# UNITED        STATES

# SECURITIES AND        EXCHANGE COMMISSION

WASHINGTON, D.C.        20549

_________________

# FORM        10-Q

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

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

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

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

|   |                                                                                                                                                                                                                                                                 |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | For the transition period from                                               to                                |

|   |                           |
|--------|--------------------------------|
|   | Commission File Number 0-31857 |

|                                                   |
|--------------------------------------------------------|
| **ALLIANCE FIBER OPTIC PRODUCTS, INC.**                |
|                                                        |
| (Exact name of registrant as specified in its charter) |

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

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

|                        |
|-----------------------------|
| (408) 736-6900              |
|                             |
| (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.        Yes þ        No o

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

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

On August 3, 2007, 40,960,756 shares        of the registrant's Common Stock, $0.001 par value per share, were outstanding.

 

----

# ALLIANCE FIBER OPTIC        PRODUCTS, INC.

# FORM 10-Q

# QUARTERLY PERIOD        ENDED JUNE 30, 2007

# INDEX

|                                                                                                                                                      | Page   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                      |   |
| PART I:                FINANCIAL INFORMATION                                                                                                              | 1      |
|                                                                                                                                                      |   |
|      ITEM                1: FINANCIAL STATEMENTS                                                                                 | 1      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Balance Sheets at June 30, 2007(unaudited)              |   |
|           and                December 31, 2006                                                          | 1      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Statements of Operations for the                        |   |
|           Three                and Six Months Ended June 30, 2007 and 2006 (unaudited)                  | 2      |
|                                                                                                                                                      |   |
|           Condensed                Consolidated Statements of Cash Flows for the                        |   |
|           Six                Months Ended June 30, 2007 and 2006 (unaudited)                            | 3      |
|                                                                                                                                                      |   |
|           NOTES                TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                           | 4      |
|                                                                                                                                                      |   |
|      ITEM                2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF                OPERATIONS | 12     |
|                                                                                                                                                      |   |
|      ITEM                3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                           | 18     |
|                                                                                                                                                      |   |
|      ITEM                4: CONTROLS AND PROCEDURES                                                                              | 18     |
|                                                                                                                                                      |   |
| PART II: OTHER                INFORMATION                                                                                                                 | 20     |
|                                                                                                                                                      |   |
|      ITEM                1A: RISK FACTORS                                                                                        | 20     |
|                                                                                                                                                      |   |
|      ITEM                4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                  | 30     |
|                                                                                                                                                      |   |
|      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,                    2007 | December 31,                    2006 |
|---------------------------------------------------------------------------------------------------|----------------------------------|--------------------------------------|
| **Assets**                                                                                        |                             |                                 |   | **(Unaudited)** |   |   |  |   |
| Current                assets:                                                                    |                             |                                 |
|  Cash and                cash equivalents                                                    |                             |                                 | $ | 4,366 |   | $ | 4,321 |   |
|  Short-term                investments                                                       |                             |                                 |   | 27,820 |   |   | 26,857 |   |
|  Accounts                receivable, net                                                     |                             |                                 |   | 5,184 |   |   | 4,009 |   |
|  Inventories,                net                                                             |                             |                                 |   | 5,226 |   |   | 4,465 |   |
|  Prepaid                expense and other current assets                                     |                             |                                 |   | 614 |   |   | 601 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                current assets                           |                             |                                 |   | 43,210 |   |   | 40,253 |   |
|                                                                                                   |                                  |                                      |
| Property and                equipment, net                                                        |                             |                                 |   | 4,217 |   |   | 4,264 |   |
| Other                assets                                                                       |                             |                                 |   | 178 |   |   | 176 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                assets                                   |                             |                                 | $ | 47,605 |   | $ | 44,693 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
| **Liabilities                and Stockholders' Equity**                                           |                             |                                 |
| Current                liabilities:                                                               |                             |                                 |
|  Accounts                payable                                                             |                             |                                 | $ | 3,873 |   | $ | 2,950 |   |
|  Accrued                expenses                                                             |                             |                                 |   | 2,903 |   |   | 2,815 |   |
|  Current                portion of bank loan                                                 |                             |                                 |   | 96 |   |   | 94 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                current liabilities                      |                             |                                 |   | 6,872 |   |   | 5,859 |   |
| Other                long-term liabilities                                                        |                             |                                 |
|  Bank                loan                                                                    |                             |                                 |   | 491 |   |   | 545 |   |
|  Other                long-term liabilities                                                  |                             |                                 |   | 413 |   |   | 385 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                long term liabilities                    |                             |                                 |   | 904 |   |   | 930 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                liabilities                              |                             |                                 |   | 7,776 |   |   | 6,789 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
| Commitments                and contingencies (Note 8)                                             |                             |                                 |   | -- |   |   | -- |   |
| Stockholders'                equity:                                                              |                             |                                 |
|  Common                stock, $0.001 par value: 250,000,000 shares authorized;               |                             |                                 |
|     40,937,256                and 40,540,128 shares issued and outstanding at |                             |                                 |
|     June                30, 2007 and December 31, 2006, respectively          |                             |                                 |   | 41 |   |   | 41 |   |
|  Additional                paid-in-capital                                                   |                             |                                 |   | 110,395 |   |   | 109,793 |   |
|  Accumulated                deficit                                                          |                             |                                 |   | (70,556 | ) |   | (71,809 | ) |
|  Accumulated other                comprehensive loss                                         |                             |                                 |   | (51 | ) |   | (121 | ) |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|  Stockholders'                equity                                                         |                             |                                 |   | 39,829 |   |   | 37,904 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |
|       Total                liabilities and stockholders' equity     |                             |                                 | $ | 47,605 |   | $ | 44,693 |   |
|                                                                                                   |                                  |                                      |  |  |
|                                                                                                   |                                  |                                      |

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

1

----

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

 

|                                                                                                       | Three Months Ended June                    30, |        | Six Months Ended June                    30, |        |
|------------------------------------------------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                       | **2007**                                       |        | **2006**                                     |        | **2007** |  | **2006** |  |
| Revenues                                                                                                   |                                           |   | $                                            | 8,701  |   | $ | 6,252 |   | $ | 15,402 |   | $ | 11,473 |   |
| Cost of                revenues                                                                            |                                           |   |                                         | 5,929  |   |   | 4,621 |   |   | 10,531 |   |   | 8,505 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
|                   Gross profit                                                                   |                                           |   |                                         | 2,772  |   |   | 1,631 |   |   | 4,871 |   |   | 2,968 |  |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
|                                                                                                            |                                                |        |                                              |        |
| Operating                expenses:                                                                         |                                           |   |
|                     Research and development                                           |                                           |   |                                         | 848    |   |   | 708 |   |   | 1,537 |   |   | 1,467 |   |
|      Sales                and marketing                                                |                                           |   |                                         | 634    |   |   | 555 |   |   | 1,203 |   |   | 1,141 |   |
|                     General and administrative                                         |                                           |   |                                         | 915    |   |   | 720 |   |   | 1,776 |   |   | 1,483 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
|                            Total operating expenses |                                           |   |                                         | 2.397  |   |   | 1,983 |   |   | 4,516 |   |   | 4,091 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
| Income (loss)                from operations                                                               |                                           |   |                                         | 375    |  |   | (352 | ) |   | 355 |  |   | (1,123 | ) |
| Interest and                other income, net                                                              |                                           |   |                                         | 489    |   |   | 371 |   |   | 898 |   |   | 769 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
| Net income                (loss)                                                                           |                                           |   |                                         | 864    |  |   | 19 |  |   | 1,253 |  |   | (354 | ) |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
| Net income                (loss) per share:                                                                |                                           |   |
|                            Basic                    |                                           |   | $                                            | 0.02   |  | $ | 0.00 |  | $ | 0.03 |  | $ | (0.01 | ) |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
|                           Diluted                        |                                           |   | $                                            | 0.02   |  | $ | 0.00 |  | $ | 0.03 |  | $ | (0.01 | ) |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
| Shares used in                computing net income (loss) per share:                                       |                                           |   |
|                           Basic                          |                                           |   |
|                                                                                                       |                                           |   |                                         | 40,825 |   |   | 40,086 |   |   | 40,706 |   |   | 39,930 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |  |
|                           Diluted                        |                                           |   |
|                                                                                                       |                                           |   |                                         | 45,608 |   |   | 43,713 |   |   | 45,489 |   |   | 39,930 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |
| Included in                costs and expenses above:                                                       |                                           |   |
| Stock based                compensation charges                                                            |                                           |   |
|      Cost                of revenue                                                    |                                           |   | $                                       | 41     |   | $  | 9 |   | $  | 92 |   | $  | 32 |   |
|                    Research                and development                                       |                                           |   |                                         | 17     |   |   | 6 |   |   | 37 |   |   | 20 |   |
|                    Sales                and marketing                                            |                                           |   |                                         | 12     |   |   | 4 |   |   | 24 |   |   | 16 |   |
|                    General                and administrative                                     |                                           |   |                                         | 33     |   |   | 13 |   |   | 74 |   |   | 41 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |
|                         Total                                      |                                           |   |                                         | 103    |   |   | 32 |   |   | 227 |   |   | 109 |   |
|                                                                                                            |                                                |        |                                              |        |  |  |  |

2

----

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

|                                                                                                                          | Six Months Ended June 30, |
|-------------------------------------------------------------------------------------------------------------------------------|---------------------------|
||
| **Cash flows from operating                activities:**                                                                      |                      |   |   |  |   |   |  |   |
|  Net                income (loss)                                                                                        |                      |   | $ | 1,253 |  | $ | (354 | ) |
|  Adjustments to reconcile                net income (loss) to net cash used                                              |                      |   |  |  |  |  |  |  |
|   in                operating activities:                                                                           |                      |   |  |  |  |  |  |  |
|   Depreciation and                amortization                                                                      |                      |   |   | 578 |   |   | 692 |   |
|   Loss on disposal of                property and equipment                                                         |                      |   |   | 52 |   |   | 5 |   |
|   Amortization of                stock-based compensation                                                           |                      |   |   | 227 |   |   | 109 |  |
|   Provision (credit)                for doubtful accounts and sales returns                                         |                      |   |   | (59) |   |   | 11 |  |
|   Provision for                inventory                                                                       |                      |   |   | (357) |  |   | 420 |  |
|   Changes in assets                and liabilities:                                                                 |                      |   |  |  |  |  |  |  |
|      Accounts                receivable, net                                                         |                      |   |   | (1,116 | ) |   | (182 | ) |
|      Inventories                                                                                     |                      |   |   | (404 | ) |   | (989 | ) |  |
|      Prepaid                expenses and other current assets                                        |                      |   |   | (13 | ) |   | 19 |  |
|      Accounts                payable                                                                 |                      |   |   | 923 |  |   | 304 |  |
|      Accrued                expenses                                                                 |                      |   |   | 88 |  |   | (103 | ) |
|      Other                assets                                                                     |                      |   |   | (2) |  |   | -- |  |
|      Other                long-term liabilities                                                      |                      |   |   | 28 |  |   | 5 |  |
|                                                                                                                               |                           |  |  |  |
|         Net                cash provided by (used in) operating activities            |                      |   |   | 1,198 |  |   | (63 | ) |
|                                                                                                                               |                           |  |  |  |
| **Cash flows                from investing activities:**                                                                      |                      |   |  |  |  |  |  |  |
|  Purchase                of short-term investments                                                                       |                      |   |   | (14,816 | ) |   | (6.612 | ) |
|  Proceeds                from sales and maturities of short-term investments                                             |                      |   |   | 13,864 |   |   | 7,710 |   |
|  Purchase                of of property and equipment                                                                    |                      |   |   | (548 | ) |   | (238 | ) |
|                                                                                                                               |                           |  |  |  |
|         Net                cash (used in) provided by  investing activities |                      |   |   | (1,500) |  |   | 860 |  |
|                                                                                                                               |                           |  |  |  |
| **Cash flows                from financing activities:**                                                                      |                      |   |  |  |  |  |  |  |
|  Proceeds                from issurance of common stock under ESPP                                                       |                      |   |   | 276 |   |   | 200 |   |
|  Proceeds                from the exercise of common stock options                                                       |                      |   |   | 99 |   |   | 168 |   |
|  Repayment of bank                borrowings                                                                             |                      |   |   | (51 | ) |   | (36 | ) |
|                                                                                                                               |                           |  |  |  |
|         Net                cash provided by financing activities                      |                      |   |   | 324 |   |   | 332 |   |
|                                                                                                                               |                           |  |  |  |
| Effect of                exchange rate changes on cash and cash equivalents                                                   |                      |   |   | 23 |  |   | (84 | ) |
|                                                                                                                               |                           |  |  |  |
| Net                increase  in cash and cash equivalents                                                                |                      |   |   | 45 |  |   | 1045 |  |
| Cash and cash                equivalents at beginning of period                                                               |                      |   |   | 4,321 |   |   | 2,714 |   |
|                                                                                                                               |                           |  |  |  |
| Cash and cash                equivalents at end of period                                                                     |                      |   | $ | 4,366 |   | $ | 3,759 |   |
|                                                                                                                               |                           |  |  |  |

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

3

----

# ALLIANCE FIBER OPTIC        PRODUCTS, INC.

# NOTES TO CONDENSED        CONSOLIDATED FINANCIAL STATEMENTS

# (Unaudited)

# 1. Summary of        Significant Accounting Policies

***The        Company***

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

***Basis of        presentation***

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

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

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

***Revenue        Recognition***

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

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

***Cash and        Cash Equivalents***

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

***Concentrations of        Risk***

Our dense wavelength division        multiplexing ("DWDM") related products contributed revenues of $3.1 million and $5.2        million for the three and six months ended June 30, 2007, respectively and $2.1 million and        $4.2 million for the three and six months ended June 30, 2006, respectively. In the six        months ended June 30, 2007 and June 30, 2006, our top 10 customers comprised 61.2% and        56.8% of our revenues, respectively. For the six months ended June 30, 2007 and June 30,        2006, one customer accounted for 21.2% and 12.8% of our revenues, respectively.

4

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# 2. Recent Accounting        Pronouncements

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

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

In July 2006, the FASB issued FASB        Interpretation 48, "Accounting for Uncertainty in Income Taxes" (FIN 48) --- an        interpretation of FASB No. 109, "Accounting for Income Taxes." FIN 48 prescribes a        comprehensive model for recognizing, measuring, presenting and disclosing in the financial        statements tax positions taken or expected to be taken on a tax return, including a        decision on whether or not to file in a particular jurisdiction. FIN 48 clarifies the        accounting for uncertainty in income taxes recognized in an enterprise's financial        statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." The        provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this        standard. Only tax positions that meet a "more-likely-than-not" recognition threshold at        the effective date may be recognized or continue to be recognized upon adoption of        FIN 48. The cumulative effect of applying the provisions of FIN 48 is reported as        an adjustment to the opening balance of retained earnings. FIN 48 is effective for        years beginning after December 15, 2006; therefore, the Company has adopted        FIN 48 as of January 1, 2007. The Company expects the adoption of this accounting        standard will increase the level of disclosure that the Company provides regarding its tax        positions. The adoption of FIN 48 is not expected to have a material impact on the        Company's consolidated financial position and results of operations.

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

# 3. Stock-based        Compensation

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

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.

5

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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, 2007, there was $0.9        million of total unrecognized compensation cost related to non-vested share-based        compensation arrangements granted under the Company's various option plans; that cost is        expected to be recognized over a period of 2.5 years.

For the three and six months ended        June 30, 2007, the fair value of SBP awards were estimated using the Binomial-Lattice        valuation model, with the following weighted-average assumptions and fair values as        follows:

|                                                          | Three Months Ended June                    30, |        | Six Months Ended June                    30, |      |
|---------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|------|
|                                                          | **2007**                                       |        | **2006**                                     |      | **2007** |  | **2006** |  |
| Volatility                (percent)*                          |                                           |   |                                              | 52.0 |   |  | 36.7 |   |  | 52.0 |   |  | 36.7 |   |
| Expected term                (in years)**                     |                                           |   |                                         | 4    |   |   | 4 |   |   | 4 |   |   | 4 |   |
| Risk free                interest rate (percent)***           |                                           |   |                                         | 4.77 |   |   | 5.00 |   |   | 4.70 |   |   | 4.82 |  |
|                                                               |                                                |        |                                              |      |
| Expected                dividend rate (percent)               |                                           |   |                                              | --   |  |  | -- |   |   | -- |   |   | -- |  |
| Forfeiture                rate (percent)****                  |                                           |   |                                         | 11   |   |   | 10 |   |   | 11 |   |   | 10 |   |
| Weighted-average fair value per                option granted |                                           |   |                                         | N/A  |   | $  | 0.66 |   | $  | 2.21 |   | $  | 0.66 |   |

* Volatility is projected using        Industry Analysis forecasts for earnings, EPS, and stock price, and the Company's earning        forecast.

** The expected term represents the        weighted average period the option is expected to be outstanding and is based primarily on        the historical exercise behavior of employees.

*** The risk free interest rate is        based on the U.S. Treasury zero-coupon yield with a maturity that approximates the expected        life of the option.

**** Forfeiture rate is the        estimated percentage of options forfeited by employees by leaving or being terminated        before vesting.

At June 30, 2007, the Company had        two stock-based compensation plans. They are: (a) 1997 Stock Option Plan and (b) 2000 Stock        Incentive Plan, which are described below.

(a) 1997 Stock Option        Plan

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

6

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(b) 2000 Stock        Incentive Plan

In November 2000, the Company        adopted its 2000 Stock Incentive Plan under which 1,500,000 shares of common stock were        reserved for issuance to eligible employees, directors and consultants upon exercise of        stock options and stock purchase rights. On January 1 of each year, beginning on        January 1, 2001, the number of shares available for grant will automatically increase by        the lesser of: (i) 1,700,000 shares; (ii) 5% of the fully diluted outstanding        shares of stock on that date; or (iii) a lesser amount as may be determined by the        Board of Directors. The Board of Directors determined not to increase the number of shares        available under the Plan on January 1, 2006 and 2007, respectively. Incentive stock options        and nonstatutory stock options are granted at 100% of the fair market value of the        Company's common stock on the date of grant.

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

The following information relates to        the stock option activity for the six months ended June 30, 2007:

|                                                                         | Six Months Ended                    June 30, 2006 |
|-------------------------------------------------------------------------|---------------------------------------------------|
||
|   Outstanding at                December 31, 2006             |                                              |   | 5,046,083 | $ | 1.24 |   |   |   |   |
|   Granted                                                     |                                              |   | 185,500 |   | 2,06 |   |   |   |   |
|   Exercised                                                   |                                              |   | (153,375) |   | 0.63 |   |   |   |   |
|   Forfeited                                                   |                                              |   | (56,250) |   | 1.56 |   |   |   |   |
|   Outstanding at June                30, 2007                 |                                              |   | 5,018,958  | $ | 1.29 |   | 6.8 Years | $ | 3,983,213  |
|   Vested and expected                to vest at June 30, 2007 |                                              |   | 4,969,625 | $ | 1.29 |   | 6.8 Years | $ | 3,932,133  |
|   Exercisable at June                30, 2007                 |                                              |   | 4,570,475  | $ | 1.31 |   | 6.7 Years | $ | 3,518,854  |

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 second quarter of fiscal 2007        and the exercise price, multiplied by the number of in-the-money options) that would have        been received by the option holders had all option holders exercised their options on June        30, 2007. This amount changes based on the fair market value of the Company's stock. The        total intrinsic value of options exercised for the three months ended June 30, 2007 and        2006 was $124,000 and $35,000, respectively. The total intrinsic value of options exercised        for the six months ended June 30, 2007 and 2006 was $211,000 and $302,000,        respectively.

No options were granted during the        quarter ended June 30, 2007. The weighted average grant date fair value of options granted        during the quarter ended June 30, 2006 was $21,000.

The expected dividend rate is 0% for        both three and six months ended June 30, 2007 and 2006 respectively.

Cash received from option exercises        during the six months ended June 30, 2007 and 2006 was $99,000 and $168,000, respectively,        and is included within the financing activities section in the accompanying consolidated        statements of cash flows.

7

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Employee Stock Purchase        Plan

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

The following information relates to        the Plan for the six months ended June 30, 2007:

| Additional Information                    About ESPP                   |  |   |         |
|------------------------------------------------------------------------|--|---|---------|
| Weighted average fair value per                share of purchase       |  | $ | 1.15    |
| Total compensationn expense for                ESPP                    |  | $ | 123,485 |
| Total amount of cash received                from the puchase of ESPP  |  | $ | 276,258 |
| Total intrinsic value of ESPP                purchase as June 30, 2007 |  | $ | 224,509 |

# 4. Inventories, net        (in thousands)

|                                            | June 30, 2007 | December 31, 2006        |
|-------------------------------------------------|---------------|--------------------------|
|                                            |          |                          |   |  |   |
| **Inventories**                                 |          |                          |   |  |   |
|    Finished                goods |          | $   1,746 |   | $     1,415 |   |
|    Work-in-process               |          | 2,244                    |   | 1,751 |   |
|    Raw                materials  |          | 1,236                    |   | 1,299 |   |
|                                                 |               |                          |  |  |
|                                            |          | $   5,226 |   | $   4,465 |   |
|                                                 |               |                          |  |  |
|                                                 |               |                          |

# 5. Net Income (Loss)        Per Share

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

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

8

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|                                                                                   | Three Months                    Ended June 30, |        | Six Months                    Ended June 30, |        |
|----------------------------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                   | **2007**                                       |        | **2006**                                     |        | **2007** |  | **2006** |  |
| Numerator                                                                              |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
|    Net income                (loss)                                     |                                           |   | $                                            | 864    |  | $ | 19 |   | $ | 1,253 |   | $ | (354) |   |
|                                                                                        |                                                |        |                                              |        |  |  |  |  |
| Denominator:                                                                           |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
|    Shares used                in computing net income (loss) per share: |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
|       Basic                                              |                                           |   |                                              | 40,825 |  |  | 40,086 |   |  | 40,706 |   |  | 39,930 |   |
|                                                                                        |                                                |        |                                              |        |  |  |  |  |
|       Diluted                                            |                                           |   |                                              | 45,608 |  |  | 43,713 |   |  | 45,489 |   |  | 39,930 |   |
|                                                                                        |                                                |        |                                              |        |  |  |  |  |
| Net income                (loss) per share:                                            |                                           |   |                                              |        |  |  |  |   |  |  |   |  |  |   |
|       Basic                                              |                                           |   | $                                            | 0.02   |  | $ | 0.00 |   | $ | 0.03 |   | $ | (0.01) |   |
|                                                                                        |                                                |        |                                              |        |  |  |  |  |
|       Diluted                                            |                                           |   | $                                            | 0.02   |  | $ | 0.00 |   | $ | 0.03 |   | $ | (0.01) |   |
|                                                                                        |                                                |        |                                              |        |  |  |  |  |

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

|                                            | Six Months                    Ended June 30, |
|-------------------------------------------------|----------------------------------------------|
||
| Options to purchase common                stock |                                         |   |   |  |   |   |  |   |
| s                                               |                                         |   |   | 4,783 |   |   | 4,630 |   |
|                                                 |                                              |  |  |  |
|                                                 |                                              |  |

# 6. Comprehensive        Income (Loss)

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

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

|                                                                                 | Three Months                    Ended June 30, |        | Six Months                    Ended June 30, |     |
|--------------------------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|-----|
|                                                                                 | **2007**                                       |        | **2006**                                     |     | **2007** |  | **2006** |  |
| Net income (loss)                                                                    |                                           |   | $                                            | 864 |   | $ | 19  |   | $ | 1,253 |   | $ | (354) |   |
| Cumulative translation                adjustments                                    |                                           |   |                                              | 62  |   |  | (1) |   |  | 59 |   |  | (24) |   |
| Unrealized gain on short-term                investments                             |                                           |   |                                              | 7   |   |  | 7 |   |  | 10 |   |  | 13 |   |
|                                                                                      |                                                |        |                                              |     |  |  |  |  |
|       Total                comprehensive income (loss) |                                           |   | $                                            | 933 |   | $ | 25 |   | $ | 1,322 |   | $ | (365) |   |
|                                                                                      |                                                |        |                                              |     |  |  |  |  |

# 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.

9

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# 8. Commitments and        Contingencies

# Litigation:

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

# Indemnification and        Product Warranty:

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

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

# Operating        Leases:

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

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

|                                                                                                                                                                                                      |        |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Six months ending December 31,                2007                                                                                                                                                   |   |   | $ | 472 |   |
| Years ending                December 31:                                                                                                                                                             |   |   |
|                                 2008 |   |   |   | 930 |   |
|                                 2009 |   |   |   | 563 |   |
|                                 2010 |   |   |   | 333 |   |
|                                 2011 |   |   |   | 94 |   |
|                                 2012 |   |   |   | 40 |   |
|                                                                                                                                                                                                      |        |  |
|  Total                                                                                                                                                                                          |   |   | $ | 2,432 |   |
|                                                                                                                                                                                                      |        |  |
|                                                                                                                                                                                                      |        |
|                                                                                                                                                                                                      |        |

# Letter of        Credit:

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

# 9. Bank        Loan

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

10

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Payments due under our bank        loan as of June 30, 2007 are as follows (in thousands):

|                                                                                                                                                                                                                                                 |        |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **Years                ending December 31**,                                                                                                                                                                                                    |   |   |   |   |   |
|                                    2007                          |   |   | $  | 56 |   |
|                                    2008                          |   |   |   | 112 |   |
|                                    2009                          |   |   |   | 112 |   |
|                                    2010                          |   |   |   | 89 |   |
|                                    2011                          |   |   |   | 77 |   |
|                                    2012                and after |   |   |   | 200 |   |
|                                                                                                                                                                                                                                                 |        |  |
|      Total                payment                                                                                                                                                                                      |   |   |   | 646 |   |
| Less: Amounts                representing interest                                                                                                                                                                                              |   |   |   | (59 | ) |
|                                                                                                                                                                                                                                                 |        |  |
| Present value                of net remaining payments                                                                                                                                                                                          |   |   |   | 587 |   |
| Less: current                portion                                                                                                                                                                                                            |   |   |   | (96 | ) |
|                                                                                                                                                                                                                                                 |        |  |
| Long-term                portion                                                                                                                                                                                                                |   |   | $ | 491 |   |
|                                                                                                                                                                                                                                                 |        |  |
|                                                                                                                                                                                                                                                 |        |

# 10. Related Party        Transactions

As of June 30, 2007, Foxconn Holding        Limited was a holder of 19.5% of the Company's common stock, based on share ownership        information set forth in a Schedule 13G filed by Foxconn Holding Limited on January 4,        2002. The Company sells products and purchases raw materials from Hon Hai Precision Company        Limited, who is the parent company of Foxconn Holding Limited, in the normal course of        business. These transactions were made at prices and terms consistent with those with        unrelated third parties. Sales of products to Hon Hai Precision Industry Company Limited        were $0.3 million and $0.4 million for the three and six months ended June 30, 2007,        respectively. Purchases of raw materials from Hon Hai Precision Company Limited were $0.7        million and $1.3 million for the three and six months ended June 30, 2007, respectively.        Amounts due from Hon Hai Precision Company Limited were $0.2 million at June 30, 2007.        Amounts due to Hon Hai Precision Company Limited were $0.5 million at June 30,        2007.

# 11. 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, |       |
|------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|-------|
|                                                             | **2007**                                       |        | **2006**                                     |       | **2007** |  | **2006** |  |
| **Revenues**                                                     |                                           |   |                                              |       |   |  |  |   |  |  |   |  |  |   |
|       North                America |                                           |   | $                                            | 4,970 |   | $ | 4,387  |   | $ | 9,364 |   | $ | 8,219 |   |
|       Europe                       |                                           |   | $                                            | 770   |   | $ | 502 |   | $ | 1,150 |   | $ | 806 |   |
|       Asia                         |                                           |   |                                              | 2,961 |   |  | 1,363  |   |  | 4,888 |   |  | 2.448 |   |
|                                                                  |                                                |        |                                              |       |  |  |  |  |
|                                    |                                           |   | $                                            | 8,701 |   | $ | 6,252  |   | $ | 15,402 |   | $ | 11,473 |   |
|                                                                  |                                                |        |                                              |       |  |  |  |  |

|                                                                                     | Three Months                    Ended June 30, |        | Six Months                    Ended June 30, |       |
|------------------------------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|-------|
|                                                                                     | **2007**                                       |        | **2006**                                     |       | **2007** |  | **2006** |  |
| **Revenues**                                                                             |                                           |   |                                              |       |   |  |  |   |  |  |   |  |  |   |
|       Optical                path mulitplexing solution    |                                           |   | $                                            | 5,571 |   | $ | 4,175 |   | $ | 10,233 |   | $ | 7,311 |   |
|       Dense                wavelength division multiplexer |                                           |   |                                              | 3,130 |   |  | 2,077 |   |  | 5,169 |   |  | 4,162 |   |
|                                                                                          |                                                |        |                                              |       |  |  |  |  |
|                                                            |                                           |   | $                                            | 8,701 |   | $ | 6,252 |   | $ | 15,402 |   | $ | 11,473 |   |
|                                                                                          |                                                |        |                                              |       |  |  |  |  |

 

11

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|                                                 | June 30,                    2007 |        | June 30,                    2006 |
|------------------------------------------------------|----------------------------------|--------|----------------------------------|
| **Property and                Equipment**            |                             |   |                             |  |   |   |  |   |
|     United                States |                             |   | $                                | 124 |   | $ | 144 |   |
|     Taiwan                       |                             |   |                             | 2,875 |   |   | 3,015 |   |
|     China                        |                             |   |                             | 1,218 |   |   | 1,105 |   |
|                                                      |                                  |        |                                  |  |
|                                                 |                             |   | $                                | 4,217 |   | $ | 4,264 |   |
|                                                      |                                  |        |                                  |  |
|                                                      |                                  |        |
|                                                      |                                  |        |

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

When used in this Report, the words        “expects,” “anticipates,” “believes”,        “estimates,” “plans,” “intends,” “could,”        “will,” “may” and similar expressions are intended to identify        forward-looking statements.  These are statements that relate to future periods and        include statements as to our operating results, revenues, sources of revenues, cost of        revenues, gross profit, net operating losses, profitability, the amount and mix of        anticipated investments, expenditures and expenses, our liquidity and the adequacy of our        capital resources, exposure to interest rate or currency fluctuation, anticipated working        capital and capital expenditures, reliance on our OPMS products, our cash flow, trends in        average selling prices, our reliance on the commercial success of our DWDM-related        products, plans for future products and enhancements of existing products, features,        benefits and uses of our products, demand for our products, our success being tied to        relationships with key customers, industry trends and market demand, our efforts to protect        our intellectual property, the potential benefit of indemnification agreements, increases        in the number of possible license offers and patent infringement claims, our competitive        position, sources of competition, consolidation in our industry, our international        strategy, inventory management, our plans for a reverse stock split, our employee        relations, the adequacy of our internal controls, the effect of recent and changing        accounting pronouncements and our critical accounting policies, estimates, models and        assumptions.  Forward-looking statements are subject to risks and uncertainties that        could cause actual results to differ materially from those projected.  These risks and        uncertainties include, but are not limited to, those risks discussed elsewhere in this        report, as well as risks related to the development of the metropolitan, last mile access,        and enterprise networks, customer acceptance of our products, our ability to retain and        obtain customers, industry-wide overcapacity and shifts in supply and demand for optical        components and modules, our ability to meet customer demand and manage inventory,        fluctuations in demand for our products, declines in average selling prices, development of        new products by us and our competitors, increased competition, inability to obtain        sufficient quantities of a raw material product, loss of a key supplier, integration of        acquired businesses or technologies, financial stability in foreign markets, foreign        currency exchange rates, interest rates, costs associated with being a public company,        failure to meet customer requirements, our ability to license intellectual property on        commercially reasonable terms, economic stability, and the risks set forth below under Part        II, Item 1A, “Risk Factors.”  These forward-looking statements speak only        as of the date hereof.  The Company expressly disclaims any obligation or undertaking        to 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,        2006.

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 *

12

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

Stock-based compensation expense        recognized under SFAS 123(R) for the three and six months ended June 30, 2007 was $0.1        million and $0.2 million, respectively, determined by the Binomial Lattice valuation model,        and represents stock-based compensation expense related to employee stock options. As of        June 30, 2007, total unrecognized compensation costs related to unnvested stock options was        $0.9 million, which is expected to be recognized as an expense over a weighted average        period of approximately 2.50 years.

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, 2006.

# Overview

We were founded in December 1995 and        commenced operations to design, manufacture and market fiber optic interconnect products,        which we call our Optical Path Management Solution, or OPMS, products. We started selling        our dense wavelength division multiplexing, or DWDM, and other wavelength management        products in July 2000. Since introduction, sales of DWDM-related products have fluctuated        with the overall market for these products.

From our inception through June 30,        2007, we derived a substantial portion of our revenues from our OPMS product line, although        revenues from our DWDM product line have increased as a percentage of revenues in the last        two years. Revenues from our DWDM products represented 36.0% and 33.2% of total revenues        for the three months ended June 30, 2007 and 2006, respectively, and 33.6% and 36.2% of        total revenues for the six months ended June 30, 2007 and 2006, respectively. We market and        sell our products predominantly through our direct sales force. One customer accounted for        22.6% and 14.5% of our total revenues for the three months ended June 30, 2007 and 2006,        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:

            o changes in manufacturing volume;

            o costs incurred in establishing additional manufacturing lines and facilities;

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

            o mix of products sold;

13

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            o changes in our pricing and pricing from our competitors;

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

            o mix of domestic and international sales.

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

Sales and marketing expenses consist        primarily of salaries, commissions and related expenses for personnel engaged in marketing,        sales and technical support functions, as well as costs associated with trade shows,        promotional activities and travel expenses. 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, |        |
|-----------------------------------------------------------------------------------------------------|------------------------------------------------|--------|----------------------------------------------|--------|
|                                                                                                | **2007**                                       |        | **2006**                                     |        | **2007** |  | **2006** |  |
| Revenues                                                                                            |                                           |   |                                              | 100.0% |   |  | 100.0% |   |  | 100.0% |   |  | 100.0% |   |
| Cost of revenues                                                                                    |                                           |   |                                              | 68.1   |   |  | 73.9  |   |  | 68.4  |   |  | 74.1  |   |
|                                                                                                     |                                                |        |                                              |        |  |  |  |  |
|       Gross                profit                                     |                                           |   |                                              | 31.9   |   |  | 26.1  |   |  | 31.6 |   |  | 25.9  |   |
|                                                                                                     |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
| Operating expenses:                                                                                 |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
|       Research                and development:                        |                                           |   |                                              | 9.7    |   |  | 11.3  |   |  | 10.0 |   |  | 12.8 |   |
|       Sales                and marketing:                             |                                           |   |                                              | 7.3    |   |  | 8.9  |   |  | 7.8 |   |  | 10.0  |   |
|       General                and administrative                       |                                           |   |                                              | 10.5   |   |  | 11.5  |   |  | 11.5 |   |  | 12.9 |   |
|                                                                                                     |                                                |        |                                              |        |  |  |  |  |
|           Total                operating expenses |                                           |   |                                              | 27.5   |   |  | 31.7  |   |  | 29.3 |   |  | 35.7 |   |
|                                                                                                     |                                           |   |                                              |        |   |  |  |   |  |  |   |  |  |   |
| Income (loss) from                operations                                                        |                                           |   |                                              | 4.4    |   |  | (5.6) |   |  | 2.3 |   |  | (9.8) |   |
| Interest and other income,                net                                                       |                                           |   |                                              | 5.6    |   |  | 5.9 |   |  | 5.8 |   |  | 6.7  |   |
|                                                                                                     |                                                |        |                                              |        |  |  |  |  |
| Net income (loss)                                                                                   |                                           |   |                                              | 10.0%  |   |  | 0.3% |   |  | 8.1% |   |  | (3.1%) |   |

*Revenues.* Revenues were $8.7        million and $6.3 million for the three months ended June 30, 2007 and 2006,        respectively. Revenues increased 39.2% in the quarter ended June 30, 2007 from the same        period in 2006, as a result of a broad base increase in demand from our customers,        especially for Datacenter related products from our Premise Market customers. Revenues were        $15.4 million and $11.5 million for the six months ended June 30, 2007 and 2006,        respectively. Revenues increased 34.2% in the six months ended June 30, 2007 from the same        period in 2006, primarily as a result of increases in sales for Fiber to the Home (FTTH)        related products, increases in Datacenter related products from our Premise Market        customers, and some general increase in demand from improved market conditions in the        overall communications market.

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*Cost of Revenues.* Cost of        revenues was $5.9 million and $4.6 million for the three months ended June 30, 2007 and        2006, respectively. Cost of revenues as a percentage of revenues decreased to 68.1% for the        three months ended June 30, 2007 from 73.9% for the three months ended June 30, 2006. Cost        of revenues was $10.5 million and $8.5 million for the six months ended June 30, 2007 and        2006, respectively. Cost of revenues as a percentage of revenues decreased to 68.4% for the        six months ended June 30, 2007 from 74.1% for the six months ended June 30, 2006. Cost of        revenues for the period ended June 30, 2007 benefited from increased factory utilization        and improved manufacturing overhead absorption as a result of increased volume shipments of        our products.

*Gross Profit.* Gross profit        increased to $2.8 million, or 31.9% of revenues, for the three months ended June 30, 2007        from $1.6 million, or 26.1% of revenues, for the same period in 2006. Gross profit        increased to $4.9 million, or 31.6% of revenues, for the six months ended June 30, 2007        from $3.0 million, or 25.9% of revenues, for the same period in 2006. For the period        ended June 30, 2007, higher utilization of our factories as a result of increased volume        shipments of our products resulted in an improved gross margin. We expect our gross profit        as a percentage of revenues continue to improve with higher production volumes, which we        anticipate will result in improved absorption of overhead expenses. However, decreasing        average selling prices will negatively impact our gross profit and may offset any benefits        from improved absorption

*Research and Development        Expenses*. Research and development expenses increased to $0.8 million for the three        months ended June 30, 2007 from $0.7 million for the same period in 2006. The increase        was primarily due to expenses for Passive Fiber Optic Components (PFOC) related tests,        shipment of new samples, and for new product development. Research and development expenses        remained at $1.5 million for the six months ended June 30, 2007 and for the same period in        2006. As a percentage of revenues, research and development expenses decreased to 9.7% in        the three months ended June 30, 2007 from 11.3% for the same period in 2006. As a        percentage of revenues, research and development expenses decreased to 10.0% in the six        months ended June 30, 2007 from 12.8% for the same period in 2006. We expect research and        development expenses on our product development efforts to increase slightly 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,        2007 and for the same period in 2006. Sales and marketing expenses increased to $1.2        million for the six months ended June 30, 2007 from $1.1 million for the same period in        2006. As a percentage of revenues, sales and marketing expenses decreased to 7.3% in the        three months ended June 30, 2007 from 8.9% for the same period in 2006. As a percentage of        revenues, sales and marketing expenses decreased to 7.8% in the six months ended June 30,        2007 from 10.0% for the same period in 2006. We expect sales and marketing expenses to        decline slightly in the next two quarters as a result of fewer trade show activities and        revenue growth.

*General and Administrative        Expenses*. General and administrative expenses increased to $0.9 million for the three        months ended June 30, 2007 from $0.7 million for the same period in 2006. The increase        was primarily due to higher legal and audit fees and accrued year-end bonuses. General and        administrative expenses increased to $1.8 million for the six months ended June 30, 2007        from $1.5 million for the same period in 2006. As a percentage of revenues, general and        administrative expenses decreased to 10.5% in the three months ended June 30, 2007 from        11.5% for the same period in 2006. As a percentage of revenues, general and administrative        expenses decreased to 11.5% in the six months ended June 30, 2007 from 12.9% for the same        period in 2006. We expect general and administrative expenses will increase due to higher        fees and costs associated with compliance with laws and regulations such as the        Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder.

*Stock-Based Compensation*.        Total stock based compensation increased to $0.1 million for the three months ended June        30, 2007 from $0.03 million for the same period in 2006. Total stock based compensation        increased to $0.2 million for the six months ended June 30, 2007 from $0.1 million for the        same period in 2006. These increases were due to higher volatility rate projected for the        year of 2007.

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*Interest and Other Income,        Net.* Interest and other income, net, was $0.5 million and $0.4 million for the three        months ended June 30, 2007 and 2006, respectively. Interest and other income, net, was $0.9        million and $0.8 million for the six months ended June 30, 2007 and 2006,        respectively.

# Liquidity and Capital        Resources

At June 30, 2007, we had cash and        cash equivalents of $4.4 million and short-term investments of        $27.8 million.

Net cash provided by operating        activities was $1.2 million for the six months ended June 30, 2007. Net cash provided by        operating activities was primarily due to net income of $1.3 million, an increase in        accounts payable of $0.9 million, and total depreciation and amortization expenses of $0.8        million, which was offset by a $1.2 million increase in accounts receivable, a $0.4 million        decreased in inventory provision and a $0.4 million increase in inventory. Net cash used in        operating activities was $0.06 million for the six months ended June 30, 2006, and was        primarily due to a net loss of $0.4 million, which was offset by total depreciation and        amortization expenses of $0.8 million and $0.4 million of inventory provision. Accounts        receivable increased by $0.2 million and accounts payable increased by $0.3 million offset        by a $1.0 million increase in inventory and a $0.1 million decrease in accrued        expenses.

Cash used in investing activities        was $1.5 million for the six months ended June 30, 2007. In the six months ended June 30,        2007, we spent a net $1.0 million for the purchase of short-term securities, and we used        $0.5 million to acquire property and equipment. Net cash provided by investing activities        was $0.9 million for the six months ended June 30, 2006. This resulted from $1.1 million in        net proceeds from sales of short-term investments offset by $0.2 million spending on        equipment purchases.

Cash provided by financing        activities was $0.3 million for the six months ended June 30, 2007 and 2006, respectively,        resulting from proceeds from exercise of options to purchase common stock and common stock        issued through our Employee Stock Purchase Plan. Cash used in financing activities was        $0.05 million and $0.04 million for the six months ended June 30, 2007 and 2006,        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 corporate headquarters are in        Sunnyvale, California where we lease the facilities from a third party. The lease has a        six-year term commencing on July 22, 2004. The facility is 34,800 square feet and the        current monthly rent is approximately $32,000.

In December 2000, we purchased        approximately 8,200 square feet of space immediately adjacent to our leased facility in        Tu-Cheng City, Taiwan for $0.8 million. Additionally, in February 2006, we entered into a        lease for a total of 21,600 square feet facility located in Hu-Kou, Taiwan. This lease will        expire in January 2009.

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

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# ITEM 3: QUANTITATIVE        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

# Interest Rate        Sensitivity

We currently maintain our funds        primarily in money market funds and highly liquid marketable securities. We do not have any        derivative financial instruments. As of June 30, 2007, $23.7 million, or 85% of our        investments, had maturities of less than three months. We expect to continue to invest a        significant portion of our existing cash in interest bearing, investment grade securities,        with maturities of less than 12 months pending their need for other uses. We do not believe        that our investments, in the aggregate, have significant exposure to interest rate risk and        we do not believe that a 10% change in interest rates will have a significant impact on our        investments or interest income

# Exchange Rate        Sensitivity

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

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

# ITEM 4: CONTROLS AND        PROCEDURES

              (a) *Evaluation of disclosure controls and procedures.* 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-benefit relationship of possible disclosure controls and procedures.        The design of any disclosure controls and procedures also is based in part upon certain        assumptions about the likelihood of future events, and there can be no assurance that any        design will succeed in achieving its stated goals under all potential future conditions.        Based on their evaluation as of the end of the period covered by this Quarterly Report on        Form 10-Q, our Chief Executive Officer and Acting Chief Financial Officer have concluded        that, as of such date, our disclosure controls and procedures were effective to ensure that        material information relating to us, including our consolidated subsidiaries, is made known        to them by others within those entities, particularly during the period in which this        Quarterly Report on Form 10-Q was being prepared.

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

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# PART II: OTHER        INFORMATION

# ITEM 1A: RISK        FACTORS

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

We had net income of approximately        $0.9 million and $0.02 million the second quarter of fiscal 2007 and 2006, respectively.        Although we generated a profit in the second quarter, we may not be able to sustain        profitability in the future. Although our cash and cash equivalents increased in the second        quarter of fiscal 2007, we could find our cash flows to be negative again in the future as        we continue to invest in our business. As of June 30, 2007, we had an accumulated deficit        of approximately $70.6 million.

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

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

Sales of our OPMS products accounted        for over 64.0% of our revenues in the quarter ended June 30, 2007 and a substantially        portion of our historical revenues. We expect to substantially depend on these products for        our near-term revenues. Any significant decline in the price of, or demand for, 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 DWDM-related products, which        we began shipping commercially in July 2000. Demand for these products has fluctuated over        the past few years, declining sharply starting in mid fiscal 2001 and then increasing        beginning in 2003. If demand for these products does not continue to increase and our        target customers do not continue to adopt and purchase our DWDM-related products, our        revenues may decline and we may have to write-off additional inventory that is currently on        our books.

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

In the quarters ended June 30, 2007        and 2006, our top 10 customers comprised 61.2% and 56.8% of our revenues, respectively. One        customer accounted for 22.6% and 14.5% of our total revenues for the three months ended        June 30, 2007 and 2006, respectively.

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

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

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

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

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

            o customer unwillingness to implement our products;

    o        any delays or difficulties that we may incur in completing the development and introduction        of our planned products or product enhancements;

    o        the success of our customers;

    o        excess inventory in the telecommunications industry;

    o        new product introductions by our competitors;

    o        any failure of our products to perform as expected; or

    o        any difficulty we may incur in meeting customers' delivery requirements or product        specifications.

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

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

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

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

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

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

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

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

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

As of June 30, 2007, we had a total        of 43 full-time employees in Sunnyvale, California, 372 full-time employees in Taiwan, and        296 full-time employees in China. Matching the scale of our operations with demand        fluctuations, combined with the challenges of expanding and managing geographically        dispersed operations, has placed, and will continue to place, a significant strain on our        management and resources. To manage the expected fluctuations in our operations and        personnel, we will be required to:

            o improve existing and implement new operational, financial and management controls,        reporting systems and procedures;

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

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

            o effectively manage relationships with our customers, suppliers, representatives and other        third parties.

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

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

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

The development of new or enhanced        fiber optic products is a complex and uncertain process. We may experience design,        manufacturing, marketing and other difficulties that could delay or prevent the        development, introduction or marketing of new products and enhancements. Development costs        and expenses are incurred before we generate revenues from sales of products resulting from        these efforts. Our total research and development expenses were approximately $0.8 million        and $0.7 million for the three months ended June 30, 2007 and 2006, respectively. Our total        research and development expenses were approximately $1.5 million for the six months ended        June 30, 2007 and 2006, respectively. We expect that our research and development expense        may increase in the second half of 2007 as we intend to continue to invest in our research        and product development efforts. Any such increase could have a negative impact on our        earnings in future periods.

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

The communications industry is        characterized by 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.

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

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

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

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

Since 2001, the United States        economy has experienced and continues to experience significant fluctuations in consumption        and demand. During the past several years, telecommunication companies have mostly        decreased their spending, which has resulted in excess inventory, overcapacity and a        decrease in demand for our products. We may experience further decreases in the demand for        our products due to a weak domestic and international economy as the fiber optics industry        copes with the effects of oversupply of products, international terrorism, war and        political instability. Even if the general economy experiences a recovery, the activity of        the United States telecommunications industry may lag behind the recovery of the overall        United States economy.

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

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

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

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

**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.**

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

**Because we experience long lead        times for materials and components, we may not be able to effectively manage our inventory        levels 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 laws requiring companies to evaluate internal controls        over financial reporting.**

Section 404 of the Sarbanes-Oxley        Act of 2002 requires our management to perform an assessment of our internal controls by        December 31, 2007, and our independent auditors to attest to the effectiveness of our        internal controls over financial reporting beginning with our year ending December 31,        2008. We have implemented an ongoing program to perform the system and process evaluation        and testing we believe to be necessary to comply with these requirements, however, we        cannot assure you that we will be successful in our efforts. We expect to incur increased        expense and to devote additional management resources to Section 404 compliance. In the        event that our chief executive officer, acting chief financial officer or independent        registered public accounting firm determine that our internal controls over financial        reporting are not effective as defined under Section 404, investor perceptions of our        company may be negatively affected and this could cause a decline in our stock        price.

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

We prepare our financial statements        to conform with generally accepted accounting principles, or GAAP, in the United States.        These accounting principles are subject to interpretation by the American Institute of        Certified Public Accountants, the Securities and Exchange Commission and various bodies        formed to interpret and create appropriate accounting policies. A change in those policies        can have a significant effect on our reported results and may affect our reporting of        transactions completed before a change is announced. Changes to those rules or the        questioning of current practices may adversely affect our reported financial results or the        way we conduct our business. For example, accounting policies affecting many aspects of our        business, including rules relating to employee stock option grants, have recently been        revised. The Financial Accounting Standards Board and other agencies have finalized changes        to U.S. generally accepted accounting principles that required us, starting in our first        quarter of 2006, to record a charge to earnings for employee stock option grants and other        equity incentives. As a result of adopting Statement No. 123(R), on January 1, 2006,        the Company's income before income tax and net income for the year ended December 31, 2006        was $657,000, or $298,000 lower than if it had continued to account for share-based        compensation under APB Opinion 25. The adoption of Statement No. 123(R) did not impact        basic and diluted income and loss per share for the year ended December 31, 2006. In        addition, since we historically have used equity-related compensation as a component of our        total employee compensation program, the accounting change could make the use of        equity-related compensation less attractive to us and therefore make it more difficult to        attract and retain employees.

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

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

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

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

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

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

Because we plan to introduce new        products and product enhancements, we must effectively transfer production information from        our product development department to our manufacturing group and coordinate our efforts        with those of our suppliers to rapidly achieve volume production. In our experience, our        yields have been lower during the early stages of introducing new product to manufacturing.        If we fail to effectively manage this process or if we experience delays, disruptions or        quality control problems in our manufacturing operations, our shipments of products to our        customers could be delayed.

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

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

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

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

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

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

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

            o loss of customers;

            o damage to our reputation;

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            o failure to attract new customers or achieve market acceptance;

            o diversion of development and engineering resources; and

            o legal actions by our customers.

The occurrence of any one or more of        the foregoing factors could 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:

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

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

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

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

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

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

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

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

The fiber optic component market is        a highly competitive industry in which we, and most other participants, rely on a        combination of patent, copyright, trademark and trade secret laws, confidentiality        procedures and licensing arrangements to establish and protect proprietary rights. The        competitive nature of our industry, rapidly changing technology, frequent new product        introductions, changes in customer requirements and evolving industry standards heighten        the importance of protecting proprietary technology rights. Since the United States Patent        and Trademark Office keeps patent applications confidential until a patent is issued, our        pending patent applications may attempt to protect proprietary technology claimed in a        third party patent application. Our existing and future patents may not be sufficiently        broad to protect our proprietary technologies as policing unauthorized use of our products        is difficult and we cannot be certain that the steps we have taken will prevent the        misappropriation or unauthorized use of our technologies, particularly in foreign countries        where the laws may not protect our proprietary rights as fully as United States laws. Our        competitors and suppliers may independently develop similar technology, duplicate our        products, or design around any of our patents or other intellectual property. If we are        unable to adequately protect our proprietary technology rights, others may be able to use        our proprietary technology without having to compensate us, which could reduce our revenues        and negatively impact our ability to compete effectively.

Litigation may be necessary to        enforce our intellectual property rights or to determine the validity or scope of the        proprietary rights of others. As a result of any such litigation, we could lose our        proprietary rights and incur substantial unexpected operating costs. Any action we take to        protect our intellectual property rights could be costly and could absorb significant        management time and attention. In addition, failure to adequately protect our trademark        rights could impair our brand identity and our ability to compete effectively.

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

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

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.

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

For the three and six months ended        June 30, 2007, sales to customers located outside of North America were 42.9% and 39.2% of        our revenues, respectively. In order to expand our business, we must increase our sales to        customers located outside of North America. We have limited experience in marketing and        distributing our products internationally and in developing versions of our products that        comply with local standards. Our international sales will be limited if we cannot establish        relationships with international distributors, establish additional foreign operations,        expand international sales channels, hire additional personnel and develop relationships        with international communications equipment manufacturers. Even if we are able to        successfully continue international operations, we may not be able to maintain or increase        international market demand for our products.

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

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

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

        On        May 18, 2007, we held our 2007 Annual Meeting of Stockholders, at which meeting our        stockholders approved the following:

     (a)       Election        of Class I directors:

|                 |  For                                                       |  Withheld                                               |
|--------------------------------------------------------------------------------------------|----------------------------------------------------------------------|-------------------------------------------------------------------|
|                                                                                       |                                                                 |                                                              |
|       Peter                C. Chang                |    29,971,782                shares    |    320,208                shares    |
|                                                                                       |                                                                 |                                                              |
|       Richard                Black       |    29,521,393                shares    |    770,597                shares    |
|                                                                                       |                                                                 |                                                              |

     (b)               Ratification of the appointment of Stonefield Josephson, Inc. as independent registered        public accountants of the Company for the 2007 fiscal year:

|             |      For                                   |      Against                           |      Abstain                           |
|--------------------------------------------------------------------|----------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------|
|                                                               |                                                                                         |                                                                                     |                                                                                     |
|                  |      30,208,972                shares      |      70,878                shares      |      12,139                shares      |

      Other        directors whose term of office as a director continued after the annual meeting        were Gwong-Yih Lee, James Yeh and Ray Sun.

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# ITEM 6:        EXHIBITS

        Exhibits

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

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

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# SIGNATURE

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

              Dated: August 10, 2007

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

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Exhibit 31.1

**Certification of the Chief        Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period        Ended June 30, 2007**  

**CERTIFICATION**          I, Peter C. Chang, certify that:  

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

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

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

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

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

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

c) Disclosed in this report any        change in the registrant's internal control over financial reporting that occurred during        the registrant's most recent fiscal quarter that has materially affected, or is reasonably        likely to materially affect, the registrant's internal control over financial reporting;        and  

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

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

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

 

   

|        | Date: August 10,                2007                                                                                                                                                                                                                                                    |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                         |
|   | By:                                /s/ Peter C.                Chang                                     |
|   |      Peter                C. Chang                                                                                                                                                                                                                                  |
|   |      Chief                Executive Officer                                                                                                                                                                                                                         |
|   |      (Principal                Executive Officer)                                                                                                                                                                                                                   |

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Exhibit 31.2

**Certification of the Chief        Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Period        Ended June 30, 2007**  

**CERTIFICATION**          I, Anita K. Ho, certify that:  

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

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

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

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

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

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

c) Disclosed in this report any        change in the registrant's internal control over financial reporting that occurred during        the registrant's most recent fiscal quarter that has materially affected, or is reasonably        likely to materially affect, the registrant's internal control over financial reporting;        and  

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

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

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

|        | Date: August 10,                2007                                                                                         |
|--------|-----------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                              |
|   | By:                                /s/ Anita K.Ho |
|   |      Anita                K. Ho                                                                          |
|   |      Acting                Chief Financial Officer                                                  |
|   |      (Principal Accounting                Officer)                                                  |

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Exhibit 32.1

#         STATEMENT OF CHIEF EXECUTIVE OFFICER UNDER 18 U.S.C. §1350

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

#                 (i)               the Quarterly Report of the Company on Form 10-Q for the period ended June 30, 2007 (the        "Report"), fully complies with the requirements of section 13(a) of the Securities Exchange        Act of 1934, and

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

|   |                                                                                                                                                                                                                                                                                                                                                                           |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | By           /s/                Peter C.                Chang                                                        |
|   | Peter C.                Chang                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                           |
|   | August 10,                2007                                                                                                                                                                                                                                                                                                                                                 |

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Exhibit 32.2

#         STATEMENT OF ACTING CHIEF FINANCIAL OFFICER UNDER 18 U.S.C.§1350

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

#                 (i)               the Quarterly Report of the Company on Form 10-Q for the period ended June 30, 2007 (the        "Report"), fully complies with the requirements of section 13(a) of the Securities Exchange        Act of 1934, and

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

|   |                                                                                                                                                                                                                                                                                                                                                                        |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | By           /s/                Anita K.                Ho                                                        |
|   | Anita K.                Ho                                                                                                                                                                                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                        |
|   | August 10,                2007                                                                                                                                                                                                                                                                                                                                              |

36

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