UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________ FORM 10-Q [X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2006  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 000-31861  OPTICAL COMMUNICATION PRODUCTS, INC. (Exact Name of Registrant as Specified in Its Charter) ____________________   **Delaware**(State or Other Jurisdictionof Incorporation or Organization)
        
        95-4344224(I.R.S. Employer  Identification No.)   **6101 Variel Avenue  Woodland Hills, California 91367** (Address of principal executive offices, including zip code)  Registrants Telephone Number, Including Area Code:(818) 251-7100  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[_] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act). Large Accelerated Filer[_]
        Accelerated Filer[_]
        Non-Accelerated Filer    [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes[_]
        No   [X] The registrant has two classes of common stock authorized, Class A Common Stock and Class B Common Stock.  The rights, preferences and privileges of each class of common stock are identical except for voting rights. The holders of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock are entitled to ten votes per share on matters to be voted on by stockholders.  As of July 31, 2006, there were approximately 47,371,000 shares of Class A common stock outstanding and 66,000,000 shares of Class B Common Stock outstanding.


OPTICAL COMMUNICATION PRODUCTS, INC. INDEX TO FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006   PAGEPART I.  FINANCIAL INFORMATIONItem 1.
        Financial Statements (unaudited)Balance Sheets as of June 30, 2006 and September 30, 2005
        1Statements of Operations for the Three Months and Nine Months Ended June 30, 2006 and 2005
        2Statements of Cash Flows for the Nine Months Ended June 30, 2006 and  2005
        3Notes to Financial Statements
        4Item 2.
        Managements Discussion and Analysis of Financial Condition and Results of Operations
        13Item 3.
        Quantitative and Qualitative Disclosure about Market Risk
        25Item 4.
        Controls and Procedures
        26PART II.  OTHER INFORMATION AND SIGNATURESItem 1.
        Legal Proceedings
        26Item 1A.
        Risk Factors
        26Item 6.
        Exhibits
        38SIGNATURES
        39


PART I. FINANCIAL INFORMATION  ITEM 1.
        FINANCIAL STATEMENTS OPTICAL COMMUNICATION PRODUCTS, INC.BALANCE SHEETS(Dollars in thousands)(Unaudited)June 30,
        
        September 30,2006
        
        2005ASSETSCURRENT ASSETS:Cash and cash equivalents
        $
        82,443
        $
        83,975Marketable securities
        
        64,660
        
        64,645Accounts receivable less allowance for doubtful accounts and salesreturns of $303 at June 30, 2006 and $426 at September 30, 2005
        
        8,500
        
        9,481Inventories
        
        21,260
        
        15,318Income taxes receivable
        
        1,200
        
        -Deferred income taxes
        
        651
        
        -Prepaid expenses and other current assets
        
        961
        
        1,017Total current assets
        
        179,675
        
        174,436Property, plant and equipment, net
        
        23,222
        
        24,914Intangible and other assets, net
        
        1,002
        
        902TOTAL ASSETS
        $
        203,899
        $
        200,252LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
        $
        3,436
        $
        3,169Accounts payable to related parties
        
        3,405
        
        4,095Accrued payroll and benefits
        
        1,489
        
        1,112Accrued bonus
        
        1,394
        
        1,916Other accrued expenses
        
        1,428
        
        1,322Income taxes payable
        
        -
        
        130Total current liabilities
        
        11,152
        
        11,744OTHER LONG-TERM LIABILITIES
        
        -
        
        200COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Class A common stock, $0.001 par value; 200,000,000 shares authorized,47,371,178 and 46,903,871 shares outstanding at June 30, 2006and September 30, 2005, respectively.
        
        47
        
        47Class B common stock $0.001 par value; 66,000,000 sharesauthorized, 66,000,000 shares issued and outstanding atJune 30, 2006 and September 30, 2005
        
        66
        
        66Additional paid-in-capital
        
        134,671
        
        133,024Retained earnings
        
        57,963
        
        55,171Total stockholders equity
        
        192,747
        
        188,308TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
        $
        203,899
        $
        200,252  See Notes to Financial Statements  1


OPTICAL COMMUNICATION PRODUCTS, INC.STATEMENTS OF OPERATIONS(In thousands, except per share data)(Unaudited)Three Months Ended June 30,
        
        Nine Months Ended June 30,2006
        
        2005
        
        2006
        
        2005REVENUE
        $
        14,913
        $
        13,621
        $
        51,003
        $
        41,172COST OF REVENUE
        
        11,557
        
        8,300
        
        34,965
        
        25,849GROSS PROFIT
        
        3,356
        
        5,321
        
        16,038
        
        15,323EXPENSES:Research and development
        
        2,521
        
        3,510
        
        8,280
        
        11,155Sales and marketing
        
        1,203
        
        1,120
        
        3,705
        
        3,574General and administrative
        
        1,612
        
        1,219
        
        5,551
        
        3,660Total expenses
        
        5,336
        
        5,849
        
        17,536
        
        18,389LOSS FROM OPERATIONS
        
        (1,980)
        
        (528)
        
        (1,498)
        
        (3,066)OTHER INCOME, Net
        
        1,702
        
        996
        
        4,588
        
        2,433INCOME (LOSS) BEFORE INCOME TAXES
        
        (278)
        
        468
        
        3,090
        
        (633)INCOME TAX PROVISION
        
        159
        
        -
        
        298
        
        -NET INCOME (LOSS)
        $
        (437)
        $
        468
        $
        2,792
        $
        (633)BASIC EARNINGS (LOSS) PER SHARE
        $
        (0.00)
        $
        0.00
        $
        0.02
        $
        (0.01)DILUTED EARNINGS (LOSS) PER SHARE
        $
        (0.00)
        $
        0.00
        $
        0.02
        $
        (0.01)BASIC SHARES OUTSTANDING
        
        113,347
        
        112,927
        
        113,187
        
        112,868DILUTED SHARES OUTSTANDING
        
        113,347
        
        113,754
        
        114,040
        
        112,868  See Notes to Financial Statements   2


OPTICAL COMMUNICATION PRODUCTS, INCSTATEMENTS OF CASH FLOWS(In thousands)(Unaudited)Nine Months Ended June 30,2006
        
        2005Operating Activities:Net income (loss)
        $
        2,792
        $
        (633)Adjustments to reconcile net income (loss) to net cash from operatingactivities:Depreciation and amortization of property, plant and equipment
        
        2,242
        
        3,727Amortization of intangibles
        
        325
        
        675Amortization of  (discount) premiums on marketable securities
        
        (636)
        
        66Deferred income taxes
        
        (651)
        
        -Stock-based compensation expense
        
        650
        
        -Changes in operating assets and liabilities:Accounts receivable, net
        
        981
        
        27Income taxes receivable
        
        (1,200)
        
        -Inventories
        
        (5,942)
        
        (2,817)Prepaid expense and other assets
        
        (368)
        
        (194)Accounts payable
        
        254
        
        1,021Accounts payable to related parties
        
        (690)
        
        1,111Accrued payroll and benefits
        
        377
        
        (624)Accrued bonuses
        
        (522)
        
        (2,629)Other accrued expenses and income taxes payable
        
        (434)
        
        (491)Net cash used in operating activities
        
        (2,822)
        
        (761)Investing Activities:Purchase of marketable securities
        
        (44,379)
        
        (39,747)Maturities of marketable securities
        
        45,000
        
        50,000Sale of assets to related party
        
        1,000
        
        -Purchase of property, plant and equipment
        
        (766)
        
        (386)Net cash provided by investing activities
        
        855
        
        9,867Financing Activities:Proceeds from the exercise of stock options
        
        435
        
        93Net cash provided by financing activities
        
        435
        
        93(Decrease) increase in cash and cash equivalents
        
        (1,532)
        
        9,199Cash and cash equivalents, beginning of period
        
        83,975
        
        75,423Cash and cash equivalents end of period
        $
        82,443
        $
        84,622Supplemental disclosures of cash flow information:Cash paid during period for:Interest
        $
        0
        $
        0Income taxes
        $
        2,428
        $
        0Supplemental disclosure of non-cash transactions:Purchase of property, plant and equipment through accounts payable
        $
        13
        $
        0  See Notes to Financial Statements  3


Optical Communication Products, Inc NOTES TO FINANCIAL STATEMENTS (Unaudited) 1.
        BASIS OF PRESENTATION The accompanying unaudited interim financial statements of Optical Communication Products, Inc., a Delaware corporation (the Company), have been prepared in accordance with accounting principles generally accepted in the United States of America and Article 10 of the Securities and Exchange Commissions Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In managements opinion, the unaudited financial statements contain all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Companys financial statements as of June 30, 2006 and for all interim periods presented.  The financial statements should be read in conjunction with the audited financial statements included in the
annual report of the Company filed on Form 10-K with the Securities and Exchange Commission for the year ended September 30, 2005. The results of operations for the period ended June 30, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2006.  The Companys operations are primarily located in Woodland Hills, California.  The Company is a majority-owned subsidiary of The Furukawa Electric Company, Ltd. of Japan (Furukawa).  Furukawa beneficially owned 58.2% of the Companys common stock at June 30, 2006, which accounts for 93.3% of the combined voting power of all of the Companys outstanding stock.  Recent Accounting Pronouncement  In June 2006, the FASB issued FASB Interpretation No. (FIN) 48  Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 . FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes, and transitional requirements upon adoption of FIN 48. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently evaluating the effect that adoption of this interpretation will have on the companys consolidated financial position and results of operations.  2.
        COLORADO FACILITY CLOSURE AND ASSET TRANSER TO FURUKAWA  The Company permanently ceased the operations of its Broomfield, Colorado facility, a research and design facility where the Company had been focused on creating VCSEL technology for fiber optic communication networks, on January 31, 2006.  The Company decided to cease the operation of its Colorado facility because the cost of Fabry-Perot lasers has been decreasing, making 1300 nm VCSEL technology less attractive as a cost-effective replacement, and because of the delay in development of the market for the next generation of optical modules.  The Company does not plan to continue development of the technology, however, the Company will use the technology as it exists in manufacturing operations.  On February 10, 2006, the Company entered into an agreement with The Furukawa Electric Co., Ltd., the Companys majority stockholder, to sell certain assets located at the Colorado facility related to VCSEL technology. The Company also granted Furukawa a non-exclusive, royalty-bearing license to use and exploit intellectual property related to the VCSEL technology.  Under  4


the terms of the license, Furukawa is required to pay the Company a royalty on sales of certain products utilizing the 1300nm VCSEL chip technology.  Total cash consideration in the transaction was $1 million, in addition to the potential royalty payments.   Because the sale involved the transfer of assets between two parties under common control, the proceeds in excess of the approximate $150,000 book value of the assets was credited to Additional Paid In Capital.  3.
        STOCK BASED COMPENSATION  On December 16, 2004, the FASB issued Statement of Financial Accounting Standards (SFAS) 123 (revised 2004), Share-Based Payment, which requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are remeasured each reporting period. Compensation cost is recognized over the period that an employee provides service in exchange for the award. SFAS 123(R) replaces SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.  SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005.  The Company
implemented SFAS 123(R) as of October 1, 2005.  The Company adopted SFAS 123(R) using the modified-prospective-transition method.  Under this transition method, compensation cost includes: a) compensation cost for all share-based payments granted prior to October 1, 2005, but not yet vested, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and b) compensation cost for all share-based payments granted subsequent to September 30, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). The results for the prior periods have not been restated.  Periods prior to the adoption of SFAS 123(R)  Prior to the adoption of SFAS 123(R), the Company provided the disclosure required under SFAS 123  as amended by SFAS 148, Accounting for Stock-Based Compensation  Transition and Disclosures.  The Company generally did not recognize stock-based compensation expense in its statements of operations for periods prior to the adoption of SFAS 123(R) as options are generally granted at an exercise price equal to the market value of the underlying stock on the date of grant.  The following table illustrates the effect on net income (loss) and net income (loss) per share as if the Company had applied the fair value recognition provisions of SFAS 123(R) to options granted under the Companys stock-based compensation plans prior to the adoption date.  For purposes of this pro forma disclosure, the value of options was estimated using a Black-Scholes option pricing formula and amortized on a straight-line basis over the respective vesting periods of the awards.  Disclosures for the three and nine months ended June 30, 2006 are not presented because stock-based compensation was accounted for under SFAS 123(R)s fair-value method during this current period.   5


Three Months Ended
        
        Nine Months EndedJune 30, 2005
        
        June 30, 2005(in thousands except per share amounts)Net income (loss):As reported:
        $
        468
        $
        (633)Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects:
        
        (252)
        
        (747)Pro forma
        $
        216
        $
        (1,380)Basic earnings (loss) per shareAs reported
        $
        0.00
        $
        (0.01)Pro forma
        $
        0.00
        $
        (0.01)Diluted earnings (loss) per shareAs reported
        $
        0.00
        $
        (0.01)Pro forma
        $
        0.00
        $
        (0.01)  Adoption of SFAS 123(R)  During the three months and nine months ended June 30, 2006, the Company recorded stock-based compensation expense in accordance with SFAS 123(R), adopted on October 1, 2005. The current period stock-based compensation recognized is based on the amortization of the fair value of stock options on their date of grant using a Black-Scholes fair value model, amortized on a straight-line basis over the vesting period of the options.  The effect of recording stock-based compensation for the three and nine months ended June 30, 2006 was as follows:  Three Months Ended
        
        Nine Months EndedJune 30, 2006
        
        June 30, 2006(in thousands except per share amounts)Stock-based compensation expense by type of awardEmployee stock options
        
        148
        
        613Employee stock purchase plan
        
        14
        
        37Total stock-based compensation expense
        
        162
        
        650Tax effect of stock-based compensation expense
        
        0
        
        0Net effect on net income
        
        162
        
        650Effect on earnings per shareBasic earnings per share
        
        0.00
        
        0.01Diluted earnings per share
        
        0.00
        
        0.01  As required by SFAS 123(R), management has estimated expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest based on a 25% estimated forfeiture rate.  During the nine months ended June 30, 2006,  the Company accelerated vesting of unvested stock options for 13 employees as part of the severance arrangements related to the closure of our  6


Colorado facility.  We recognized approximately $52,000 of stock-based compensation expense related to this modification of terms.  Stock Options  The Companys 2000 Stock Incentive Plan authorizes 12,121,680 options for grant and provides that options may have a maximum contractual term of  10 years, and become exercisable and vest in increments.  The normal vesting is 25% per year.  All options under this plan are granted with the exercise price equal to the fair market value of the Companys common stock on the date of grant.  During the three and nine months ended June 30, 2006, the Company granted 38,000 and 279,228  stock options, respectively,  with an estimated total grant-date fair value of approximately $83,000 and $489,000, respectively.  During the three and nine months ended June 30, 2006, the Company recorded stock-based compensation related to stock options of $148,000 and $613,000, respectively, for all unvested options granted prior to and all options granted after the adoption of SFAS 123(R).  Employee Stock Purchase Plan (ESPP)  The Company has an Employee Stock Purchase Plan (ESPP) that allows employees to purchase a limited amount of the Companys common stock at a 15% discount to a defined fair market value.  The stock-based compensation cost related to the plan for the three and nine months ended June 30, 2006 was $14,000 and $37,000, respectively. The total stock based compensation cost related to employee purchases of stock under the ESPP is amortized on a straight-line basis over a weighted-average period of approximately 1 year.  Valuation assumptions  Three months ended June 30,
        
        Nine months ended June 30,2006
        2005
        
        2006
        2005Dividend yield
        
        0%
        0%
        
        0%
        0%Expected volatility
        
        88.2%
        92.6%
        
        88.2%
        92.6%Risk-free rate of return
        5.1%
        3.9%
        
        4.7%
        4.1%Expected life (years)
        
        8.0
        8.0
        
        8.0
        8.0  Expected Volatility: The fair value of stock-based awards made through the three and nine month periods ended June 30, 2006 were valued using the Black-Scholes valuation model with a volatility factor based on the Companys historical stock prices.  Risk-free Rate of Return:  The Company based the risk-free interest rate used in the Black-Scholes valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent expected life.  Expected Life:  The Companys expected life represents the period that the Companys stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards.  Estimating Forfeitures:  The Company uses historical forfeiture experience to derive an estimated rate of forfeiture.  Compensation expense for any period, as derived using the Black-Scholes valuation model, is adjusted based on this estimated rate of forfeiture.   7


The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions listed above represent managements best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, our recorded and pro forma stock-based compensation expense could have been materially different from that depicted above. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be materially different.  Stock Option Activity  The following is a summary of stock option activity during the three and nine months ended June 30, 2006: Options Outstanding Options Available for Grant
        Number of Options
        Weighted  Average Exercise PriceBalance as of September 30, 2005
        5,739,146
        7,991,882
        $        8.49Options granted
        (195,228)
        195,228
        1.94Options exercised
        -
        (63,024)
        1.02Options forfeited
        120,440
        (120,440)
        2.09Options canceled
        106,855
        (106,855)
        8.81Balance as of December 31, 2005
        5,771,213
        7,896,791
        $        8.49Options granted
        (46,000)
        46,000
        3.18Options exercised
        -
        (230,083)
        1.18Options forfeited
        24,589
        (24,589
        1.78Options canceled
        70,005
        (70,005)
        7.65Balance as of March 31, 2006
        5,819,807
        7,618,114
        $        8.70Options granted
        (38,000)
        38,000
        2.64Options exercised
        -
        (37,225)
        .40Options forfeited
        3,327
        (3,327)
        2.76Options canceled
        28,205
        (28,205)
        8.77Balance as of June 30, 2006
        5,813,339
        7,587,357
        $        8.71  The following table summarizes information regarding options outstanding at June 30, 2006: Options Outstanding                                Options Exercisable Range of Exercise Prices
        Number Outstanding
        Weighted Average Remaining Contractual Life
        Weighted Average Exercise Price
        Shares Exercisable
        Weighted Average Remaining Contractual Life
        Weighted AverageExercise Price$0.00 $1.69*
        966,352
        4.1
        $      0.60
        848,399
        3.8
        $                  0.53$1.81 $3.31*
        1,559,930
        7.9
        $      2.24
        592,357
        6.3
        $                  2.33$3.56 $4.55
        30,400
        8.4
        $      3.66
        9,000
        6.8
        $                 3.97$8.05 $9.72
        47,520
        5.1
        $      8.33
        47,520
        5.1
        $                  8.33$11.00$17.38
        4,983,155
        4.3
        $    12.35
        4,983,155
        4.3
        $               12.357,587,357
        5.0
        $      8.71
        6,480,431
        4.4
        $                 9.85   8


* The aggregate intrinsic value for options outstanding and exercisable options outstanding at June 30, 2006 was $1,408,607 and $1,260,751, respectively.  The weighted average estimated grant date fair value per share of options granted during the three and nine months ended June 30, 2006 was $2.19 and $1.82, respectively.  The total intrinsic value of options exercised during the three and nine months ended June 30, 2006 was $73,000 and $555,000, respectively.  ESPP Activity  There were a total of 26,419 and 59,436 shares of the Companys common stock issued at a weighted average purchase price of $1.42 and $1.41 pursuant to the employee stock purchase plan during the three and nine months ended June 30, 2006, respectively.  There are a total of 50,027 shares available for future issuance under the plan at June 30, 2006.  Non-vested  Options  As of June 30, 2006, there was approximately $1.3 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements that is expected to be substantially amortized in full by March 31, 2010.   4.
        INVENTORIES Inventories consist of the following (in thousands):  June 30, 2006
        
        September 30, 2005Raw materials
        $
        12,600
        $
        8,393Work-in-process
        
        6,523
        
        5,094Finished goods
        
        2,137
        
        1,831Total inventories
        $
        21,260
        $
        15,318  5.
        PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following (in thousands):  June 30, 2006
        
        September 30, 2005
        Useful LifeLand
        $
        6,729
        $
        6,729Building improvements
        
        14,949
        
        14,949
        39 yearsMachinery and equipment
        
        19,415
        
        20,419
        5 yearsComputer hardware and software
        
        1,811
        
        1,681
        3 yearsFurniture and fixtures
        
        382
        
        382
        5 yearsLeasehold improvements
        
        181
        
        181
        9 years43,467
        
        44,341Less accumulated depreciation
        
        20,245
        
        19,427$
        23,222
        $
        24,914   9


6.
        INTANGIBLE AND OTHER ASSETS The Companys intangible assets by major asset class are as follows:  WeightedAverageJune 30,2006
        
        September 30,2005
        AmortizationPeriod(in thousands)
        (Years)Patents
        
        950
        
        950
        5.0Accumulated Amortization
        
        (696)
        
        (554)Acquired Technology
        
        1,216
        
        1,216
        5.0Accumulated Amortization
        
        (892)
        
        (710)Total intangible assets, net
        $
        578
        $
        902  Aggregate amortization expense related to intangible assets was approximately $108,000 and $225,000 for the three months ended June 30, 2006 and 2005, respectively and $325,000 and $675,000 for the nine months ended June 30, 2006 and 2005, respectively.  Following is a summary of future amortization expense in each of the next three fiscal years.  (in thousands)Remaining three months fiscal 2006
        $
        109fiscal 2007
        
        433fiscal 2008
        
        36$
        578  Intangible and other assets also includes capitalized costs of $424,000 associated with the acquisition of GigaComm (see Note 9 to the financial statements).  10


7.
        EARNINGS (LOSS) PER SHARE The following is a calculation of basic and diluted income (loss) per share (EPS):  Three Months EndedJune 30,
        
        Nine Months EndedJune 30,2006
        
        2005
        
        2006
        
        2005(in thousands, except per share data)BASIC EPS COMPUTATIONNet income (loss) applicable to common stock
        $
        (437)
        $
        468
        $
        2,792
        $
        (633)Weighted average common shares outstanding
        
        113,347
        
        112,927
        
        113,187
        
        112,868Basic earnings (loss) per share
        $
        (0.00)
        $
        0.00
        $
        0.02
        $
        (0.01)DILUTED EPS COMPUTATIONNet income (loss) applicable to common stock
        
        (437)
        
        468
        
        2,792
        
        (633)Weighted average common shares outstanding and common share equivalents
        $
        113,347
        $
        113,754
        $
        114,040
        $
        112,868Diluted earnings (loss) per share
        $
        (0.00)
        $
        0.00
        $
        0.02
        $
        (0.01)  The weighted average diluted common shares outstanding for the three months ended June 30, 2006 and June 30, 2005 excludes the dilutive effect of approximately 6,239,877 and 7,070,357 options, respectively, which are excluded because their exercise price is in excess of the average market value of the Companys Common Stock during the three month periods.  In addition, for the three months ended June 30, 2006, there were stock options to purchase 1,347,480 shares outstanding that were excluded from the computation of diluted earnings per share because they were anti-dilutive as a result of the Companys net loss for the period.  The weighted average diluted common shares outstanding for the nine months ended June 30, 2006 and June 30, 2005 excludes the dilutive effect of approximately and 6,233,849 and 7,101,901 options, respectively, which are excluded because their exercise price is in excess of the average market value of the Companys Common Stock during the nine month periods.  In addition, for the nine months ended June 30, 2005, there were stock options to purchase 589,406 shares outstanding that were excluded from the computation of diluted earnings per share because they were anti-dilutive as a result of the Companys net loss for the period.  8.
        COMMITMENTS AND CONTINGENCIES Operating Leases  The Company has operating leases for certain facilities.  Lease payments are made monthly.  The Companys leases are renewable monthly, semiannually, annually or for five years.  Rent expense for these leases for the three months ended June 30, 2006 and 2005 was $46,000 and $113,000, respectively and for the nine months ended June 30, 2006 and 2005 was $258,000 and $379,000, respectively.   11


Following is a summary of future minimum payments due under operating leases that have initial or remaining noncancelable lease terms in excess of one year at June 30, 2006:  (in thousands)Remaining three months fiscal 2006
        $
        422007
        
        572008
        
        422009
        
        422010
        
        42Thereafter
        
        36Total minimum lease payments
        $
        261  Warranty Accruals  The Company provides a standard warranty of its products from defects in materials and workmanship.  The warranty is limited to repair or replacement, at the Companys option, of defective items authorized for return within one year from the date of the sale.  The table below sets forth the activity of the Companys warranty reserve (in thousands):   Three Months Ended
        Nine Months EndedJune 30,
        June 30,
        June 30,
        June 30,2006
        2005
        2006
        2005Balance at beginning of period
        $15
        $38
        $14
        $31Additions charged to expense
        27
        1
        44
        26Deductions
        (9)
        (8)
        (25)
        (26)Balance at end of period
        $33
        $31
        $33
        $31   Contingency  The landlord of our former Colorado facility has contacted us claiming that the Company is responsible for approximately $1,145,000 in environmental clean-up and related costs at that location.  The Company disputes the landlords allegations and intends to contest these claims.   9.
        SUBSEQUENT EVENT  On July 14, 2006, the Company entered into a Primary Stock Purchase Agreement  (the agreement) with GigaComm Corporation, a Taiwan corporation , certain stockholders of GigaComm  and YEONGYI (Asia) Co., Ltd., a Taiwan corporation, as a Selling Stockholder and the representative of the Selling Stockholders. Pursuant to this agreement, the Company will acquire at least 90% of the issued and outstanding shares of GigaComm common stock. The agreement also contemplates that additional holders of common stock holding at least three percent of the total issued and outstanding shares of GigaComm common stock will execute either a Secondary Stock Purchase Agreement or an Additional Stock Purchase Agreement  and will sell all of their shares of GigaComm common stock to the Company.  In connection with its acquisition of the GigaComm common stock, the Company will pay total consideration of
$19,400,000 consisting of both cash payments to stockholders of GigaComm and the repayment  12


of all of GigaComms outstanding debt obligations on the date that the Stock Purchase is consummated.   ITEM 2.
        MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to such financial statements included elsewhere in this Report.  The following discussion contains forward-looking statements that involve risks and uncertainties.  Words such as anticipates, expects, intends, plans, believes, may, will or similar expressions are intended to identify forward-looking statements.  The statements are based on current expectations and actual results could differ materially from those discussed herein.  Factors that could cause or contribute to the differences are discussed below in this Report under Risk Factors and elsewhere in this Report, and in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (SEC) for the year ended September 30, 2005.  Critical Accounting Policies  The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Financial Statements and accompanying notes. Note 2 to the Financial Statements in the Annual Report on Form 10-K for the fiscal year ended September 30, 2005 describes the significant accounting policies and methods used in the preparation of the Financial Statements. Estimates are used for, but not limited to, the accounting for the allowance for doubtful accounts and sales returns, valuation of excess and obsolete inventory, warranty accruals, long-lived assets, SFAS 123(R) fair value calculations for stock-based compensation and income taxes. Actual results could differ from these estimates. The following critical accounting policies are
impacted significantly by judgments, assumptions and estimates used in the preparation of our Financial Statements.  Allowance for Doubtful Accounts and Sales Returns  Our accounts receivable balance, net of allowance for doubtful accounts and sales returns, was $8.5 million and $9.5 million as of June 30, 2006 and September 30, 2005, respectively. The allowance for doubtful accounts and sales returns as of June 30, 2006 was $303,000, compared with $426,000 as of September 30, 2005. The allowance is based on our assessment of the collectability of customer accounts and potential returns. We regularly review the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, current economic conditions that may affect a customers ability to pay and historical customer returns. If a major customers creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if actual future customer returns were to deviate from our expectations, our estimates of the
recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our operations.  Inventory Write-downs  Our inventory balance was $21.3 million as of June 30, 2006, compared with $15.3 million as of September 30, 2005.  At June 30, 2006 and September 30, 2005, inventory with a historical cost of  $7.9 million and $9.0 million, respectively, had been written down as excess and obsolete inventory.  We estimate our excess and obsolete inventory primarily through reference to historical usage and future  13


demand forecasts.  We operate in a highly-volatile industry with high and unpredictable rates of inventory obsolescence.  At the point of write down, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. We do not necessarily discard written down inventory and have, periodically, discovered that written down inventory was not obsolete or excess, as previously estimated. In those situations, the written down inventory is sold and reflected in cost of sales at the new written down basis. If there were to be a sudden and significant decrease in demand for our products, or if there were a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, we could be required to increase inventory write-downs, and our gross margin
could be adversely affected.  Long-Lived Assets  We monitor and evaluate the recoverability of our long-lived assets whenever events or changes in circumstances indicate that the carrying value of an asset may no longer be recoverable. If the carrying amount of a long-lived asset exceeds the expected future cash flows (undiscounted and without interest charges) from the use of the asset, we recognize an impairment loss in the amount of the difference between the carrying amount and the fair value of the asset. Our long-lived assets subject to impairment are our property, plant and equipment and our intangible assets which had net carrying values of $23.2 million and $578,000, respectively, at June 30, 2006.  At our September 30, 2005 year-end, we  estimated that undiscounted future cash flows would be sufficient to recover the value of our long-lived assets. However, these estimates of future cash flows are subject to change. Should
these estimates of future undiscounted cash flows indicate that the carrying value of our long-lived assets may not be recoverable, we would be required to determine the fair value of those assets and record a loss for the difference, if any, between the carrying value and the fair value of those assets. There were no indicators of long-lived asset impairment at June 30, 2006.  Stock-based Compensation  During the three and nine months ended June 30, 2006, the Company recorded stock-based compensation expense of $162,000 and $650,000, respectively, in accordance with SFAS 123(R), adopted on October 1, 2005.  As described in Note 2 to the financial statements, this expense includes compensation expense related to the Companys Employee Stock Purchase Plan. The current period stock-based compensation recognized is based on the amortization of the fair value of stock options on their date of grant using a Black-Scholes option valuation model. The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility.  In addition, management has made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest based on a 25%
estimated forfeiture rate.  These assumptions represent managements best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, our recorded and pro forma stock-based compensation expense could have been materially different from that depicted above. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be materially different.  Income Taxes  At June 30, 2006 our deferred income tax assets were principally comprised of federal and state net operating loss carry-forwards and/or credit carry-forwards and differences between the book and tax bases of our inventories. The provisions of SFAS No. 109 Accounting for Income Taxes, require a valuation allowance when, based upon currently available information and other factors, it is more likely than not that all or a portion of the deferred income tax asset will not be realized.  During 2006, we  14


released valuation allowance to the extent of our estimated federal tax expense, as it is more likely than not that a portion of our deferred income tax assets attributable to federal credits and federal book-tax differences will be realized. We expect to continue releasing the valuation allowance attributable to federal tax-based deferred tax assets on a quarterly basis to the extent of our federal tax expense and maintain the remaining valuation allowance until sufficient evidence exists to support full reversal of the valuation allowance on all deferred tax assets.  Overview  We design, manufacture and sell a comprehensive line of high performance, highly reliable fiber optic subsystems and modules for fiber optic transmission systems that are used to address the bandwidth limitations in the metropolitan area network, or MAN, local area network, or LAN, and storage area network, or SAN, markets.  Our subsystems and modules include optical transmitters, receivers, transceivers and transponders that convert electronic signals into optical signals and back to electronic signals, enabling high-speed communication of voice and data traffic over public and private networks.  We began our operations and shipped our first products in November of 1991.  Furukawa beneficially owns all of our outstanding Class B common stock, representing 58.2% of our outstanding shares of common stock and 93.3% of the combined voting power of all of our outstanding common stock as of the fiscal quarter ended June 30, 2006.  Since our inception, we have purchased substantially all of our lasers and the majority of our other fiber optic components from Furukawa.  We have relied on Furukawas research and development capabilities to provide us with technologically advanced lasers and fiber optic components that we purchase from Furukawa for inclusion in our products.  We currently purchase the majority of lasers from Furukawa under a one-year Master Purchase Agreement, which we entered into with Furukawa on October 1, 2003. This Agreement renews automatically on October 1 of each year unless it is terminated upon written notice by either Furukawa or us
prior to renewal. This agreement was automatically renewed on October 1, 2005.  In the last two years, we have negotiated price reductions for the lasers we purchase from Furukawa.  However, the laser price reductions that we have been able to obtain from Furukawa have been less than the price reductions for the associated products that we have given our customers in response to market conditions.  As a result, our gross margins have been negatively impacted, and may be negatively impacted in the future.  While we continue to negotiate with Furukawa with respect to the pricing of the lasers we purchase from them, and while we are exploring alternative sources of supply for the lasers we purchase from Furukawa, there can be no assurance that these efforts will be successful in addressing this  negative impact on our gross margins.  We operate in one industry segment, the design and manufacture of fiber optic subsystems and modules. We sell our products to communication equipment manufacturers, or CEMs, their contract manufacturers, or CMs, who incorporate them into systems they assemble for CEMs, and to distributors.  We define our customers as CEMs who have purchased our products directly or indirectly through CMs and distributors.  We recognize revenue upon product shipment, and sales returns and allowances have been insignificant.  Historically, a relatively small number of customers have accounted for a significant percentage of our revenue.  Our 10 largest customers accounted for approximately 70.2% and 66.9% of our total revenue for the nine months ended June 30, 2006 and 2005, respectively. Alcatel, Cisco Systems and Huawei (including sales to each of their CMs) accounted for approximately 19.6%, 14.1% and
13.0%, respectively, of our total revenue for the nine months ended June 30, 2006.  Cisco Systems and Alcatel (including sales to each of their CMs) accounted for approximately 16.7% and 16.3%, respectively, of our total revenue for the nine months ended June 30, 2005. No other end-user customer accounted for more than 10.0% of our total revenue for the nine months ended June 30, 2006 or 2005.   15


We also ship directly to CMs who place purchase orders with us directly.  No such direct customer accounted for more than 10.0% of our total revenue for the three months or nine months ended June 30, 2006 or 2005.  Although our revenue from sales to our other customers continues to increase, we expect that significant customer concentration will continue for the foreseeable future.  Our sales are made on a purchase order basis rather than by long-term purchase commitments.  Our customers may cancel or defer purchase orders without penalty on short notice.  The unfavorable economic conditions in the United States that began in 2001 detrimentally affected the U.S. manufacturing industry, particularly sales of fiber optics equipment to service providers and communication equipment companies. Announcements by fiber optics equipment manufacturers and their customers at the time indicated that there was a reduction in spending for fiber optic equipment as a result of the economic slowdown and efforts to reduce then-existing inventories. Based on these and other factors, some of our customers reduced, modified, cancelled or rescheduled orders for our products and expressed uncertainty as to their future requirements.  Despite an improvement in general economic conditions in the United States since that time, capital spending by service providers in the fiber optic communications industry on network infrastructure has remained substantially below
pre-2001 levels.  During the nine months ended June 30, 2006, we have seen a higher level of activity from our customers which resulted in an increase in new orders compared to previous quarters. We cannot provide any assurance that the increase in customer activity will continue or that our business will not be negatively impacted in the future as a result of our customers' declining business activities.  The average selling prices of our products generally decrease as the products mature from factors such as increased competition, the introduction of new products or technology, increased unit volumes, and price concessions required by our customers.  We anticipate that average selling prices of our existing products will continue to decline in future periods although the timing and degree of the declines cannot be predicted with any certainty.  In order to increase average selling prices, we must continue to develop and introduce, on a timely basis, new products that incorporate features that can be sold at higher average selling prices.  Our cost of revenue consists principally of materials, as well as salaries and related expenses for manufacturing personnel. Our materials include the purchase of several key components from a limited number of suppliers, or from a single supplier.  Our research and development expenses consist primarily of salaries and related expenses for design engineers and other technical personnel, the cost of developing prototypes, and depreciation of test and prototyping equipment.  Our research and development expenses also consist of materials and overhead costs related to major product development projects.  We charge all research and development expenses to operations as incurred.  We believe that continued investment in research and development is critical to our future success.  Accordingly, we may continue to expand our internal research and development capabilities in the future to develop new technology or products and, as a result, our research and development expenses in absolute dollar amounts may increase in future periods.  Sales and marketing expenses consist primarily of salaries and related expenses for sales and marketing personnel, commissions paid to sales personnel and independent manufacturers representatives, marketing and promotion costs.  We believe that investment in sales and marketing is critical to our success.  As a result, we may expand our sales and marketing operations and efforts in order to increase sales and market awareness of our products and these expenses may increase in future periods.  General and administrative expenses consist primarily of salaries, stock compensation and related expenses for our administrative, finance, information systems and human resources personnel, professional fees and other corporate expenses.  Our legal and consulting fees include fees associated with our analysis of strategic alternatives, including future business opportunities that may be evaluated and  16


pursued by our management and board of directors.  Our financial expenses include internal expenses and consulting fees associated with our compliance to the rules and regulations associated with the Sarbanes-Oxley legislation, as well as other new or modified accounting rules and regulations.  As a result, our general and administrative  expenses in absolute dollars may continue to increase in future periods.  Results of Operations  Comparison of Three Months Ended June 30, 2006 and 2005  Revenues (dollars in thousands)  Three Months Ended June 30, 2006
        2005  Revenues
        $
        14,913
        $
        13,621Percentage Increase
        9.5%  The increase in revenue was primarily a result of increased demand from existing customers.  Revenue attributable to our top ten customers was approximately $1.7 million more in the quarter ended June 30, 2006 as compared to the quarter ended June 30, 2005.  The most significant product increase in absolute dollars was in Transceivers. The following table sets forth revenue attributable to each of our product groups for the periods presented (in thousands). Three months ended June 30,2006
        
        2005Transceivers
        
        $13,166
        
        88.3%
        
        $  12,158
        
        89.3%Transmitters
        
        844
        
        5.7%
        
        662
        
        4.9%Receivers
        
        822
        
        5.5%
        
        671
        
        4.9%Other
        
        81
        
        0.5%
        
        130
        
        0.9%$14,913
        
        100.0%
        
        $  13,621
        
        100.0%   We cannot assure you that our increase in revenue will continue in future periods and revenue was lower in the third quarter ending June 30, 2006 as compared to each of the first two quarters of fiscal 2005.  The average selling price in the quarter ended June 30, 2006 was 31% lower than the average selling price in the quarter ended June 30, 2006 even as the number of units sold was substantially greater in the current quarter.   We continue to experience pressure from customers to make price reductions and the average selling prices for existing products may continue to decline in response to product introductions by competitors or us, or other factors, including the reduction of customer demand for our products.     17


Gross Profit (dollars in thousands)  Three Months Ended June 30, 2006
        2005  Gross Profit
        $
        3,356
        $
        5,321Gross Margin
        22.5%
        39.1%   Cost of revenue increased 39.2% to $11.6 million in the quarter ended June 30, 2006 from $8.3 million in the quarter ended June 30, 2005.  The decrease in gross margin is related to increases in direct labor and material costs as a percentage of sales.  Labor increased as a percentage of sales to 6.9% in the quarter ended June 30, 2006 as compared to 4.0% of sales in the quarter ended June 30, 2005.  This increase is attributable to increases in base compensation and a decrease in average selling price, which results in a greater number of units and related labor hours required to produce a certain level of revenue.  Material  costs increased as a percentage of sales to 52.6% from 40.3% in the quarters ended June 30, 2006 and 2005, respectively. Changes in product mix, increased raw material costs as a percentage of revenue and a decrease in average selling price for products sold are the
primary factors in the increase in material costs as a percentage of revenue.  In addition, the usage of previously written down inventory decreased to approximately $400,000 in the quarter ended June 30, 2006 from $543,000 in the quarter ended June 30, 2005.  Such factors may continue to impact gross margin in the future.  Research and Development (dollars in thousands)  Three Months Ended June 30, 2006
        2005  R&D Expense
        $
        2,521
        $
        3,510Percentage Decrease
        -28.2%   Research and development expenses decreased $989,000 in the quarter ended June 30, 2006 from the quarter ended June 30, 2005.  The decrease in research and development expense is primarily related to the closure of the Colorado facility (see Note 2 to the financial statements). We believe that continued investment in research and development is critical to our future success and these expenses may increase in absolute dollars in the future.  Sales and Marketing (dollars in thousands)  Three Months Ended June 30, 2006
        2005  Sales and marketing expense
        $
        1,203
        $
        1,120Percentage Increase
        7.4%   18


Sales and marketing expenses increased $83,000 for the quarter ended June 30, 2006 from the quarter ended June 30, 2005.  The increase was primarily related to an increase in commissions paid to outside sales representatives due to increased revenues.  We believe that investment in sales and marketing is critical to our success and these expenses may increase in absolute dollars in the future.  General and Administrative (dollars in thousands)  Three Months Ended June 30, 2006
        2005  G&A expense
        $
        1,612
        $
        1,219Percentage Increase
        32.2%   General and administrative expenses increased $393,000 in the quarter ended June 30, 2006 from the quarter ended June 30, 2005 including an increase of $357,000 in professional services.  Our legal and consulting fees include fees associated with our analysis of strategic alternatives, including future business opportunities that may be evaluated and pursued by our management and board of directors.  Our financial expenses include internal expenses and consulting fees associated with our compliance with new rules and regulations associated with the Sarbanes-Oxley legislation, as well as other new or modified accounting rules and regulations.  During the quarter we capitalized approximately $424,000 of professional services related to the GigaComm transaction (see Note 9 to the financial statements).  .  We expect the GigaComm acquisition to be completed during our fourth quarter ending
September 30, 2006.  If for any reason the acquisition does not occur, we would charge these capitalized expenses to general and administrative expense in the fourth quarter.  Other Income, net (dollars in thousands)  Three Months Ended June 30, 2006
        2005  Other income, net
        $
        1,702
        $
        996Percentage Increase
        70.9%  Other income, net increased $706,000 in the quarter ended June 30, 2006 from the quarter ended June 30, 2005.  This increase was primarily due to the increase in investment income as the result of rising interest rates.  Income tax provision (dollars in thousands)  Three Months Ended June 30, 2006
        2005  Income tax provision
        $
        159
        $
        -   19


The income tax provision of $159,000 for the quarter ended June 30, 2006 was comprised of foreign taxes in the amount of $149,000 and state income taxes of $10,000. There was no income tax provision recorded for the quarter ended June 30, 2005 due to the loss position and valuation allowance recorded against net deferred tax assets. There is no federal tax expense recorded during the quarter ended June 30, 2006 as we released valuation allowance to the extent of our estimated quarterly federal tax expense, as it is more likely than not that a portion of our deferred income tax assets attributable to federal credits and federal book-tax differences will be realized.  Results of Operations  Comparison of Nine Months Ended June 30, 2006 and 2005  Revenues (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  Revenues
        $
        51,003
        $
        41,172Percentage Increase
        23.9%  The increase in revenue was primarily a result of increased demand from existing customers.  Revenue attributable to our top ten customers was approximately $8.3 million more in the nine months ended June 30, 2006 as compared to the nine months ended June 30, 2005.  The most significant product increase in absolute dollars was in Transceivers.  The following table sets forth revenue attributable to each of our product groups for the periods presented (in thousands). Nine months ended June 30,2006
        
        2005Transceivers
        
        $   44,676
        
        88.3%
        
        $    35,792
        
        86.9%Transmitters
        
        3,622
        
        5.7%
        
        2,529
        
        6.2%Receivers
        
        2,476
        
        5.5%
        
        2,279
        
        5.5%Other
        
        229
        
        0.5%
        
        571
        
        1.4%$ 51,003
        
        100.0%
        
        $41,172
        
        100.0% We cannot assure you that our increase in revenue will continue in future periods and revenue was lower in the third quarter ending June 30, 2006 as compared to each of the first two quarters of fiscal 2006.  The average selling price for the nine months ended June 30, 2006 was approximately 18% lower than the average selling price for the nine months ended June 30, 2005 even as the number of units sold increased significantly in the current nine month period. We continue to experience pressure from customers to make price reductions and the average selling prices for existing products may continue to decline in response to product introductions by competitors or us, or other factors, including the reduction of customer demand for our products.    20


Gross Profit (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  Gross Profit
        $
        16,038
        $
        15,323Gross Margin
        31.4%
        37.2%   Cost of revenue increased 35.3% to $34.9 million in the nine months ended June 30, 2006 from $25.8 million in the quarter ended June 30, 2005.  The decrease in gross margin is related to increases in direct labor and material costs as a percentage of sales.  Labor increased as a percentage of sales to 5.6% in the nine months ended June 30, 2006 as compared to 4.1% of sales in the nine months ended June 30, 2005.  This increase is attributable to increases in base compensation and a decrease in average selling price which results in a greater number of units and related labor hours required to produce a certain level of revenue.  Material  costs increased as a percentage of sales to 47.1% from 40.7% in the nine months ended June 30, 2006 and 2005, respectively. Changes in product mix, increased raw material costs as a percentage of revenue and a decrease in average selling price for
products sold are the primary factors in the increase in material costs as a percentage of revenue. In addition, the usage of previously written down inventory decreased to approximately $1.8 million in the nine months ended June 30, 2006 from $2.0 million in the nine months ended June 30, 2005.  Such factors may continue to impact gross margin in the future.  Research and Development (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  R&D Expense
        $
        8,281
        $
        11,155Percentage Decrease
        -25.8%   Research and development expenses decreased $2.9 million in the nine months ended June 30, 2006 from the nine months ended June 30, 2005.  Approximately $1.9 million of the decrease in research and development was related to the closure of the Colorado facility. In addition, there has been an approximate 7% reduction in engineering staff from June 30, 2005 to June 30, 2006 at other facilities, particularly in Woodland Hills.  During the current fiscal year, engineering staffing at facilities other than Colorado have been as much as 13% lower than in the same period in fiscal 2005.  As a result, compensation and benefits expense were approximately $700,000 less in the Woodland Hills facility during the current nine month period.  Although we do not expect that the decrease in research and development expenses will have a material impact on our research and development efforts in the near
future, we cannot be certain of its potential impact on a longer term basis.  We believe that continued investment in research and development is critical to our future success and these expenses may increase in absolute dollars in the future.    21


Sales and Marketing (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  Sales and marketing expense
        $
        3,705
        $
        3,574Percentage Increase
        3.7%  Sales and marketing expenses increased $131,000 for the nine months ended June 30, 2006 from the nine months ended June 30, 2005.  The increase was primarily related to an approximate $184,000 increase in commissions paid to outside sales representatives due to increased revenues offset by decreased spending for advertising of approximately $48,000.  We believe that investment in sales and marketing is critical to our success and these expenses may increase in absolute dollars in the future.  General and Administrative (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  G&A expense
        $
        5,551
        $
        3,660Percentage Increase
        51.7%   General and administrative expenses increased $1.9 million in the nine months ended June 30, 2006 from the nine months ended June 30, 2005, including an increase of $1.6 million in professional services.  Our legal and consulting fees include fees associated with our analysis of strategic alternatives, including future business opportunities that may be evaluated and pursued by our management and board of directors.  Our financial expenses include internal expenses and consulting fees associated with our compliance with new rules and regulations associated with the Sarbanes-Oxley legislation, as well as other new or modified accounting rules and regulations.  During the quarter we capitalized approximately $424,000 of professional services related to the GigaComm transaction (see Note 9 to the financial statements).  We expect the GigaComm acquisition to be completed during our fourth
quarter ending September 30, 2006.  If for any reason the acquisition does not occur, we would charge these capitalized expenses to general and administrative expense in the fourth quarter.  Compensation related expense increased approximately $600,000, which is attributable to $296,000 of stock based compensation expense and an expansion of our accounting and executive staff.  This was offset by a $400,000 decrease in other expense attributable to decreases in both D&O insurance and bad debt expense.  Other Income, net (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  Other income, net
        $
        4,589
        $
        2,433Percentage Increase
        88.6%   22


Other income, net increased $2.2 million in the nine months ended June 30, 2006 from the nine months ended June 30, 2005.  This increase was primarily due to the increase in investment income as the result of rising interest rates.  Income tax provision (dollars in thousands)  Nine Months Ended June 30, 2006
        2005  Income tax provision
        $
        298
        $
        -  The income tax expense was $298,000 for the nine months ended June 30, 2006 and was comprised of foreign taxes in the amount of $270,000 and state income taxes of $28,000. There was no income tax provision recorded for the nine months ended June 30, 2005 due to the loss position and valuation allowance recorded against net deferred tax assets.   There is no federal tax expense recorded during the nine months ended June 30, 2006 as we released valuation allowance to the extent of our estimated federal tax expense, as it is more likely than not that a portion of our deferred income tax assets attributable to federal credits and federal book-tax differences will be realized  Liquidity and Capital Resources  As of June 30, 2006, our primary source of liquidity was our cash and cash equivalents balance of $82.4 million and our marketable securities balance of $64.7 million, which consists primarily of United States Treasury notes and bonds. At September 30, 2005, we had $84.0 million in cash and cash equivalents and $64.6 million in current marketable securities.  Current assets and current liabilities  Since inception, we have financed our operations primarily with cash generated from operations.  Additional financing has been generated through lines of credit and term loans, and through our initial public offering of our Class A common stock, which we completed on November 3, 2000.  As of June 30, 2006, our working capital was $168.5 million with a current ratio of 16.1:1 compared to our working capital of $162.7 million with a current ratio of 14.9:1 as of September 30, 2005.  Inventory and accounts receivables were the main components of the increase in working capital and increasing revenues allowed us to increase these current assets without increasing current liabilities. We believe that additional cash could be borrowed if necessary; however, cash flow from operations, cash and equivalents, and marketable securities are expected to be sufficient to fund operations for the next twelve months.  Cash flows provided by/ (used in)  The following table sets forth, for the periods indicated, selected cash flow information (dollars in thousands):     23


Nine months Ended  June 30  2006
        2005Operating Activities
        $      (2,822)
        $          (761)Investing Activities
        855
        9,867Financing Activities
        435
        93Net (decrease) increase in cash and cash equivalents
        $     (1,532)
        $        9,199   During the nine months ended June 30, 2006, net income as adjusted for non-cash depreciation and amortization contributed approximately $5 million to cash from operations.  The most significant use of cash was a $5.9 million increase in inventory.  Changes in other working capital items aggregated to an additional $1.9 million cash used in operating activities.  During the nine months ended June 30, 2005, cash used by operations was the result of a net loss and a significant payout of accrued bonuses. There was also an increase in inventories during that period.  During the nine months ended June 30, 2006, cash provided by investing activities included $1 million attributable to the sale of assets to The Furukawa Electric Co., Ltd., the Companys majority stockholder (see Note 2 to Financial Statements).  The maturation of marketable securities net of the conversion of cash and cash equivalents to marketable securities provided cash of $620,000.  Purchases of property, plant and equipment were $766,000.  During the nine months ended June 30, 2005, cash provided by investing activities was primarily the result of the maturation of marketable securities net of the conversion of cash and cash equivalents to marketable securities for a net cash provided of $10.3 million as offset by capital expenditures of $386,000.  During the nine months ended June 30, 2006 and 2005 cash provided by financing activities was from the exercise of stock options.  We believe that our existing cash, cash equivalents and marketable securities on hand, together with cash that we expect to generate from our operations, will be sufficient to meet our capital needs for at least the next twelve months. However, it is possible that we may need or elect to raise additional funds to fund our activities beyond the next year or to consummate acquisitions of other businesses, products or technologies. We might raise such funds by selling more stock to the public or to selected investors, or by borrowing money.  We cannot assure you that we will be able to obtain additional funds on commercially favorable terms, or at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced. In addition, the equity or debt securities that we issue may have rights,
preferences or privileges senior to those of the holders of our common stock.  Although we believe we have sufficient capital to fund our activities for at least the next twelve months, our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including:  
        the market acceptance of our products; 
        the levels of promotion and advertising that will be required to launch our new products and achieve and maintain a competitive position in the marketplace; 
        price discounts on our products to our customers; 
        our business, product, capital expenditure and research and development plans and product and technology roadmaps; 
        the levels of inventory and accounts receivable that we maintain; 
        capital improvements to new and existing facilities; 
        technological advances; 
        our competitors response to our products;  24



        our pursuit of strategic alternatives, including future market opportunities; and 
        our relationships with suppliers and customers.  In addition, we may require additional capital to accommodate planned growth, hiring, infrastructure and facility needs or to consummate acquisitions of other businesses, products or technologies.  Inflation  Inflation has not had a material adverse effect on our results of operations, however, our results of operations may be materially and adversely affected by inflation in the future.  Off-Balance Sheet Arrangements  We do not have any off-balance sheet arrangements, as such term is defined in rules promulgated by the Securities and Exchange Commission, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.  Contractual Obligations  There have been no material changes to the contractual obligations as of September 30, 2005 disclosed in our Form 10-K filed with the SEC on December 29, 2005.  ITEM 3.
        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are currently exposed to interest rate risk on our investment portfolio. We do not have any term loan debt as of June 30, 2006.  The primary objective of our investment activities is to preserve capital.  We have not used derivative financial instruments in our investment portfolio.  Our cash and cash equivalents includes $82.4 million, the majority of which is invested in money market and other interest bearing accounts.   In addition, we have $64.7 million invested in marketable securities, which represents investments in United States treasury notes and treasury bonds.  As of June 30, 2006, our investment in marketable securities had a weighted-average time to maturity of approximately 136 days. Marketable securities represent United States treasury notes and treasury bonds with maturity on the date purchased of greater than three months.  These securities are classified as held to maturity because we have the intention and ability to hold the securities to maturity.  Gross unrealized gains and losses on held-to-maturity marketable securities have historically not been material.  Maturities on the date purchased of held-to-maturity marketable debt securities can range from one to thirteen months.  If interest rates were to increase or decrease 1%, the result would be an annual increase or decrease of interest income of  $1.5 million on our investment portfolio.   This analysis does not consider the effect of the change in the level of overall economic activity that could exist in such an environment.
Sales to foreign customers are denominated in U.S. dollars and as such we have no foreign currency fluctuation risk.   25


ITEM 4.
        CONTROLS AND PROCEDURES  Evaluation of Disclosure Controls and Procedures  Our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) are effective as of the end of the period covered by this quarterly report based on their evaluation of these controls and procedures required by paragraph (b) of Rules 13a-15 or 15d-15 under the Exchange Act.  Changes in Internal Control  There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  PART II. OTHER INFORMATION AND SIGNATURES  ITEM 1.
        LEGAL PROCEEDINGS We are not currently involved in any material legal proceedings.  We are not aware of any material legal proceedings threatened or pending against us. From time to time, however, we may become subject to additional legal proceedings, claims, and litigation arising in the ordinary course of business. In addition, in the past we have received, and we may continue to receive in the future, letters alleging infringement of patent or other intellectual property rights. Our management believes that these letters generally are without merit and intend to contest them vigorously.  ITEM 1A.
        RISK FACTORS  This Report contains forward-looking statements based on the current expectations, assumptions, estimates and projections about us and our industry.  Our actual results could differ materially from those discussed in these forward-looking statements as a result of certain factors, as more fully described in this section and elsewhere in this Report. These forward-looking statements involve risks and uncertainties.  You should carefully consider the following risks before you decide to buy shares of our Class A common stock.  The risks and uncertainties described below are not the only ones facing us.  Additional risks and uncertainties, including those risks set forth in Managements Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this Report, may also adversely impact and impair our business.  If any of the following risks
actually occur, our business, results of operations or financial condition would likely suffer.  In such case, the trading price of our Class A common stock could decline, and you may lose all or part of the money you paid to buy our stock. We do not undertake to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. Our continued success in generating revenue depends on growth in construction of fiber optic MANs, LANs, and SANs.  Our fiber optic subsystems and modules are used primarily in MAN, LAN, and SAN applications.  These markets are rapidly evolving, and it is difficult to predict their potential size or future growth rate.  In addition, we are uncertain as to the extent to which fiber optic technologies will be used in these markets.  Our success in generating revenue will depend on the growth of these markets and their adoption of fiber optic technologies. A substantial portion of our revenue is derived from sales of our   26


product in the MAN market.  Sales of our products for the MAN market represented approximately 88.7%, and 88.9% of our revenue for the nine months ended June 30, 2006, and 2005, respectively.  As the result of currently uncertain economic and market conditions, (a) our revenue may decline, (b) we may be unable to predict future revenue accurately, and (c) we are currently unable to provide long-term guidance for future financial performance. The conditions contributing to this difficulty include:  
        lower near term revenue visibility; and 
        general market and economic uncertainty.  Based on these and other factors, major customers may reduce orders for our products and, as a result, our revenue in future periods may decline. In addition, our ability to meet financial expectations for future periods may be harmed.  We derive a significant portion of our total revenue from a few significant customers, and our total revenue may decline significantly if any of these customers cancels, reduces or delays purchases of our products or extracts price concessions from us.  Our success depends on our continued ability to develop and maintain relationships with a limited number of significant customers.  We sell our products into markets dominated by a relatively small number of systems manufacturers, a fact that limits the number of our potential customers.  Our dependence on orders from a relatively small number of customers makes our relationship with each customer critical to our business.  We do not have long-term sales contracts with our customers.  Instead, sales to our customers are made on the basis of individual purchase orders that our customers may cancel or defer on short notice without significant penalty.  In the past, some of our major customers canceled, delayed or significantly accelerated orders in response to changes in the manufacturing schedules for their systems, and they are likely to do so in the future.  The reduction, cancellation or delay of individual customer purchase orders would cause our revenue to decline.  Moreover, these uncertainties complicate our ability to accurately plan our manufacturing schedule.  Additionally, if any of our customers cancel or defer orders, our operating expenses may increase as a percentage of revenue.  In the past, our customers have sought price concessions from us, and they are likely to continue to do so in the future.  In addition, some of our customers may shift their purchases of products from us to our competitors.  The loss of one or more of our significant customers, our inability to successfully develop relationships with additional customers or future price concessions could cause our revenue to decline significantly.  We are dependent on a limited number of suppliers for most of our key components.  If these suppliers are unable or unwilling to meet our manufacturing requirements, if they raise prices of their products, or if they discontinue certain key components, we may experience production delays leading to delays in shipments, increased costs and cancellation of orders for our products.  We purchase several key components that we incorporate into our products from a limited number of suppliers.  We also purchase the majority of our lasers from Furukawa under a Master Purchase Agreement.  We do not have long-term supply contracts with any of our other key suppliers and
our agreement with Furukawa is only for one year.  Our dependence on a small number of suppliers and our lack of longer term supply contracts exposes us to several risks, including our potential inability to obtain an adequate supply of quality components, the discontinuance of key components from our suppliers, price increases and late deliveries.  For example, we face the risk that price increases imposed on us by our suppliers will be higher than the price increases (or cost increases) imposed on our  27


competitors when they purchase (or manufacture) similar components; and we face a corresponding risk that any price decreases that we are able to obtain from our suppliers will be less than the price decreases (or cost reductions) that our competitors obtain when they purchase (or manufacture) similar components.  We have experienced shortages and delays in obtaining, and the discontinuation of key
components in the past and expect to experience shortages, delays, and the discontinuation of key components in the future.  In the past, industry capacity has been constrained and some of our component suppliers placed limits on the number of components sold to us.  If industry capacity becomes constrained in the future, our component suppliers may place similar limits on us.  We do not have any control over these limits, and our suppliers may choose to allocate more of their production to our competitors.  A disruption in, or termination of, our supply relationship with Furukawa or any of our other key suppliers, or our inability to develop relationships with new suppliers would interrupt and delay the manufacturing of our products, which could result in delays in our revenue, or the cancellation of orders for our products.  We may not be able to identify and integrate alternative suppliers in a timely fashion, or at all.  Any transition to alternative suppliers would likely result in delays in shipment, quality control issues and increased expenses, any of which would limit our ability to deliver products to our customers.  Furthermore, if we are unable to identify an alternative source of supply, we may have to redesign or modify our products, which would cause delays in shipments, increase design and manufacturing costs and require us to increase the prices of our products.  In the last two years, we have negotiated price reductions for the lasers we purchase from Furukawa. However, on a percentage basis, those price reductions have been significantly less than the price reductions we have offered our customers, on products that incorporate these lasers, in response to competitive pressures and associated customer demands. As a result, our gross margins have been unfavorably impacted. While we continue to negotiate with Furukawa with respect to the pricing of the lasers we purchase from them, and while we are exploring alternative sources of supply for the lasers we purchase from Furukawa including using GigaComm as a second source for lasers, we cannot assure you that these efforts will be successful in addressing and/or reversing this erosion in our gross margins.  Our future operating results are likely to fluctuate from quarter to quarter, and if we fail to meet the expectations of securities analysts or investors, our stock price could decline significantly.  Our historical quarterly operating results have varied significantly, and our future quarterly operating results are likely to continue to vary significantly from period to period.  As a result, we believe that period-to-period comparisons of our operating results should not be relied upon as an indicator of our future performance.  Some of the factors that could cause our operating results to vary include:  
        fluctuations in demand for, and sales of, our products, which is dependent on the implementation of fiber optic networks; 
        the timing of customer orders, particularly from our significant customers; 
        competitive factors, including introductions of new products, product enhancements and the introduction of new technologies by our competitors, the entry of new competitors into the fiber optic subsystems and modules market and pricing pressures; 
        our ability to control expenses; 
        the mix of our products sold; and 
        economic conditions specific to the communications and related industries.  We incur expenses from time to time that may not generate revenue until subsequent quarters such as expenditures required to increase manufacturing capacity.  In addition, in connection with new product introductions, we incur research and development expenses and sales and marketing expenses that are not matched with revenue until a subsequent quarter when the new product is introduced.  We  28


cannot assure you that our expenditures on manufacturing capacity will generate increased revenue in subsequent quarters or that new product introductions will generate sufficient revenue in subsequent quarters to recover our research and development expenditures.  If growth in our revenue does not outpace the increase in our expenses, our quarterly operating results may fall below expectations and cause our stock price to decline significantly.  Due to these and other factors, we believe that our quarterly operating results are not an indicator of our future performance.  If our operating results are below the expectations of public market analysts or investors in future quarters, the trading price of our Class A common stock would be likely to decrease significantly.  General economic factors could negatively impact our growth plan.  The unfavorable economic conditions in the United States that began in 2001 detrimentally affected the U.S. manufacturing industry, particularly sales of fiber optics equipment to service providers and communication equipment companies. Announcements by fiber optics equipment manufacturers and their customers at the time indicated that there was a reduction in spending for fiber optic equipment as a result of the economic slowdown and efforts to reduce then-existing inventories. Based on these and other factors, some of our customers reduced, modified, cancelled or rescheduled orders for our products and expressed uncertainty as to their future requirements.  Despite an improvement in general economic conditions in the United States since that time, capital spending by service providers in the fiber optic communications industry on network infrastructure has remained substantially below
pre-2001 levels.  Our business, operating results and financial condition are likely to suffer if the global economy, or economic conditions in the United States, experiences another downturn.  If we do not develop and introduce new products with higher average selling prices in a timely manner, the overall average selling prices of our products will decrease.  The market for fiber optic subsystems and modules is characterized by declining average selling prices for existing products due to increased competition, the introduction of new products, product obsolescence and increased unit volumes as manufacturers deploy new network equipment.  We have in the past experienced, and in the future may experience, period-to-period fluctuations in operating results due to declines in our overall average selling prices.  We anticipate that the selling prices for our existing products will decrease in the future in response to product introductions by competitors or us, or other factors, including pressure from significant customers for price concessions.  Therefore, we must continue to develop and introduce new products, on a timely basis, that can be sold at higher prices to maintain our overall average selling prices.  Failure to do so could cause our
revenue and gross margins to decline.  If our customers do not approve our manufacturing processes and qualify our products, we will lose significant customer sales and opportunities.  Customers generally will not purchase any of our products before they qualify them and approve our manufacturing processes and quality control system. Our customers may require us to register under international quality standards, such as ISO 9001.  We are currently registered under ISO 9001:2000.  Delays in product qualification or loss of ISO 9001 certification may cause a product to be dropped from a long-term supply program and result in a significant lost revenue opportunity. If particular customers do not approve of our manufacturing processes, we will lose the sales opportunities with those customers.  If we fail to predict our manufacturing requirements accurately, we could incur additional carrying costs and have excess and obsolete inventory or we could experience manufacturing delays, which could cause us to lose orders or customers.   29


We currently use historical data, a backlog of orders and estimates of future requirements to determine our demand for components and materials.  We must accurately predict both the demand for our products and the lead-time required to obtain the necessary components and materials.  Lead times for components and materials vary significantly depending on factors such as the specific supplier, the size of the order, contract terms and demand for each component at a given time.  We generally maintain levels of inventories that increase our inventory carrying costs and periodically cause us to have excess and obsolete inventory. However, if we were to underestimate our purchasing requirements, manufacturing could be interrupted, resulting in delays in shipments.  Our markets are highly competitive, some of our customers are also our competitors, and our other customers may choose to purchase our competitors products rather than our products or develop internal capabilities to produce their own fiber optic subsystems and modules.  The market for fiber optic subsystems and modules is highly competitive and we expect competition to intensify in the future. Our primary competitors include Avago Technologies, ExceLight Communications, Finisar, JDSU, MRV Communications, OpNext, Picolight, and Stratos Lightwave.   We also face indirect competition from public and private companies providing products that address the same networking needs that our products address, and which are based on non-fiber-optic technologies.  The development of alternative solutions to fiber optic transmission problems by our competitors, particularly systems companies that also manufacture modules, such as Fujitsu and JDSU, could significantly limit our growth and harm our competitive position.  Many of our current competitors and potential competitors have longer operating histories and significantly greater financial, technical, sales and marketing resources than we do.  As a result, these competitors are able to devote greater resources to the development, promotion, sale and support of their products.  In addition, our competitors that have large market capitalization or cash reserves are in a much better position to acquire other companies in order to gain new technologies or products that may displace our products.  Any of these potential acquisitions could give our competitors a strategic advantage.  In addition, many of our competitors have much greater brand name recognition, more extensive customer bases, more developed distribution channels and broader product offerings than we do.  These companies can use their broader customer bases and product offerings and adopt
aggressive pricing policies to gain market share.  In addition, existing and potential customers, especially in China, Japan and other international markets, may also become competitors.  These customers have the internal capabilities to integrate their operations by producing their own optical subsystems and modules or by acquiring our competitors or the rights to produce competitive products or technologies, which may allow them to reduce their purchases or cease purchasing from us.  We expect our competitors to introduce new and improved products with lower prices, and we will need to do the same to remain competitive.  We may not be able to compete successfully against either current or future competitors with respect to new products.  We believe that competitive pressures may result in price reductions, reduced margins and our loss of market share.  Our sales cycle runs from our customers initial design to production for commercial sale.  This cycle is long and unpredictable and may cause our revenue and operating results to vary from our forecasts.  The period of time between our initial contact with a customer and the receipt of a purchase order from that customer may span more than a year and varies by product and customer.  During this time, customers may perform or require us to perform extensive evaluation and qualification testing of our products.  Generally, they consider a wide range of issues before purchasing our products, including interoperation with other subsystems and components, product performance and reliability.  We may   30


incur substantial sales and marketing expenses and expend significant management effort while potential customers are qualifying our products.  Even after incurring these costs, we ultimately may not sell any or sell only small amounts of our products to a potential customer.  If sales forecasts to specific customers are not realized, our revenue and results of operations may be negatively impacted.  If we do not achieve acceptable manufacturing yields in a cost-effective manner, or we are required to develop new manufacturing processes to improve our yields, our operating results would be impaired.  The manufacture of our products involves complex and precise processes.  As a result, it may be difficult to cost-effectively meet our production goals.  In addition, changes in our manufacturing processes or those of our suppliers, or our suppliers inadvertent use of defective materials, could significantly reduce our manufacturing yields, increase our costs and reduce our product shipments.  To increase our gross margin, while offering products at prices acceptable to customers, we will need to develop new manufacturing processes and techniques that will involve higher levels of automation.  We could be subjected to litigation regarding intellectual property rights, which may divert management attention, cause us to incur significant costs or prevent us from selling our products.  In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights in the networking technologies industry.  Many companies aggressively use their patent portfolios to bring infringement claims against competitors.  As a result, we may be a party to litigation or be involved in disputes over our alleged infringement of others intellectual property in the future.  These claims and any resulting lawsuit, if successful, could subject us to significant liability for damages and prevent us from making or selling some of our products.  These lawsuits, regardless of their merit, would likely be time-consuming and expensive to resolve and would divert managements time and attention.  Any potential intellectual property litigation also could force us to do one or more of the following:  
        stop selling, incorporating or using our products that use the infringed intellectual property; 
        obtain a license to make, sell or use the relevant technology from the owner of the infringed intellectual property, which license may not be available on commercially reasonable terms, if at all; or 
        redesign the products to not use the infringed intellectual property, which may not be technically or commercially feasible.  If we are forced to take any of these actions, we may be limited in our ability to execute our business plan.  We may in the future initiate claims or litigation against third parties for infringement of our proprietary rights.  These claims could result in costly litigation and the diversion of our technical and management personnel.  In the process of asserting our intellectual property rights, these rights could be found to be invalid, unenforceable or not infringed.  Failure to successfully assert our intellectual property rights could result in our inability to prevent our competitors from utilizing our proprietary rights.  If we are unable to protect our proprietary technology, this technology could be appropriated by others, which would make it difficult for us to compete in our industry.  Our success and ability to compete is dependent in part on our proprietary technology. We rely primarily on patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and other methods, to establish and protect our proprietary rights.  Existing patent, copyright, trademark and trade secret laws afford only limited protection.  While we are pursuing foreign patent protection, the laws of some foreign countries do not protect the unauthorized use of our proprietary technology and processes  31


to the same extent as do the laws of the United States, and policing the unauthorized use of our products is difficult.  Many U.S. companies have encountered substantial infringement problems in some foreign countries.  Because we sell some of our products overseas, we have exposure to foreign intellectual property risks. Any infringement of our proprietary rights could
result in costly litigation, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in the loss of some of our competitive advantage and a decrease in our revenue.  If we are unable to generate adequate additional revenue as a result of the expansion of our sales operations, our competitive position may be harmed and our revenue or margins may decline.  Historically, we have relied primarily on a limited direct sales force, supported by third party manufacturers representatives and distributors, to sell our products.  Our sales strategy focuses primarily on developing and expanding our direct sales force, manufacturers representatives and distributors.  We have incurred and may continue to incur significant costs related to the expansion of our sales operations.  If the expansion of our sales operations does not generate adequate additional revenue, our operating margins may decline.  To the extent we are unsuccessful in developing our direct sales force, we will likely be unable to compete successfully against the significantly larger and well-funded sales and marketing operations of many of our current or potential competitors.  In addition, if we fail to develop relationships with significant manufacturers
representatives or distributors, or if these representatives or distributors are not successful in their sales or marketing efforts, sales of our products may decrease and our competitive position would be harmed.  Our representatives or distributors may not market our products effectively or may not continue to devote the resources necessary to provide us with effective sales, marketing and technical support.  Our inability to effectively manage our domestic and foreign sales and support staff or maintain existing or establish new relationships with manufacturer representatives and distributors would harm our revenue and result in declining margins.  The market for our products is characterized by rapid technological changes and evolving industry standards.  If we do not respond to the changes in a timely manner, our products likely will not achieve market acceptance.  The market for our products is characterized by rapid technological change, new and improved product introductions, changes in customer requirements and evolving industry standards.  Our future success will depend to a substantial extent on our ability to develop, introduce and support cost-effective new products and technology on a successful and timely basis.  Because the costs for research and development of new products and technology are expensed as incurred, we expect a negative impact on our reported net operating results.  If we fail to develop and deploy new cost-effective products and technologies or enhancements of existing products on a timely basis, or if we experience delays in the development, introduction or enhancement of our products and technologies, our products will no longer be competitive and our revenue will decline.  The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends.  We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products on a timely basis, if at all.  Furthermore, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards.  Our failure to respond to product announcements, technological changes or industry
changes in standards would likely prevent our products from gaining market acceptance and harm our competitive position.  Terrorist activities and resulting military and other actions and the potential outbreak of Avian Flu could adversely affect our business.  32


The September 11, 2001 terrorist attacks in the United States and recent terrorist attacks in other parts of the world, as well as continued threats of global terrorism, current and future military response to them, the United States military action in Iraq, and the potential outbreak of Avian Flu have created many economic and political uncertainties that make it extremely difficult for us, our customers and our suppliers to accurately forecast and plan future business activities.  The potential outbreak of Avian Flu, especially in China, where we have significant customer and supply relationships, could also disrupt our operations, sales, and supply chain or those of our customers, which has made it more difficult to predict and plan for future business activities.  This reduced predictability challenges our ability to operate profitably or to grow our business. In particular, it is
difficult to develop and implement strategies, sustainable business models and efficient operations, and effectively manage contract manufacturing and supply chain relationships.  In addition, the continued threats of terrorism, the heightened security measures in response to such threats, and the potential outbreak of Avian Flu have caused and may continue to cause significant disruption to commerce throughout the world.  Disruption in air transportation in response to these threats or future attacks, or Avian Flu, may result in transportation and supply-chain disruptions, increase our costs for both receipt of inventory and shipment of products to our customers, and cause customers to defer their purchasing decisions.  Disruptions in commerce could also cause consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets and economy. They also could result in economic recession in the U.S. or abroad. Any of these
occurrences could have a significant impact on our operating results, revenue and costs and may result in the volatility of the market price for our Class A common stock and on the future price of our Class A common stock.  Our success depends on our key personnel, including our executive officers, the loss of any of whom could harm our business.  Our success depends on the continued contributions of our senior management and other key research and development, sales and marketing and operations personnel, including Philip F. Otto, our Chief Executive Office and Interim Chief Financial Officer, Muoi Van Tran, our Chief Technology Officer, Susie Nemeti, our Senior Vice President of Corporate Affairs and Administration, Dr. Liew-Chuang Chiu, our Vice President of Manufacturing and Mohammad Ghorbanali, our Chief Operating Officer and Vice President of Technical Operations. Competition for employees in our industry is intense.  We do not have life insurance policies covering any of our executives.  There can be no assurance that we will be successful in retaining such key personnel, or that we will be successful in hiring replacements or additional key personnel.  Our loss of any key employee, the failure of any key employee to
perform in his or her current position, or the inability of our officers and key employees to expand, train and manage our employee base may prevent us from executing our growth strategy.  We will need to attract and retain highly qualified managers, sales and marketing and technical support personnel.  We have had difficulty hiring the necessary engineering, sales and marketing and management personnel in the past.  If we fail to hire and retain qualified personnel when needed, our product development efforts and customer relations will suffer.  Some of our key management personnel have limited experience in managing the growth of technologically complex businesses in a rapidly evolving environment.  If we are unable to manage our growth effectively, we will incur additional expenses that will negatively impact our operating results.  Our products may have defects that are not detected until full deployment of a customers system.  Any of these defects could result in a loss of customers, damage to our reputation and substantial costs.  We design our products for large and complex fiber optic networks, and our products must be compatible with other components of the network system, both current and future.  We have experienced in the past, and may continue to experience in the future, defects in our products.  Defects in our products or incompatibilities in our products may appear only when deployed in networks for an extended period  33


of time.  In addition, our products may fail to meet our customers design specifications, or our customers may change their design specifications after the production of our product.  A failure to meet our customers design specifications often results in a loss of the sale due to the length of time required to redesign the product.  We may also experience defects in third party components that we incorporate into our products.  We have experienced and may continue to experience
the following due to our inability to detect or fix errors:  
        increased costs associated with the replacement of defective products, redesign of products to meet customer design specifications and/or refund of the purchase price; 
        diversion of development resources; and 
        increased service and warranty costs.  Our products and the systems into which our products are incorporated must comply with domestic and international governmental regulations, and if our products do not meet these regulations, our ability to sell our products will be restricted.  Our products are subject to various regulations of U.S. and foreign governmental authorities principally in the areas of radio frequency emission standards and eye safety.  Radio frequency emission standards govern allowable radio interference with other services.  Eye safety standards govern the labeling and certification of laser products to ensure that they are used in a way that does not create a hazard to the human eye.  Our products and the systems into which they are incorporated must also comply with international standards and governmental standards of the foreign countries where our products are used.  Our inability, or the inability of our customers, to comply with existing or evolving standards established by regulatory authorities, or to obtain timely domestic or foreign regulatory approvals or certificates will restrict our ability to sell our products.  We are subject to environmental laws and other legal requirements that have the potential to subject us to substantial liability and increase our cost of doing business.  Our properties and business operations are subject to a wide variety of federal, state and local environmental, health and safety laws and other legal requirements, including those relating to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous substances.  We may be required to incur substantial costs to comply with current or future legal requirements.  In addition, if we fail to obtain required permits or otherwise fail to operate within these or future legal requirements, we may be required to pay substantial penalties, suspend our operations or make costly changes to our manufacturing processes or facilities.  We believe our properties and business operations are in compliance with applicable environmental laws.  We do not anticipate any material capital expenditures for environmental control activities for the 2006 fiscal year.  However, the landlord of our former Colorado facility has contacted us claiming that the Company is responsible for approximately $1,145,000 in environmental clean-up and related costs at that location.  The Company disputes the landlords allegations and intends to contest these claims.   However, we expect that we will not be able to resolve this dispute without litigation.  Further, any litigation resulting from this dispute could result in substantial costs and divert our managements attention and resources.  We face risks associated with our international operations that could prevent us from marketing and distributing our products internationally.  Although a significant portion of our sales has historically been in North America, a growing percentage of our revenue is generated from sales outside North America.  Sales of our products outside North America accounted for approximately 49.8%, and 42.7% of our revenue for the nine months ended   34


June 30, 2006, and 2005, respectively.  We expect that our sales outside of North America will continue to contribute materially to our revenue.  In addition, international operations are subject to other risks, including:  
        greater difficulty in accounts receivable collection and longer collection periods; 
        difficulties and costs of staffing and managing foreign operations with personnel who have expertise in fiber optic technology; 
        unexpected changes in regulatory or certification requirements for optical networks; and 
        political or economic instability.  A portion of our international revenue and expenses may be denominated in foreign currencies in the future.  Accordingly, we could experience the risks of fluctuating currencies and may choose to engage in currency hedging activities.  These factors could adversely impact our international sales or increase our costs of doing business abroad or impair our ability to expand into international markets, and therefore could significantly harm our business.  Disruption of our operations at our Woodland Hills, California manufacturing facility could require us to lease alternative manufacturing facilities or limit our manufacturing operations.  In August 2003, we relocated our headquarters from Chatsworth, California to Woodland Hills, California.All of our manufacturing operations are conducted in our Woodland Hills, California headquarters.  Due to this geographic concentration, a disruption of our manufacturing operations, resulting from sustained process abnormalities, human error, government intervention or natural disasters, such as earthquakes, fires or floods, or other causes, could require us to cease or limit our manufacturing operations.  Our limited experience in acquiring other businesses, product lines and technologies may make it difficult for us to overcome problems encountered in connection with any acquisition we may undertake.  We expect to review opportunities to buy other businesses, products or technologies that would enhance our technical capabilities, complement our current products or expand the breadth of our markets or which may otherwise offer growth opportunities.  Our acquisition of businesses or technologies will require significant commitment of resources.  We may be required to pay for any acquisition with cash, but we cannot be certain that additional capital will be available to us on favorable terms, if at all.  In lieu of paying cash, we could issue stock as consideration for an acquisition that would dilute existing stockholders percentage ownership, incur substantial debt or assume contingent liabilities.  We have little experience in acquiring other businesses and technologies.  Potential acquisitions also involve numerous risks, including:  
        problems assimilating the purchased operations, technologies or products; 
        unanticipated costs associated with the acquisition; 
        diversion of managements attention from our core business; 
        adverse effects on existing business relationships with suppliers and customers; 
        risks associated with entering markets in which we have no or limited prior experience; and 
        potential loss of key employees of purchased organizations.  Our stock price is likely to be volatile and could drop unexpectedly.  Our Class A common stock has been publicly traded since November 3, 2000. The market price of our Class A common stock has been subject to significant fluctuations since the date of our initial public offering.  The stock market has from time to time experienced significant price and volume   35


fluctuations that have affected the market prices of securities, particularly securities of telecommunications and fiber optic companies. As a result, the market price of our Class A common stock may materially decline, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular companys securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation of this type is often expensive and diverts managements attention and resources.  We may not be able to maintain our listing on the Nasdaq Global Market and if we fail to do so, the price and liquidity of our Class A common stock may decline.  The Nasdaq Stock Market has quantitative maintenance criteria for the continued listing of securities on the Nasdaq Global Market.  The current requirements affecting us include maintaining a minimum bid price per share of $1.  Our bid price has been below $1 in the past.  If the bid price of our Class A common stock drops below $1 per share and remains at that level for more than 30 consecutive trading days, we will be in violation of Nasdaqs listing standards.  If within 90 days thereafter, our Class A common stock does not have a minimum bid price of $1 per share for 10 consecutive trading days, Nasdaq will commence proceedings to delist our Class A common stock from the Nasdaq Global Market.  If we fail to maintain continued listing on the Nasdaq Global Market and must move to a market with less liquidity, 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 Class A common stock.  We have potential business conflicts of interest with Furukawa, the resolution of which may not be as favorable to us as if we were dealing with an unaffiliated third party.  We have historically relied on Furukawas research and development capabilities to provide us with technologically advanced lasers and fiber optic components that we purchase from Furukawa for inclusion in our products, and we expect to continue to rely on Furukawa in this manner in the future.  We currently purchase the majority of lasers from Furukawa under a Master Purchase Agreement. We cannot assure you that Furukawa will renew the Agreement upon its expiration on September 30, 2006 or whether it will continue to provide services and components to us, and if not, whether or on what terms we could find adequate alternative sources for these services and components.  In the last two years, we have negotiated price reductions for the lasers we purchase from Furukawa. However, the laser price reductions that we have been able to obtain from Furukawa have been less than the price reductions for the associated products that we have given our customers in response to market conditions. As a result, our gross margins have been negatively impacted, and may be negatively impacted in the future. While we continue to negotiate with Furukawa with respect to the pricing of the lasers we purchase from them, and while we are exploring alternative sources of supply for the lasers we purchase from Furukawa, we cannot assure you that these efforts will be successful in addressing this negative impact on our gross margins.  Furukawa can control the outcome of any stockholder votes, as discussed below.  The terms of future transactions with Furukawa may or may not be comparable to those that would be available from unaffiliated third parties.  Potential conflicts of interest exist between Furukawa and us in a number of areas, including the nature and quality of services rendered by Furukawa to us, potential competitive business activities, sales or distributions by Furukawa of all or any portion of its ownership interest in us, or Furukawas ability to control our management and affairs.  It is possible that business decisions made by management that are in the best interest of our stockholders may conflict with Furukawas interests.  For example, we may decide to enter into or acquire a line of business competitive with Furukawa, or Furukawa may decide to enter into or acquire a line of business competitive with us.  Any of these events may alter or eliminate   36


our ability to rely on Furukawa to supply key components to us in the future, increase our costs of producing our products and result in increased competition
in our markets.  We cannot assure you that we will be able to resolve any conflicts we may have with Furukawa or, if we are able to do so, that the resolution will be favorable to us.  Furukawa will control the outcome of stockholder voting and there may be an adverse effect on the price of our Class A common stock due to disparate voting rights of our Class A common stock and our Class B common stock.  Furukawa beneficially owns all of our outstanding shares of Class B common stock, which as of June 30, 2006 represented 93.3% voting control over all stockholder issues.  The holders of our Class A common stock and Class B common stock have identical rights except that holders of our Class A common stock are entitled to one vote per share while holders of our Class B common stock are entitled to ten votes per share on matters to be voted on by stockholders.  The differential in the voting rights of our Class A common stock and Class B common stock could adversely affect the price of our Class A common stock to the extent that investors or any potential future purchaser of our shares of Class A common stock give greater value to the superior voting rights of our Class B common stock.  Each share of our Class B common stock will automatically convert into one share of Class A common stock
if it is transferred to any entity, other than an entity controlling, controlled by or under common control with Furukawa.  In addition, our Class B common stock will automatically convert into shares of our Class A common stock if the total number of outstanding shares of Class B common stock falls below 20% of total number of outstanding shares of our common stock.  As long as Furukawa has a controlling interest, it will continue to be able to elect our entire board of directors and generally be able to determine the outcome of all corporate actions requiring stockholder approval.  As a result, Furukawa will be in a position to continue to control all matters affecting us, including:  
        a change of control, including a merger; 
        our acquisition or disposition of assets; 
        our future issuances of common stock or other securities; 
        our incurrence of debt; and 
        our payment of dividends on our common stock.  Three members of our board of directors are also executives of Furukawa. These individuals have obligations to both our Company and Furukawa and may have conflicts of interest with respect to matters potentially or actually involving or affecting us, such as acquisitions and other corporate opportunities that may be suitable for both Furukawa and us.  Our exploration of strategic alternatives may not be successful.  We have a special committee of our board of directors that evaluates strategic alternatives.  The special committee, which is comprised of our three independent directors, has retained Bear, Stearns & Co. Inc. to advise it in evaluating strategic alternatives, including a special dividend, share repurchase, strategic merger or sale of the Company.  We are uncertain as to what strategic alternatives may be available to us or what impact any particular strategic alternative will have on our stock price if accomplished. Uncertainties and risks relating to our exploration of strategic alternatives include:  
        the exploration of strategic alternatives may disrupt operations and distract management, which could have a material adverse effect on our operating results; 
        the process of exploring strategic alternatives may be more time consuming and expensive than we currently anticipate;   37



        we may not be able to successfully achieve the benefits of the strategic alternative undertaken by us; and 
        perceived uncertainties as to the future direction of the Company may result in the loss of employees or business partners.  Our internal controls over financial reporting may not be adequate and our independent auditors may not be able to certify as to their adequacy, which could have a significant and adverse effect on our business and reputation. We are evaluating our internal controls over financial reporting in order to allow management to report on, and our independent auditors to attest to, our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and rules and regulations of the SEC there-under, which we refer to as Section 404.  Section 404 requires a reporting company such as ours to, among other things, annually review and report on its internal controls over financial reporting, and evaluate and disclose changes in its internal controls over financial reporting quarterly.  We may be required to comply with Section 404 as of September 30, 2007.    In the course of our ongoing evaluation, we have identified areas of our internal controls requiring improvement, and plan to design enhanced processes and controls to address these and any other issues that might be identified
through this review.  As a result, we expect to incur additional expenses and diversion of managements time.  We cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations and may not be able to ensure that the process is effective or that the internal controls are or will be effective in a timely manner.  If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, our independent auditors may not be able to certify as to the effectiveness of our internal control over financial reporting and we may be subject to sanctions or investigation by regulatory authorities, including the SEC.  As a result, there could be an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements.  In addition, we may be required to incur costs in improving our internal control system and the hiring of
additional personnel.  Any such action could have an adverse effect on our business, results of operations and financial condition.   ITEM 6.
        EXHIBITS  Exhibit Number
        Description10.1*
        Employment Agreement by and between Philip F. Otto and the Company dated as of April 26, 2006.10.2*
        Amendment No. 1 to Employment Agreement by and between Susie L. Nemeti and the Company dated as of April 26, 2006.31.1
        Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
        Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
        Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. * Filed as an exhibit to the Current Report on Form 8-K dated April 27, 2006 and incorporated herein by reference.   38


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.  OPTICAL COMMUNICATION PRODUCTS, INC., a Delaware corporation   Date:
        August 11, 2006
        By:
        /s/ Philip F. OttoName:
        Philip F. OttoTitle:
        Chief Executive Officer(Principal Executive Officer)    Date:
        August 11, 2006
        BY:
        /s/ Philip F. OttoName:
        Philip F. Otto Title:
        Interim Chief Financial Officer (Principal Financial and Accounting Officer)   39


EXHIBIT INDEX   Exhibit Number
        Description10.1*
        Employment Agreement by and between Philip F. Otto and the Company dated as of April 26, 2006.10.2*
        Amendment No. 1 to Employment Agreement by and between Susie L. Nemeti and the Company dated as of April 26, 2006.31.1
        Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
        Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
        Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.   * Filed as an exhibit to the Current Report on Form 8-K dated  April 27 , 2006 and incorporated herein by reference.