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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q

|                                                  |  |   |  |                                                                                         
|------------------------------------------------- |  | - |  | ----------------------------------------------------------------------------------------
|(Mark One)                                        |  | x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|                                                 
|For the Quarterly Period Ended September 30, 2002
|                                                 
|or                                               
|                                                 
|                                                  |  |  ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                                 
|For the transition period from  to               

Commission File Number 0-31857

ALLIANCE FIBER OPTIC PRODUCTS, INC.

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(Exact name of registrant as specified in its charter)


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

735 North Pastoria Avenue, Sunnyvale, California 94085

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(Address of Principal Executive Offices) (Zip Code)


Registrants telephone number, including area code: (408) 736-6900



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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. YesxNo   ̈
On, November 8, 2002, 35,510,579 shares of the Registrants Common Stock,
$0.001 par value per share, were outstanding.TABLE OF CONTENTS

|                              |                                                                                               |                                            |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION
|                              | ITEM 1: FINANCIAL STATEMENTS                                                                 
|                              |                                                                                               | Consolidated Balance Sheets               
|                              |                                                                                               | Consolidated Statements of Operations     
|                              |                                                                                               | Consolidated Statements of Cash Flows     
|                              |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND INTEREST RATE RISK    
|                              | ITEM 4: CONTROLS AND PROCEDURES                                                              
|PART II: OTHER INFORMATION   
|                              | ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURE                    
|                              |                                                                                               | CERTIFICATIONS                            
|EXHIBIT INDEX                
|EXHIBIT 4.1                  



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ALLIANCE FIBER OPTIC PRODUCTS, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

INDEX

|                              |                                                                                               |                                                                                                       |    |      |   | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- | -- | ---- | - | 
|                              |                                                                                               |                                                                                                       |    | Page
|                              |                                                                                               |                                                                                                       |    |     
|Part I: Financial Information |                                                                                               |                                                                                                       | 1  |     
|                              | Item 1: Financial Statements                                                                  |                                                                                                       |    | 1    |  
|                              |                                                                                               | Consolidated Balance Sheets at December 31, 2001 and September 30, 2002                               |    |      | 1 | 
|                              |                                                                                               | Consolidated Statements of Operations for the Three and Nine Months
Ended September 30, 2001 and 2002 |    |      | 2 | 
|                              |                                                                                               | Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2001 and 2002           |    |      | 3 | 
|                              |                                                                                               | Notes to Consolidated Financial Statements                                                            |    |      | 4 | 
|                              | Item 2: Managements Discussion and Analysis of Financial Condition and
Results of Operations |                                                                                                       |    | 7    |  
|                              | Item 3: Quantitative and Qualitative Disclosures About Market Risk and
Interest Rate Risk     |                                                                                                       |    | 21   |  
|                              | Item 4: Controls and Procedures                                                               |                                                                                                       |    | 22   |  
|Part II: Other Information    |                                                                                               |                                                                                                       | 23 |     
|                              | Item 6: Exhibits and Reports on Form 8-K                                                      |                                                                                                       |    | 23   |  
|Signatures                    |                                                                                               |                                                                                                       | 24 |     
|Certifications                |                                                                                               |                                                                                                       | 25 |     
|Exhibit Index                 |                                                                                               |                                                                                                       | 27 |     





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##### Table of Contents






PART I: FINANCIAL INFORMATION




ITEM 1: FINANCIAL STATEMENTS




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

|                                       |                                                                                                                        |                                            |       |          |        |           |       |         |        | 
|-------------------------------------- | ---------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ | --------- | ----- | ------- | ------ | 
|                                       |                                                                                                                        |                                            |       | Dec. 31, |        | Sept. 30,
|                                       |                                                                                                                        |                                            |       | 2001     |        | 2002     
|                                       |                                                                                                                        |                                            |       |          |        |          
|Assets                                 |                                                                                                                        |                                            |       |          |        |           |       |        
|Current assets:                        |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       | Cash and cash equivalents                                                                                              |                                            | $     | 16,947   |        |           | $     | 11,400  |       
|                                       | Short-term investments                                                                                                 |                                            |       | 33,118   |        |           |       | 33,316  |       
|                                       | Accounts receivable, net                                                                                               |                                            |       | 2,645    |        |           |       | 1,036   |       
|                                       | Inventories, net                                                                                                       |                                            |       | 7,419    |        |           |       | 3,125   |       
|                                       | Prepaid expense and other current assets                                                                               |                                            |       | 1,106    |        |           |       | 1,071   |       
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       |                                                                                                                        | Total current assets                       |       |          | 61,235 |           |       |         | 49,948 | 
|Property and equipment, net            |                                                                                                                        |                                            | 7,381 |          |        |           | 5,501 |        
|Other assets                           |                                                                                                                        |                                            | 575   |          |        |           | 389   |        
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       |                                                                                                                        | Total assets                               |       | $        | 69,191 |           |       | $       | 55,838 | 
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|Liabilities and Stockholders Equity   |                                                                                                                        |                                            |       |          |        |           |       |        
|Current liabilities:                   |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       | Accounts payable                                                                                                       |                                            | $     | 1,425    |        |           | $     | 944     |       
|                                       | Accrued expenses                                                                                                       |                                            |       | 1,819    |        |           |       | 2,640   |       
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       |                                                                                                                        | Total current liabilities                  |       |          | 3,244  |           |       |         | 3,584  | 
|Long-term liabilities                  |                                                                                                                        |                                            | 182   |          |        |           | 966   |        
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       |                                                                                                                        | Total liabilities                          |       |          | 3,426  |           |       |         | 4,550  | 
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|Commitments and contingencies (Note 8) |                                                                                                                        |                                            |       |          |        |           |       |        
|Stockholders equity:                  |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       | Common stock, $0.001 par value: 250,000,000 shares authorized;
35,409,524 and 35,510,579 shares issued and outstanding |                                            |       | 35       |        |           |       | 36      |       
|                                       | Additional paid-in-capital                                                                                             |                                            |       | 108,755  |        |           |       | 105,084 |       
|                                       | Receivables from stockholders                                                                                          |                                            |       | (1,934   | )      |           |       | (1,628  | )     
|                                       | Deferred stock-based compensation                                                                                      |                                            |       | (7,261   | )      |           |       | (2,919  | )     
|                                       | Accumulated deficit                                                                                                    |                                            |       | (33,709  | )      |           |       | (49,221 | )     
|                                       | Accumulated other comprehensive loss                                                                                   |                                            |       | (121     | )      |           |       | (64     | )     
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       | Stockholders equity                                                                                                   |                                            |       | 65,765   |        |           |       | 51,288  |       
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        
|                                       |                                                                                                                        | Total liabilities and stockholders equity |       | $        | 69,191 |           |       | $       | 55,838 | 
|                                       |                                                                                                                        |                                            |       |          |        |           |       |        

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

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

|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |        |        |  
|-------------------------------------------- | -------------------------- | ------------------------ | ------ | ---------------------------- | ------ | --------------------------- | ------ | ----- | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | -
|                                             |                            |                          |        | Three Months Ended Sept. 30, |        | Nine Months Ended Sept. 30,
|                                             |                            |                          |        |                              |        |                            
|                                             |                            |                          |        | 2001                         |        | 2002                        |        | 2001  |        | 2002
|                                             |                            |                          |        |                              |        |                             |        |       |        |     
|Revenues                                     |                            | $                        | 4,280  |                              |        | $                           | 3,105  |       |        | $    | 16,217  |        |        | $ | 10,302  |       
|Cost of revenues                             |                            |                          | 3,237  |                              |        |                             | 3,804  |       |        |      | 23,973  |        |        |   | 13,547  |       
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             | Gross profit (loss)        |                          |        | 1,043                        |        |                             |        | (699  | )      |      |         | (7,756 | )      |   |         | (3,245 | )     
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Operating expenses:                          |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             | Research and development   |                          |        | 2,192                        |        |                             |        | 1,309 |        |      |         | 8,172  |        |   |         | 5,906  |       
|                                             | Sales and marketing        |                          |        | 618                          |        |                             |        | 706   |        |      |         | 2,745  |        |   |         | 2,242  |       
|                                             | General and administrative |                          |        | 751                          |        |                             |        | 1,016 |        |      |         | 4,594  |        |   |         | 3,302  |       
|                                             | Excess facility charge     |                          |        |                             |        |                             |        | 1,680 |        |      |         |       |        |   |         | 1,680  |       
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             |                            | Total operating expenses |        |                              | 3,561  |                             |        |       | 4,711  |      |         |        | 15,511 |   |         |        | 13,130 |  
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Loss from operations                         |                            |                          | (2,518 | )                            |        |                             | (5,410 | )     |        |      | (23,267 | )      |        |   | (16,375 | )     
|Interest and other income, net               |                            |                          | 347    |                              |        |                             | 72     |       |        |      | 1,966   |        |        |   | 871     |       
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Loss before income taxes                     |                            |                          | (2,171 | )                            |        |                             | (5,338 | )     |        |      | (21,301 | )      |        |   | (15,504 | )     
|Income tax provision                         |                            |                          | 97     |                              |        |                             | (14    | )     |        |      | 223     |        |        |   | 8       |       
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Net loss                                     |                            | $                        | (2,268 | )                            |        | $                           | (5,324 | )     |        | $    | (21,524 | )      |        | $ | (15,512 | )     
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Net loss per share:                          |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             |                            | Basic and diluted        |        | $                            | (0.07  | )                           |        | $     | (0.15  | )    |         | $      | (0.65  | ) |         | $      | (0.45  | )
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Shares used in computing net loss per share: |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             |                            | Basic and diluted        |        |                              | 33,439 |                             |        |       | 34,846 |      |         |        | 33,021 |   |         |        | 34,587 |  
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Included in costs and expenses above:        |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|Stock based compensation charges             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             | Cost of revenue            |                          |        | 318                          |        |                             |        | (110  | )      |      |         | 1,230  |        |   |         | 395    |       
|                                             | Research and development   |                          |        | 448                          |        |                             |        | (79   | )      |      |         | 2,970  |        |   |         | 441    |       
|                                             | Sales and marketing        |                          |        | 6                            |        |                             |        | 24    |        |      |         | 591    |        |   |         | (105   | )     
|                                             | General and administrative |                          |        | (248                         | )      |                             |        | 154   |        |      |         | 1,488  |        |   |         | 686    |       
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       
|                                             |                            | Total                    |        |                              | 524    |                             |        |       | (11    | )    |         |        | 6,279  |   |         |        | 1,417  |  
|                                             |                            |                          |        |                              |        |                             |        |       |        |      |         |        |        |   |         |       

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

|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |         |       |       |        |  
|------------------------------------------------------------ | ---------------------------------------------------------------------------------- | ----------------------------------------------- | --------------------------------- | ----------------------------------------- | ----- | --------------------------- | ------- | ------- | ----- | ----- | ------ | -
|                                                             |                                                                                    |                                                 |                                   |                                           |       | Nine Months Ended Sept. 30,
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                            
|                                                             |                                                                                    |                                                 |                                   |                                           |       | 2001                        |         | 2002   
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Cash flows from operating activities:                        |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             | Net loss                                                                           |                                                 | $                                 | (21,524                                   | )     |                             | $       | (15,512 | )    
|                                                             | Adjustments to reconcile net loss to net cash used
in operating activities:        |                                                 |                                   |                                           |       |                             |         |         |      
|                                                             |                                                                                    | Depreciation                                    |                                   |                                           | 1,349 |                             |         |         | 1,285 |      
|                                                             |                                                                                    | Amortization of stock-based compensation        |                                   |                                           | 6,279 |                             |         |         | 627   |      
|                                                             |                                                                                    | Impairment/write down in property and equipment |                                   |                                           | 5,200 |                             |         |         | 972   |      
|                                                             |                                                                                    | Provision for inventory                         |                                   |                                           | 6,543 |                             |         |         | 4,402 |      
|                                                             |                                                                                    | Excess facility charge                          |                                   |                                           |      |                             |         |         | 1,680 |      
|                                                             |                                                                                    | Interest income receivable                      |                                   |                                           |      |                             |         |         | (30   | )    
|                                                             |                                                                                    | Changes in assets and liabilities:              |                                   |                                           |       |                             |         |         |       |      
|                                                             |                                                                                    |                                                 | Accounts receivable, net          |                                           |       | 2,575                       |         |         |       | 1,611 |       
|                                                             |                                                                                    |                                                 | Inventories, net                  |                                           |       | (5,144                      | )       |         |       | (40   | )     
|                                                             |                                                                                    |                                                 | Prepaid expenses and other assets |                                           |       | (537                        | )       |         |       | 230   |       
|                                                             |                                                                                    |                                                 | Accounts payable                  |                                           |       | (1,510                      | )       |         |       | (486  | )     
|                                                             |                                                                                    |                                                 | Accrued expenses                  |                                           |       | (470                        | )       |         |       | 119   |       
|                                                             |                                                                                    |                                                 | Other long-term liabilities       |                                           |       | (11                         | )       |         |       | 61    |       
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             |                                                                                    |                                                 |                                   | Net cash used in operating activities     |       |                             | (7,250  | )       |       |       | (5,081 | )
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Cash flows from investing activities:                        |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             | Purchase of short-term investments, net                                            |                                                 |                                   | (14,946                                   | )     |                             |         | (237    | )    
|                                                             | Purchase of property and equipment                                                 |                                                 |                                   | (6,779                                    | )     |                             |         | (617    | )    
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             |                                                                                    |                                                 |                                   | Net cash used in investing activities     |       |                             | (21,725 | )       |       |       | (854   | )
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Cash flows from financing activities:                        |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             | Proceeds from issuance of common stock under ESPP                                  |                                                 |                                   | 212                                       |       |                             |         | 151     |      
|                                                             | Proceeds from the exercise of common stock options                                 |                                                 |                                   | 108                                       |       |                             |         | 30      |      
|                                                             | Proceeds from the repayment of notes receivable                                    |                                                 |                                   |                                          |       |                             |         | 200     |      
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             |                                                                                    |                                                 |                                   | Net cash provided by financing activities |       |                             | 320     |         |       |       | 381    |  
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Effect of exchange rate changes on cash and cash equivalents |                                                                                    |                                                 | 17                                |                                           |       |                             | 7       |        
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Net decrease in cash and cash equivalents                    |                                                                                    |                                                 | (28,638                           | )                                         |       |                             | (5,547  | )      
|Cash and cash equivalents at beginning of period             |                                                                                    |                                                 | 42,548                            |                                           |       |                             | 16,947  |        
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Cash and cash equivalents at end of period                   |                                                                                    | $                                               | 13,910                            |                                           |       | $                           | 11,400  |        
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Supplemental disclosures of cash flow information:           |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             | Income taxes paid                                                                  |                                                 | $                                 | 391                                       |       |                             | $       |        |      
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|Non-cash investing and financing activities:                 |                                                                                    |                                                 |                                   |                                           |       |                             |         |        
|                                                             | Repurchase of common stocks via cancellation
of notes receivable from stockholders |                                                 | $                                 |                                          |       |                             | $       | 138     |      
|                                                             |                                                                                    |                                                 |                                   |                                           |       |                             |         |        

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

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ALLIANCE FIBER OPTIC PRODUCTS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. 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 is located
in Sunnyvale, California and it has operations in Taiwan and China.

2. Basis of presentation

The consolidated financial information as of September 30, 2002 included
herein is unaudited and 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 generally
accepted accounting principles accepted in the Unites 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 for the year ended December
31, 2001 included in the Companys Annual Report on Form 10-K, as filed on
March 27, 2002, with the Securities and Exchange Commission (SEC). The
results of operations for the three and nine months ended September 30, 2002
are not necessarily indicative of the results to be expected for any future
periods.

Certain reclassifications have been made to amounts reported in prior
periods, none of which affect the Companys financial position, results of
operations, or cash flows.

3. Inventories (in thousands)

|            |                                                 |   |          |        |           |   |       |        |  
|----------- | ----------------------------------------------- | - | -------- | ------ | --------- | - | ----- | ------ | -
|            |                                                 |   | Dec. 31, |        | Sept. 30,
|            |                                                 |   | 2001     |        | 2002     
|            |                                                 |   |          |        |          
|Inventories |                                                 |   |          |        |           |   |       |       
|            | Finished goods                                  |   | $        | 3,241  |           |   | $     | 2,418  |  
|            | Work-in-process                                 |   |          | 5,977  |           |   |       | 1,341  |  
|            | Raw materials                                   |   |          | 2,966  |           |   |       | 2,644  |  
|            | Less: Reserve for excess and obsolete inventory |   |          | (4,765 | )         |   |       | (3,278 | )
|            |                                                 |   |          |        |           |   |       |       
|            |                                                 | $ | 7,419    |        |           | $ | 3,125 |       
|            |                                                 |   |          |        |           |   |       |       

4. Net Loss per share

Basic net loss per share is computed by dividing net loss for the period
by the weighted average number of shares of common stock outstanding during the
period. Diluted net loss per share is computed by dividing the net loss for
the period by the weighted average number of common and potential common
equivalent shares outstanding during the period. The calculation of diluted
net loss per share excludes potential common shares if the effect is
anti-dilutive. Potential common shares are composed of shares of common stock
subject to repurchase and common stock issuable upon the exercise of stock
options. As the Company is in a net loss position, diluted net loss per share
is the same as basic net loss per share.

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

|                    |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |         |        |  
|------------------- | -------------------------------------------- | --------------------------------------------------- | - | --------------- | ------ | --------------- | - | ------ | ------ | ---- | - | ------- | ------ | - | - | ------- | ------ | -
|                    |                                              |                                                     |   | Three Months    |        | Nine Months    
|                    |                                              |                                                     |   | Ended Sept. 30, |        | Ended Sept. 30,
|                    |                                              |                                                     |   |                 |        |                
|                    |                                              |                                                     |   | 2001            |        | 2002            |   | 2001   |        | 2002
|                    |                                              |                                                     |   |                 |        |                 |   |        |        |     
|Numerator:          |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|                    | Net loss                                     |                                                     | $ | (2,268          | )      |                 | $ | (5,324 | )      |      | $ | (21,524 | )      |   | $ | (15,512 | )     
|                    |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|Denominator:        |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|                    | Shares used in computing net loss per share: |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |         |       
|                    |                                              | Weighted average common shares outstanding          |   |                 | 35,094 |                 |   |        | 35,510 |      |   |         | 34,926 |   |   |         | 35,453 |  
|                    |                                              | Less: Weighted average shares subject to repurchase |   |                 | (1,655 | )               |   |        | (664   | )    |   |         | (1,905 | ) |   |         | (866   | )
|                    |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|                    |                                              | Basic and diluted                                   |   |                 | 33,439 |                 |   |        | 34,846 |      |   |         | 33,021 |   |   |         | 34,587 |  
|                    |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|Net loss per share: |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        
|                    |                                              | Basic and diluted                                   |   | $               | (0.07  | )               |   | $      | (0.15  | )    |   | $       | (0.65  | ) |   | $       | (0.45  | )
|                    |                                              |                                                     |   |                 |        |                 |   |        |        |      |   |         |        |   |   |        

All warrants, outstanding stock options and shares subject to repurchase
by the Company have been excluded from the calculation of diluted net loss 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 loss per
share is as follows (in thousands):

|                                                                  |  |                 |       |                 |  |      |     |      |  |  |       |  |  |  |       | 
|----------------------------------------------------------------- |  | --------------- | ----- | --------------- |  | ---- | --- | ---- |  |  | ----- |  |  |  | ----- | 
|                                                                  |  | Three Months    |       | Nine Months    
|                                                                  |  | Ended Sept. 30, |       | Ended Sept. 30,
|                                                                  |  |                 |       |                
|                                                                  |  | 2001            |       | 2002            |  | 2001 |     | 2002
|                                                                  |  |                 |       |                 |  |      |     |     
|Options to purchase common stock and
shares subject to repurchase |  |                 | 3,184 |                 |  |      | 699 |      |  |  | 4,010 |  |  |  | 1,151 | 

5. Comprehensive Loss

Comprehensive income (loss) 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 loss and comprehensive
loss for the Company is due to foreign exchange translations adjustments and
unrealized gain (loss) on available-for-sale securities.

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

|                                                 |                          |   |                 |        |                 |   |        |        |      |   |         |         |   |   |         |         |  
|------------------------------------------------ | ------------------------ | - | --------------- | ------ | --------------- | - | ------ | ------ | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                                                 |                          |   | Three Months    |        | Nine Months    
|                                                 |                          |   | Ended Sept. 30, |        | Ended Sept. 30,
|                                                 |                          |   |                 |        |                
|                                                 |                          |   | 2001            |        | 2002            |   | 2001   |        | 2002
|                                                 |                          |   |                 |        |                 |   |        |        |     
|Net loss                                         |                          | $ | (2,268          | )      |                 | $ | (5,324 | )      |      | $ | (21,524 | )       |   | $ | (15,512 | )      
|Cumulative translation adjustments               |                          |   | 33              |        |                 |   | 17     |        |      |   | 49      |         |   |   | 96      |        
|Unrealized gain (loss) on short-term investments |                          |   | 99              |        |                 |   | 19     |        |      |   | 178     |         |   |   | (39     | )      
|                                                 |                          |   |                 |        |                 |   |        |        |      |   |         |         |   |   |         |        
|                                                 | Total comprehensive loss |   | $               | (2,136 | )               |   | $      | (5,288 | )    |   | $       | (21,297 | ) |   | $       | (15,455 | )
|                                                 |                          |   |                 |        |                 |   |        |        |      |   |         |         |   |   |         |        

6. Geographic Segment Information

The Company operates in a single industry segment. This industry segment
is characterized by rapid technological change and significant competition.
One customer accounted for 11.4% of the Companys revenues in the quarter ended
September 30, 2002.

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The following is a summary of the Companys revenues by shipping
destination, and identifiable assets situated in, geographic segments (in
thousands):

|         |                        |   |                              |       |                             |   |       |       |      |   |        |        |  |   |        |       | 
|-------- | ---------------------- | - | ---------------------------- | ----- | --------------------------- | - | ----- | ----- | ---- | - | ------ | ------ |  | - | ------ | ----- | 
|         |                        |   | Three Months Ended Sept. 30, |       | Nine Months Ended Sept. 30,
|         |                        |   |                              |       |                            
|         |                        |   | 2001                         |       | 2002                        |   | 2001  |       | 2002
|         |                        |   |                              |       |                             |   |       |       |     
|Revenues |                        |   |                              |       |                             |   |       |       |      |   |        |        |  |   |        |      
|         | United States & Canada |   | $                            | 3,422 |                             |   | $     | 2,808 |      |   | $      | 13,431 |  |   | $      | 9,344 | 
|         | Asia & Australia       |   | $                            | 515   |                             |   | $     | 106   |      |   | $      | 1,765  |  |   | $      | 639   | 
|         | Europe & Others        |   |                              | 343   |                             |   |       | 191   |      |   |        | 1,021  |  |   |        | 319   | 
|         |                        |   |                              |       |                             |   |       |       |      |   |        |        |  |   |        |      
|         |                        | $ | 4,280                        |       |                             | $ | 3,105 |       |      | $ | 16,217 |        |  | $ | 10,302 |      
|         |                        |   |                              |       |                             |   |       |       |      |   |        |        |  |   |        |      

|                    |               |       |   |          |        |           |   |        |        | 
|------------------- | ------------- | ----- | - | -------- | ------ | --------- | - | ------ | ------ | 
|                    |               |       |   | Dec. 31, |        | Sept. 30,
|                    |               |       |   | 2001     |        | 2002     
|                    |               |       |   |          |        |          
|Identifiable Assets |               |       |   |          |        |           |   |       
|                    | United States |       | $ | 60,156   |        |           | $ | 49,118 |       
|                    | Taiwan        |       |   | 8,554    |        |           |   | 5,734  |       
|                    | China         |       |   | 481      |        |           |   | 986    |       
|                    |               |       |   |          |        |           |   |       
|                    |               | Total |   | $        | 69,191 |           |   | $      | 55,838 | 
|                    |               |       |   |          |        |           |   |       

The Companys identifiable assets in Taiwan and China consist primarily of
manufacturing plants and machinery, and inventory for the manufacturing of the
Companys products.

7. Excess Facility Charges

Due to the decline in business conditions and reduced headcount in the
United States, the Company consolidated its operations in the United States
from three buildings to two buildings in Sunnyvale, California. As a
consequence, the Company recorded an excess facility charge of $1.7 million
during the third quarter of 2002, comprising $1.4 million of future
non-cancelable lease payments, which are expected to be paid over the next 2
years net of expected sublease income, and $0.3 million of fixed assets written
off.

8. Contingencies

From time to time, the Company may be involved in litigation in the normal
course of business.

9. Recent Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for
Costs Associated with Exit or Disposal Activities (SFAS 146). This Statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). This Statement requires that a liability for costs associated
with an exit or disposal activity be recognized and measured initially at fair
value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company is currently
assessing the impact of SFAS 146 on its financial statements.

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

When used in this discussion, the words expects, anticipates,
believes, estimates, plans, and similar expressions are intended to
identify forward-looking statements. These statements, which include
statements as to our critical accounting policies, our sources of revenues, our
gross margin as a percentage of revenues, anticipated revenue levels, our net
losses and negative cash flow, the fluctuation of our cost of revenues as a
percentage of revenues, our net losses, the amount and mix of our anticipated
expenditures and expenses, including research and development, sales and
marketing, and general and administrative expenses, increase or decrease of our
expenses or expenditures, our competitive advantage, our ability to compete,
the sources of our competition, the necessary expenditures to remain
competitive, our plans to expand our product development efforts, our plans to
introduce new products and product enhancements, additional inventory reserves
in future periods, our reliance on our OPMS products, our future growth and
future revenues being dependent on our DWDM products, our increased expenses if
demand for our products increases, amortization of our deferred stock-based
compensation, the adequacy of our capital resources, period-to-period
comparisons of our operating results, our ability to obtain raw materials and
components and maintain and develop supplier relationships, our ability to
establish and maintain relationships with key customers, our success being tied
to relationships with key customers, our ability to maintain appropriate
inventory levels, factors that affect a customers decision to choose a
supplier, our patent applications and intellectual property, an increase in
patent infringement claims, our exposure to currency rate fluctuations, our
need for additional financing, investments of our existing cash, our exposure
to interest rate risk, and the continued denomination of our international
revenues in predominately United States dollars, are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include, but are not limited to,
those risks discussed below, as well as competition including the impact of
competitive products and pricing, timely design acceptance by our customers,
our success attracting new customers, our customers adopting our new products,
loss of a key customer, timely introduction of new products and technologies,
our ability to ramp new products into volume production, our ability to attract
and retain highly skilled personnel, industry wide shifts in supply and demand
for optical components and modules, the development of the market for our DWDM
products, a further or continued decrease in spending by telecommunications
companies, additional future inventory reserves or excess facility charges,
increased competition or consolidation in our industry, our ability to license
intellectual property, industry overcapacity, financial stability in foreign
markets, our continued listing on the Nasdaq SmallCap Market and the matters
discussed in Factors That May Affect Results. These forward-looking
statements speak only as of the date hereof. The Company expressly disclaims
any obligation or undertaking to release publicly any updates or revisions to
any forward-looking statements contained herein to reflect any change in the
Companys expectations with regard thereto or any change in events, conditions
or circumstances on which any such statement is based.

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 Statements and the notes thereto, for the year ended December 31,
2001.

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

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. Our OPMS product line now includes
attenuators and fused fiber products, most of which were introduced between
1997 and 2000. In early 1999, we started developing our dense wavelength
division multiplexing, or DWDM, and other wavelength management products,
forming a new product line based in part on our proprietary technology. We
started selling our DWDM devices in July 2000. Since introduction, sales of
DWDM-related products have been lower than expected, which has lead to
inventory reserves.

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From our inception through September 30, 2002, we derived substantially
all of our revenues from our OPMS product line. Revenues from our DWDM
products represented approximately 9.2% of total revenues for the year ended
December 31, 2001. For the nine months ended September 30, 2002, our DWDM
products contributed revenues of $0.8 million, or 8.2% of total revenues.

We market and sell our products predominantly through our direct sales
force, which we began building since 1996. Although we derived a significant
portion of our revenues between 1996 and 1998 from overseas customers, an
increasing percentage of our sales from early 1999 through the second quarter
of 2002 were in North America. During the third quarter of 2002, sales to
customers outside of North America were 15.9%. For the nine months ended
September 30, 2001 and 2002, revenues derived from sales outside of North
America were 17.5% and 9.2%, respectively.

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



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

Research and development expenses consist primarily of salaries and
related personnel expenses, fees paid to outside service providers, materials
costs, test units, facilities, overhead and other expenses related to the
design, development, testing and enhancement of our products. We expense our
research and development costs as they are incurred. We believe that a
significant level of investment for product research and development is
required to remain competitive. We expect our research and development
expenses to stay relatively flat from third quarter levels as we believe that
continued investment in research and development functions is critical to our
success.

Sales and marketing expenses consist primarily of salaries, commissions
and related expenses for personnel engaged in marketing, sales and technical
support functions, as well as costs associated with trade shows, promotional
activities and travel expenses. We believe our future success depends upon
establishing successful relationships with a variety of key customers. We
believe that continued investment in sales and marketing functions is critical
to our success, but due to the slowdown in business, we expect these expenses
to decrease slightly from third quarter levels during the fourth quarter of
2002.

General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, administrative, accounting and human
resources personnel, insurance and professional fees for legal and accounting
support. We expect these expenses to increase for the fourth quarter of 2002,
due to fees associated with transferring our common stock from the Nasdaq
National Market to the Nasdaq SmallCap Market that will be incurred in the
fourth quarter and due to increased rates and fees from professional services.

In connection with the grant of stock options to employees and
consultants, we recorded deferred stock-based compensation of approximately
$24.4 million through December 31, 2001, which represents the difference
between the estimated fair market value of our common stock and the exercise
price of these options at the date of grant. We amortize deferred stock-based
compensation using the graded vesting method, under which each option grant is
separated into portions based on its vesting terms, which results in
acceleration of amortization expense for the overall award. We will amortize
the deferred

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stock-based compensation balance of $2.9 million as of September 30, 2002
on an accelerated basis over the vesting periods of the option grants, which
are generally four years.

Our application to transfer the listing of our common stock from the
Nasdaq National Market to the Nasdaq SmallCap Market has been approved.
Beginning at the commencement of trading on November 8, 2002, our common stock
began to trade on the Nasdaq SmallCap Market. We will have to comply with all
of the Nasdaq SmallCap Markets quantitative criteria for the continued listing
of our common stock including the $1.00 per share minimum bid price
requirement. If we are unable to comply with the $1.00 per share minimum bid
price for at least 10 consecutive trading days prior to January 13, 2003, we
may be delisted from the Nasdaq SmallCap Market.

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 Sept. 30, |      | Nine Months Ended Sept. 30,
|                               |                             |                          |       |                              |      |                            
|                               |                             |                          |       | 2001                         |      | 2002                        |        | 2001  |       | 2002
|                               |                             |                          |       |                              |      |                             |        |       |       |     
|Revenues                       |                             |                          | 100.0 | %                            |      |                             | 100.0  | %     |       |      | 100.0  | %     |      |  | 100.0  | %    
|Cost of revenues:              |                             |                          | 75.6  |                              |      |                             | 122.5  |       |       |      | 147.8  |       |      |  | 131.5  |      
|                               |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      
|                               | Gross profit (loss)         |                          |       | 24.4                         |      |                             |        | (22.5 | )     |      |        | (47.8 | )    |  |        | (31.5 | )    
|Operating expenses:            |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      
|                               | Research and development:   |                          |       | 51.2                         |      |                             |        | 42.2  |       |      |        | 50.4  |      |  |        | 57.3  |      
|                               | Sales and marketing:        |                          |       | 14.4                         |      |                             |        | 22.7  |       |      |        | 16.9  |      |  |        | 21.8  |      
|                               | General and administrative: |                          |       | 17.5                         |      |                             |        | 32.7  |       |      |        | 28.3  |      |  |        | 32.1  |      
|                               | Excess facility charge      |                          |       |                             |      |                             |        | 54.1  |       |      |        |      |      |  |        | 16.3  |      
|                               |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      
|                               |                             | Total operating expenses |       |                              | 83.2 |                             |        |       | 151.7 |      |        |       | 95.6 |  |        |       | 127.5 | 
|Loss from operations           |                             |                          | (58.8 | )                            |      |                             | (174.2 | )     |       |      | (143.5 | )     |      |  | (158.9 | )    
|Interest and other income, net |                             |                          | 8.1   |                              |      |                             | 2.3    |       |       |      | 12.1   |       |      |  | 8.5    |      
|                               |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      
|Loss before income taxes       |                             |                          | (50.7 | )                            |      |                             | (171.9 | )     |       |      | (131.3 | )     |      |  | (150.5 | )    
|Income tax provision           |                             |                          | 2.3   |                              |      |                             | (0.5   | )     |       |      | 1.4    |       |      |  | 0.1    |      
|                               |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      
|Net loss                       |                             |                          | (53.0 | )%                           |      |                             | (171.5 | )%    |       |      | (132.7 | )%    |      |  | (150.6 | )%   
|                               |                             |                          |       |                              |      |                             |        |       |       |      |        |       |      |  |        |      

Revenues.Revenues were $4.3 million and $3.1 million for the three
months ended September 30, 2001 and 2002, respectively. Revenues decreased
27.9% from September 30, 2001 to September 30, 2002 due primarily to the
continued slowdown in the telecommunications industry. Revenues from our
DWDM-related products were $373,000 and $257,000 for the three months ended
September 30, 2001 and 2002, respectively. Revenues were $16.2 million and
$10.3 million for the nine months ended September 30, 2001 and 2002,
respectively. Revenues for the nine months ended September 30, 2002 decreased
36.4% from the same period in 2001 due to the continued slowdown in the
telecommunications industry.

Gross Profit (Loss).The gross loss increased from $1.0 million gross
profit for the three months ended September 30, 2001, to $0.7 million gross
loss for the same period in 2002. For the nine month periods, gross loss
decreased from $7.8 million, or 47.8% of revenues, in 2001, to $3.2 million, or
31.5% of revenues, for the same period in 2002. The primary reason that gross
loss increased for the three months ended September 30, 2002 compared to the
same period in 2001 was because charges for excess and obsolete inventory were
higher in the three months ended September 30, 2002 than in the same period
last year.

In the quarter ended September 30, 2002, due to the continued adverse
effects of the industry slowdown and economic outlook, the Company determined
that future demand for its DWDM-related products would be lower than expected
and, therefore, an additional inventory reserve of $0.8 million was

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recorded in accordance with the Companys policy of reserving against
inventory levels in excess of expected future demand. In addition, an inventory
reserve of $0.4 million relating to obsolete OPMS products was also recorded.

We expect our gross margin as a percentage of revenues to continue to be
negatively impacted in the near term due to low production volumes and
unabsorbed overhead. The anticipated growth of our DWDM product sales has been
significantly impacted by the continued overall industry slowdown. After the
additional inventory reserve in the quarter ended September 30, 2002, we had
approximately $0.65 million in DWDM-related net inventory on hand at September
30, 2002. Although we continue to take steps to attempt to manage future
inventory levels, we may have to record additional inventory reserves in future
periods if the decrease in demand continues.

Research and
Development Expenses. Research and development expenses
decreased from $2.2 million, or 51.2% of revenues, for the three months ended
September 30, 2001 to $1.3 million, or 42.2% of revenues, for the same period
in 2002. Research and development expenses decreased from $8.2 million, or
50.4% of revenues, for the nine months ended September 30, 2001 to $5.9
million, or 57.3% of revenues, for the same period in 2002. This decrease is
due to lower compensation expenses as a result of reduced headcount. We
expect our quarterly research and development expenses to stay relatively flat
from third quarter levels as we believe that continued investment in research
and development is an important component in our success.

Sales and
Marketing Expenses. Sales and marketing expenses increased
slightly from $0.6 million for the three months ended September 30, 2001 to
$0.7 million for the three months ended September 30, 2002, but increased as a
percentage of revenue from 14.4% for the three months ended September 30, 2001,
to 22.7% for the three months ended September 30, 2002 due to decreased
revenues. Sales and marketing expenses decreased from $2.7 million, or 16.9%
of revenues, for the nine months ended September 30, 2001 to $2.2 million, or
21.8% of revenues, for the nine months ended September 30, 2002 due to lower
stock based compensation charges. We expect our quarterly sales and marketing
expenses to decline slightly from third quarter levels for the fourth quarter
of 2002.

General and Administrative Expenses.General and administrative expenses
increased from $0.8 million, or 17.5% of revenues, for the three months ended
September 30, 2001 to $1.0 million, or 32.7% of revenues, for the same period
in 2002. General and administrative expenses reflected a credit of $0.2 million
and a charge of $0.1 million for stock based compensation for three months
ended September 30, 2001 and 2002, respectively. General and administrative
expenses decreased from $4.6 million, or 28.3% of revenues, for the nine months
ended September 30, 2001 to $3.3 million, or 32.1% of revenues, for the same
period in 2002. The decrease was a result of our efforts to control our
expenses. We expect our quarterly general and administrative expenses to
increase for the fourth quarter due to fees associated with transferring the
listing of our common stock from the Nasdaq National Market to the Nasdaq
SmallCap Market which will be incurred during the fourth quarter of 2002 and
due to increased rates and fees from professional services.

Excess Facility Charge.Due to the decline in business conditions and
reduced headcount in the United States, the Company consolidated its
operations in the United States from three buildings to two buildings in
Sunnyvale, California. As a consequence, the Company recorded an excess
facility charge of $1.7 million during the third quarter of 2002, comprising of
$1.4 million of future non-cancelable lease payments, which are expected to be
paid over the next 2 years net of expected sublease income, and $0.3 million of
fixed assets that were written-off.

Stock-Based Compensation.Total stock-based compensation decreased from
$0.5 million, or 12.2% of revenues, in the three months ended September 30,
2001, to a credit of $0.01 million, or (0.4%) of revenues in the three months
ended September 30, 2002. Stock-based compensation decreased from $6.3 million,
or 38.7% of revenues, for the nine months ended September 30, 2001 to $0.6
million, or 6.1% of revenues, for the nine months ended September 30, 2002.
These decreases were partially due to the accounting policy adopted by the
Company which requires the Company to amortize a larger proportion of deferred
compensation expense during the early vesting periods of the option grants, and
partially due to the reversal of compensation expense for unvested stock
options of employees whose employment was terminated during the three months
ended September 30, 2002.

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Interest and Other Income, Net.Interest and other income, net, was $0.3
million and $0.07 million for the three months ended September 30, 2001 and
2002, respectively. Interest and other income, net, was $2.0 million and $0.9
million for the nine months ended September 30, 2001 and 2002, respectively.
The decrease was the result of significantly lower fund balances available for
investment and lower applicable interest rates.

Income Taxes. The income tax provision/benefit is relatively minor for
the periods presented because the company incurred tax losses and the
realization of deferred tax assets is uncertain.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through sales
of stock and bank debt. Additionally, in November 2000, we completed our
initial public offering of common stock, raising approximately $44.4 million,
net of costs and expenses. On September 30, 2002, we had cash and cash
equivalents of $11.4 million and short-term investments of $33.3 million.

Net cash used in operating activities was $7.3 million and $5.1 million
for the nine months ended September 30, 2001 and 2002, respectively. For the
nine months ended September 30, 2002, net cash used was primarily due to our
net loss of $15.5 million, offset by non-cash adjustments, including provision
for inventory of $4.4 million, write-offs of property and equipment of $1.0
million, excess facility charge of $1.7 million, depreciation and amortization
of $1.3 million, stock-based compensation expense of $0.6 million, and net
changes in working capital of $11.8 million. For the nine months ended
September 30, 2001, net cash used in operating activities was due to losses of
$21.5 million and an increase in inventories of $5.1 million, partially offset
by non-cash stock-based compensation expense of $6.3 million, non-cash
impairment charge for property and equipment of $5.2 million and provision for
excess inventories of $6.5 million.

Cash used in investing activities was $21.7 million and $0.9 million for
the nine months ended September 30, 2001 and 2002, respectively. In the nine
months ended September 30, 2001, $14.9 million was invested in high-grade,
short-term investments, while $6.8 million was used to acquire property and
equipment. In the nine months ended September 30, 2002, $0.2 million was
invested in high-grade, short-term investments, while $0.6 million was used to
acquire property and equipment.

Cash generated by financing activities was $0.3 million and $0.4 million
for the nine months ended September 30, 2001 and 2002, respectively, resulting
from proceeds from the exercise of options to purchase shares of our common
stock and common stock issued through our employee stock purchase plan. For
the nine months ended September 30, 2002, cash generated also included net
proceeds from the repayment of notes receivable of $0.2 million.

In July 2000 and February 2001, we entered into leases for 10,500 and
10,600 square feet of space, respectively, near our existing facility in
Sunnyvale, California. In September 2002, we consolidated our operations in
California into two buildings. As a result of the consolidation, we recorded
an excess facility charge in the third quarter of 2002. In Taiwan, we lease a
total of approximately 38,800 square feet in one facility located in Tu-Cheng
City, Taiwan. Additionally, in December 2000, the Company purchased
approximately 8,200 square feet of space immediately adjacent to the leased
facility for $0.8 million. As of September 30, 2002, we had a lease for a
facility in the Shenzhen area totaling approximately 12,000 square feet, which
will expire in December 2002. In August 2002, we entered into a new lease for
a 62,000 square foot facility in the same Shenzhen area, which will expire in
July 2007. Our operations in China moved into the new building in August 2002.
The future minimum lease payments under our operating leases are as follows
(in thousands):

|                           |                     |      |       |    |       | 
|-------------------------- | ------------------- | ---- | ----- | -- | ----- | 
|Years ending December 31,: |                     |      |       |   
|                           |                     | 2003 |       |    | 2,001 | 
|                           |                     | 2004 |       |    | 1,125 | 
|                           |                     | 2005 |       |    | 55    | 
|                           |                     | 2006 |       |    | 55    | 
|                           | 2007 and thereafter |      |       | 32 |      
|                           |                     |      |       |   
|Total                      |                     | $    | 3,776 |   
|                           |                     |      |       |   

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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, any
future growth, including potential acquisitions, may require additional
funding. If cash generated from operations is insufficient to satisfy our
long-term liquidity requirements, we may need to raise capital through
additional equity or debt financings or additional credit facilities. If
additional funds are raised through the issuance of securities, these
securities could have rights, preferences and privileges senior to holders of
common stock, and the terms of any debt facility could impose restrictions on
our operations. The sale of additional equity or debt securities could result
in additional dilution to our stockholders, and additional financing may not be
available in amounts or on terms acceptable to us, if at all. If we are unable
to obtain additional financing, we may be required to reduce the scope of our
product development and marketing efforts, which could harm our business,
financial condition and operating results.

Recent Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for
Costs Associated with Exit or Disposal Activities (SFAS 146). This Statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). This Statement requires that a liability for costs associated
with an exit or disposal activity be recognized and measured initially at fair
value only when the liability is incurred. The provisions of this Statement are
effective for exit or disposal activities that are initiated after December 31,
2002. The Company is currently assessing the impact of SFAS 146 on its
financial statements.

Compliance with Certification Requirements

The certification by such officers of this report on Form 10-Q, as
required by Section 906 of the Sarbanes-Oxley Act of 2002, has been submitted
to the SEC as additional correspondence accompanying this report.

Factors that May Affect Results

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

We incurred net losses of approximately $21.5 million and $15.5 million in
the first nine months of fiscal 2001 and 2002, respectively, and expect that
our net losses and negative cash flows will continue for the foreseeable future
as we continue to invest in our business. As of September 30, 2002, we had an
accumulated deficit of approximately $ 49.2 million.

Although we are currently experiencing continued decreased demand for our
products, we are hopeful that demand for our products will increase in the
future. If this happens, we expect to incur significant and increasing
expenses for expansion of our manufacturing operations, research and
development, sales and marketing, and administration, and in developing direct
sales and distribution channels. Given our early stage of development, the
rate at which competition in our industry intensifies, and the significant
downturn in demand for our products, we may not be able to adequately control
our costs and expenses or achieve or maintain adequate operating margins. As a
result, to achieve and maintain profitability, we will need to generate and
sustain substantially higher revenues while maintaining reasonable cost and
expense levels. We may not be able to achieve and sustain profitability on a
quarterly or an annual basis.

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

We believe that period-to-period comparisons of our operating results are
not a good indication of our future performance. Our quarterly operating
results have fluctuated in the past and are likely to

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fluctuate significantly in the future due to a number of factors. For
example, the timing and expenses associated with product introductions,
declining average selling prices of our products, the timing and extent of
product sales, the mix of products sold and significant decreases in the demand
for our products have caused our operating results to fluctuate in the past.
Because we incur operating expenses based on anticipated revenue trends, and a
high percentage of our expenses are fixed in the short term, any delay in
generating or recognizing revenues or any decrease in revenues could
significantly harm our quarterly results of operations. Other factors, many of
which are more fully discussed in other risk factors below, may also cause our
results to fluctuate. Many of the factors that may cause our results to
fluctuate are outside of our control. If our quarterly or annual operating
results do not meet the expectations of investors and securities analysts, the
trading price of our common stock could significantly decline.

Our optical path management solution (OPMS) products have historically
represented substantially all of our revenues, and if we are unsuccessful in
commercially selling our DWDM-related products or if we experience significant
decreases in OPMS sales, our business will be seriously harmed.

Sales of our OPMS products accounted for over 92% of our revenues in the
quarter ended September 30, 2002, 92% of our revenues for the nine months ended
September 30, 2002, and substantially all of our historical revenues. We
expect to substantially depend on these products for our near-term revenues.
Any significant decline in the demand for these products, or failure to
increase their market acceptance, would seriously harm our business. Declining
average selling prices of our products during the last year/quarter have
negatively impacted our revenues. The Company took charges of $1.0 million,
$0.4 million, and $0.4 million against excess OPMS-related inventory in the
quarters ended March 31, 2002, June 30, 2002, and September 30, 2002,
respectively. 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 declined sharply starting in mid fiscal 2001. Based on the reduced
demand and reduced revenue projections for this product line, we took charges
of $6.5 million, $1.2 million, $0.4 million, and $0.8 million against excess
DWDM-related inventory in the quarters ended June 30, 2001, March 31, 2002,
June 30, 2002, and September 30, 2002, respectively. If demand for these
products does not increase and our target customers do not adopt and purchase
our DWDM-related products, our revenues may decline further and we may have to
write-off additional inventory currently on our books.

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

The United States economy experienced a significant slowdown in
consumption and demand for fiber optic products most of 2001 as well as the
first three quarters of 2002. During the last 21 months, telecommunication
companies have decreased their spending which has resulted in excess inventory
and 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 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 United States
telecommunications industry may lag behind the recovery of the overall United
States economy.

Effective at the beginning of trading on November 8, 2002, the listing of our
common stock was transferred to the Nasdaq SmallCap Market and if we are unable
to maintain our listing on the Nasdaq SmallCap Market, the price and liquidity
of our common stock may decline.

Our application to transfer the listing of our common stock from the
Nasdaq National Market to the Nasdaq SmallCap Market has been approved.
Beginning at the commencement of trading on November 8, 2002, our common stock
was listed on the Nasdaq SmallCap Market. The transfer of our common stock to
the Nasdaq SmallCap Market will result in decreased liquidity of our common
stock and may further decrease the price per share of our common stock.

There can be no assurance that we will be able to satisfy all of the
quantitative maintenance criteria for continued listing on the Nasdaq SmallCap
Market including a minimum of $2.5 million in stockholders equity and a
continued minimum bid price of $1.00 per share. The current requirement
affecting us is the minimum $1.00 per share bid price. If we are unable to
comply with this criteria for at

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least 10 consecutive trading days before January 13, 2003, we may be
delisted from the Nasdaq SmallCap Market, which could further decrease the
price per share and the liquidity of our common stock, and make it more
difficult for us to raise capital in the future.

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

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



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

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

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

The market for fiber optic components is intensely competitive. We
believe that our principal competitors are the major manufacturers of optical
components and integrated modules, including vendors selling to third parties
and business divisions within communications equipment suppliers. Our
principal competitors in the components market include Avanex, Corning, DiCon
Fiberoptics, Gould, JDS Uniphase, Luminent (merged into MRV Communications,
Inc.), Oplink, Stratos Lightwave and Tyco Electronics. We believe that we
primarily compete with diversified suppliers for the majority of our product
line and to a lesser extent with niche companies that offer a more limited
product line. Competitors in any portion of our business may also rapidly
become competitors in other portions of our business. In addition, our
industry has recently experienced significant consolidation, and we anticipate
that further consolidation will occur. This consolidation has further
increased competition.

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

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

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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 recent
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 the demand for our products
experienced in 2001 and that continues to date. Additionally, we implemented a
reduction in force to reduce the number of employees during the second and
third quarters of 2001 to match our operations to this decreased demand for our
products. As of September 30, 2002, we had a total of 102 full-time employees
in Sunnyvale, California, 174 full-time employees in Taiwan, and 47 full-time
employees in China. Matching the scale of our operations with the recent
demand fluctuations, combined with the challenges of expanding and managing
geographically dispersed operations, has placed, and will continue to place, a
significant strain on our management and resources. To manage the expected
fluctuations in our operations and personnel, we will be required to:



| |  |  | improve existing and implement new operational, financial and
management controls, reporting systems and procedures;                
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | hire, train, motivate and manage additional qualified personnel, if
we experience a significant increase in demand for our products;
|
| |  |  | effectively expand or reduce our manufacturing capacity, attempting
to adjust it to customer demand; and                            
|
| |  |  | effectively manage relationships with our customers, suppliers,
representatives and other third parties.                            

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

Our success also depends, to a large degree, on the efficient and
uninterrupted operation of our facilities. We have expanded our manufacturing
facilities in Taiwan and manufacture many of our products there. During the
third quarter of 2002, we entered into a lease for a new facility in China,
which continues through July 2007. There is significant political tension
between Taiwan and China. If there is an outbreak of hostilities between
Taiwan and China, our manufacturing operations may be disrupted or we may have
to relocate our manufacturing operations. Tensions between Taiwan and China
may also affect our training facility in China. Relocating a portion of our
employees could cause temporary disruptions in our operations and divert
managements attention.

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

The development of new or enhanced fiber optic products is a complex and
uncertain process. We may experience design, manufacturing, marketing and
other difficulties that could delay or prevent the development, introduction or
marketing of new products and enhancements. Development costs and expenses are
incurred before we generate revenues from sales of products resulting from
these efforts. Our total research and development expenses, excluding non-cash
compensation expenses, were approximately $5.2 million and $5.5 million for the
nine months ended September 30, 2001 and 2002,

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respectively. We intend to continue to invest in our research and product
development efforts, which could have a negative impact on our earnings in
future periods.

If we 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 reduction in
demand for fiber optic products.

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

Decreased spending by telecommunications companies over the 21 months has
resulted in decreased 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 a decrease in demand for our products, an
increase in our inventory, and erosion in the average selling prices.

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

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

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

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declines have contributed to a decline in our gross margins and may
continue to decline in the future, which could harm our results of operations.

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

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

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
that could result in fewer orders, may increase our costs, may reduce our
control over quality and delivery schedules and require us to redesign our
products. If a supplier became unable or unwilling to continue to manufacture
or ship materials or components in required volumes, we would have to identify
and qualify an acceptable replacement. A delay or reduction in shipments or
any need to identify and qualify replacement suppliers would harm our business.
All of our graded index, or GRIN, lenses, which are incorporated into
substantially all of our filter-based DWDM products, are obtained from one
supplier, Nippon Sheet Glass. Replacements for the GRIN lenses have been
incorporated into newer products wherever practical to help mitigate this risk
in the future.

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

Because we experience long lead times for materials and components and are
often required to purchase significant amounts of materials and components far
in advance of product shipments, we may not effectively manage our inventory
levels, which could harm our operating results. We recorded significant charges
for excess and obsolete inventory in the quarters ended June 30, 2001, March
31, 2002, June 30, 2002, and September 30, 2002. Alternatively, if we
underestimate our raw material requirements, we may have inadequate inventory,
which could result in delays in shipments and loss of customers. If we
purchase raw materials and increase production in anticipation of orders that
do not materialize or that shift to another quarter, we will, as we have in the
past, have to carry or write off excess inventory and our gross margins will
decline. Either situation could cause our results of operations to be below
the expectations of investors and public market analysts, which could, in turn,
cause the price of our common stock to decline. The time our customers require
to incorporate our products into their own can vary significantly and generally
exceeds several months, which further complicates our planning processes and
reduces the predictability of our forecasts. Even if we receive these orders,
the additional manufacturing capacity that we add to meet our customers
requirements may be underutilized in a subsequent quarter.

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

Our success depends to a significant degree upon the continued
contributions of the principal members of our technical sales, marketing,
engineering and management personnel, many of whom perform important management
functions and would be difficult to replace. We particularly depend upon the
continued services of our executive officers, particularly Peter Chang, our
President and Chief Executive Officer; David Hubbard, our Vice President, Sales
and Marketing; Wei-shin Tsay, our Senior Vice President of Product Development;
Anita Ho, Acting CFO 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
regularly, we must effectively transfer production information from our product
development department to our manufacturing group and coordinate our efforts
with those of our suppliers to rapidly achieve volume production. In our
experience, our yields have been lower during the early stages of introducing
new product to manufacturing. If we fail to effectively manage this process or
if we experience delays, disruptions or quality control problems in our
manufacturing operations, our shipments of products to our customers could be
delayed.

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

In the communications industry, service providers and optical systems
manufacturers often undertake extensive qualification processes prior to
placing orders for large quantities of products such as ours, because these
products must function as part of a larger system or network. This process may
range from three to six months and sometimes longer. Once they decide to use a
particular suppliers product or component, these potential customers design
the product into their system, which is known as a design-in win. Suppliers
whose products or components are not designed in are unlikely to make sales to
that customer until at least the adoption of a future redesigned system. Even
then, many customers may be reluctant to incorporate entirely new products into
their new systems, as this could involve

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significant additional redesign efforts. If we fail to achieve design-in
wins in our potential customers qualification processes, we will lose the
opportunity for significant sales to those customers for a lengthy period of
time.

In addition, some of our customers require that our products be subjected
to standards-based qualification testing, which can take up to nine months or
more. While our customers are evaluating our products and before they place an
order with us, we may incur substantial sales and marketing and research and
development expenses, expend significant management efforts, increase
manufacturing capacity and order long lead-time supplies. Even after the
evaluation process, it is possible a potential customer will not purchase our
products. In addition, product purchases are frequently subject to unplanned
processing and other delays, particularly with respect to larger customers for
which our products represent a very small percentage of their overall purchase
activity. Accordingly, our revenues and operating results may vary
significantly and unexpectedly from quarter to quarter.

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

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

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

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



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

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

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

The market for fiber optic components is new and characterized by rapid
technological change, frequent new product introductions, changes in customer
requirements and evolving industry standards.

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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 long-haul, metropolitan, last mile, and enterprise access segments of the
networks, is critical to our future success. Potential end-user customers who
have invested substantial resources in their existing copper lines or other
systems may be reluctant or slow to adopt a new approach, such as optical
networks. Our success in generating revenues in this emerging market will
depend on:



| |  |  | the education of potential end-user customers and network service
providers about the benefits of optical networks; and      
| | - |  | -----------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the continued growth of the long-haul, 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.

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 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 may
in the future enter into agreements to indemnify our customers for any expenses
or liabilities resulting from claimed infringements of patents, trademarks or
copyrights of third parties. Any litigation arising from claims asserting that
our products infringe or may infringe the proprietary rights of third parties,
whether the litigation is with or without merit, could be time-consuming,
resulting in significant expenses and diverting the efforts of our technical
and management personnel. We do not have insurance against our alleged or
actual infringement of intellectual property of others. These claims could
cause us to stop selling our products, which

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incorporate the challenged intellectual property, and could also result in
product shipment delays or require us to redesign or modify our products or to
enter into licensing agreements. These licensing agreements, if required,
would increase our product costs and may not be available on terms acceptable
to us, if at all.

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

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

For the nine months ended September 30, 2001 and 2002, sales to customers
located outside of North America were 17.5% and 9.2% of our revenues,
respectively. The percentage decrease in sales was mainly caused by lower
sales to five customers outside of North America that was partially offset by
higher sales to one customer outside of North America. In order to expand our
business, we must increase our sales to customers located outside of North
America. We have limited experience in marketing and distributing our products
internationally and in developing versions of our products that comply with
local standards. Our international sales will be limited if we cannot
establish relationships with international distributors, establish additional
foreign operations, expand international sales channels, hire additional
personnel and develop relationships with international communications equipment
manufacturers. Even if we are able to successfully continue international
operations, we may not be able to maintain or increase international market
demand for our products.

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

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




ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND
INTEREST RATE 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, 2002, $17.0 million, or 48% of our
investments, had maturities of less than three months. We expect we will
continue to invest a significant portion of our existing cash in interest
bearing, investment grade securities, with maturities of less than 12 months.
We do not believe that our investments, in the aggregate, have significant
exposure to interest rate risk.

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 or our sales
are made in

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United States dollars; hence, we have minimal exposure to foreign currency
rate fluctuations relating to sales transactions.

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 will 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. Our Chief Executive
Officer and our Chief Financial Officer have concluded, based on their
evaluation as of a date within 90 days prior to the filing date of this
quarterly report, that the Companys disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 (the Exchange Act)) were effective.

(b)  Changes
in internal controls. There have not been any significant
changes in the Companys internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
There were no significant deficiencies or material weakness, and therefore no
corrective actions were taken.

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PART II: OTHER INFORMATION




ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K



| | (a) |  | Exhibits.                   
| | --- |  | ----------------------------
|
| | 4.  |  | 1 Form of Stock Certificate.
|
| | (b) |  | Reports on Form 8-K.        

The Company did not file any reports on Form 8-K with the Securities and
Exchange Commission during the quarter ended September 30, 2002.

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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 12, 2002

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

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CERTIFICATIONS

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 quarterly 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 quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;

4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures 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 quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6. The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002

|                                      
|--------------------------------------
|/s/Peter C. Chang                     
|                                      
|Peter C. Chang
Chief Executive Officer

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I, Anita 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 quarterly 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 quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;

4. The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures 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 quarterly report is being prepared;

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5. The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrants ability to record, process,
summarize and report financial data and have identified for the registrants
auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal controls;
and

6. The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002

| |  |                                        
| |  | ---------------------------------------
| |  | /s/ Anita Ho                           
| |  |                                        
| |  | Anita Ho
Acting Chief Financial Officer

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EXHIBIT INDEX

TO

ALLIANCE FIBER OPTIC PRODUCTS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2002

|            |  |                          
|----------- |  | -------------------------
|Exhibit No. |  | Exhibit Description      
|            |  |                          
|4.1         |  | Form of Stock Certificate

27