# UNITED STATES

# SECURITIES AND
EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_________________

# FORM 10-QSB

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

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

| |                                                  
| | -------------------------------------------------
| | For the quarterly period ended September 30, 2003

| |   |                                                  
| | - | -------------------------------------------------
| | 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 small business issuer as specified in its charter)

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

|                                                      
|------------------------------------------------------
|735 North Pastoria Avenue, Sunnyvale, California 94085
|                                                      
|(Address of Principal Executive Offices)              

|                           
|---------------------------
|(408) 736-6900             
|                           
|(Issuer's telephone number)

On November 6, 2003, 36,449,806
shares of the Registrants Common Stock, $0.001 par value per share, were
outstanding.

Transitional Small Business Disclosure Format (Check One):  Yes o   No þ



---

# ALLIANCE FIBER OPTIC
PRODUCTS, INC.

# FORM 10-QSB

# QUARTERLY PERIOD ENDED
SEPTEMBER 30, 2003

# INDEX

| |                                                                                                       | Page
| | ----------------------------------------------------------------------------------------------------- | ----
| | Part I:  Financial Information                                                                        | 1   
| | Item 1:  Financial Statements                                                                         | 1   
| | Consolidated Balance Sheets at December 31, 2002 and September 30, 2003                               | 1   
| | Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2002 and 2003 | 2   
| | Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2002 and 2003           | 3   
| | Notes to Consolidated Financial Statements                                                            | 4   
| | Item 2:  Management's Discussion and Analysis of Financial Condition and Results of Operations        | 8   
| | Item 3:  Controls and Procedures                                                                      | 23  
| | Part II:  Other Information                                                                           | 24  
| | Item 5:  Other Events                                                                                 | 24  
| | Item 6:  Exhibits and Reports on Form 8-K                                                             | 24  
| | Signature                                                                                             | 25  

i

---

# PART I: FINANCIAL INFORMATION

# ITEM 1: FINANCIAL STATEMENTS

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

|                                                               | Dec. 31, | Sept. 30,
|-------------------------------------------------------------- | -------- | ---------
|
|                                                               |          |          
|Assets                                                         |          |          
|Current assets:                                                |          |          
|Cash and cash equivalents                                      |          |          
|Short-term investments                                         |          |          
|Accounts receivable, net                                       |          |          
|Inventories, net                                               |          |          
|Prepaid expense and other current assets                       |          |          
|                                                               |          |          
|                                                               |          |          
|Total current assets                                           |          |          
|Property and equipment, net                                    |          |          
|Other assets                                                   |          |          
|                                                               |          |          
|                                                               |          |          
|Total assets                                                   |          |          
|                                                               |          |          
|                                                               |          |          
|Liabilities and Stockholders' Equity                           |          |          
|Current liabilities:                                           |          |          
|Accounts payable                                               |          |          
|Income tax payable                                             |          |          
|Accrued expenses                                               |          |          
|Accrued excess facility charge-short term                      |          |          
|                                                               |          |          
|                                                               |          |          
|Total current liabilities                                      |          |          
|Accrued excess facility charge-long term                       |          |          
|Other long-term liabilities                                    |          |          
|                                                               |          |          
|                                                               |          |          
|Total liabilities                                              |          |          
|                                                               |          |          
|                                                               |          |          
|Commitments and contingencies (Note 9)                         |          |          
|Stockholders' equity:                                          |          |          
|Common stock, $0.001 par value: 250,000,000 shares authorized; |          |          
|35,580,871 and 35,817,657 shares issued and outstanding at     |          |          
|December 31, 2002 and September 30, 2003, respectively         |          |          
|Additional paid-in-capital                                     |          |          
|Receivables from stockholders                                  |          |          
|Deferred stock-based compensation                              |          |          
|Accumulated deficit                                            |          |          
|Accumulated other comprehensive loss                           |          |          
|                                                               |          |          
|                                                               |          |          
|Stockholders' equity                                           |          |          
|                                                               |          |          
|                                                               |          |          
|Total liabilities and stockholders' equity                     |          |          
|                                                               |          |          

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

1

---

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

|                                             | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|-------------------------------------------- | ---------------------------- | ---------------------------
|
|Revenues                                     |                              |                            
|                                             |                              |                            
|Cost of revenues                             |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Gross profit (loss)                          |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Operating expenses:                          |                              |                            
|Research and development                     |                              |                            
|Sales and marketing                          |                              |                            
|General and administrative                   |                              |                            
|Excess facility charge                       |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Total operating expenses                     |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Loss from operations                         |                              |                            
|Interest and other income, net               |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Loss before income taxes                     |                              |                            
|Income tax provision                         |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Net loss                                     |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Net loss per share:                          |                              |                            
|Basic and diluted                            |                              |                            
|                                             |                              |                            
|                                             |                              |                            
|Shares used in computing net loss per share: |                              |                            
|Basic and diluted                            |                              |                            
|                                             |                              |                            

2

---

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

|                                                     | Nine Months Ended Sept. 30,
|---------------------------------------------------- | ---------------------------
|
|Cash flows from operating activities:                |                            
|Net loss                                             |                            
|Adjustments to reconcile net loss to net cash used   |                            
|in operating activities:                             |                            
|Depreciation                                         |                            
|Amortization of stock-based compensation             |                            
|Impairment/write down in property and equipment      |                            
|Provision for inventory                              |                            
|Excess facility charge                               |                            
|Changes in assets and liabilities:                   |                            
|Accounts receivable, net                             |                            
|Inventories, net                                     |                            
|Prepaid expenses and other assets                    |                            
|Accounts payable                                     |                            
|Accrued expenses                                     |                            
|Other long-term liabilities                          |                            
|                                                     |                            
|                                                     |                            
|Net cash used in operating activities                |                            
|                                                     |                            
|                                                     |                            
|Cash flows from investing activities:                |                            
|Proceeds (purchase) from short-term investments      |                            
|Purchase of property and equipment                   |                            
|                                                     |                            
|                                                     |                            
|Net cash (used in) provided by investing activities  |                            
|                                                     |                            
|                                                     |                            
|Cash flows from financing activities:                |                            
|Proceeds from issuance of common stock under ESPP    |                            
|Proceeds from the exercise of common stock options   |                            
|Proceeds from the repayment of notes receivable      |                            
|                                                     |                            
|                                                     |                            
|Net cash provided by financing activities            |                            
|                                                     |                            
|                                                     |                            
|Net (decrease) increase in cash and cash equivalents |                            
|Cash and cash equivalents at beginning of period     |                            
|                                                     |                            
|                                                     |                            
|Cash and cash equivalents at end of period           |                            
|                                                     |                            
|                                                     |                            
|Non-cash investing and financing activities:         |                            
|Repurchase of common stock via cancellation          |                            
|of notes receivable from stockholders                |                            
|                                                     |                            

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

3

---

# ALLIANCE FIBER OPTIC PRODUCTS, INC.

# NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

# (Unaudited)

# 1.  The Company

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

# 2.  Basis of presentation

The consolidated  financial  information as of September 30, 2003 included herein is unaudited and has been prepared by the
Company in accordance with generally  accepted  accounting  principles in the United States of America,  and reflects all  adjustments,
consisting  only of normal  recurring  adjustments,  which in the opinion of  management  are  necessary to state fairly the  Company's
consolidated financial position, results of its consolidated operations, and consolidated cash flows for the periods presented.

The  preparation  of financial  statements in conformity  with generally  accepted  accounting  principles  accepted in the
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, 2002.  The results of operations  for the three
and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for any future periods.

# 3. Stock-based compensation

The Company  accounts for stock-based  compensation  arrangements  in accordance with the provisions of Accounting  Principles
Board ("APB")  Opinion  No. 25,  "Accounting  for Stock Issued to  Employees".  In addition,  the Company  complies with the disclosure
provisions of SFAS No. 123,  "Accounting  for Stock-Based  Compensation"  and SFAS No. 148,  "Accounting for Stock-Based  Compensation,
Transition and Disclosure."  Equity  instruments  issued to  non-employees  are accounted for in accordance with the provisions of SFAS
No. 123, SFAS 148 and Emerging Issues Task Force ("EITF") Issue No. 96-18, which require the award to be recorded at its fair value.

4

---

Had  compensation  cost been determined based upon the fair value on the grant date,  consistent with the methodology  prescribed under
SFAS  No. 123,  the  Company's pro forma net loss and pro forma basic and diluted net loss per share under SFAS No. 123 would have been
as follows (in thousands, except per share data):

|                                                        | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------------------------------------------------- | ---------------------------- | ---------------------------
|
|Net loss, as reported:                                  |                              |                            
|                                                        |                              |                            
|Add: Stock-based employee compensation expense included |                              |                            
|in reported net income                                  |                              |                            
|Deduct: Total stock-based employee compensation expense |                              |                            
|determined under fair value based method for all awards |                              |                            
|                                                        |                              |                            
|                                                        |                              |                            
|Pro forma net loss:                                     |                              |                            
|                                                        |                              |                            
|                                                        |                              |                            
|                                                        |                              |                            
|Net loss per share attributable to common stockholders, |                              |                            
|basic and diluted:                                      |                              |                            
|As reported                                             |                              |                            
|                                                        |                              |                            
|Pro forma                                               |                              |                            
|                                                        |                              |                            
|Shares used in EPS calculation (basic and diluted)      |                              |                            
|                                                        |                              |                            

# 4. Inventories (in
thousands)

|                                                | Dec. 31, | Sept. 30,
|----------------------------------------------- | -------- | ---------
|
|Inventories                                     |          |          
|Finished goods                                  |          |          
|Work-in-process                                 |          |          
|Raw materials                                   |          |          
|Less: Reserve for excess and obsolete inventory |          |          
|                                                |          |          
|                                                |          |          
|                                                |          |          
|                                                |          |          

# 5. Impairment of property and equipment

In the third  quarter of 2002, as a result of the business  decline and reduced  headcount in the United  States,  the Company
consolidated  its operations in the United States from three buildings into two buildings in Sunnyvale,  California.  As a consequence,
the Company  recorded excess facility  charges of $1.8 million during 2002,  comprised of $1.6 million of future  non-cancelable  lease
payments,  which were  expected  to be paid over the next two years,  and $0.2  million of fixed  assets  that were  written-off.  Cash
payments in the quarters  ended March 31, 2003,  June 30, 2003 and  September  30, 2003 each amounted to $0.2 million and an additional
$0.8 million remains on the consolidated balance sheet in accrued excess facility charges at September 30, 2003.

# 6.  Net loss per share

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

5

---

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

|                                                       | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------------------------------------------------ | ---------------------------- | ---------------------------
|
|Numerator:                                             |                              |                            
|Net loss                                               |                              |                            
|                                                       |                              |                            
|                                                       |                              |                            
|                                                       |                              |                            
|Denominator:                                           |                              |                            
|Shares used in computing net loss per share:           |                              |                            
|Weighted average of common shares outstanding          |                              |                            
|Less: Weighted average of shares subject to repurchase |                              |                            
|                                                       |                              |                            
|                                                       |                              |                            
|Basic and diluted                                      |                              |                            
|                                                       |                              |                            
|                                                       |                              |                            
|Net loss per share:                                    |                              |                            
|Basic and diluted                                      |                              |                            
|                                                       |                              |                            

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

|                                     | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------------------------------ | ---------------------------- | ---------------------------
|
|Options to purchase common stock and |                              |                            
|shares subject to repurchase         |                              |                            
|                                     |                              |                            

# 7. Comprehensive Loss

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

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

|                                                 | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------------------------------------------ | ---------------------------- | ---------------------------
|
|Net loss                                         |                              |                            
|                                                 |                              |                            
|Cumulative translation adjustments               |                              |                            
|Unrealized gain (loss) on short-term investments |                              |                            
|                                                 |                              |                            
|                                                 |                              |                            
|Total comprehensive loss                         |                              |                            
|                                                 |                              |                            

6

---

# 8. Geographic Segment
Information

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

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

|              | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------- | ---------------------------- | ---------------------------
|
|Revenues      |                              |                            
|United States |                              |                            
|              |                              |                            
|Taiwan        |                              |                            
|              |                              |                            
|              |                              |                            
|              |                              |                            
|              |                              |                            

|                    | Dec. 31, | Sept. 30,
|------------------- | -------- | ---------
|
|Identifiable Assets |          |          
|United States       |          |          
|Taiwan              |          |          
|China               |          |          
|                    |          |          
|                    |          |          
|Total               |          |          
|                    |          |          

# 9. Contingencies

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.

# 10. Subsequent Event

On
October 31, 2003, the Company signed an agreement to acquire substantially all the assets
of the Photonics business of Ritek Corporation, a company incorporated in Taiwan, in
exchange for up to 1.7 million shares of the Companys common stock. Riteks
Photonics business is located in Hsin Chu Industrial Park, Taiwan, and we may continue to
operate the business at this facility rent-free for two years after the closing. In
addition, Ritek will pay us $1.5 million in cash as a part of this agreement. The
transaction is expected to be completed in December 2003 and is subject to various closing
conditions.

7

---

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

When
used in this discussion, the words expects, anticipates,
believes, estimates, plans, and similar expressions
are intended to identify forward-looking statements. These statements, which include
statements as our sources of revenues, anticipated level of revenues, our profitability,
those actions necessary to achieve and maintain profitability, the fluctuation of our cost
of revenues as a percentage of revenues and the factors contributing to these
fluctuations, our net and operating losses, our negative cash flow, our gross profit as a
percentage of revenues, the amount and mix of our anticipated expenditures and expenses,
expenditures required to remain competitive, increases or decreases in the level of our
expenses, the need for additional inventory reserves or provisions, customer demand for
our products, strategies to increase business including increasing sales to customers
outside of the United States, our reliance on our OPMS products sales levels,
reliance on the commercial success of our DWDM-related products, our ability to complete
business transactions including our proposed acquisition, our success being tied to
relationships with key customers, our ability to establish and maintain relationships with
key customers, the adequacy of our capital resources and need for additional funding,
period-to-period comparisons of our operating results, our ability to obtain raw materials
and components and maintain and develop supplier relationships, our anticipated use of
resources, our ability to maintain appropriate inventory, factors that affect a
customers decision to choose a supplier, our competitors, competition in our
industry, our competitive advantage and consolidation in our industry are subject to risks
and uncertainties that could cause actual results to differ materially from those
projected. These risks and uncertainties include, but are not limited to, those risks
discussed below, further decreased demand for and sales of our products, our ability to
realize the benefits of our investment strategy, continued domestic and international
economic instability, the results of the transfer of the listing of our common stock to
the Nasdaq SmallCap Market, competition, including the impact of competitive products and
pricing, timely design acceptance by our customers, our success in attracting new
customers, loss of a key customer, our customers not adopting our new products, failure to
accurately predict market needs, timely introduction of new technologies, our ability to
integrate acquired businesses, whether our proposed acquisitions will be consummated, our
ability to ramp new products into volume production, our ability to attract and retain
highly skilled personnel, loss of a key supplier, industry wide shifts in supply and
demand for optical components and modules, industry overcapacity, financial stability in
foreign markets and the matters discussed in Factors That May Affect Results.
These forward-looking statements speak only as of the date hereof. The Company expressly
disclaims any obligation or undertaking to release publicly any updates or revisions to
any forward-looking statements contained herein to reflect any change in the
Companys expectations with regard thereto or any change in events, conditions or
circumstances on which any such statement is based.

This
Managements Discussion and Analysis of Financial Condition and Results of Operations
should be read in conjunction with the section entitled Managements Discussion
and Analysis of Financial Condition and Results of Operations in the Companys
Annual Report on Form 10-K, its Consolidated Financial Statement and the Notes thereto,
for the year ended December 31, 2002.

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

# Critical Accounting
Policies and Estimates

Managements
discussion and analysis of our financial conditions and results of operations are based on
our unaudited 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.

8

---

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, 2002.

# Overview

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

From
our inception through September 30, 2003, we derived substantially all of our revenues
from our OPMS product line. Revenues from our DWDM products represented approximately 8.6%
of total revenues for the year ended December 31, 2002. For the nine months ended
September 30, 2003, our DWDM products contributed revenues of $1.4 million, or 17.8% of
total revenues. For the nine months ended September 30, 2002 and September 30, 2003, our
top ten customers comprised 48.4% and 48.7% of our revenues, respectively. No customer
accounted for 10% or more of revenues for the nine months ended September 30, 2002. For
the nine months ended September 30, 2003, two customers each accounted for 10.2% and 10.1%
of our total revenues, respectively.

We
market and sell our products predominantly through our direct sales force. For the nine
months ended September 30, 2002 and September 30, 2003, revenues derived from sales to
customers located outside of North America were 9.2% and 9.7%, 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 fixed asset write-downs related to manufacturing assets;
|  |                                                                                   
|o | mix of products sold;                                                             
|  |                                                                                   
|o | changes in our pricing and pricing from our competitors;                          
|  |                                                                                   
|o | mix of sales channels through which our products are sold; and                    
|  |                                                                                   
|o | mix of domestic and international sales.                                          
|  |                                                                                   

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

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

9

---

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.

In
connection with the grant of stock options to employees and consultants, we recorded
deferred stock-based compensation of approximately $26.8 million in
stockholders equity prior to our initial public offering, representing the
difference between the estimated fair market value of our common stock and the exercise
price of these options at the date of grant. Deferred stock-based compensation is being
amortized using the graded vesting method, under which each option grant is separated into
portions based on its vesting terms which results in acceleration of amortization expense
for the overall award. The deferred stock-based compensation balance of $1.3 million as of
September 30, 2003 will be fully amortized on an accelerated basis by December 1, 2004.

In
October 2003, Mr. Kenny Liu resigned from our Board of Directors.

On October
31, 2003 we signed a definitive agreement to acquire substantially all of the assets of
Ritek Corporations photonics division which is located in Taiwan. Pursuant to the
terms of the agreement, we will acquire the assets in exchange for up to 1.7 million
shares of our common stock and our assumption of certain Ritek personnel and product
warranty expenses as well as the assumption of certain contractual obligations.
Riteks Photonics business is located in Hsin Chu Industrial Park, Taiwan, and we may
continue to operate the business at this facility rent-free for two years after the
closing. In addition, Ritek will pay us $1.5 million in cash as a part of this agreement.
We expect that the transaction will be completed in December 2003 and is subject to
standard closing conditions.

# Results of Operations

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

|                               | Three Months Ended Sept. 30, | Nine Months Ended Sept. 30,
|------------------------------ | ---------------------------- | ---------------------------
|
|Revenues                       |                              | 100                        
|Cost of revenues:              |                              | 122                        
|                               |                              |                            
|Gross profit (loss)            |                              | (22                        
|Operating expenses:            |                             
|Research and development:      |                              | 42                         
|Sales and marketing:           |                              | 22                         
|General and administrative:    |                              | 32                         
|Excess facility charge         |                              | 54                         
|                               |                              |                            
|Total operating expenses       |                              | 151                        
|Loss from operations           |                              | (174                       
|Interest and other income, net |                              | 2                          
|                               |                              |                            
|Loss before income taxes       |                              | (171                       
|Income tax provision           |                              | (0                         
|                               |                              |                            
|Net loss                       |                              | (171                       
|                               |                              |                            

Revenues.Revenues were $3.1 million and $3.0 million for the three months ended
          September 30, 2002 and 2003, respectively. Revenues decreased 3.2% from
          September 30, 2002 to September 30, 2003. Revenues from our OPMS-related
          products were $2.8 million and $2.3 million for the three months ended September
          30, 2002 and 2003, respectively. Revenues from our DWDM-related products were
          $0.3 million and $0.7 million for the three months ended September 30, 2002 and
          2003, respectively.

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Revenues
were $10.3 million and $8.0 million for the nine months ended September 30, 2002
and 2003, respectively. Revenues from our OPMS-related products were $9.5 million and $6.6
million for the nine months ended September 30, 2002 and 2003, respectively. The decrease
in revenues derived from OPMS related products of 30.5% was primarily due to decreased
volume shipments of and decreased demand for our OPMS-related products as a result of
continuing poor market conditions. Revenues from our DWDM-related products were $0.8
million and $1.4 million for the nine months ended September 30, 2002 and 2003,
respectively. The DWDM revenue increase of 75.0% was primarily due to increased volume
shipments of and increased demand for our DWDM-related products as a result of new
customer purchases of our coarse wavelength division multiplexing, or CWDM, products.

Cost
of Revenues.Cost of revenues was $3.8 million and $2.5 million for the three months
ended September 30, 2002 and 2003, respectively. Cost of revenues as a percentage of net
revenues decreased from 122.5% for the three months ended September 30, 2002 to 82.0% for
the three months ended September 30, 2003. Cost of revenues was $13.5 million and $6.9
million for the nine months ended September 30, 2002 and 2003, respectively. Cost of
revenues for the nine months ended September 30, 2002 was primarily impacted by write-offs
for excess and obsolete inventory resulting from a slowdown in telecommunications capital
spending and the general downturn in the United States economy which resulted in a charge
of $2.8 million for DWDM-related material and $1.5 million for OPMS-related material.

Gross
Profit (Loss).We incurred a gross loss of $0.7 million for the three months
ended September 30, 2002, and earned a gross profit of $0.5 million for the same period in
2003. We incurred a gross loss of $3.2 million, or (31.5%) of revenues, for the nine
months ended September 30, 2002, and we earned a gross profit of $1.1 million, or 13.5% of
revenues, for the same period in 2003. The improvement for the three month and nine month
periods ended September 30, 2003 when compared to the same periods in 2002 was mainly due
to lower excess and obsolete inventory charges and lower product costs for DWDM-related
material.

We
expect our gross profit as a percentage of revenues to continue to be negatively impacted
in the near term by low production volumes and the under-utilization of our manufacturing
operations. We had approximately $1.0 million in DWDM-related net inventory and $2.0
million in OPMS-related net inventory on hand at September 30, 2003. Although we take
steps to manage future inventory levels, we may have to record additional inventory
reserves in future periods if there is a decrease in demand.

Research
and Development Expenses. Research and development expenses increased from $1.3
million, or 42.2% of revenues, for the three months ended September 30, 2002 to
$1.5 million, or 51.4% of revenues, for the same period in 2003. Research and
development expenses decreased from $5.9 million, or 57.3% of revenues, for the nine
months ended September 30, 2002 to $4.3 million, or 54.3% of revenues, for the same period
in 2003. This decrease in the nine month period is due to lower compensation expenses as a
result of reduced headcount. We expect our quarterly research and development expenses to
stay relatively flat from third quarter levels as we continue to invest in research and
development.

Sales
and Marketing Expenses. Sales and marketing expenses decreased from $0.7 million, or
22.7% of revenues, for the three months ended September 30, 2002 to $0.4 million, or 14.2%
of revenues, for the three months ended September 30, 2003. Sales and marketing expenses
decreased from $2.2 million, or 21.8% of revenues, for the nine months ended September 30,
2002 to $1.5 million, or 19.0% of revenues, for the nine months ended September 30, 2003
due to lower stock based compensation charges. We expect sales and marketing expenses to
remain relatively flat due to uncertainty about customer demand for our products in the
current economic environment.

General
and Administrative Expenses.General and administrative expenses decreased from $1.0
million, or 32.7% of revenues, for the three months ended September 30, 2002 to $0.7
million, or 24.3% of revenues, for the same period in 2003. General and administrative
expenses decreased from $3.3 million, or 32.1% of revenues, for the nine months ended
September 30, 2002 to $2.6 million, or 32.0% of revenues, for the same period in 2003. The
decrease in expenses for both the three month and nine month periods was primarily due to
lower headcount levels and related expenditures. We expect our quarterly general and
administrative expenses to increase for the fourth quarter due to increased rates and fees
for professional services.

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Stock-Based
Compensation.Total stock-based compensation increased from a credit of $0.01 million,
or (0.4)% of revenues, in the three months ended September 30, 2002, to $0.3 million, or
9.8% of revenues in the three months ended September 30, 2003. Stock-based compensation
increased from $0.6 million, or 6.1% of revenues, for the nine months ended September 30,
2002 to $0.8 million, or 10.0% of revenues, for the nine months ended September 30, 2003.

Interest
and Other Income, Net.Interest and other income, net, was $0.07 million and $0.2
million for the three months ended September 30, 2002 and 2003, respectively. Interest and
other income, net, was $0.9 million and $0.6 million for the nine months ended September
30, 2002 and 2003, respectively. The decrease for the nine month period was due to a lower
cash balance and lower interest rates.

Income
Taxes. We reported an income tax credit of $0.01 million and an expense of $0.01
million for the three months and nine months ended September 30, 2002, respectively. We
had no income tax expense for the three months or nine months ended September 30, 2003.

# Liquidity and Capital
Resources

Since
inception, we have financed our operations primarily through sales of stock and bank debt.
Additionally, in November 2000, we completed our initial public offering of common stock,
raising approximately $44.4 million, net of costs and expenses. On September 30,
2003, we had cash and cash equivalents of $5.2 million and short-term investments of
$32.4 million.

Net
cash used in operating activities was $5.1 million and $5.6 million for the nine months
ended September 30, 2002 and 2003, respectively. For the nine months ended September 30,
2003, net cash used was primarily due to our net loss of $6.7 million, offset by non-cash
adjustments, including depreciation and amortization of $1.7 million. For the nine months
ended September 30, 2002, net cash used was primarily due to our net loss of $15.5
million, offset by non-cash adjustments, including provision for inventory of $4.4
million, write-offs of property and equipment of $1.0 million, excess facility charge of
$1.7 million, depreciation and amortization of $1.3 million, stock-based compensation
expense of $0.6 million, and net changes in working capital of $11.8 million.

Cash
used in investing activities was $0.8 million and $1.6 million for the nine months
ended September 30, 2002 and 2003, respectively. In the nine months ended September 30,
2002, $0.2 million was invested in high-grade, short-term investments, while $0.6 million
was used to acquire property and equipment. In the nine months ended September 30, 2003,
we invested $1.2 million in high-grade, short-term investments, while we invested $0.3
million which was used to acquire property and equipment.

Cash
generated by financing activities was $0.4 million and $0.6 million for the nine months
ended September 30, 2002 and 2003, respectively, resulting from proceeds from the exercise
of options to purchase shares of our common stock and common stock issued through our
employee stock purchase plan. Cash generated also included net proceeds from the repayment
of notes receivable of $0.2 million and $0.5 million for the nine months ended September
30, 2002 and 2003, respectively.

In
July and December 2000, we entered into leases for 10,500 and 10,600 square feet of space,
respectively, near our existing facility in Sunnyvale, California. In September 2002, we
consolidated our operations in California into two buildings and vacated the 10,600 square
foot facility. As a result of the consolidation, we recorded an excess facility charge of
$1.8 million in the year ended December 31, 2002. Additionally, in December 2000, the
Company purchased approximately 8,200 square feet of space immediately adjacent to our
leased facility in Tu-Cheng City, Taiwan for $0.8 million. In April 2001, we entered into
a lease in China but cancelled it, without penalty, in the third quarter of 2001. We had a
lease for a facility near the Shenzhen area of China totaling approximately 12,000 square
feet, which expired in December 2002. In August 2002, we entered into a new lease for
62,000 square foot facility near the same Shenzhen area which will expire in July 2007.

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

12

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# FACTORS THAT MAY
AFFECT RESULTS

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

We
incurred net losses of approximately $15.5 million and $6.7 million in the first nine
months of fiscal 2002 and 2003, respectively, and expect that our net losses and negative
cash flows will continue for the foreseeable future as we continue to invest in our
business. As of September 30, 2003, we had an accumulated deficit of approximately $ 58.7
million.

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

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

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

Our Optical Path Management
Solution (OPMS) products have historically represented substantially all of our revenues,
and if we are unsuccessful in commercially selling our DWDM-related products, our business
will be seriously harmed.

Sales
of our OPMS products accounted for over 76% of our revenues in the quarter ended September
30, 2003, 82% of our revenues for the nine months ended September 30, 2003, and
substantially all of our historical revenues. We expect to substantially depend on these
products for our near-term revenues. Any significant decline in the 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. 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 further and we may have to write-off
additional inventory that is currently on our books.

13

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

Since
2001, the United States economy has experienced and continues to experience a significant
slowdown in consumption and demand. During the past few years, telecommunication companies
have 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.

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

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

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

14

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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 recent sudden and dramatic downturn in demand for
our products, our operating results could be harmed.

We
rapidly expanded our operations domestically and internationally in the final two quarters
of 2000. We have had to carefully manage and re-evaluate this expansion given the sudden
and dramatic downturn in demand for our products that began in 2001 and that continues to
date. As of September 30, 2003, we had a total of 79 full-time employees in Sunnyvale,
California, 164 full-time employees in Taiwan, and 99 full-time employees in China.
Matching the scale of our operations with the recent demand fluctuations, combined with
the challenges of expanding and managing geographically dispersed operations, has placed,
and will continue to place, a significant strain on our management and resources. To
manage the expected fluctuations in our operations and personnel, we will be required to:

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

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

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

15

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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 $5.9 million and $4.3 million for the nine months ended September 30, 2002
and 2003, respectively. We intend to continue to invest a substantial amount of funds in
our research and product development efforts, which could have a negative impact on our
earnings in future periods.

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

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

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

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

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

16

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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 and
lenses, and if we are not able to obtain sufficient quantities of these items at
acceptable prices, our ability to fill orders would be limited and our operating results
could be harmed.

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

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

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

17

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

18

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

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

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

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

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

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

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

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

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

19

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

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

|  |                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------
|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 long-haul, metropolitan, last mile, and enterprise access segments of the communications network.
|  |                                                                                                                              

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

We may be unable to consummate our
pending acquisition of the photonics division of Ritek Corporation or potential
acquisitions or 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.
For example, we recently announced our pending acquisition of the photonics division of
Ritek Corporation. We may be unable to identify other suitable acquisitions at reasonable
prices or on reasonable terms, or consummate our pending acquisition, 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 the photonics division of
Ritek Corporation or of any other 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 National 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 National Market to the Nasdaq SmallCap Market. As a result, we
will 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 National Market. For example, 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 to our
charter document 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.

20

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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 may independently develop similar technology, duplicate our
products, or design around any of our patents or other intellectual property. If we are
unable to adequately protect our proprietary technology rights, others may be able to use
our proprietary technology without having to compensate us, which could reduce our
revenues and negatively impact our ability to compete effectively.

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

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

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

21

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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 nine months ended September 30, 2002 and 2003, sales to customers located outside of
North America were 9.2% and 9.7% 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.

The outbreak of Severe Acute
Respiratory Syndrome, or SARS, poses a risk to the Companys business.

The
outbreak of SARS has developed into an international health concern, especially in Asia.
We have manufacturing facilities located in Taiwan and China. An outbreak of SARS among
our employees in Asia could disrupt our Asian manufacturing operations for an extended
period of time, which could limit our ability to supply our products to our customers in
sufficient quantities on a timely basis. A shutdown of our Asian facilities due to fear of
spread of infection or because of a quarantine could result in our inability to supply our
customers. If we are unable to fulfill demand for our products, our relationships with our
customers would be harmed and our revenues could be impacted. We also rely on companies in
Asia for many of the components necessary to manufacture our products. If our suppliers
experience a significant disruption in their businesses as a result of SARS, we may not be
able to obtain the parts necessary to make our products which could negatively impact our
revenues. In addition, if any of our customers experiences a significant disruption in
their business as a result of SARS, they may delay or cancel purchases of our products
which could harm our business. Also, certain of our key employees travel to Asia to
oversee our Asian operations and to meet with our suppliers and customers. If any of our
key employees are infected with SARS on such a trip or if these employees are quarantined
when they return to the United States, our business could be negatively impacted. These
conditions and uncertainties make it difficult for us, our suppliers and our customers to
accurately forecast and plan future business activities.

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

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

22

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# ITEM 3: 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. 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-QSB, our Chief Executive Officer and Acting Chief Financial Officer have concluded
that, subject to the limitations noted above, 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-QSB was being prepared.

(b)       
          Changes in internal controls. There was no change in our internal control
          over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act)
          identified in connection with the evaluation described in Item 3(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.

23

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# PART II: OTHER INFORMATION

# ITEM 5: OTHER EVENTS

Our
2004 Annual Meeting of Stockholders will be held on May 14, 2004 at such place and
time as will be set forth in our proxy statement relating to that meeting. A stockholder
proposal not included in the proxy statement for the 2004 Annual Meeting will be
ineligible for presentation at the meeting unless the stockholder gives timely notice of
the proposal in writing to our Secretary at our principal executive offices and otherwise
complies with the provisions of our Bylaws. To be timely, the Companys Bylaws
provide that the Company must have received the stockholders notice not less than
60 days nor more than 90 days prior to the scheduled date of such meeting.
However, if notice or prior public disclosure of the date of the annual meeting is given
or made to stockholders less than 75 days prior to the meeting date, the Company must
receive the stockholders notice by the earlier of (i) the close of business on
the 15th day after the earlier of the day the Company mailed notice of the annual meeting
date or provided such public disclosure of the meeting date and (ii) two days prior
to the scheduled date of the annual meeting. For the Companys 2004 Annual Meeting of
Stockholders, stockholders must submit written notice to the Secretary in accordance with
the foregoing Bylaw provisions no later than March 14, 2004.

# ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

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

_________

** In accordance  with Item  601(b)(32)(ii)  of Regulation  S-K and SEC Release Nos.  33-8238 and  34-47986,  Final Rule:  Management's
Reports on Internal  Control  Over  Financial  Reporting  and  Certification  of  Disclosure  in Exchange  Act  Periodic  Reports,  the
certifications  furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany  this Form 10-QSB 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.

(b) Reports on Form 8-K.

On July 23, 2003, we filed a Current Report on Form 8-K furnishing  under Item 12 the Company's press release  relating to its
financial results for the quarter ended June 30, 2003.

24

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# SIGNATURE

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

Dated:  November 10, 2003

| |                                     |                                                        
| | ----------------------------------- | -------------------------------------------------------
| | 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)                                  

25

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# EXHIBIT INDEX

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

26

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