it is possible a potential customer will not purchase our        products. In addition, product purchases are frequently subject to unplanned processing and        other delays, particularly with respect to larger customers for which our products        represent a very small percentage of their overall purchase activity. Accordingly, our        revenues and operating results may vary significantly and unexpectedly from quarter to        quarter.

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

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

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

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

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|  | o    | loss of                    customers; |
|--|---------------------|---------------------------------------|

|  | o     | damage to our                    reputation; |
|--|---------------------------|----------------------------------------------|

|  | o     | failure to attract new                    customers or achieve market acceptance; |
|--|---------------------------|-----------------------------------------------------------------------------------|

|  | o     | diversion of development                    and engineering resources; and |
|--|---------------------------|----------------------------------------------------------------------------|

|  | o    | legal actions by our                    customers. |
|--|---------------------|----------------------------------------------------|

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

**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 different        approach, such as optical networks. Our success in generating revenues in this emerging        market will depend on:

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

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

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

**We may be unable to successfully integrate acquired businesses or assets 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.

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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.

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

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

        For the three and nine months ended September 30, 2007, sales to customers located outside        of North America were 39.6% and 39.4% of our revenues, respectively. In order to expand our        business, we must increase our sales to customers located outside of North America. We have        limited experience in marketing and distributing our products internationally and in        developing versions of our products that comply with local standards. Our international        sales will be limited if we cannot establish relationships with international distributors,        establish additional foreign operations, expand international sales channels, hire        additional personnel and develop relationships with international communications equipment        manufacturers. Even if we are able to successfully continue international operations, we        may not be able to maintain or increase international market demand for our products.

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

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

     

**ITEM 6:        EXHIBITS**

Exhibits

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

___________________

**In accordance with Item 601(b)(32)(ii)        of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management's        Reports on Internal Control Over Financial Reporting and Certification of Disclosure in        Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2        hereto are deemed to accompany this Form 10-Q and will not be deemed "filed" for purpose of        Section 18 of the Exchange Act.

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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.

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**SIGNATURE**

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

Dated: November 13, 2007

ALLIANCE FIBER OPTIC PRODUCTS,        INC.

By/s/ Anita K. Ho             

Anita K. Ho        Acting Chief Financial Officer        (Principal Financial and Accounting Officer and Duly        Authorized Signatory)

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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        September 30,        200****7**

         

**CERTIFICATION**

         

I, Peter C. Chang, certify        that:

         

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

         

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

         

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

         

4. The registrant's other certifying        officer and I are responsible for establishing and maintaining disclosure controls and        procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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) 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

         

c) 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 that has materially affected, or is reasonably        likely to materially affect, the registrant's internal control over financial reporting;        and

         

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

         

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

         

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

         

Date: November 13, 2007

By/s/Peter C. Chang

Peter C. Chang        Chief Executive Officer        (Principal Executive Officer)

 

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Exhibit 31.2

**Certification of the Chief Financial        Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period Ended        September 30,        200****7**

         

**CERTIFICATION**

         

I, Anita K. Ho, certify        that:

         

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

         

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

         

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

         

4. The registrant's other certifying        officer and I are responsible for establishing and maintaining disclosure controls and        procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) 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) 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

         

c) 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 that has materially affected, or is reasonably        likely to materially affect, the registrant's internal control over financial reporting;        and

         

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

         

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

         

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

         

Date: November 13,2007         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. § 1350**

I, Peter C. Chang, the chief executive        officer of Alliance Fiber Optic Products, Inc. (the "Company"), certify for the purposes of        section 1350 of chapter 63 of title 18 of the United States Code that, to the best of        my knowledge,                  (i)     the Quarterly Report of the Company on Form 10-Q for        the period ended September 30, 2007(the "Report"), fully complies with the        requirements of section 13(a) of the Securities Exchange Act of 1934, and                  (ii)     the information contained in the Report fairly presents,        in all material respects, the financial condition and results of operations of the        Company.

          /s/        Peter C. Chang         

          Peter        C. Chang

          November        13, 2007

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Exhibit 32.2

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

I, Anita K. Ho, the acting chief        financial officer of Alliance Fiber Optic Products, Inc. (the "Company"), certify for the        purposes of section 1350 of chapter 63 of title 18 of the United States Code that, to        the best of my knowledge,                  (i)     the Quarterly Report of the Company on Form 10-Q for        the period ended September 30, 2007(the "Report"), fully complies with the        requirements of section 13(a) 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

          November        13,2007

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