****UNITED STATES****

**SECURITIES AND EXCHANGE COMMISSION**

WASHINGTON, D.C. 20549        ____________________

**FORM 10-Q**

(Mark        One)                                                                                                                                             

 

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

For the quarterly period ended June 30, 2009

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

 

For the transition period from __________ to __________

 

   Commission File Number        0-31857                                                                                                                                            

| **ALLIANCE FIBER OPTIC PRODUCTS, INC.**                |  |
|--------------------------------------------------------|--|
| (Exact name of registrant as specified in its charter) |  |
|                                                   |  |   |  |
| Delaware                                               |  | 77-0554122 |  |
| (State or other jurisdiction of                        |  | (I.R.S. employer |  |
| Incorporation or organization)                         |  | identification number) |  |
|                                                   |  |   |  |
| 275 Gibraltar Drive, Sunnyvale, California 94089  |  |
|  (Address of Principal Executive Offices)         |  |
|                                                   |  |   |  |
| (408) 736-6900                                         |  |
| (Issuer’s telephone number)                      |  |

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.                Yesþ     Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                Yes?  Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “accelerated filer”,”large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o      Accelerated Filer o    Non-accelerated filer o     Smaller reporting        company þ

                     (Do not check if a smaller reporting        company)          

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

On August 3, 2009, 42,164,247shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

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 **ALLIANCE FIBER OPTIC PRODUCTS, INC.**

# FORM 10-Q

# QUARTERLY PERIOD ENDED JUNE 30, 2009

# INDEX

|                                                                                                                           | Page   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                           |   |
| PART I: FINANCIAL INFORMATION                                                                                                  | 1      |
|                                                                                                                           |   |
|      ITEM 1: FINANCIAL STATEMENTS                                                                     | 1      |
|                                                                                                                           |   |
|           Condensed Consolidated Balance Sheets at June 30, 2009 (unaudited) |   |
|           and December 31, 2008                                              | 1      |
|                                                                                                                           |   |
|           Condensed Consolidated Statements of Operations for the            |   |
|           Three and Six Months Ended June 30, 2009 (unaudited) and 2008      | 2      |
|                                                                                                                           |   |
|           Condensed Consolidated Statements of Cash Flows for the            |   |
|           Six Months Ended June 30, 2009 (unaudited) and 2008                | 3      |
|                                                                                                                           |   |
|           NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS     | 4      |
|                                                                                                                           |   |
|      ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    | 14     |
|                                                                                                                           |   |
|      ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                               | 20     |
|                                                                                                                           |   |
|      ITEM 4T: CONTROLS AND PROCEDURES                                                                 | 20     |
|                                                                                                                           |   |
| PART II: OTHER INFORMATION                                                                                                     | 21     |
|                                                                                                                           |   |
|      ITEM 1A: RISK FACTORS                                                                            | 21     |
|                                                                                                                           |   |
|      ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                      | 31     |
|                                                                                                                           |   |
|      ITEM 6: EXHIBITS                                                                                 | 31     |
|                                                                                                                           |   |
| SIGNATURE                                                                                                                      | 32     |

----

# **PART I: FINANCIAL INFORMATION**

# **ITEM 1: FINANCIAL STATEMENTS**

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

|                                                                                                 |        |        |
|------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                      |        |        |  | **June 30,                    2009** |  |  | **December 31,                        2008** |  |
| **Assets**                                                                                           |   |   |   | **(Unaudited)** |   |   |  |   |
| Current assets:                                                                                      |   |   |  |  |  |  |  |  |
|     Cash and cash equivalents                                                         |   |   | $ | 7,348 |   | $ | 12,185 |   |
|     Short-term investments                                                            |   |   |   | 31,622 |   |   | 11,769 |   |
|     Accounts receivable, net                                                          |   |   |   | 5,062 |   |   | 4,708 |   |
|     Inventories, net                                                                  |   |   |   | 4,816 |   |   | 5,614 |   |
|     Prepaid expense and other current assets                                          |   |   |   | 2,387 |   |   | 379 |   |
|          Total current assets                                |   |   |   | 51,235 |   |   | 34,655 |   |
|                                                                                                 |        |        |
| Long-term investments                                                                                |        |        |  | - |  |  | 13,718 |  |
| Property and equipment, net                                                                          |   |   |   | 4,382 |   |   | 4,653 |   |
| Other assets                                                                                         |   |   |   | 189 |   |   | 2,772 |   |
|         Total assets                                              |   |   | $ | 55,806 |   | $ | 55,798 |   |
|                                                                                                      |        |        |
| **Liabilities and Stockholders' Equity**                                                             |   |   |  |  |  |  |  |  |
| Current liabilities:                                                                                 |   |   |  |  |  |  |  |  |
|     Accounts payable                                                                  |   |   | $ | 3,005 |   | $ | 3,572 |   |
|     Accrued expenses                                                                  |   |   |   | 2,996 |   |   | 3,237 |   |
|     Current portion of bank loan                                                      |   |   |   | 132 |   |   | 137 |   |
|         Total current liabilities                                 |   |   |   | 6,133 |   |   | 6,946 |   |
|                                                                                                      |        |        |  |  |  |  |  |  |
| Long-term liabilities                                                                                |   |   |  |  |  |  |  |  |
|     Bank loan                                                                         |   |   |   | 349 |   |   | 413 |   |
|     Other long-term liabilities                                                       |   |   |   | 481 |   |   | 478 |   |
|         Total long term liabilities                               |   |   |   | 830 |   |   | 891 |   |
|         Total liabilities                                         |   |   |   | 6,963 |   |   | 7,837 |   |
|                                                                                                      |        |        |
| Commitments and contingencies (Note 8)                                                               |   |   |   |  |   |   |  |   |
| Stockholders' equity:                                                                                |   |   |  |  |  |  |  |  |
|     Common stock, $0.001 par value: 250,000,000 shares authorized;                    |   |   |  |  |  |  |  |  |
|        42,164,247 and 42,001,635 shares issued and outstanding at |   |   |  |  |  |  |  |  |
|        June 30, 2009 and December 31, 2008.                            |   |   |   | 42 |   |   | 42 |   |
|  Additional paid-in-capital                                                                     |   |   |   | 111,857 |   |   | 111,687 |   |
|  Accumulated deficit                                                                            |   |   |   | (63,646 | ) |   | (64,380 | ) |
|  Accumulated other comprehensive income                                                         |   |   |   | 590 |  |   | 612 |  |
|                                                                                                      |        |        |
|  Stockholders' equity                                                                           |   |   |   | 48,843 |   |   | 47,961 |   |
|                                                                                                      |        |        |
|       Total liabilities and stockholders' equity                       |   |   | $ | 55,806 |   | $ | 55,798 |   |
|                                                                                                      |        |        |

1

----

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

 

|                                                                                             | Three Months Ended June 30, |        | Six Months Ended June 30, |        |
|---------------------------------------------------------------------------------------------|-----------------------------|--------|---------------------------|--------|
|                                                                                        | **2009**                    |        | **2008**                  |        | **2009** |  | **2008** |  |
|                                                                                             |                             |        |                           |        |  |  |  |  |
| Revenues                                                                                    |                        |   | $                         | 7,723  |   | $ | 10,323 |   | $ | 15,366 |   | $ | 19,724 |   |
| Cost of revenues                                                                            |                        |   |                      | 5,322  |   |   | 7,069 |   |   | 10,667 |   |   | 13,524 |   |
|      Gross profit                                                       |                        |   |                      | 2,401  |   |   | 3,254 |   |   | 4,699 |   |   | 6,200 |  |
|                                                                                        |                             |        |                           |        |
| Operating expenses:                                                                         |                        |   |                           |        |  |  |  |  |  |  |  |  |  |  |
|      Research and development                                           |                        |   |                      | 762    |   |   | 895 |   |   | 1,491 |   |   | 1,793 |   |
|      Sales and marketing                                                |                        |   |                      | 577    |   |   | 645 |   |   | 1,211 |   |   | 1,313 |   |
|      General and administrative                                         |                        |   |                      | 770    |   |   | 893 |   |   | 1,615 |   |   | 1,787 |   |
|             Total operating expenses |                        |   |                      | 2,109  |   |   | 2,433 |   |   | 4,317 |   |   | 4,893 |   |
|                                                                                             |                             |        |                           |        |  |  |  |  |  |  |  |  |  |  |
| Income from operations                                                                      |                        |   |                      | 292    |  |   | 821 |  |   | 382 |  |   | 1,307 |  |
|                                                                                        |                             |        |                           |        |  |  |  |  |  |  |  |  |  |  |
| Interest and other income, net                                                              |                        |   |                      | 172    |   |   | 281 |   |   | 394 |   |   | 677 |   |
| Net income before tax                                                                       |                             |        | $                         | 464    |  | $ | 1,102 |  | $ | 776 |  | $ | 1,984 |  |
| Income tax                                                                                  |                             |        |                           | 32     |  |  | 21 |  |  | 42 |  |  | 83 |  |
| Net income                                                                                  |                        |   | $                    | 432    |  | $  | 1,081 |  | $  | 734 |  |  $ | 1,901 |  |
|                                                                                             |                             |        |                           |        |  |  |  |  |
| Net income per share:                                                                       |                        |   |                           |        |  |  |  |  |  |  |  |  |  |  |
|             Basic                    |                        |   | $                         | 0.01   |  | $ | 0.03 |  | $ | 0.02 |  | $ | 0.05 |  |
|             Diluted                       |                        |   | $                         | 0.01   |  | $ | 0.03 |  | $ | 0.02 |  | $ | 0.04 |  |
| Shares used in computing net income per share:                                              |                        |   |                           |        |  |  |  |  |  |  |  |  |  |  |
|             Basic               |                        |   |                      | 41,979 |   |   | 41,574 |   |   | 41,926 |   |   | 41,483 |   |
|             Diluted             |                        |   |                      | 42,115 |   |   | 42,674 |   |   | 41,969 |   |   | 42,659 |   |

----

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

|                                                                                                                                                                                    | Six Months Ended June 30, |        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------|--------|
|                                                                                                                                                                                         |                           |        | **2009** |  | **2008** |  |  |
| **Cash flows from operating activities:**                                                                                                                                               |                      |   |   |  |   |   |  |   |  |
|  Net income                                                                                                                                                                        |                      |   | $ | 734 |  | $ | 1,901 |  |  |
|  Adjustments to reconcile net income to net cash provided                                                                                                                          |                      |   |  |  |  |  |  |  |  |
|        by (used in) operating activities:                                                                                                            |                      |   |  |  |  |  |  |  |  |
|        Depreciation and amortization                                                                                                                      |                      |   |   | 533 |   |   | 529 |   |  |
|        Loss on disposal of property and equipment                                                                                                    |                      |   |   | 4 |   |   | - |   |  |
|        Amortization of stock-based compensation                                                                                                           |                      |   |   | 50 |   |   | 97 |  |  |
|        Provision for inventory                                                                                                                       |                      |   |   | (85) |  |   | (370 | ) |  |
|        Changes in assets and liabilities:                                                                                                                 |                      |   |  |  |  |  |  |  |  |
|               Accounts receivable, net                                                                                 |                      |   |   | (353 | ) |   | (1,267 | ) |  |
|               Inventories                                                                                         |                      |   |   | 883 |  |   | (617 | ) |  |
|               Prepaid expenses and other assets                                                                   |                      |   |   | (215 | ) |   | (31 | ) |  |
|               Accounts payable                                                                                         |                      |   |   | (567 | ) |   | 864 |  |  |
|               Accrued expenses                                                                                         |                      |   |   | (241 | ) |   | (215 | ) |  |
|               Other assets                                                                                   |                           |        |  | 1 |  |  | (23 | ) |  |
|               Other long-term liabilities                                                                              |                      |   |   | 3 |  |   | 50 |  |  |
|                        Net cash provided by operating activities          |                      |   |   | 747 |  |   | 918 |  |  |
|                                                                                                                                                                                    |                           |        |  |  |  |
| **Cash flows from investing activities:**                                                                                                                                               |                      |   |  |  |  |  |  |  |  |
|        Purchase of short-term investments                                                                                                                 |                      |   |   | (5,799 | ) |   | (13,349 | ) |  |
|        Proceeds from sales and maturities of short-term investments                                                                                       |                      |   |   | 573 |   |   | 23,780 |   |  |
|        Purchase of of property and equipment                                                                                                              |                      |   |   | (278 | ) |   | (470 | ) |  |
|                       Net cash provided by (used in) investing activities |                      |   |   | (5,504 | ) |   | 9,961 |  |  |
|                                                                                                                                                                                    |                           |        |  |  |  |
| **Cash flows from financing activities:**                                                                                                                                               |                      |   |  |  |  |  |  |  |  |
|        Proceeds from issurance of stock under ESPP                                                                                                        |                      |   |   | 118 |   |   | 207 |   |  |
|        Proceeds from the exercise of common stock options                                                                                                 |                      |   |   | 3 |   |   | 133 |   |  |
|        Repayment of bank borrowings                                                                                                                       |                      |   |   | (74 | ) |   | (75 | ) |  |
|                       Net cash provided by financing activities                |                      |   |   | 47 |   |   | 265 |   |  |
|                                                                                                                                                                                    |                           |        |  |  |  |
| Effect of exchange rate changes on cash and cash equivalents                                                                                                                            |                      |   |   | (127 | ) |   | 218 |  |  |
| Net increase (desrease)  in cash and cash equivalents                                                                                                                              |                      |   |   | (4,837 | ) |   | 11,362 |  |  |
| Cash and cash equivalents at beginning of period                                                                                                                                        |                      |   |   | 12,185 |   |   | 4,945 |   |  |
| Cash and cash equivalents at end of period                                                                                                                                              |                      |   | $ | 7,348 |   | $ | 16,307 |   |  |
|                                                                                                                                                                                    |                           |        |   |  |   |  |  |
| **Supplemental disclosure of cash flow information:**                                                                                                                                   |                           |        |  |  |  |  |  |  |  |
|         Unrealized (loss) gain on investments                                                                                                        |                           |        | $ | 46 |  | $ | (947 | ) |  |
|       Cash paid for income taxes                                                                                                                          |                           |        | $ | - |  | $ | (50 | ) |  |
|                                                                                                                                                                                         |                           |        |  |  |  |

3

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**ALLIANCE FIBER OPTIC PRODUCTS, INC.**         

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 **(Unaudited)**

**1. Summary of Significant Accounting Policies         **

***The Company***

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

***Basis of presentation***

The accompanying condensed consolidated balance sheet as of December 31, 2008, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of June 30, 2009 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the        “SEC”) and include the accounts of Alliance Fiber Optic Products, Inc. and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 and filed with the SEC on March 20, 2009. The unaudited condensed consolidated        financial statements as of June 30, 2009, and for the three and six months ended June 30, 2009 and 2008, reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial information set forth herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any subsequent interim period or for an entire year. The December 31, 2008 balance        sheet was derived from audited financial statements at that date, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

There have been no significant changes in the Company’s critical accounting policies during the six months ended June 30, 2009 as compared to what was previously disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2008 as filed with the SEC on March 20, 2009.

***Revenue Recognition***

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

***Cash and Cash Equivalents         ***

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

 

4

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***Concentrations of Risk***

Our connectivity products (formerly named optical path multiplexing solution) contributed 58.3% and 65.3% of our revenues for the three months ended June 30, 2009 and 2008, respectively. Our optical passive products (formerly named dense wavelength division multiplexing) contributed 41.7% and 34.7% of our revenues for the three months ended June 30,        2009 and 2008, respectively. Our connectivity products contributed 57.3% and 64.2% of our revenues for the six months ended June 30, 2009 and 2008, respectively. Our optical passive products contributed 42.7% and 35.8% of our revenues for the six months ended June 30, 2009 and 2008, respectively.

In the quarters ended June 30, 2009and 2008, our top 10 customers comprised 64.6%and 67.6% of our revenues, respectively. For the quarter ended June 30, 2009, two customers accounted for 17.5% and 17.2%        of our total revenues, respectively. For the quarter ended June 30, 2008, two customers accounted for 18.0% and 10.9% of our total revenues, respectively. 

In the six months ended June 30, 2009and 2008, our top 10 customers comprised 66.6%and 66.0% of our revenues, respectively. For the six months ended June 30, 2009, two customers each accounted for 19.1 % of our total        revenues. For the six months ended June 30, 2008, two customers accounted for 19.2% and 10.0% of our total revenues, respectively. 

**2. Recent Accounting Pronouncements**

In April, 2009, the Financial Accounting Standards Board (“FASB”)Staff issued amendments to FASB Statement No. 107, “Disclosure about Fair Value of Financial Instruments” and amendments to APB Opinion No. 28        “Interim Financial Reporting” (“FSP FAS 107-1 and APB 28-1”), which are effective for interim reporting periods ending after June 15, 2009.  FAS 107-1 and APB 28-1 were issued to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements.  They also require disclosures in summarized financial information to be reported at interim periods.  The        adoption of FSP FAS 107-1 and APB 28-1 did not have an impact on the Company’sfinancial statements or results of operations.

 

In April, 2009, the FASB Staff issued additional guidance for estimating fair value in accordance with FASB Statement No. 157, “Fair Value Measurements” when the volume and level of activity for the asset or liability have significantly decreased (“FSP FAS 157-4”), which is effective for interim        reporting periods ending after June 15, 2009.  FSP FAS 157-4 emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between        market participants at the measurement date under current market conditions.  The adoption of FSP FAS 157-4 did not have animpacton the Company’sfinancial statements or results of operations.

In May 2009, the FASB issued FASB Statement No. 165, “Subsequent Events” (“FAS 165”). FAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. FAS        165, which includes a new required disclosure of the date through which an entity has evaluated subsequent events, is effective for interim or annual periods ending after June 15, 2009. The adoption of FAS 165 did not have an impact on the Company’sfinancial statements or results of operations.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which is effective for us beginning January 1, 2010. This Statement amends FIN 46(R), Consolidation of Variable Interest Entities an interpretation of ARB No. 51, to require revised evaluations of whether entities represent variable interest        entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. We do not believe the adoption of this pronouncement will have a material impact on our financial statements. 

In June, 2009, the FASB Staff issued FASB Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FAS Statement No. 162” (“FAS 168”), which is effective July 1, 2009 and will        apply to all interim periods ending after September 15, 2009.  FAS 168 establishes the FASB Accounting Standards Codification (the “Codification”) as the single source of authoritative U.S. accounting and reporting standards applicable for all non-governmental entities, with the exception of guidance issued by the SEC and its staff. FAS 168 will amend the Company’s disclosure for references        to accounting guidance to include reference to the applicable section of the Codification. 

5

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

 

**3. Stock-based Compensation**

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

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

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

As of June 30, 2009, there was no unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s option plans. 

For the three and six months ended June 30, 2009, the fair value of SBP awards were estimated using the BinomialLattice valuation model, with the following weighted-average assumptions and fair values as follows: 

|                                           | Three Months Ended June 30, |        | Six Months Ended June 30, |      |
|------------------------------------------------|-----------------------------|--------|---------------------------|------|
|                                           | **2009**                    |        | **2008**                  |      | **2009** |  | **2008** |  |
| Volatility (percent)*                          |                        |   |                           | 35.5 |   |  | 36.4 |   |  | 35.5 |   |  | 36.4 |   |
| Expected term (in years)**                     |                        |   |                      | 4    |   |   | 4 |   |   | 4 |   |   | 4 |   |
| Risk free interest rate (percent)***           |                        |   |                      | 1.73 |   |   | 3.02 |   |   | 1.65 |   |   | 2.65 |  |
| Expected dividend rate (percent)               |                        |   |                           | -    |  |  | - |   |   | - |   |   | - |  |
| Forfeiture rate (percent)****                  |                        |   |                      | 10   |   |   | 10 |   |   | 10 |   |   | 10 |   |
| Weighted-average fair value per option granted |                        |   |                      | -    |   |   | N/A |   | $  | - |   | $  | 1.81 |   |
|                                           |                             |        |                           |      |  |  |  |  |  |  |  |  |  |  |

 

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

 

6

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N/A: No options were granted during the three months ended June 30, 2008.         

At June 30, 2009, the Company had two stock-based compensation plans. They are: (a) 1997 Stock Option Plan and (b) 2000 Stock Incentive Plan, which are described below.                   (a) 1997 Stock Option Plan                  In May 1997, the Company adopted its 1997 Stock Plan under which 3,000,000 shares of common stock were reserved for issuance to eligible employees, directors and consultants upon exercise of stock options and stock purchase rights. During the year ended December 31, 2000, an additional 5,200,000 shares were reserved for issuance under the 1997 Stock Plan. Incentive stock options are granted at a price not less than 100% of the fair market value of the Company’s common stock        and at a price of not less than 110% of the fair market value for grants to any person who owned more than 10% of the voting power of all classes of stock on the date of grant. Nonstatutory stock options are granted at a price not less than 85% of the fair market value of the common stock and at a price not less than 110% of the fair market value for grants to a person who owned more than 10% of the voting power of all classes of stock on the date of the grant. Options granted under the        1997 Stock Plan generally vest over four years and are exercisable for not more than ten years (five years for grants to any person who owned more than 10% of the voting power of all classes of stock on the date of the grant). In November 2000, the 1997 Stock Plan was replaced by the 2000 Stock Incentive Plan.                  (b) 2000 Stock Incentive Plan                  In November 2000, the Company adopted its 2000 Stock Incentive Plan under which 1,500,000 shares of common stock were reserved for issuance to eligible employees, directors and consultants upon exercise of stock options and stock purchase rights. On January 1 of each year, beginning on January 1, 2001, the number of shares available for grant will automatically increase by the lesser of: (i) 1,700,000 shares; (ii) 5% of the fully diluted outstanding shares of stock on        that date; or (iii) a lesser amount as may be determined by the Board of Directors. The Board of Directors determined not to increase the number of shares available under the Plan on January 1, 2009 and 2008, respectively. Incentive stock options and nonstatutory stock options are granted at 100% of the fair market value of the Company’s common stock on the date of grant.                  Options granted under the 2000 Stock Incentive Plan generally vest over four years. However, most options granted in the pastthreeyearshave been fully vested at the time of grant. Options are exercisable for not more than ten years.

The following information relates to the stock option activity for the six months ended June 30, 2009: 

          

| Options                                                  |   | Weighted                    Average                    Exercise                    Price | Weighted                    Average                    Remaining                    Contractual                    Life | Aggregate                    Intrinstc                    Value |
|----------------------------------------------------------|--------|------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------|
|                                                     |        |                                                                                          |                                                                                                                         |                                                                 |  |  |  |  |  |
|   Outstanding at December 31, 2008             |   |                                                                                     | 4,856,083                                                                                                               | $                                                               | 1.40 |   |   |   |   |
|   Granted                                      |   |                                                                                     | 30,000                                                                                                                  |                                                            | 0.88 |   |   |   |   |
|   Exercised                                    |   |                                                                                     | (3,000)                                                                                                                 |                                                            | 0.96 |   |   |   |   |
|   Forfeited                                    |   |                                                                                     | (12,500)                                                                                                                |                                                            | 1.31 |   |   |   |   |
|   Outstanding at June 30, 2009                 |        |                                                                                          | 4,870,583                                                                                                               | $                                                               | 1.39 |  | 5.27 Years | $ | 544,947 |
|   Vested and expected to vest at June 30, 2009 |   |                                                                                     | 4,844,416                                                                                                               | $                                                               | 1.39 |   | 5.26 Years | $ | 542,596 |
|   Exercisable at June 30, 2009                 |   |                                                                                     | 4,670,173                                                                                                               | $                                                               | 1.39 |   | 5.16 Years | $ | 526,356 |

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the secondquarter of fiscal 2009 and the exercise price, multiplied by the        number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2009. This amount changes based on the fair marketvalue of the Company’s stock. The total intrinsic value of options exercised for the threeand sixmonths ended        June30, 2009was de minimis.

7

 

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The Company granted 30,000 options to purchase common stockto one of the members of the Board of Directorsduring the quarter ended June30, 2009. The option vests as to one thirty-sixth of the shares on the grant        date and an additional onethirty-sixth of the shares vest on the first day of each full month thereafter. The weighted average grant date fair value of options granted during the quarter ended June30, 2009was de minimis.         Expected dividend rate is 0% for both three month periods ended June30, 2009 and 2008 respectively.          

Cash received from option exercises during the three and six months ended June 30, 2009was $2,880, and is included within the financing activities section in the accompanying consolidated statements of cash flows.         

The following table summarizesemployee stock-based compensation expense resulting from stock options and employee stock purchase plan (in thousands):

          

|                                                                     | Three Months Ended June 30, |        | Six Months Ended June 30, |    |
|--------------------------------------------------------------------------|-----------------------------|--------|---------------------------|----|
|                                                                     | **2009**                    |        | **2008**                  |    | **2009** |  | **2008** |  |
| Included in cost of revenue:                                             |                        |   | $                         | 11 |   | $ | 20 |   | $ | 25 |   | $ | 42 |   |
| Included in operating expenses:                                          |                        |   |                      |    |   |   |  |   |   |  |   |   |  |   |
|        Research and development            |                        |   |                      | 5  |   |   | 9 |   |   | 11 |   |   | 19 |  |
|        Sales and marketing            |                        |   |                           | 2  |  |  | 6 |   |   | 6 |   |   | 13 |  |
|        General and administrative          |                        |   |                      | 4  |   |   | 11 |   |   | 8 |   |   | 23 |   |
|             Total |                        |   |                      | 11 |   |   | 26 |   |   | 25 |   |   | 55 |   |
|                                                                     |                             |        |                           |    |  |  |  |  |  |  |  |  |  |  |
| Total stock-based compensation expense                                   |                             |        | $                         | 22 |  | $ | 46 |  | $ | 50 |  | $ | 97 |  |

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

 

|                              |             June 30, |  December 31,  |
|-----------------------------------|-----------------------------------------------------------------------------|-------------------------------|
|                                   |                                                                             | ** 2009**                |  | ** 2008** |  |
|                              |                                                                        | **(unaudited)**               |   |  |   |
| **Inventories**                   |                                                                             |                               |  |  |  |
|    Finished goods  |                                                                        | $   1,619      |   | $      1,880 |   |
|    Work-in-process |                                                                        | 1,434                         |   | 1,393 |   |
|    Raw materials   |                                                                        | 1,763                         |   | 2,341 |   |
|                              |                                                                        | $   4,816      |   | $   5,614 |   |
|                                   |                                                                             |                               |  |  |
|                                   |                                                                             |                               |

**5. Net Income Per Share**

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

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

 

8

 

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|                                                      | Three Months Ended June 30, |        | Six Months Ended June 30, |        |
|------------------------------------------------------|-----------------------------|--------|---------------------------|--------|
|                                                 | **2009**                    |        | **2008**                  |        | **2009** |  | **2008** |  |
|                                                 |                             |        |                           |        |  |  |  |  |  |  |  |  |  |  |
|                                                      |                        |   | $                         | 432    |  | $ | 1,081 |   | $ | 743 |   | $ | 1,901 |   |
|                                                      |                             |        |                           |        |  |  |  |  |
| Weighted-average common shares - basic               |                        |   |                           | 41,979 |   |  | 41,574 |   |  | 41,926 |   |  | 41,483 |   |
|                                                      |                        |   |                           |        |   |  |  |   |  |  |   |  |  |   |
| Dilutive effect of employee stock option plan        |                        |   |                           | 136    |  |  | 1,100 |   |  | 43 |   |  | 1,176 |   |
|                                                      |                        |        |                      |        |   |  |   |  |
| Weighted-average common shares outstanding - diluted |                        |   |                           | 42,115 |  |  | 42,674 |   |  | 41,969 |   |  | 42,659 |   |
|                                                      |                             |        |                           |        |  |  |  |  |
|                                                      |                        |   |                           |        |  |  |  |   |  |  |   |  |  |   |
| Basic earnings per common share                      |                        |   | $                         | 0.01   |  | $ | 0.03 |   | $ | 0.02 |   | $ | 0.05 |   |
| Diluted earnings per common share                    |                        |   | $                         | 0.01   |  | $ | 0.03 |   | $ | 0.02 |   | $ | 0.04 |   |
|                                                      |                        |        |                      |        |   |  |  |  |

For the three and six months ended June 30, 2009, 4.7 millionand 4.8 millionoutstanding weighted average stock options were excluded from the calculation of diluted earnings per common share. For the three and six months        ended June 30, 2008, 2.0 millionand 0.2 millionoutstanding weighted average stock options were excluded from the calculation of diluted earnings per common share. The Companyexcluded these stock optionsbecause theirexercise prices were greater than the average market value of the common shares. These options could be included in the calculation in the future if the average market value of the common shares increases and is greater than the exercise price of these options. 

. 

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

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

          

|                                                           | Three Months                Ended June 30, |        | Six Months                Ended June 30, |     |
|----------------------------------------------------------------|--------------------------------------------|--------|------------------------------------------|-----|
|                                                           | **2009**                                   |        | **2008**                                 |     | **2009** |  | **2008** |  |
| Net income                                                     |                                       |   | $                                        | 432 |   | $ | 1,081 |   | $ | 734 |   | $ | 1,901 |   |
| Cumulative translation adjustments                             |                                       |   |                                          | 113 |   |  | 143 |   |  | (69) |   |  | 521 |   |
| Unrealized gain (loss) on short-term investments          |                                       |   |                                          | 212 |   |  | (227) |   |  | 47 |   |  | (947) |   |
|       Total comprehensive income |                                       |   | $                                        | 757 |   | $ | 997 |   | $ | 712 |   | $ | 1,475 |   |
|                                                                |                                            |        |                                          |     |  |  |  |  |

**7. Income Taxes         **

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

**8. Commitments and Contingencies**

**Litigation:**         

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

 

9

 

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**Indemnification and Product Warranty:          **

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

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

**Operating Leases:          **

The Company leases office space under long-term operating leases expiring at various dates through 2014.

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

|                                                                                                                                                                                                      |        |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Six months ending December 31, 2009                                                                                                                                                             |   |   | $ | 428 |   |
| Years ending December 31:                                                                                                                                                                            |   |   |  |  |  |
|                                 2010 |   |   |   | 672 |   |
|                                 2011 |   |   |   | 203 |   |
|                                 2012 |   |   |   | 154 |   |
|                                 2013 |        |  |  | 152 |  |
|                                 2014 |        |  |  | 127 |  |
|  Total                                                                                                                                                                                          |   |   | $ | 1,736 |   |

**Letter of Credit:          **

The Company had a letter of credit of $0.4 million which expired on April 12, 2009.

**9. Bank Loans**

In November 2004, the Company entered into a ten-year loan of $0.5 million in Taiwan with an interest rate of 2.3% for the first two years and 3.6% for the following years. In November 2006, the Company entered into a seven-year loan of $0.2 million in Taiwan with an interest rate of 2.8%. Both loans are secured by the Company’s        building in Taiwan. The net book value of the building was $0.6 million as of June 30, 2009. 

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

Payments due under our bank loansas of June 30, 2009wereas follows (in thousands):

 

10

 

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|                                             |        |
|---------------------------------------------|--------|
| **Years ending December 31,**               |   |   |   |   |   |
| 2009                                        |   |   | $ | 74 |   |
| 2010                                        |   |   |   | 120 |   |
| 2011                                        |   |   |   | 99 |   |
| 2012                                        |   |   |   | 92 |   |
| 2013                                        |   |   |   | 73 |   |
| 2014 and after                              |   |   |   | 47 |   |
|      Total payment |   |   |   | 505 |   |
| Less: Amounts representing interest         |   |   |   | (24) |  |
| Present value of net remaining payments     |   |   |   | 481 |   |
| Less: current portion                       |   |   |   | (132) |  |
| Long-term portion                           |   |   | $ | 349 |   |

**10. Related Party Transactions**

As of June 30, 2009, Foxconn Holding Limited was a holder of 18.97% of the Company’s common stock, based on share ownership information set forth in a Schedule 13G filed by Foxconn Holding Limited on January 4, 2002. The Company sells products and purchases raw materials from Hon Hai Precision Industry Company Limited, who is the parent company        of Foxconn Holding Limited, in the normal course of business. These transactions were made at prices and terms consistent with those with unrelated third parties. There were no sales of products to Hon Hai Precision Industry Company Limited for the three months ended June 30, 2009. Sales of products to Hon Hai Precision Industry Company Limited were $0.01 million for the six months ended June 30, 2009. Purchases of raw materials from Hon Hai Precision Company Limited were $0.5 million        and $0.9 million for the three and six months ended June 30, 2009, respectively. There were no amounts due from Hon Hai Precision Company Limited at June 30, 2009. Amounts due to Hon Hai Precision Company Limited were $0.5 million at June 30, 2009.

**11.****Fair Value of Financial instruments         **

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

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

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

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

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

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

11

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The Company measures the following financial assets at fair value on a recurring basis. The fair value of these financial assets at June 30, 2009(in thousands) are as follows:

|                                   |                                                         |
|----------------------------------------|--------------------------------------------------------------|
|                                   | ****Fair value Measurements at** Reporting Data Using** |
|                                        |                                                              |  |  | **Quoted Prices** |   |   |   |   |   |
|                                   |                                                         |   |   | ** in Active** |   | **Significant ** |   |   |   |
|                                   |                                                         |   |   | **Markets for** |   | ** Other** |   | **Significant ** |   |
|                                   |                                                         |   |   | **Identical** |   | **Observable** |   | **Unobservable** |   |
|                                   |                                                         | **Balance at ** |   | **Assets ** |   | **Inputs ** |   | **Inputs  ** |   |
|                                   |                                                         | **June 30, 2009** |   | **(Level 1)** |   | **(level 2)** |   | **(Level 3)** |   |
|                                        |                                                              |  |  |  |  |  |  |  |  |
| **Cash and cash equivalents**          | $                                                            | 3,999 | $ | 3,999 | $ | - | $ | - |  |
| **Short-term investments**             |                                                              | 31,622 |  | 17,190 |  | - |  | 14,432 |  |
| **Other current assets - Rights** |                                                         | 1,793 |   | - |   | - |   | 1,793 |   |
| **Total**                              | $                                                            | 37,414 | $ | 21,189 | $ | - | $ | 16,225 |   |

As of June30, 2009, the Company held investments in corporate bonds, agencies (Federal Home Loan Mortgage Corporation), certificates of deposit, money market securities, and ARS. The Company’s cash and cash equivalents are comprised of        investments of 90 days or less from the date of purchase and these investment instruments are classified withinLevel 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets. The Company’s short-term investments are comprised of corporate bonds and agenciesof 91 days or more from the date of purchase. These investment        instruments are classified withinLevel 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets.

As of June 30, 2009, the Company held investments in auction rate securities (“ARS”) that are required to be measured at fair value on a recurring basis. Since February 2008,allARS investments in the Company’s portfolio have experienced failed auctions. Due to the lack of liquidity, the Company reclassified its ARS portfolio from short-term available-for-sale to long-term available-for-sale investment securities as of March 31, 2008. The Company’s ARS investments have been classified within Level 3 as their valuation requires substantial judgment and estimation of factors that        are not currently observable in the market due to the lack of trading. This valuation may be revised in future periods as market conditions evolve.The Company estimated the fair value of its ARSbased on estimates contained in broker statements that were compiled utilizing Level 3 inputs including, but not limited to factors such as tax status, credit quality, duration,        insurance wraps and the portfolio composition of The Federal Family Education Loan Program loans. 

 

On June 8, 2009 and June 23, 2009, the Pennsylvania Higher Education completed a partial call of the ARS at par and the Company received settlement of $50,000 and $25,000, respectively. On June 30, 2009, the Company reclassified the ARS and the related Right (as defined below) from        long-term investments to short-term investments and current other assets.

 

In November 2008, the Company accepted an offer from UBS, the Company’s investment advisor, granting the Company the right to require UBS to purchase the Company’s ARS at their par value of $16.3 million anytime during the two-year period beginning June 30, 2010 (“Right”).        UBS has also established a program which allows the Company to establish a no net cost line of credit and borrow up to 75 percent of the market value of the ARS at interest rates equal to the return the Company would receive on the underlying ARS securities. Management reviewed the UBS offer, credit rating, and financial stability and believed that UBS will purchase the Company’s ARS at par value beginningon June 30, 2010. The Right represents an instrument by which the Company may require UBS to repurchase its ARS at par value. The Company has valued the Right as the difference between the par value and the fair value of its ARS as adjusted for any bearer risk associated with UBS’ financial ability to repurchase the Company’s ARS beginning on June 30, 2010. Upon election for fair value option for the Right under FAS 159, the Company will        continue to measure the value of the Right at the difference between par value and fair value in subsequent periods.

12

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In conjunction with the adoption of FAS 159, the Company elected the fair value option for its ARS and the Right. Since the Right is directly related to the Company’s ARS investments, the Company elected the fair value option for these financial assets and they have been classified within Level 3 as ARS investments.In conjunction with the adoption of FAS 159,the Company elected a one-time transfer of ARS subject to settlements from available-for-sale to the trading category. As of June30, 2009, the Companyhasrecognized the Right as other assets on the balance sheet        and recorded a gain of $0.8 million as other income.

The following table provides a reconciliation of the beginning and ending balance for the assets measured at fair value using significant unobservable inputs (Level 3) (in thousands):

|                                         |   | **Significant**  |   |
|-----------------------------------------|--------|------------------|--------|
|                                    |   | **Unobservable** |   |
|                                    |   | **Inputs ** |   |
|                                    |   | **(Level 3)**    |        |
| **Fair value December 31, 2008**        | $      | 16,300           |        |
| **Gain on Short-term investments**      |        | 788              |        |
| **Loss on other assets**                |        | (788)            |        |
| **Sale on short-term investments** |   | (75)             |        |
| **Fair value June 30, 2009**       | $      | 16,225           |        |

**1****2****.****Geographic Segment Information**

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

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

 

|                                              | Three Months Ended June 30, |        | Six Months Ended June 30, |       |
|---------------------------------------------------|-----------------------------|--------|---------------------------|-------|
|                                              | **2009**                    |        | **2008**                  |       | **2009** |  | **2008** |  |
| **Revenues**                                      |                        |   |                           |       |   |  |  |   |  |  |   |  |  |   |
|       North America |                        |   | $                         | 3,558 |   | $ | 5,771 |   | $ | 6,573 |   | $ | 10,705 |   |
|       Europe        |                        |   |                           | 1,958 |   |  | 1,543 |   |  | 4,219 |   |  | 2,619 |   |
|       Asia          |                        |   |                           | 2,207 |   |  | 3,009 |   |  | 4,574 |   |  | 6,400 |   |
|                          |                        |   | $                         | 7,723 |   | $ | 10,323 |   | $ | 15,366 |   | $ | 19,724 |   |
|                                                   |                             |        |                           |       |  |  |  |  |

|                                                         | Three Months Ended June 30, |        | Six Months Ended June 30, |       |
|--------------------------------------------------------------|-----------------------------|--------|---------------------------|-------|
|                                                         | **2009**                    |        | **2008**                  |       | **2009** |  | **2008** |  |
| **Revenues**                                                 |                        |   |                           |       |   |  |  |   |  |  |   |  |  |   |
|       Connectivity products    |                        |   | $                         | 4,504 |   | $ | 6,736 |   | $ | 8,811 |   | $ | 12,671 |   |
|       Optical passive products |                        |   |                           | 3,219 |   |  | 3,587 |   |  | 6,555 |   |  | 7,053 |   |
|                                |                        |   | $                         | 7,723 |   | $ | 10,323 |   | $ | 15,366 |   | $ | 19,724 |   |
|                                                         |                             |        |                           |       |  |  |  |  |

|                                            | **Jun 30,                2009** |        | **Dec 31,                2008** |
|-------------------------------------------------|---------------------------------|--------|--------------------------------------|
|                                                 |                            |   |                                 | **(unaudited)** |   |  |   |  |   |
| **Property and Equipment**                      |                            |   |                                 |  |   |  |   |  |   |
|     United States           |                            |   | $                                    | 107 |   |  | $ | 133 |   |
|     Taiwan                  |                            |   |                                 | 2,538 |   |  |   | 2,793 |   |
|     China                   |                            |   |                            | 1,737 |   |  |    | 1,727 |    |
|        Total |                            |   | $                                    | 4,382 |   |  | $ | 4,653 |   |

13

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

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K, its        Consolidated Financial Statement and the notes thereto, for the year ended December 31, 2008.                  The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and Notes thereto.          

**Critical Accounting Policies and Estimates         **

*Stock-based Compensation Expense*

 

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including        employee stock options and employee stock purchases pursuant to our Employee Stock Purchase Plan (“ESPP”) based on estimated fair values. We adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our 2006 fiscal year. 

 

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Stock-based compensation expense recognized under SFAS 123(R) for the three and six months ended June 30, 2009was $0.02million and $0.05million, respectively, determined by the Binomial Latticevaluation model, and represents stock-based compensation expense related to our employee stock purchase plan. As of June 30, 2009, there was no unrecognized compensation cost related to non-vested share-based compensation arrangementsunder the Company’s        stock option plan.         

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

For additional information regarding our critical accounting policies and estimates, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2008.

**Overview         **

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

Our connectivity products contributed revenues of $4.5 million and $6.7 million for the three months ended June 30, 2009 and 2008, respectively. Our optical passive products contributed revenues of $3.2 million and $3.6 million for the three months ended June 30, 2009 and 2008, respectively. Our connectivity products contributed 57.3% and 64.2% of our        revenues for the six months ended June 30, 2009 and 2008, respectively. Our optical passive products contributed 42.7% and 35.8% of our revenues for the six months ended June 30, 2009 and 2008, respectively.

In the three monthsended June 30, 2009and 2008, our top 10 customers comprised 64.6% and 67.6% of our revenues, respectively. For the three months ended June 30, 2009, two customers accounted for 17.5%        and 17.2% of our total revenues. For the three months ended June 30, 2008, two customers accounted for 18.0% and 10.9% of our total revenues. We market and sell our products predominantly through our direct sales force. 

In the six months ended June 30, 2009 and 2008, our top 10 customers comprised 66.6%and 66.0% of our revenues, respectively. For the six months ended June 30, 2009, two customers each accounted for 19.1% of our total revenues. For the six months ended June 30, 2008, two customers        accounted for 19.2% and 10.0% of our total revenues, 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 impairment charges related to manufacturing assets; |
|--|----------------------------------------|-------------------------------------------------------------------------------|

|  | ·      | mix of products sold; |
|--|----------------------------------------|-----------------------|

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

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

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

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

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

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

**Results of Operations          **

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

|                                                                                 | Three Months                Ended June 30, |        | Six Months                Ended June 30, |        |
|--------------------------------------------------------------------------------------|--------------------------------------------|--------|------------------------------------------|--------|
|                                                                                 | **2009**                                   |        | **2008**                                 |        | **2009** |  | **2008** |  |
| Revenues                                                                             |                                       |   |                                          | 100.0% |   |  | 100.0% |   |  | 100.0% |   |  | 100.0% |   |
| Cost of revenues                                                                     |                                       |   |                                          | 68.9   |   |  | 68.5 |   |  | 69.4 |   |  | 68.6 |   |
|       Gross profit                                     |                                       |   |                                          | 31.1   |   |  | 31.5 |   |  | 30.6 |   |  | 31.4 |   |
|                                                                                 |                                       |   |                                          |        |   |  |  |   |  |  |   |  |  |   |
| Operating expenses                                                                   |                                       |   |                                          |        |   |  |  |   |  |  |   |  |  |   |
|       Research and development                         |                                       |   |                                          | 9.8    |   |  | 8.7 |   |  | 9.7 |   |  | 9.1 |   |
|       Sales and marketing                              |                                       |   |                                          | 7.5    |   |  | 6.2 |   |  | 7.9 |   |  | 6.7 |   |
|       General and administrative                       |                                       |   |                                          | 10.0   |   |  | 8.7 |   |  | 10.5 |   |  | 9.0 |   |
|           Total operating expenses |                                       |   |                                          | 27.3   |   |  | 23.6 |   |  | 28.1 |   |  | 24.8 |   |
|                                                                                 |                                       |   |                                          |        |   |  |  |   |  |  |   |  |  |   |
| Income from operations                                                               |                                       |   |                                          | 3.8    |   |  | 7.9 |   |  | 2.5 |   |  | 6.6 |   |
| Interest and other income, net                                                       |                                       |   |                                          | 2.2    |   |  | 2.7 |   |  | 2.6 |   |  | 3.4 |   |
| Net income                                                                           |                                       |   |                                          | 6.0%   |   |  | 10.6% |   |  | 5.1% |   |  | 10.0% |   |

*Revenues.*Revenues were $7.7million and $10.3 million for the three months ended June 30, 2009and 2008, respectively.        Revenues decreased 25.2% in the three monthsended June 30, 2009from the same period in 2008. Revenues were $15.4million and $19.7 million for the six months ended June 30, 2009and 2008, respectively. Revenues decreased 22.1% in the six months        ended June 30, 2009from the same period in 2008.Thedecrease for the three and six months ended June 30, 2009 was mainlydue to reduced orders from our customers as a result of an industry wide slow down due to macro economic conditions.Declines in average selling prices were a secondary cause of the decrease in revenuesand resulted from pricing pressure from customers, competitive pricing by other suppliers and general product maturity. We expect we may experiencesimilar levels of average selling prices decline in the future. 

*Cost of Revenues.*Cost of revenues was $5.3million and $7.1million for the three months ended June 30, 2009and 2008, respectively. Cost of revenues as a percentage of revenues increased to 68.9% for the three months ended June 30, 2009from 68.5% for the three months ended June 30, 2008. Cost of revenues was $10.7million and $13.5 million for the six months ended June 30, 2009and 2008, respectively. Cost of revenues as a percentage of revenues increased to 69.4% for the six months ended June 30, 2009from 68.6% for the six months ended June 30, 2008. The higher cost of revenues as a percentage of revenues for the period ended June 30, 2009was due to the lower sales ofconnectivity products, which have highergross margins.

 

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*Gross Profit.*Gross profit decreased in dollars to $2.4million, or 31.1% of revenues, for the three months ended June 30, 2009from $3.3 million, or        31.5% of revenues, for the same period in 2008. Gross profit decreased to$4.7million, or 30.6% of revenues, for the six months ended June 30, 2009from $6.2 million, or 31.4% of revenues, for the same period in 2008. For the three and six monthsended June 30, 2009, the lowergross profit was due to the lower utilization of our factories as a result of decreased volume shipments to our customers.Declines in average selling prices were offset by cost improvements other than utilization, includingmaterial purchase prices and yield and cycle time improvements. 

*Research and Development Expenses*. Research and development expenses decreased to $0.8million for the three months ended June 30, 2009from $0.9 million        for the same period in 2008.Research and development expenses decreased to $1.5million for the six months ended June 30, 2009from $1.8 million for the same period in 2008. The decrease was primarily due to costs control and fewer products indevelopment.         

As a percentage of revenues, research and development expenses increased to 9.8% in the three months ended June 30, 2009from 8.7% for the same period in 2008. As a percentage of revenues, research and development expenses increased to 9.7% in the six months ended June 30,        2009from 9.1% for the same period in 2008. The higher research and development expenses as a percentage of revenueswas mainly due to decreased revenuelevels. We expect research and development expenses on our product development efforts to increase in the near term as we intend to continue to invest in our        research and product development efforts.

*Sales and Marketing Expenses*. Sales and marketing expenses remained at$0.6 million for the three months ended June 30, 2009and 2008, respectively. Sales        and marketing expenses decreased to $1.2million for the six months ended June 30, 2009from $1.3million for the same period in 2008. As a percentage of revenues, sales and marketing expenses increased to 7.5% in the three months ended June 30, 2009from        6.2% for the same period in 2008.         

As a percentage of revenues, sales and marketing expenses increased to 7.9% in the six months ended June 30, 2009from 6.7% for the same period in 2008. The higher sales and marketing expenses as a percentage of revenueswas mainly due to decreased revenuelevels. We expect sales and marketing expenses will remain relatively flatin the next two quarters.

*General and Administrative Expenses*. General and administrative expenses decreased to $0.8 million for the three months ended June 30, 2009 from $0.9 million for the same period in 2008.General and administrative        expenses decreased to $1.6 million for the six months ended June 30, 2009 from $1.8 million for the same period in 2008.         

As a percentage of revenues, general and administrative expenses increased to 10.0% in the three months ended June 30, 2009from 8.7% for the same period in 2008. As a percentage of revenues, general and administrative expenses increased to 10.5% in the six months ended June 30,        2009from 9.0% for the same period in 2008. The higher general and administrative expenses as a percentage of revenue was mainly due to decreased revenue levels. We expect general and administrative expenses will increasedue to higher fees and costs associated with compliance with laws and regulations such as the Sarbanes-Oxley Act of 2002 and the regulations        promulgated thereunder.

*Stock-Based Compensation*. Total stock-based compensation decreased to $22,000for the three months ended June 30, 2009from $46,000for the same period in 2008. Total stock-based compensation decreased to $50,000for the six months ended June 30, 2009from $97,000for the same period in 2008. These decreases were because themajority        of optionsgranted in the past three yearswere fully vested at the time of grant.

*Interest and Other Income, Net.*Interest and other income, net, was $0.2million and $0.3million for the three months ended June 30, 2009and 2008, respectively. Interest and other income, net, was $0.4million and $0.7million for the six months ended June 30, 2009and 2008, respectively. 

 

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*Income**T**ax**E**xpense.*Income tax expense was approximately $0.03 million and $0.02million for the three months ended June 30, 2009and 2008, respectively. Income tax expense was approximately $0.04 million and $0.08 million for the six months ended June 30, 2009 and 2008, respectively. During the first quarter of 2008, we paid        $0.05 million income tax for the year ended December 31, 2007.

**Liquidity and Capital Resources**

At June30, 2009, we had cash and cash equivalents of $7.3 millionand short-term investments of $31.6 million, which includes our ARS of $14.4 million. We also hold $1.8 millionofARS Rightsin other current assets. On June 30, 2009,we reclassified $16.2 million of ARS and the related ARS Right from long-term to current assets. The ARS and associated Rights are not saleable by us at the date hereof. Accordingly, we do not consider the        ARS or the Rights as sources of liquidity at this time.

Net cash provided by operating activities was $0.7million for the six months ended June 30, 2009. The increase in net cash provided by operating activities was primarily due to net income of $0.7million. Additionally,        cash used for accounts payable of $0.6 million, accounts receivable of $0.4 million, prepaid expenses of $0.2 million, and accrued liabilities of $0.2 million, offset cash provided by decreases in inventory of $0.9million, and depreciation and amortization of $0.5million.         Net cash provided by operating activities was $0.9 million for the six months ended June 30, 2008. Net cash provided by operating activities was primarily due to net income of $1.9 million, an increase in accounts payable of $0.9 million, and total depreciation and amortization expenses of $0.6 million, which was offset by a $1.3 million increase in accounts receivable, a $0.4 million decrease in inventory provision and a $0.6 million        increase in inventory.

Cash used in investing activities was $5.5million for the six months ended June 30, 2009. This resulted from $5.2million in net purchasesof short-term        investments and reclassification of long-term investmentsto short-term investments. We also used $0.3million cashon equipment purchases. Cash provided by investing activities was $10.0 million for the six months ended June 30, 2008. This resulted from $10.4 million in net proceeds from sales of short-term        investments offset by $0.5 million spending on equipment purchases.         

Cash provided by financing activities was $0.05 million and $0.3 for the six months ended June 30, 2009 and 2008, respectively, and was comprised of proceeds from the exercise of options to purchase our common stock and the sale of our common stock through our Employee Stock Purchase Plan. Cash used in financing activities was $0.08 million each for        the six months ended June 30, 2009 and 2008, respectively, and was used for repayment of bank borrowings.

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

**Contractual Obligations         **

Our long-term debt obligations are for principal and interest on mortgage and equipment loans from financial institutions in Taiwan.

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

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In Taiwan, we lease a total of approximately 38,800 square feet in one facility located in Tu-Cheng City, Taiwan. This lease expires at various times from May 2010to December 2011. In December 2000, the Company purchased approximately 8,200 square feet of space immediately adjacent to the leased        facility for $0.8 million, bringing the total square footage to approximately 47,000 square feet. 

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

In August2009, we expanded our facility in the Shenzhen area of China. We replaced the existingtwo leases with a new lease for a 132,993 square foot facility in Shenzhen, which lease will expire in October 2014.

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

Not required.

**Recent Accounting Pronouncements**

 

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

 

**ITEM 4T: CONTROLS AND PROCEDURES**

 

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

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

 

 

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|  | **PART II:      ** | **OTHER INFORMATION     ** |
|--|---------------------------------------------|-----------------------------------------------------|

**ITEM 1A: RISK FACTORS**

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

We had net income of approximately $0.4million and $1.1million in the second quarter of fiscal 2009and 2008, respectively. Although we generated a profit in the        second quarter of fiscal 2009and 2008, we may not be able to sustain profitability in the future. Although our cash and cash equivalents increased in the second quarter of fiscal 2009, our cash flows may be negative again in the future as we continue to invest in our business. As of June 30, 2009, we had an accumulated deficit of approximately $63.6million.                  We continue to experience fluctuating demand for our products. If demand for our products increases in the future, we expect to incur significant and increasing expenses for expansion of our manufacturing operations, research and development, sales and marketing, and administration, and in expanding direct sales and distribution channels. Given the rate at which competition in our industry intensifies and the fluctuations in demand for our products, we may not be able to adequately        control our costs and expenses or achieve or maintain adequate operating margins. As a result, to maintain profitability, we will need to generate and sustain substantially higher revenues while maintaining reasonable cost and expense levels. We may not be able to sustain profitability on a quarterly or an annual basis.

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

Sales of our connectivity products accounted for over 58.3% of our revenues in the quarter ended June 30, 2009 and a majority of our historical revenues. We expect to substantially depend on these products for the majority of our near-term revenues. Any significant decline in the price of, or demand for, these products, or failure to increase their        market acceptance, would seriously harm our business. In addition, we believe that our future growth and a significant portion of our future revenues will depend on the commercial success of our optical passive products, which we began shipping commercially in July 2000. Demand for these products has fluctuated over the past few years, declining sharply starting in mid fiscal 2001 and then increasing beginning in 2003. If demand for these products does not continue to increase and our        target customers do not continue to adopt and purchase our optical passive products, our revenues may decline and we may have to write-off additional inventory that is currently on our books.

**Declining general economic or business conditions may have a negative impact on our business.**

Concerns over inflation, deflation, energy costs, geopolitical issues, the availability and cost of credit, the Federal stimulus packageand budget process, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased        volatility and diminished expectations for the global economy and expectations of slower global economic growth going forward. These factors, combined with volatile oil prices, declining business and consumer confidence, a declining stock market and increased unemployment, have precipitated an economic slowdown and recession. If the economic climate in the U.S. does not improve or continues to deteriorate, our business, including our customers and our suppliers, could be negatively        affected, resulting in a negative impact on our revenues.

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

 

In the quarters ended June 30, 2009 and 2008, our top 10 customers comprised 64.6% and 67.6% of our revenues, respectively. Two customers accounted for 17.5% and 17.2% of our total revenues for the three months ended June 30, 2009. Two customers accounted for 19.1% each of our total revenues for the six months ended June 30, 2009.

 

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

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

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

**U****ncertainty in the credit markets****has and may continue to****impact the value****and liquidity****of****our****auction-rate securities****, or ARS****.**

Credit concerns in the capital markets have significantly reduced our ability to liquidate $16.2million in ARS that we classify as current assetson our balance sheetatJune 30, 2009. All ARS we hold have failed to sell at auction since February 2008 due to an insufficient number of bidders. In June 2009, one of the issuer of the ARScompleted a partial call at par and the Company received settlement of        $75,000. In November 2008, we accepted the right to require UBS to repurchase ourARS investment at par value beginning on June 30, 2010, or the Right. We cannot assure you that UBS will have the ability to purchase our ARS at par or at any other price in the future. Accordingly, we may not be able to exercise the Right or        liquidatethese securities and use the cash to finance our business. In future periods, the estimated fair value of our ARS and the Right could decline based on market conditions, which could result in impairmentcharges. 

**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. |
|--|----------------------------------------|----------------------------------------------------------------------------------------------------------|

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

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

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

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

The market for fiber optic components is intensely competitive. We believe that our principal competitors are the major manufacturers of optical components and integrated modules, including vendors selling to third parties and business divisions within communications equipment suppliers. Our principal competitors in the components market        include Avanex Corp., DiCon Fiberoptics, Inc., JDS Uniphase Corp., Oplink Communications Inc., Stratos International, Inc. and Tyco Electronics Corporation. We believe that we primarily compete with diversified suppliers for the majority of our product line and to a lesser extent with niche companies that offer a more limited product line. Competitors in any portion of our business may also rapidly become competitors in other portions of our business.                   Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing, manufacturing and other resources than we do. As a result, these competitors may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, to devote more resources to the development, promotion and sale of products, to negotiate lower prices on raw materials and components, or to deliver competitive products at lower        prices.                  Several of our existing and potential customers are also current and potential competitors of ours. These companies may develop or acquire additional competitive products or technologies in the future and subsequently reduce or cease their purchases from us. In light of the consolidation in the optical networking industry, we also believe that the size of suppliers will be an increasingly important part of a purchaser’s decision-making criteria in the future. We may not be able to        compete successfully with existing or new competitors, and we cannot ensure that the competitive pressures we face will not result in lower prices for our products, loss of market share, or reduced gross margins, any of which could harm our business.                  New and competing technologies are emerging due to increased competition and customer demand. The introduction of products incorporating new or competing technologies or the emergence of new industry standards could make our existing products noncompetitive. For example, there are technologies for the design of wavelength division multiplexers that compete with the technology that we incorporate in our products. If our products do not incorporate technologies demanded by customers, we        could lose market share causing our business to suffer.

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

 

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As of June 30, 2009, we had a total of 41full-time employees in Sunnyvale, California, 256full-time employees in Taiwan, and 539full-time employees in China.        Matching the scale of our operations with demand fluctuations, combined with the challenges of expanding and managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management and resources. To manage the expected fluctuations in our operations and personnel, we will be required to: 

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

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

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

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

 

In addition, we will need to coordinate our domestic and international operations and establish the necessary infrastructure to implement our international strategy. If we are not able to manage our operations in an efficient and timely manner, our business will be severely harmed.                  Our success also depends, to a large degree, on the efficient and uninterrupted operation of our facilities. We have expanded our manufacturing facilities in Taiwan and manufacture many of our products there. Our facility in China also houses a substantial portion of our manufacturing operations. There is significant political tension between Taiwan and China. If there is an outbreak of hostilities between Taiwan and China, our manufacturing operations may be disrupted or we may have to        relocate our manufacturing operations. Tensions between Taiwan and China may also affect our facility in China. Relocating a portion of our employees could cause temporary disruptions in our operations and divert management’s attention. 

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

The development of new or enhanced fiber optic products is a complex and uncertain process. We may experience difficulties in design, manufacturing, marketing and other areas that could delay or prevent the development, introduction or marketing of new products and enhancements. Development costs and expenses are incurred before we generate revenues        from sales of products resulting from these efforts. Our total research and development expenses were approximately $0.8 million and $0.9 million for the three months ended June 30, 2009 and 2008, respectively. Our total research and development expenses were approximately $1.5 million and $1.8 million for the six months ended June 30, 2009 and 2008, respectively. We expect that our research and development expense may increase in the second half of 2009 as we intend to continue to        invest in our research and product development efforts. Any such increase could have a negative impact on our earnings in future periods.

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

The communications industry is characterized by continued 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.

 

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to perform an assessment of our internal controls as of December 31, 2008, and our independent auditors to attest to the effectiveness of our internal controls over financial reporting beginning with our year ending December 31, 2009. We have implemented an ongoing program to        perform the system and process evaluation and testing we believe to be necessary to comply with these requirements, however, we cannot assure you that we will be successful in our efforts. We expect to incur increased expenses and to devote additional management resources to Section 404 compliance. In the event that our chief executive officer, acting chief financial officer or independent registered public accounting firm determine that our internal controls over financial reporting        are not effective as defined under Section 404, investor perceptions of our company may be negatively affected and this could cause a decline in our stock price.

**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.**

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

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

Complex and precise processes are required for the manufacture of our products. Changes in our manufacturing processes or those of our suppliers, or the inadvertent use of defective materials, could significantly reduce our manufacturing yields and product reliability. Because the majority of our manufacturing costs are relatively fixed,        manufacturing yields are critical to our results of operations. Lower than expected production yields could delay product shipments and impair our operating results. We may not obtain acceptable yields in the future.                  In some cases, existing manufacturing techniques, which involve substantial manual labor, may not allow us to cost-effectively meet our production goals so that we maintain acceptable gross margins while meeting the cost targets of our customers. We may not achieve adequate manufacturing cost efficiencies.                  Because we plan to introduce new products and product enhancements, we must effectively transfer production information from our product development department to our manufacturing group and coordinate our efforts with our suppliers to rapidly achieve volume production. In our experience, our yields have been lower during the early stages of introducing new product to manufacturing. If we fail to effectively manage this process or if we experience delays, disruptions or quality control        problems in our manufacturing operations, our shipments of products to our customers could be delayed.

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

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

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

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

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

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

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

|  | ·      | loss of customers; |
|--|----------------------------------------|--------------------|

|  | ·      | damage to our reputation; |
|--|----------------------------------------|---------------------------|

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

There can be no assurance that we will be able to satisfy all of the quantitative maintenance criteria for continued listing on the Nasdaq Capital Market, including a requirement that we maintain a continued minimum bid price of $1.00 per share.Beginning on July 20, 2009, if the closing bid        price of our common stock falls and remains below $1.00 for 30 consecutive trading days,as it has for significant periods of time in the past, our common stock may not remain listed on the Nasdaq Capital Market.If we fail to maintain continued listing on the Nasdaq Capital Market and must move to a market with less liquidity, our financial condition could beharmed and our stock price would likely decline. If we are delisted, it could have a material adverse effect on the market price of our common stock as well as the liquidity of the trading market for our common stock.

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

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

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

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

Our industry is very competitive and is characterized by frequent intellectual property litigation based on allegations of infringement of intellectual property rights. Numerous patents in our industry have already been issued, and as the market further develops and participants in our industry obtain additional intellectual property        protection, litigation is likely to become more frequent. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies or rights that are important to our business. In addition, we have and we may continue to enter into agreements to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. Any litigation arising from claims        asserting that our products infringe or may infringe the proprietary rights of third parties, whether the litigation is with or without merit, could be time-consuming, resulting in significant expenses and diverting the efforts of our technical and management personnel. We do not have insurance against our alleged or actual infringement of intellectual property of others. These claims could cause us to stop selling our products, which incorporate the challenged intellectual property,        and could also result in product shipment delays or require us to redesign or modify our products or to enter into licensing agreements. These licensing agreements, if required, would increase our product costs and may not be available on terms acceptable to us, if at all.                  Although we are not aware of any intellectual property lawsuits filed against us, we may be a party to litigation regarding intellectual property in the future. We may not prevail in any such actions, given their complex technical issues and inherent uncertainties. Insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. If there is a successful claim of infringement or we fail to develop non-infringing        technology or license the proprietary rights on a timely basis, our business could be harmed.

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

Our primary manufacturing operation islocated in Tu-Cheng City, Taiwan,an active earthquake fault zone. Thisregion hasexperienced 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. Alarge earthquake or typhoon in Taiwan could disrupt our manufacturing operation in Taiwan 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.

 

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**ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

On May 15, 2009, we held our 2009 Annual Meeting of Stockholders, at which meeting our stockholders approved the following:

(a)     Election of Class IIdirectors:

For                              Withheld     

     

                               Gwong-Yih        Lee          30,839,723shares          2,950,328shares                        James C. Yeh          32,431,811 shares          1,358,240 shares     

 

         (b)     Ratification of the appointment of Stonefield Josephson, Inc. as independent registered public accountants of the Company for the 2009 fiscal year:

 For                           Against                         Abstain          

                        32,263,885shares     137,874shares               1,388,288shares     

Other directors whose term of office as a director continued after the Annual Meeting were Peter Chang, Richard Black, and Ray Sun.

**ITEM 6: EXHIBITS**

Exhibits

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

___________________

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

 

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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: August 12, 2009

> 
   ALLIANCE FIBER OPTIC PRODUCTS, INC.

By /s/ Anita K. Ho       

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

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