<PAGE>

                                  UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                              --------------------

                                    FORM 10-Q

(Mark One)

              [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the Quarterly Period Ended June 30, 2002

                                       or

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

        For the transition period from _______________ to _______________

                         Commission File Number 0-31857

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

<TABLE>
  <S>                                       <C>
              Delaware                            77-0554122
  -------------------------------           ----------------------
  (State or other jurisdiction of              (I.R.S. employer
   Incorporation or organization)           identification number)
</TABLE>


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

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

                              --------------------

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

On August 6, 2002, 35,516,829 shares of the Registrant's Common Stock, $0.001
par value per share, were outstanding.


<PAGE>

                       ALLIANCE FIBER OPTIC PRODUCTS, INC.

                                    FORM 10-Q

                      QUARTERLY PERIOD ENDED JUNE 30, 2002

                                      INDEX

<TABLE>
<CAPTION>
                                                                                   Page
                                                                                   ----
<S>                                                                                <C>
Part I:  Financial Information................................................      1

    Item 1:  Financial Statements.............................................      1

        Consolidated Balance Sheets at December 31, 2001 and June                   1
           30, 2002...........................................................

        Consolidated Statements of Operations for the Three and                     2
           Six Months Ended June 30, 2001 and 2002............................

        Consolidated Statements of Cash Flows for the Six Months                    3
           Ended June 30, 2001 and 2002.......................................

        Notes to Consolidated Financial Statements............................      4

    Item 2:  Management's Discussion and Analysis of Financial                      7
        Condition and Results of Operations...................................

    Item 3:  Quantitative and Qualitative Disclosures About Market                  23
        Risk and Interest Rate Risk...........................................

Part II:  Other Information...................................................      24

    Item 4:  Submission of Matters to a Vote of Security Holders..............      24

    Item 6:  Exhibits and Reports on Form 8-K.................................      24

Signatures....................................................................      25
</TABLE>


                                        i
<PAGE>

                          PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS


                       ALLIANCE FIBER OPTIC PRODUCTS, INC.
                           CONSOLIDATED BALANCE SHEETS
                  (UNAUDITED, IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                           DEC. 31,        JUNE 30,
                                                                             2001            2002
                                                                          ---------       ---------
<S>                                                                       <C>             <C>
ASSETS
Current assets:
    Cash and cash equivalents                                             $  16,947       $  10,305
    Short-term investments                                                   33,118          36,049
    Accounts receivable, net                                                  2,645           1,680
    Inventories, net                                                          7,419           4,470
    Prepaid expense and other current assets                                  1,106           1,143
                                                                          ---------       ---------
         Total current assets                                                61,235          53,647
Property and equipment, net                                                   7,381           6,036
Other assets                                                                    575             411
                                                                          ---------       ---------
         Total assets                                                     $  69,191       $  60,094
                                                                          =========       =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable                                                      $   1,425       $   1,315
    Income tax payable                                                          153             140
    Accrued expenses                                                          1,666           1,914
                                                                          ---------       ---------
         Total current liabilities                                            3,244           3,369
Long-term liabilities                                                           182             241
                                                                          ---------       ---------
         Total liabilities                                                    3,426           3,610
                                                                          ---------       ---------
Commitments and contingencies (Note 8)

Stockholders' equity:
    Common stock, $0.001 par value: 250,000,000 shares authorized at
      December 31, 2001 and June 30, 2002; and 35,409,524 and
      35,508,579 shares issued and outstanding at December 31, 2001
         and June 30, 2002, respectively                                         35              36
    Additional paid-in-capital                                              108,755         106,603
    Receivables from stockholders                                            (1,934)         (1,730)
    Deferred stock-based compensation                                        (7,261)         (4,431)
    Accumulated deficit                                                     (33,709)        (43,896)
    Accumulated other comprehensive loss                                       (121)            (98)
                                                                          ---------       ---------
    Stockholders' equity                                                     65,765          56,484
                                                                          ---------       ---------
         Total liabilities and stockholders' equity                       $  69,191       $  60,094
                                                                          =========       =========
</TABLE>

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


                                        1
<PAGE>

                       ALLIANCE FIBER OPTIC PRODUCTS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                   THREE MONTHS ENDED JUNE 30,   SIX MONTHS ENDED JUNE 30,
                                                   ---------------------------   -------------------------
                                                       2001            2002         2001            2002
                                                   ----------       ----------   ----------       ---------
<S>                                                <C>              <C>          <C>              <C>
Revenues                                             $  4,568       $  3,665       $ 11,937       $  7,197

Cost of revenues                                       15,267          4,859         19,824         10,028
Stock-based compensation charge                           427            (70)           912           (285)
                                                     --------       --------       --------       --------
     Total cost of revenues                            15,694          4,789         20,736          9,743
                                                     --------       --------       --------       --------
     Gross profit (loss)                              (11,126)        (1,124)        (8,799)        (2,546)
                                                     --------       --------       --------       --------
Operating expenses:
     Research and development                           1,784          1,966          3,458          4,077
     Stock-based compensation charge                    1,275            250          2,522            520
                                                     --------       --------       --------       --------
          Total research and development                3,059          2,216          5,980          4,597
     Sales and marketing                                  733            746          1,542          1,665
     Stock-based compensation charge                      292           (200)           585           (129)
                                                     --------       --------       --------       --------
          Total sales and marketing                     1,025            546          2,127          1,536
     General and administrative                         1,148            930          2,107          1,753
     Stock-based compensation charge                      755            156          1,736            532
                                                     --------       --------       --------       --------
          Total general and administrative              1,903          1,086          3,843          2,285
                                                     --------       --------       --------       --------
          Total operating expenses                      5,987          3,848         11,950          8,418
                                                     --------       --------       --------       --------
Loss from operations                                  (17,113)        (4,972)       (20,749)       (10,964)
Interest and other income, net                            636            486          1,619            799
                                                     --------       --------       --------       --------
Loss before income taxes                              (16,477)        (4,486)       (19,130)       (10,165)
Income tax provision                                        3             10            126             22
                                                     --------       --------       --------       --------
Net loss                                             $(16,480)      $ (4,496)      $(19,256)      $(10,187)
                                                     ========       ========       ========       ========
Net loss per share:
          Basic and diluted                          $  (0.50)      $  (0.13)      $  (0.59)      $  (0.30)
                                                     ========       ========       ========       ========
Shares used in computing net loss per share:

          Basic and diluted                            32,987         34,546         32,809         34,455
                                                     --------       --------       --------       --------
</TABLE>

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


                                        2
<PAGE>

                       ALLIANCE FIBER OPTIC PRODUCTS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  (UNAUDITED, IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                  SIX MONTHS ENDED JUNE 30,
                                                                  -------------------------
                                                                     2001           2002
                                                                  --------       ----------
<S>                                                               <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
    Net loss                                                      $(19,256)      $(10,187)
    Adjustments to reconcile net loss to net cash used
      in operating activities:
      Depreciation                                                     974            832
      Amortization of stock-based compensation                       5,755            638
      Impairment/write down in property and equipment                5,200            972
      Provision for inventory                                        6,543          3,157
      Interest income receivable                                        --            (20)
      Changes in assets and liabilities:
         Accounts receivable, net                                    2,423            966
         Inventories, net                                           (6,185)          (168)
         Prepaid expenses and other assets                             (17)           131
         Accounts payable                                             (577)           (97)
         Income tax payable                                            (79)           (13)
         Accrued expenses                                             (133)           260
         Other long-term liabilities                                   (20)            60
                                                                  --------       --------
                Net cash used in operating activities               (5,372)        (3,469)
                                                                  --------       --------
CASH FLOWS FROM INVESTING ACTIVITIES:
    Purchase of short-term investments                             (11,848)        (2,988)
    Purchase of property and equipment                              (4,320)          (459)
                                                                  --------       --------
                Net cash used in investing activities              (16,168)        (3,447)
                                                                  --------       --------
CASH FLOWS FROM FINANCING ACTIVITIES:
    Proceeds from issuance of common stock under ESPP                  210            151
    Proceeds from the exercise of common stock options                  71             28
    Proceeds from the repayment of notes receivable                     --             88
                                                                  --------       --------
                Net cash provided by financing activities              281            267
                                                                  --------       --------
Effect of exchange rate changes on cash and cash equivalents             4              7
                                                                  --------       --------
Net decrease in cash and cash equivalents                          (21,255)        (6,642)
Cash and cash equivalents at beginning of period                    42,548         16,947
                                                                  --------       --------
Cash and cash equivalents at end of period                        $ 21,293       $ 10,305
                                                                  ========       ========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
  Repurchase of common stocks via cancellation
    of notes receivable from stockholders                         $     --       $    116
                                                                  ========       ========
</TABLE>


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


                                        3
<PAGE>

                       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 in
Sunnyvale, California and it has operations in Taiwan and China.

2. BASIS OF PRESENTATION

            The consolidated financial information as of June 30, 2002 included
herein is unaudited, has been prepared by the Company in accordance with
generally accepted accounting principles in the United States of America, and
reflects all adjustments, consisting only of normal recurring adjustments, which
in the opinion of management are necessary to state fairly the Company's
consolidated financial position, results of its consolidated operations, and
consolidated cash flows for the periods presented.

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

        These financial statements should be read in conjunction with the
Company's audited Consolidated Financial Statements for the year ended December
31, 2001 included in the Company's Annual Report on Form 10-K, as filed on March
27, 2002 with the Securities and Exchange Commission ("SEC"). The results of
operations for the three and six months ended June 30, 2002 are not necessarily
indicative of the results to be expected for any future periods.

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

3. INVENTORIES (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                        DEC. 31,      JUNE 30,
                                                          2001          2002
                                                        --------      --------
<S>                                                     <C>           <C>
INVENTORIES
   Finished goods                                       $ 3,241       $ 2,534
   Work-in-process                                        5,977         5,389
   Raw materials                                          2,966         2,872
   Less: Reserve for excess and obsolete inventory       (4,765)       (6,325)
                                                        -------       -------
                                                        $ 7,419       $ 4,470
                                                        =======       =======
</TABLE>

4. WRITE DOWN OF PROPERTY AND EQUIPMENT

        Certain of the Company's equipment and machinery located in Taiwan for
the production of fused fiber products were determined to be non-functional or
damaged. Accordingly, the Company recorded a write down charge of approximately
$1 million in the three months ended June 30, 2002 for this non-functional or
damaged equipment and machinery.

5. NET LOSS PER SHARE


                                        4
<PAGE>

        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.

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

<TABLE>
<CAPTION>
                                                                        THREE MONTHS                  SIX MONTHS
                                                                       ENDED JUNE 30,                ENDED JUNE 30,
                                                                   -----------------------       -----------------------
                                                                     2001           2002           2001           2002
                                                                   --------       --------       --------       --------
<S>                                                                <C>            <C>            <C>            <C>
Numerator:
  Net loss                                                         $(16,480)      $ (4,496)      $(19,256)      $(10,187)
                                                                   ========       ========       ========       ========
Denominator:
  Shares used in computing net loss per share:
    Weighted average of common shares outstanding                    34,960         35,433         34,841         35,424
    Less: Weighted average of shares subject to repurchase           (1,973)          (887)        (2,032)          (969)
                                                                   --------       --------       --------       --------
    Basic and diluted                                                32,987         34,546         32,809         34,455
                                                                   ========       ========       ========       ========
Net loss per share:
    Basic and diluted                                              $  (0.50)      $  (0.13)      $  (0.59)      $  (0.30)
                                                                   --------       --------       --------       --------
</TABLE>

6. 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):

<TABLE>
<CAPTION>
                                                            THREE MONTHS                  SIX MONTHS
                                                           ENDED JUNE 30,                ENDED JUNE 30,
                                                      -----------------------       -----------------------
                                                        2001           2002           2001           2002
                                                      --------       --------       --------       --------
<S>                                                   <C>            <C>            <C>            <C>
Net loss                                              $(16,480)      $ (4,496)      $(19,256)      $(10,187)
Cumulative translation adjustments                          52             91             16             78
Unrealized gain (loss) on short-term investments           (94)            56             79            (57)
                                                      --------       --------       --------       --------
    Total comprehensive loss                          $(16,522)      $ (4,349)      $(19,161)      $(10,166)
                                                      ========       ========       ========       ========
</TABLE>

7. GEOGRAPHIC SEGMENT INFORMATION

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

        Revenues billed to customers outside of the United States for the six
months ended June 30, 2001 and 2002 totaled were 18.3% and 9.2% of revenues,
respectively. No one customer accounted for 10% or more of the Company's
revenues.


                                        5
<PAGE>

<TABLE>
<CAPTION>
                         DEC. 31,     JUNE 30,
                          2001         2002
                         --------     --------
<S>                      <C>          <C>
IDENTIFIABLE ASSETS
    United States        $60,341      $51,973
    Taiwan                 8,554        7,394
    China                    481          727
                         -------      -------
       Total             $69,376      $60,094
                         =======      =======
</TABLE>

8. CONTINGENCIES

        From time to time, the Company may be involved in litigation in the
normal course of business. Management believes that the outcome of such matters
to date will not have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.

9. RECENT ACCOUNTING PRONOUNCEMENTS

        In June 2002, the Financial Accounting Standards Board ("FASB') issued
Statement of Financial Accounting Standards ("SFAS") No. 146 ("SFAS 146"),
"Accounting for Exit or Disposal Activities". SFAS 146 addresses significant
issues regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to the guidance that the Emerging
Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). The scope of
SFAS 146 also includes (1) costs related to terminating a contract that is not a
capital lease and (2) termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time arrangement that is not an
ongoing benefit arrangement or an individual deferred-compensation contract.
SFAS 146 will be effective for exit or disposal activities that are initiated
after December 31, 2002. The Company is in the process of reviewing the effect
the adoption of this statement will have on the Company's Financial Statements.


                                        6
<PAGE>

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

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

        This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the Company's Annual Report on Form 10-K, its Consolidated
Financial Statement and the notes thereto, for the year ended December 31, 2001.

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Management's discussion and analysis of our financial condition and
results of operations are based on our 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,


                                        7
<PAGE>

inventories, asset write-downs, 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.

        We believe the following critical accounting policies affect
management's more significant judgments and estimates used in the preparation of
the Company's Consolidated Financial Statements:

        We recognize revenues upon the shipment of our products to our customers
provided that we have received a purchase order, the price is fixed, and the
collection of the resulting receivable is probable. Subsequent to the sale of
the products, we have no obligation to provide any modification or
customization, upgrades, enhancements, or post-contract customer support.

        We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If the
financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.

        Our inventory write-downs for estimated excess and obsolete or
unmarketable inventory equal to the difference between the cost of inventory and
the excess and estimated market values are based on assumptions about future
demand and market conditions. If actual demand or market conditions are less
favorable than those projected by management, additional inventory write-downs
may be required. Based on reduced demand and revenue projections for our
DWDM-related products and the rapid technological change for our OPMS products,
we took net charges of $6.5 million and $0.9 million for inventory in the
quarters ended June 30, 2001 and 2002, respectively.

        We review the valuation of long-lived assets and assess the write-down
of the assets whenever events or changes in circumstances indicate that the
carrying value may not be recoverable due to significant underperformance
relative to expected or historical or projected future operating results,
significant changes in the manner or condition of the assets or the strategy for
the overall business, and significant negative industry or economic trends. When
we determine that the carrying value of long-lived assets may not be recoverable
based on the existence of one or more of the above indicators of write-down, we
measure any write-down based on the condition of the assets. In the quarter
ended June 30, 2002, we recorded a write-down charge of $1.0 million for the
property and equipment used to manufacture our fused fiber-related products, as
these were determined to be non-functional or damaged.

        We estimate our income taxes in each of the jurisdictions in which we
operate. This process involves us estimating our actual current tax exposure
together with assessing temporary differences resulting from differing treatment
of items for tax and accounting purposes. These differences result in deferred
tax assets and liabilities, which are included in our Consolidated Balance
Sheet. We must then assess the likelihood that our deferred tax assets will be
recovered from future taxable income and to the extent we believe that recovery
is not likely, we must establish a valuation allowance. To the extent we
establish a valuation allowance or increase this allowance in a period, we must
include an expense within the tax provision in the statement of operations. To
date, we have recorded a full allowance against our deferred tax assets.

OVERVIEW

        We were founded in December 1995 and commenced operations to design,
manufacture and market fiber optic interconnect products, which we call our
Optical Path Management Solution, or OPMS. Our OPMS product line now includes
attenuators and fused fiber products, most of which were introduced between 1997
and 2000. In early 1999, we started developing our dense wavelength division
multiplexing, or DWDM, and other wavelength management products, forming a new
product line based in part on our proprietary technology. We started selling our
DWDM devices in July 2000. Since introduction, sales of DWDM-related products
have been less than expected, leading to additional inventory reserves.


                                        8
<PAGE>

        From our inception through June 30, 2002, we derived substantially all
of our revenues from our OPMS product line. Revenues from our DWDM products
represented approximately 9.2% of total revenues for the year ended December 31,
2001. For the six months ended June 30, 2002, our DWDM products contributed
revenues of $0.6 million, or 8.1% of total revenues.

        We market and sell our products predominantly through our direct sales
force, which we began building in early 1998. Although we derived a significant
portion of our revenues between 1996 and 1998 from overseas customers, an
increasing percentage of our sales since early 1999 have been in North America.
For the six months ended June 30, 2001 and 2002, revenues derived from sales
outside of North America were 18.3% and 9.2%, respectively.

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

     -    changes in manufacturing volume;

     -    costs incurred in establishing additional manufacturing lines and
          facilities;

     -    inventory write-downs and fixed asset write-downs related to
          manufacturing assets;

     -    mix of products sold;

     -    changes in our pricing and pricing from our competitors;

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

     -    mix of domestic and international sales.

        Research and development expenses consist primarily of salaries and
related personnel expenses, fees paid to outside service providers, materials
costs, test units, facilities, overhead and other expenses related to the
design, development, testing and enhancement of our products. We expense our
research and development costs as they are incurred. We believe that a
significant level of investment for product research and development is required
to remain competitive. We expect our research and development expenses,
excluding stock-based compensation, to decline from second quarter levels
for the remaining quarters of 2002.

        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 expand 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 any increased expenditures will result in higher revenues. In addition, we
believe our future success depends upon establishing successful relationships
with a variety of key customers. We believe that continued investment in sales
and marketing functions is critical to our success, but due to the slowdown in
business, we expect these expenses, excluding stock-based compensation, to
decrease slightly from second quarter levels for the remaining quarters of 2002.

        General and administrative expenses consist primarily of salaries and
related expenses for executive, finance, administrative, accounting and human
resources personnel, insurance and professional fees for legal and accounting
support. We expect these expenses, excluding stock-based compensation, to
remain at approximately the same level throughout the remaining quarters of
2002, as we continue to monitor the costs incurred through the growth of
our business and our operations.

        In connection with the grant of stock options to employees and
consultants, we recorded deferred stock-based compensation of approximately
$24.4 million in stockholders' equity through December 31,


                                        9
<PAGE>

2001, 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. We
amortize deferred stock-based compensation using the graded vesting method,
under which each option grant is separated into portions based on its vesting
terms, which results in acceleration of amortization expense for the overall
award. We plan to amortize the deferred stock-based compensation balance of $4.4
million as of June 30, 2002 on an accelerated basis over the vesting periods of
the option grants, which are generally four years.

        During the third quarter of 2002, Mr. Philip J. Rehkemper, our Chief
Financial Officer, left the Company to pursue other interests.

        The price of our common stock has closed below the Nasdaq minimum $1.00
per share requirement for thirty consecutive trading days. Therefore, in
accordance with Marketplace Rule 4450(e)(2), we have ninety calendar days, or
until October 14, 2002, to regain compliance. If, at anytime before October 14,
2002, the bid price of the Company's stock has not closed at $1.00 per share or
more for a minimum of ten consecutive trading days, our common stock may be
delisted or we may apply to transfer our securities to The Nasdaq SmallCap
Market. To transfer, the Company must satisfy the continued inclusion
requirements for the SmallCap Market, which makes available an extended grace
period for the minimum $1.00 bid price requirement. If the Company submits a
transfer application and pays the applicable listing fees by October 14, 2002,
initiation of the delisting proceedings will be stayed pending Nasdaq staff's
review of the transfer application. If the transfer application is approved, the
Company will be afforded the 180 calendar day Nasdaq SmallCap Market grace
period, which commences on July 15, 2002, or until January 13, 2003 to regain
compliance with the minimum bid requirement. The Company may also be eligible
for an additional one hundred and eighty calendar day grace period provided that
it meets the initial listing criteria for The Nasdaq SmallCap Market under
marketplace Rule 4310(c)(2)(A).


                                       10
<PAGE>

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:

<TABLE>
<CAPTION>
                                               THREE MONTHS ENDED JUNE 30,   SIX MONTHS ENDED JUNE 30,
                                               ---------------------------   -------------------------
                                                   2001          2002           2001          2002
                                               ----------     -----------    ---------      ----------
<S>                                            <C>            <C>            <C>            <C>
Revenues                                           100.0%       100.0%          100.0%       100.0%

Cost of revenues:                                  334.2        132.6           166.1        139.3
Stock-based compensation charge                      9.3         (1.9)            7.6         (4.0)
                                                  ------       ------          ------       ------
      Total cost of revenues                       343.6        130.7           173.7        135.4

      Gross profit (loss)                         (243.6)       (30.7)          (73.7)       (35.4)
                                                  ------       ------          ------       ------
Operating expenses:
      Research and development:                     39.1         53.6            29.0         56.6
      Stock-based compensation charge               27.9          6.8            21.1          7.2
                                                  ------       ------          ------       ------
           Total research and development           67.0         60.5            50.1         63.9
      Sales and marketing:                          16.0         20.4            12.9         23.1
      Stock-based compensation charge                6.4         (5.5)            4.9         (1.8)
                                                  ------       ------          ------       ------
           Total sales and marketing                22.4         14.9            17.8         21.3
      General and administrative:                   25.1         25.4            17.7         24.4
      Stock-based compensation charge               16.5          4.3            14.5          7.4
                                                  ------       ------          ------       ------
           Total general and administrative         41.7         29.6            32.2         31.7
                                                  ------       ------          ------       ------
           Total operating expenses                131.1        105.0           100.1        117.0
                                                  ------       ------          ------       ------
Loss from operations                              (374.6)      (135.7)         (173.8)      (152.3)
Interest and other income, net                      13.9         13.3            13.6         11.1
                                                  ------       ------          ------       ------
Loss before income taxes                          (360.8)      (122.5)         (160.4)      (141.3)
Income tax provision                                 0.1          0.3             1.1          0.3
                                                  ------       ------          ------       ------
Net loss                                          (360.9)%     (122.8)%        (161.4)%     (141.6)%
                                                  ======       ======          ======       ======
</TABLE>

        Revenues. Revenues were $4.6 million and $3.7 million for the three
months ended June 30, 2001 and 2002, respectively. Revenues decreased 19.8% from
June 30, 2001 to June 30, 2002 due primarily to an overall slowdown in the
telecommunications industry. Revenues from our DWDM-related products were $0.2
million and $0.5 million for the three months ended June 30, 2001 and 2002,
respectively. Revenues were $11.9 million and $7.2 million for the six months
ended June 30, 2001 and 2002 respectively. Revenues for the six months ended
June 30, 2001 and 2002 declined 39.5% due to an overall slowdown in the
telecommunications industry.

        Gross Profit (loss). Excluding stock-based compensation expense from
cost of sales, gross loss decreased from $10.7 million for the three months
ended June 30, 2001, to $1.2 million for the same period in 2002. For the six
month periods, gross loss decreased from $7.9 million, or (66.1%) of revenues,
for the six months ended June 30, 2001, to $2.8 million, or (39.3%) of revenues,
for the same period in 2002. The primary reason that gross loss decreased for
the three months ended June 30, 2002 compared to the same period in 2001 was
because charges for excess and obsolete inventory were lower in the three months
ended June 30, 2002 than in the same period last year.


                                       11
<PAGE>

        In the quarter ended June 30, 2002, due to the continued adverse effects
of the industry slowdown and economic outlook, the Company determined that
future demand for its DWDM-related products would be lower than expected and,
therefore, an additional inventory reserve of $0.4 million was recorded in
accordance with the Company's policy of reserving against inventory levels in
excess of future demand. In addition, $0.4 million of DWDM inventory was written
down due to obsolescence. An inventory reserve of $0.1 million relating to
obsolete OPMS products was also recorded.

        We expect our gross margin as a percentage of revenues to continue to be
negatively impacted in the near term due to low production volumes and
unabsorbed overhead. The anticipated growth of our DWDM product sales has been
significantly impacted by the overall industry slowdown. With the additional
inventory reserve in the quarter ended June 30, 2002, we had approximately $1.1
million in DWDM-related net inventory on hand at June 30, 2002. Although we
continue to take steps to attempt to manage future inventory levels, we may have
to record additional inventory reserves in future periods if the decrease in
demand continues.

        Research and Development Expenses. Excluding stock-based compensation
expense, research and development expenses increased from $1.8 million, or 39.1%
of revenues, for the three months ended June 30, 2001 to $2.0 million, or 53.6%
of revenues, for the same period in 2002. Research and development expenses
increased from $3.5 million, or 29.0% of revenues, for the six months ended June
30, 2001 to $4.1 million, or 56.6% of revenues, for the same period in 2002. The
increase in expenses was primarily due to costs related to the development of
new products and increases in the number of research and development personnel
and related costs. However, we expect our quarterly research and development
expenses to decline from second quarter levels for the remaining quarters of
2002.

        Sales and Marketing Expenses. Excluding stock-based compensation
expense, sales and marketing expenses remained flat at $0.7 million for the
three months ended June 30, 2002, but increased as a percentage of revenue from
16.0% for the three months ended June 30, 2001, to 20.4% for the three months
ended June 30, 2002 due to decreased revenues. Sales and marketing expenses
increased from $1.5 million, or 12.9% of revenues, for the six months ended June
30, 2001 to $1.7 million, or 23.1% of revenues, for the six months ended June
30, 2002. This increase was due to the continued expansion of our sales and
marketing efforts including the introduction and promotion of new products in
the first two quarters of 2002. However, we expect our quarterly sales and
marketing expenses to decline slightly from second quarter levels for the
remaining quarters of 2002.

        General and Administrative Expenses. Excluding stock-based compensation
expense, general and administrative expenses decreased from $1.1 million, or
25.1% of revenues, for the three months ended June 30, 2001 to $0.9 million, or
25.4% of revenues, for the same period in 2002. General and administrative
expenses decreased from $2.1 million, or 17.7% of revenues, for the six months
ended June 30, 2001 to $1.8 million or 24.4% of revenues, for the same period in
2002. The decrease was a result of our efforts to control cost. We expect our
quarterly general and administrative expenses to remain approximately at the
same level throughout the remaining quarters of 2002.

        Stock-based compensation. Total stock-based compensation decreased from
$2.7 million, or 60.1% of revenues, in the three months ended June 30, 2001, to
$0.1 million, or 3.7% of revenues in the three months ended June 30, 2002.
Stock-based compensation decreased from $5.8 million, or 48.1% of revenues, for
the six months ended June 30, 2001 to $0.6 million, or 8.8% of revenues, for the
six months ended June 30, 2002. These decreases were partially due to the
Company's accounting policy, which required it to amortize a larger proportion
of deferred compensation expense in earlier periods, and partially due to the
reversal of compensation expense for unvested stock options of employees whose
employment was terminated during the three months ended June 30, 2002.

        Interest and Other Income, Net. Interest and other income, net, was $0.6
million and $0.5 million for the three months ended June 30, 2001 and 2002,
respectively. Interest and other income, net, was $1.6 million and $0.8 million
for the six months ended June 30, 2001 and 2002, respectively. The decrease was
the result of significantly lower fund balances available for investment and
lower applicable interest rates.


                                       12
<PAGE>

        Income Taxes. Income tax expense, which was relatively minor due to
losses on a consolidated basis, was the result of taxable income from our Taiwan
subsidiary.

LIQUIDITY AND CAPITAL RESOURCES

        Since inception, we have financed our operations primarily through
private sales of convertible preferred 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. At June 30, 2002, we had
cash and cash equivalents of $10.3 million and short-term investments of $36.1
million.

        Net cash used in operating activities was $5.4 million and $3.4 million
for the six months ended June 30, 2001 and 2002, respectively. For the six
months ended June 30, 2002, net cash used was primarily due to our net loss of
$10.2 million, offset by non-cash adjustments, including provision for inventory
of $3.2 million, write down of property and equipment of $1 million,
depreciation and amortization of $1.5 million, and net changes in working
capital of $1 million. For the six months ended June 30, 2001, net cash used in
operating activities was due to losses of $19.3 million and an increase in net
working capital of $4.5 million, offset by non-cash adjustments for inventory
provision of $6.5 million, impairment of property and equipment of $5.2 million
and depreciation and amortization of $6.7 million.

        Cash used in investing activities was $16.2 million and $3.4 million for
the six months ended June 30, 2001 and 2002, respectively. In the six months
ended June 30, 2001, $11.9 million was invested in high-grade, short-term
investments, while $4.3 million was used to acquire property and equipment. In
the six months ended June 30, 2002, $3.0 million was invested in high-grade,
short-term investments, while $459,000 was used to acquire property and
equipment.

        Cash generated by financing activities was $0.3 million and $0.06
million for the six months ended June 30, 2001 and 2002, respectively, resulting
from proceeds from the exercise of options to purchase shares of our common
stock and common stock issued through our employee stock purchase plan. For the
six months ended June 30, 2002, cash generated also included net proceeds from
the repayment of notes receivable of $0.09 million.

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

<TABLE>
<CAPTION>
        PERIOD ENDING                               AMOUNT DUE
-------------------------------------------         -----------
<S>                                                 <C>
Six months ending December 31, 2002                     $1,010
Years ending December 31,:
             2003                                        1,970
             2004                                        1,126
             2005                                           55
             2006 and there after                           87
                                                        -------
Total                                                   $4,248
                                                        =======
</TABLE>

        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 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


                                       13
<PAGE>

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.

RECENT ACCOUNTING PRONOUNCEMENTS

        In June 2002, the Financial Accounting Standards Board ("FASB') issued
Statement of Financial Accounting Standards No. 146 (SFAS 146), Accounting for
Exit or Disposal Activities. SFAS 146 addresses significant issues regarding the
recognition, measurement, and reporting of costs that are associated with exit
and disposal activities, including restructuring activities that are currently
accounted for pursuant to the guidance that the Emerging Issues Task Force
(EITF) has set forth in EITF Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring). The scope of SFAS 146 also includes
(1) costs related to terminating a contract that is not a capital lease and (2)
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS 146 will be
effective for exit or disposal activities that are initiated after December 31,
2002. The Company is in the process of reviewing the effect the adoption of this
statement will have on the Company's Financial Statements.

                         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 $19.3 million and $10.2 million
in the first six months of fiscal 2001 and 2002, respectively, and expect that
our net losses and negative cash flows will continue for the foreseeable future
as we continue to invest in our business. As of June 30, 2002, we had an
accumulated deficit of approximately $43.9 million.

        Although we are currently experiencing decreased demand for our
products, we are hopeful that demand for our products will increase in the
future. If this happens, we expect we will incur significant and increasing
expenses for expansion of our manufacturing operations, research and
development, sales and marketing, and administration, and in developing direct
sales and distribution channels. Given 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, 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


                                       14
<PAGE>

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 86% of our revenues in the
quarter ended June 30, 2002, 92% of our revenues for the six months ended June
30, 2002, and substantially all of our historical revenues. We expect to
substantially depend on these products for our near-term revenues. Any
significant decline in the price of, or demand for, these products, or failure
to increase their market acceptance, would seriously harm our business. In the
quarter ended June 30, 2002, we determined that OPMS inventory of $0.1 million
no longer met current customer specifications and was deemed to be obsolete. We
believe that our future growth and a significant portion of our future revenues
will depend on the commercial success of our DWDM-related products, which we
began shipping commercially in July 2000. Demand for these products declined
sharply starting in mid fiscal 2001. Based on the reduced demand and reduced
revenue projections for this product line, we took a charge of $6.5 million
against excess DWDM inventory in the quarter ended June 30, 2001 and charges of
$1.2 million and $0.4 million against excess DWDM-related inventory in the
quarters ended March 31, 2002 and June 30, 2002, respectively. If demand for
these products does not increase and our target customers do not adopt and
purchase our DWDM-related products, our revenues may decline further and we may
have to write-off additional inventory currently on our books.

WE ARE EXPERIENCING A DECREASE IN MARKET DEMAND DUE TO A RECESSION IN THE UNITED
STATES AS THE SLUMPING ECONOMY IS FURTHER STYMIED BY INTERNATIONAL TERRORISM,
WAR AND POLITICAL INSTABILITY.

        The United States economy experienced a significant slowdown in
consumption and demand for fiber optic products most of 2001 as well as the
first half of 2002. We may experience further decreases in the demand for our
products due to a weak domestic economy as the fiber optics industry copes with
the effects of international terrorism, war and political instability. Even if
the general economy experiences a recovery, the activity of United States
telecommunications industry may lag behind the recovery of the overall United
States economy.

WE MAY NOT BE ABLE TO MAINTAIN OUR LISTING ON THE NASDAQ NATIONAL MARKET AND IF
WE FAIL TO DO SO, THE PRICE AND LIQUIDITY OF OUR COMMON STOCK MAY DECLINE.

        The Nasdaq Stock Market has quantitative maintenance criteria for the
continued listing of common stock on The Nasdaq National Market. The current
requirements affecting us include (i) having net tangible assets of at least $4
million and (ii) maintaining a minimum bid price per share of $1. As of June 30,
2002, our stock price closed at $0.71. The price of the Company's common stock
has closed below the minimum $1.00 per share for 30 consecutive trading days
since May 30, 2002. Therefore, in accordance with Marketplace Rule 4450(e)(2),
the Company has 90 calendar days, or until October 14, 2002, to regain
compliance with The Nasdaq National Market's revised quantitative maintenance
criteria including a new minimum requirement of $10 million in stockholders'
equity. There can be no assurance that we will be able to comply with the
quantitative maintenance criteria or any of The Nasdaq National Market's rules
in the future. If we fail to maintain continued listing on The Nasdaq National
Market and must move to a market with less liquidity, our financial condition
could be harmed and our stock price would likely decline. If we are delisted, it
could have a material adverse effect on the market price of, and the liquidity
of the trading market for, our common stock.


                                       15
<PAGE>

IF WE CANNOT ATTRACT MORE OPTICAL COMMUNICATIONS EQUIPMENT MANUFACTURERS TO
PURCHASE OUR PRODUCTS, WE MAY NOT BE ABLE TO INCREASE OR SUSTAIN OUR REVENUES.

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

     -    customer unwillingness to implement our products;

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

     -    the success of our customers;

     -    new product introductions by our competitors;

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

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

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

THE MARKET FOR FIBER OPTIC COMPONENTS IS INCREASINGLY COMPETITIVE, AND IF WE ARE
UNABLE TO COMPETE SUCCESSFULLY OUR REVENUES COULD DECLINE.

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

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

        Several of our existing and potential customers are also current and
potential competitors of ours. These companies may develop or acquire additional
competitive products or technologies in the future and subsequently reduce or
cease their purchases from us. In light of the consolidation in the optical
networking industry, we also believe that the size of suppliers will be an
increasingly important part of a purchaser's decision-making criteria in the
future. We may not be able to compete successfully with existing or new
competitors, nor can we 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.


                                       16
<PAGE>

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

IF WE FAIL TO EFFECTIVELY MANAGE OUR OPERATIONS, SPECIFICALLY GIVEN THE RECENT
SUDDEN AND DRAMATIC DOWNTURN IN DEMAND FOR OUR PRODUCTS, OUR OPERATING RESULTS
COULD BE HARMED.

        We rapidly expanded our operations domestically and internationally in
the final two quarters of 2000. We had to carefully manage and re-evaluate this
expansion given the sudden and dramatic downturn in demand for our products
experienced in 2001 and that continue to date. Additionally, we implemented a
reduction in force to reduce employees during the second and third quarters of
2001 to match our operations to this decreased demand for our products. As of
June 30, 2002, we had a total of 110 full-time employees in Sunnyvale,
California, 182 full-time employees in Taiwan, and 41 full-time employees in
China. Matching the scale of our operations with the recent demand fluctuations,
combined with the challenges of expanding and managing geographically dispersed
operations, has placed, and will continue to place, a significant strain on our
management and resources. To manage the expected fluctuations in our operations
and personnel, we will be required to:

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

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

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

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

        In addition, we will need to coordinate our domestic and international
operations and establish the necessary infrastructure to implement our
international strategy. If we are not able to manage our growth 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. We recently
entered into a lease for a new facility in China, which continues through July
2007. There is significant political tension between Taiwan and China. If there
is an outbreak of hostilities between Taiwan and China, our manufacturing
operations may be disrupted or we may have to relocate our manufacturing
operations. Tensions between Taiwan and China may also affect our training
facility in China. We plan to lease additional facilities, as necessary, to
support our growth. Relocating a portion of our employees could cause temporary
disruptions in our operations and divert management's attention. Because of past
shortages of office and manufacturing space in Northern California, we cannot
assure you that we will be able to locate suitable space on acceptable terms or
at all in the future.

BECAUSE OF THE TIME IT TAKES TO DEVELOP FIBER OPTIC COMPONENTS, WE INCUR
SUBSTANTIAL EXPENSES FOR WHICH WE MAY NOT EARN ASSOCIATED REVENUES.

        The development of new or enhanced fiber optic products is a complex and
uncertain process. We may experience design, manufacturing, marketing and other
difficulties that could delay or prevent the development, introduction or
marketing of new products and enhancements. Development costs and expenses are
incurred before we generate revenues from sales of products resulting from these
efforts. Our total research and development expenses, excluding non-cash
compensation expenses, were approximately $3.5 million and $4.1 million for the
six months ended June 30, 2001 and 2002,


                                       17
<PAGE>

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.

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


                                       18
<PAGE>

delay or reduction in shipments or any need to identify and qualify replacement
suppliers would harm our business. All of our graded index, or GRIN, lenses,
which are incorporated into substantially all of our filter-based DWDM products,
are obtained from one supplier, Nippon Sheet Glass. Replacements for the GRIN
lenses have been incorporated into newer products wherever practical to help
mitigate this risk in the future.

BECAUSE WE EXPERIENCE LONG LEAD TIMES FOR MATERIALS AND COMPONENTS, WE MAY NOT
BE ABLE TO EFFECTIVELY MANAGE OUR INVENTORY LEVELS, WHICH COULD HARM OUR
OPERATING RESULTS.

        Because we experience long lead times for materials and components and
are often required to purchase significant amounts of materials and components
far in advance of product shipments, we may not effectively manage our inventory
levels, which could harm our operating results. We recorded significant charges
for excess and obsolete inventory in the quarters ended June 30, 2001, March 31,
2002 and June 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.

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, 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. In July
2002, our Chief Financial Officer resigned.

        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
facility in Taiwan. 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


                                       19
<PAGE>

while meeting the cost targets of our customers. We may not achieve adequate
manufacturing cost efficiencies.

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

BECAUSE THE QUALIFICATION AND SALES CYCLE ASSOCIATED WITH FIBER OPTIC COMPONENTS
IS LENGTHY AND VARIED, IT IS DIFFICULT TO PREDICT THE TIMING OF A SALE OR
WHETHER A SALE WILL BE MADE, WHICH MAY CAUSE US TO HAVE EXCESS MANUFACTURING
CAPACITY OR INVENTORY AND NEGATIVELY IMPACT OUR OPERATING RESULTS.

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


                                       20
<PAGE>

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

    -   loss of customers;

    -   damage to our reputation;

    -   failure to attract new customers or achieve market acceptance;

    -   diversion of development and engineering resources; and

    -   legal actions by our customers.

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

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. Additionally, if growth in demand for
our products exceeds the demand for our customers' products, our customers may
experience an oversupply of inventory and decrease orders of our products.
Future demand for our products is uncertain and will depend heavily on the
continued growth and upgrading of optical networks, especially in the long-haul,
metropolitan, last mile, and enterprise access segments of the networks.

        Decreased spending by telecommunications companies over the 18 months
has resulted in decreased demand for our products. The rate at which
communication service providers and other fiber optic network users have built
new fiber optic networks or installed new systems in their existing fiber optic
networks has fluctuated in the past and these fluctuations may continue in the
future. These fluctuations may result in reduced demand for new or upgraded
fiber optic systems that utilize our products and, therefore, may result in
reduced demand for our products. Declines in the development of new networks and
installation of new systems have resulted in a decrease in demand for our
products, an increase in our inventory, and erosion in the average selling
prices.

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

THE 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.


                                       21
<PAGE>

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

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

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

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

IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY BE ABLE
TO USE OUR TECHNOLOGIES, WHICH COULD WEAKEN OUR COMPETITIVE POSITION, REDUCE OUR
REVENUES OR INCREASE OUR COSTS.

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

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

WE MAY BE SUBJECT TO INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS THAT ARE COSTLY
TO DEFEND AND COULD LIMIT OUR ABILITY TO USE SOME TECHNOLOGIES IN THE FUTURE.

        Our industry is very competitive and is characterized by frequent
intellectual property litigation based on allegations of infringement of
intellectual property rights. Numerous patents in our industry have already been
issued, and as the market further develops and participants in our industry
obtain additional intellectual property protection, litigation is likely to
become more frequent. From time to time, third parties may assert patent,
copyright, trademark and other intellectual property rights to technologies or
rights that are important to our business. In addition, we may in the future
enter into agreements to indemnify our customers for any expenses or liabilities
resulting from claimed infringements of patents, trademarks or copyrights of
third parties. Any litigation arising from claims asserting that our products
infringe or may infringe the proprietary rights of third parties, whether the
litigation is with or without merit, could be time-consuming, resulting in
significant expenses and diverting the efforts of our technical and


                                       22
<PAGE>

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.

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 year ended December 31, 2001 and the six months ended June 30,
2002, sales to customers located outside of North America were 17.8% and 9.2% of
our revenues, respectively. In order to expand our business, we must increase
our sales to customers located outside of North America. We have limited
experience in marketing and distributing our products internationally and in
developing versions of our products that comply with local standards. Our
international sales will be limited if we cannot establish relationships with
international distributors, establish additional foreign operations, expand
international sales channels, hire additional personnel and develop
relationships with international communications equipment manufacturers. Even if
we are able to successfully continue international operations, we may not be
able to maintain or increase international market demand for our products.

BECAUSE OUR MANUFACTURING OPERATIONS ARE LOCATED IN ACTIVE EARTHQUAKE FAULT
ZONES IN CALIFORNIA AND TAIWAN, AND OUR TAIWAN LOCATION IS SUSCEPTIBLE TO THE
EFFECTS OF A TYPHOON, WE FACE THE RISK THAT A NATURAL DISASTER COULD LIMIT OUR
ABILITY TO SUPPLY PRODUCTS.

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

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND INTEREST
RATE RISK

INTEREST RATE SENSITIVITY

        We currently maintain our funds primarily in money market accounts and
highly liquid marketable securities. We do not have any derivative financial
instruments. As of June 30, 2002, $6.4 million, or 46.5% of our investments, had
maturities of less than three months. We expect we will continue to invest a
significant portion of our existing cash in interest bearing, investment grade
securities, with maturities of less than 12 months. We do not believe that our
investments, in the aggregate, have significant exposure to interest rate risk.

EXCHANGE RATE SENSITIVITY

        We currently have operations in the United States, Taiwan and China. The
functional currency of our subsidiaries in Taiwan and China are the local
currencies, and we are subject to foreign currency exchange rate fluctuations
associated with the translation to United States dollars. Though some


                                       23
<PAGE>

expenses are incurred by our Taiwan and China operations, substantially all of
our sales are made in United States dollars; hence, we have minimal exposure to
foreign currency rate fluctuations relating to sales transactions.

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

                           PART II: OTHER INFORMATION

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

        On May 17, 2002, we held our 2002 Annual Meeting of Stockholders, at
which meeting our stockholders approved the following:

        (a)    Election of Michael Tung as the Class II director:

<TABLE>
<CAPTION>
                      For                   Withheld
               <S>                          <C>
               20,993,988 shares            265,101 shares
</TABLE>

        (b)    Ratification of the appointment of PricewaterhouseCoopers LLP as
               independent auditors of the Company for the current fiscal year:

<TABLE>
<CAPTION>
                      For              Against              Abstain
               <S>                  <C>                   <C>
               21,253,153 shares    5,191 shares          745 shares
</TABLE>

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

<TABLE>
<CAPTION>
        (a)    Exhibits.            Exhibit Description
               ---------            -------------------
               <S>           <C>
               10.1          Full Recourse Promissory Note between the Company and Wei-Shin
                             Tsay dated as of May 1, 2002.
</TABLE>

        (b)    Reports on Form 8-K.

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


                                       24
<PAGE>

                                   SIGNATURES

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

        Dated:  August 12, 2002

                             ALLIANCE FIBER OPTIC PRODUCTS, INC.



                            By            /s/ Anita Ho
                              --------------------------------------------------
                                               Anita Ho
                             Acting Chief Financial Officer/Corporate Controller
                              (Principal Financial and Accounting Officer and
                                          Duly Authorized Signatory)


                                       25
<PAGE>

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
Exhibit Number                           Exhibit Description
--------------                           -------------------
<S>                                      <C>
    10.1                                 Full Recourse Promissory Note
                                         between the Company and
                                         Wei-Shin Tsay dated as of
                                         May 1, 2002.
</TABLE>