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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

DICON FIBEROPTICS, INC.

(510) 620-5000
(Registrant’s Telephone Number, Including Area Code)

     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 o

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

DiCon Fiberoptics, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)

The accompanying notes are an integral part of these condensed consolidated financial statements.

(1) Balances at March 31, 2003 are derived from the audited Financial Statements at that date.

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DiCon Fiberoptics, Inc. and Subsidiary
Condensed Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except per share data)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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DiCon Fiberoptics, Inc. and Subsidiary
Condensed Consolidated Statement of Cash Flows
(in thousands, except per share data)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

1.		Nature of Operations
		DiCon Fiberoptics, Inc. and Subsidiary (“DiCon” or the “Company”) develops, manufactures and markets optical components, modules, and test instruments for the optical communications markets. The Company is incorporated in California and has a domestic manufacturing facility and headquarters in California. The Company, through Global Fiberoptics Inc. (“Global Fiberoptics”), its wholly owned Taiwanese subsidiary, formed in December 1999, also operates a manufacturing and sales facility in Kaohsiung, Taiwan, and conducts manufacturing, marketing and sales activities.
2.		Basis of presentation
		The Company operates and reports based on a fiscal year that ends on March 31st. The accompanying unaudited condensed consolidated financial statements as of September 30, 2003 and for the three and six months ended September 30, 2003 and September 30, 2002, respectively, have been prepared in accordance with generally accepted accounting principles in the United State of America for interim financial information and on the same basis of presentation as the audited financial statements included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (SEC) on June 27, 2003 (the “Company’s 10-K”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for audited financial statements. In the opinion of the Company’s management, the interim information includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. Certain parts of the footnote disclosures related to the interim financial information included herein are also unaudited. Such financial information should be read in conjunction with the consolidated financial statements and related notes thereto for the year ended March 31, 2003 as included in the Company’s 10-K.
		The preparation of financial statements in accordance with generally accepted accounting principles in the US requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates.
		Certain prior year balances have been reclassified to conform to the current year presentation.
3.		Recent accounting pronouncements
		The Company accounts for stock-based compensation issued to employees using the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and, accordingly, presents disclosure of pro forma information required under Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” Stock and other equity instruments issued to non-employees are accounted for in accordance with SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services,” and recorded at their fair value.
		Had compensation cost for the Company’s stock option plans been determined based on the fair value of such awards at the grant dates as prescribed by SFAS No. 123, stock-based compensation costs would have impacted net (loss) income and (loss) income per common share for the fiscal period ended September 30, as follows:

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

		In January 2003, the EITF issued Issue No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”. This EITF establishes the criteria for recognizing revenue in arrangements when several items are bundled into one agreement. EITF 00-21 does not allow revenue recognition unless the fair value of the undelivered element is available and the element has stand-alone value to the customer. EITF 00- 21 also provides guidance on allocating the total contract revenue to the individual elements based upon the available fair value of each deliverable. The Company does not expect the implementation of this statement to have a material impact on its consolidated financial position, results of operations or cash flows.
		In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity, if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company believes the adoption of FIN 46 will not have a material impact on its consolidated financial position, results of operations or cash flows.
		In May 2003, the FASB has issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. It requires that those instruments be classified as liabilities in balance sheets. Most of the guidance in SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the Company’s third quarter of fiscal 2003. On November 5, 2003, the FASB deferred the effective date for certain financial instruments for non-public companies. Management anticipates that the adoption of SFAS No. 150 will not have a material impact on the Company’s consolidated financial statements.

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

4.		Basic net loss per share
		Basic (loss) earnings per share is computed by dividing the net (loss) income (numerator) by the weighted average number of common shares outstanding (denominator) during the periods, excluding the dilutive effect of stock options. Diluted net (loss) income per share gives effect to all potentially dilutive common stock equivalents outstanding during the period. In computing diluted net (loss) income per share, the average stock price for the period is used in determining the number of shares assumed to be purchased from the proceeds of stock option exercises.
		The following is a reconciliation of the numerators and denominators of the basic and diluted net (loss) income per share computations for the periods presented below:

		As a result of the losses incurred by the Company for the three months and the six months ended September 30, 2003, weighted average options to purchase 4,647 and 4,677 shares of common stock were anti-dilutive and excluded from the net loss per share calculations. For the three and six months ended September 30, 2002, weighted average options to purchase 10,642 and 10,627 shares of common stock were anti-dilutive and excluded from the net loss per share calculations.
5.		Marketable Securities
		Available for sale securities included in the consolidated balance sheets as of September 30, 2003 and March 31, 2003 are as follows:

Debt securities include certificates of deposit with original maturities of greater than 90 days.

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

6.		Inventories, net
		Inventories consist of the following as of September 30, 2003 and March 31, 2003:

7.		Property, Plant and Equipment, net
		Property, plant and equipment consist of the following as of September 30, 2003 and March 31, 2003:

		Depreciation expense was $4,761 and $10,245 for the six months period ended September 30, 2003 and for the year ended March 31, 2003.
		During the period ended September 30, 2003, the Company disposed of equipment and furniture with a net book value of $38 for proceeds of $24.
8.		Accounts Payable and Accrued Liabilities
		Accounts payable and accrued liabilities consist of the following as of September 30, 2003 and March 31, 2003:

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

9.		Mortgage and Other Debt
		The Company financed, in part, a new corporate campus by borrowing from a bank a construction loan of $27,000 on August 24, 2000. In November 2001, the same lender refinanced the outstanding balance of the construction loan with a mortgage loan maturing November 20, 2004 with an amortization schedule based on a 25-year loan. Interest on the mortgage loan is accrued at a variable interest rate based on changes in the lender’s prime rate as of the 20th of each month (4.0 percent at September 30, 2003). Principal and interest are payable monthly. The balance of the mortgage loan as of September 30, 2003 was $25,864 and the balance of the loan at maturity is estimated to be $25,071 at the current interest rate. During the year ended March 31, 2002, the Chairman, President and Chief Executive Officer of the institution with which the Company maintains the mortgage loan was appointed to the Company’s Board of Directors.
		In April 2001, the Company obtained an equipment loan from a bank in the amount of $7,250. The loan is secured by specific pieces of equipment. The loan is repayable in equal monthly installments of principal and interest over 60 months beginning May 30, 2001. On September 30, 2003, the loan balance was $3,746. Effective April 30, 2002 and annually on April 30 of each year thereafter, the Company may elect to fix the interest rate on the equipment loan for a twelve month period at a rate of one-half of one percentage point (0.5 percent) per annum in excess of the prime rate. As of September 30, 2003, the Company had not elected the fixed rate option and the loan bore an interest rate of prime plus 0.5 percent (4.5 percent on September 30, 2003). On March 31, 2003, the Company was in violation of two of the financial covenants under this loan agreement. The bank agreed to waive the covenants, but added an additional covenant requiring the Company to maintain a balance of cash and marketable securities (excluding equity securities) of at least two times the outstanding loan balance. The waiver was extended through March 31, 2004. The Company was in compliance with the additional covenant as of September 30, 2003.
		In December 2001, Global Fiberoptics issued commercial paper in the amount of 20,000 New Taiwan Dollars. Proceeds were used to repay borrowings under the bank line of credit for Global Fiberoptics. This loan was repaid in April 2002.
		In December 2002, Global Fiberoptics renewed its line of credit in Taiwan backed by commercial paper issued by Global Fiberoptics for a maximum of 220,000 New Taiwan Dollars (or US$6,518 as of September 30, 2003). The line will mature on December 24, 2003 and the interest rate is based on a rate set by the bank at the time funds are drawn. The outstanding balance of any commercial paper under this line must be fully secured by either cash deposit or bond fund certificate. As of September 30, 2003, Global Fiberoptics had issued commercial paper in the amount of 27,500 New Taiwan Dollars (or US$815 as of September 30, 2003) and 60,000 New Taiwan Dollars (or US$1,778 as of September 30, 2003) with interest rate of 1.05 % and 1.1 %, respectively.
		In September 2003, Global Fiberoptics renewed its line of credit of 100,000 New Taiwan Dollars (or US$2,963 as of September 30, 2003) from a Taiwan bank, with interest based on a rate set by the bank at the time funds are drawn. 10,000 New Taiwan Dollars (or US$296 ) was drawn as of September 30, 2003 with the interest rate of 3.0%. The loan will mature on January 06, 2004.
10.		Stock Plans and Deferred Compensation Liability
		As an incentive for employees to assist in growing the Company, prior to March 31, 2001 the Company maintained a phantom stock plan (the “Phantom Stock Plan”) under which it granted eligible employees phantom stock units that entitled the employees to participate in the current and future value of the Company. In addition, the Company made contingent commitments to eligible employees to grant stock units in the future (the “Contingently Promised Stock Units”). The shares under the plan were valued semiannually, typically in May and December. These stock units vested 50 percent upon receipt and 50 percent on the first anniversary of the grant date and had an exercise price of zero. During the service period of one-year following the date of the grant, the vested units could be redeemed for cash on a net basis by forfeiting additional units equal to the number of units redeemed. Thereafter, a maximum of 60 percent of the units could be redeemed while the holder was still an employee of the Company. The Company recorded a liability for the value of the unredeemed vested shares at the current value as of the financial statement date.

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to the Condensed Consolidated Financial Statements
(amounts in thousands, except per share data)

		On March 31, 2001, the Company offered its employees two new equity incentive plans, an Employee Stock Option Plan (the “Option Plan”) and an Employee Stock Purchase Plan (the “Purchase Plan”). Grants under the Phantom Stock Plan have been discontinued. Under both the Option Plan and the Purchase Plan, the exercise or purchase price is not less than 85 percent of the stock’s fair value at the time of grant under the Option Plan or purchase under the Purchase Plan. New options granted under the Option Plan generally vest over five years and expire after ten years.
		Under the terms of the Option Plan, employees who were participants in the Phantom Stock Plan could convert their awarded phantom stock units and their Contingently Promised Stock Units into (1) options with an exercise price of $4.11 per share and cash payments of $4.11 per share (paid over four years); (2) additional options with an exercise price of $4.11; or (3) a combination of both (1) and (2). The cash payments and the options that were converted from vested stock units vested immediately. The cash payments and the options that were converted from Contingently Promised Units will vest in accordance with the original vesting schedule, but not less than 20 percent per year. At March 31, 2001, all phantom stock units for current employees under the Phantom Stock Plan were converted to options or options and cash payments pursuant to one of the alternatives noted above.
		Cash payments related to the conversion are payable in four annual installments beginning on March 31, 2002. As of March 31, 2001, the Company anticipated making four annual payments of $5,930 each commencing March 31, 2002 for those employees whom elected to receive a cash payout in lieu of additional options. The present value of the cash payments related to the conversion of vested phantom stock units of $15,131 was recorded as a liability as of March 31, 2001. The cash payments related to the conversion of the Contingently Promised Units are subject to continuing employment and, accordingly, the related expense and liability are accrued as earned by the employees. The first annual installment of $5,812 to those employees electing to receive cash in lieu of additional options was paid on March 28, 2002.
		As of December 31, 2002, the total remaining undiscounted future payments related to the conversion of the Company’s Phantom Stock Plan to its Option Plan totaled $7,645, payable in three equal annual installments beginning March 31, 2003. In order to reduce this liability, the Company offered the participants an opportunity to receive an early payment in January 2003. As a result, under the terms of the early payment program, the Company paid $1,979 on January 10, 2003 and reduced the future liability for Contingently Promised Units by $2,058.
		The second annual installment of $416 to those employees electing to receive cash in lieu of additional options was paid on March 31, 2003.
		The Purchase Plan was available to all eligible employees who meet certain service requirements. Effective April 1, 2001 employees participating in the Purchase Plan could elect to deduct up to 10 percent of gross pay to purchase stock in the Company. Stock transactions pursuant to the Purchase Plan occurred semiannually on September 30 and March 31. The Company could sell up to 3,230 shares of stock under the Purchase Plan. Employees purchased 70 shares at a price of $3.85 per share on September 30, 2001 and 174 shares at a price of $2.10 on March 31, 2002. In May 2002, the Company issued 659 additional shares of common stock to employees under the Purchase Plan for aggregate cash consideration of $1,384 at a price of $2.10. In September 2002, the Company suspended the sale of shares to employees under the Purchase Plan.

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DiCon Fiberoptics, Inc. and Subsidiary
Notes to the Consolidated Financial Statements
(amounts in thousands, except per share data)

Compensation expense related to the Company’s stock compensation plans has been reflected in the Consolidated Statement of Operations and Comprehensive Income (Loss) for the three months and six months ended September 30, 2003 and 2002 as follows:

11.		Income Taxes
		The Company’s income tax benefit of $573 for the six months ended September 30, 2003 is composed of a decrease in the net deferred tax liability arising from temporary differences between the financial reporting and tax bases of assets and liabilities. Due to uncertainty surrounding the realization of the favorable tax attributes in future tax returns, the Company recorded a valuation allowance against its net operating losses and credits of $6,178 at March 31, 2003. Management regularly evaluates the recoverability of the deferred tax asset and the level of the valuation allowance. At such time as it is determined that it is more likely than not that the deferred tax asset will be realizable, the valuation allowance will be reduced.
12.		Product Warranties
		The Company normally provides warranties for its products for one year. The Company provides reserves for the estimated cost of product warranties at the time revenue is recognized. Estimates of the costs of warranty obligations are based on the Company’s historical experience of known project failure rates, use of materials and service delivery costs incurred in correcting product failures. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Should the Company’s accrual experience relative to these factors differ from estimates, the Company may be required to record additional warranty reserves. Alternatively, if the Company provides more reserves than needed, the Company may reverse a portion of such provision in future periods.
		Changes in the Company’s warranty accrual, which is included as a component of accounts payable and accrued liabilities on the Consolidated Balance Sheets, are as follows:

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

		Certain statements contained in this report on Form 10-Q that are not purely historical are “forward-looking statements” within the meaning of the federal securities laws, including, without limitation, statements regarding DiCon’s expectations, beliefs, anticipations, commitments, intentions and strategies regarding the future. Actual results could differ from those projected in any forward-looking statements. Factors that could contribute to such differences include, but are not limited to, those specific points discussed under “Risk Factors” in the Annual Report Form 10-K filed by DiCon with the SEC on June 27, 2003.
		Overview
		DiCon designs and manufactures passive optical components, modules and test instruments for current and next-generation optical communications markets. DiCon designs and manufactures a broad portfolio of technically advanced products that filter, split, combine and route light in optical networks. DiCon also sells products used for testing optical devices and systems. DiCon’s products are based on its proprietary technologies, including thin-film coating, micro-optic design, optical element finishing, Micro Electro-Mechanical Systems (“MEMS”), advanced packaging and process automation. DiCon was founded in 1986 and first became profitable in 1988. It remained profitable each fiscal year until the fiscal year ended March 31, 2002.
		DiCon’s communications products include Wavelength Division Multiplexers (“WDMs”), amplifier components, switches and attenuators, MEMS devices and modules. Its measurement products include variable attenuators, tunable filters, and test instruments. DiCon markets and sells its products worldwide through its direct sales force, its subsidiary Global Fiberoptics and through selected distributors.
		The optical networking industry is rapidly changing and the volume and timing of orders are difficult to predict. Since the fourth quarter of 2000, the fiberoptics industry has been in a significant period of consolidation following a dramatic curtailment of capital spending by most carriers faced with substantial excess bandwidth capacity and very high levels of corporate debt. DiCon believes its customers, who typically are manufacturers of telecommunications equipment, generally view the purchase of DiCon’s products as a significant and strategic decision. As a result, customers typically expend substantial effort in evaluating, testing and qualifying DiCon, its products and its manufacturing processes. This customer evaluation and qualification process frequently results in a lengthy initial sales cycle of nine months or longer.
		Beginning in January 2001, as the industry entered its downturn and consolidation phase, various customers cancelled existing orders. In some cases, DiCon was able to recover a portion of its costs through subsequent transactions with these customers. However, the Company also incurred substantial costs associated with obsolete inventory and cancelled orders. During the fiscal year ended March 31, 2003, DiCon wrote off $4.1 million of obsolete inventory as compared to $9.2 million in the prior year. The Company assesses its inventory position on a monthly and quarterly basis with its then current forecasts. The Company attempts to mitigate the impact of such corrections by maintaining close, proactive relationships with its major customers to obtain as much information about each customer’s needs as possible. During the six months ended September 30, 2003, DiCon wrote off approximately $0.3 million of obsolete inventory and took an additional $0.6 million inventory impairment charge.
		In 2001, DiCon relocated its operations from leased facilities in Berkeley, California, to a newly owned 200,000 square feet facility in Richmond, California, which currently contains all of DiCon’s domestic manufacturing, R&D, sales and administration operations. DiCon has continued its efforts to consolidate its operations from different facilities in Berkeley and Richmond, California. The Company has terminated six of its leased facilities. The remaining lease obligations for the unutilized facilities, net of expected sublease income, have been accrued as a liability in the consolidated financial statements. The Company has reduced this reserve from $1.8 million as of March 31, 2002, to $0.5 million as of March 31, 2003 as a result of those terminations. The balance of this reserve is approximately $0.3 million as of September 30, 2003.
		DiCon began its overseas manufacturing operations at its 44,000 square foot WDM product assembly facility in Kaohsiung, Taiwan in January 2000. This facility subsequently has been expanded through the purchase of an additional 44,000 square feet of space adjacent to the original facility. Although DiCon owns a condominium interest in the building, it is located on a ground lease that extends through 2011. The ground lease may be renewed indefinitely, and there is no penalty for early cancellation, except for forfeiture of the owned facility.
		DiCon’s cost of goods sold consists primarily of the cost of direct materials, labor and manufacturing overhead, scrap and rework associated with products sold, as well as production start up costs. As demand changes, DiCon attempts to manage its manufacturing capacity to meet demand for existing and new products; however, a certain portion of its costs are fixed and as volumes decrease, these expenses are difficult to reduce proportionately, if at all.

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		Research and development expenses consist primarily of salaries and related personnel expenses, fees paid to consultants and outside service providers, material and equipment costs, and other expenses related to the design, development, testing and enhancement of DiCon’s fiberoptic products. DiCon expenses all of its research and development costs as incurred and does not capitalize any research and development expenditures except for equipment which has a useful life longer than one year and is useful for purposes other than the current research and development project. DiCon believes that research and development is critical to strategic product development and expects to continue to devote significant resources to product research and development, even in the face of decreased demand and a slow economy. DiCon expects its research and development expenses to fluctuate both in absolute dollars and as a percentage of sales based on its perceived need for, and expected return from, its research and development efforts.
		Selling, general and administrative expenses include salaries, benefits, commissions, product promotion and administrative expenses. DiCon expects these expenses to continue to be substantial as the Company strives to sustain its market share in the fiberoptic component manufacturing business.
		Other income (expenses), net consists primarily of interest and dividend income, offset by interest expense, plus realized gains or losses on investments.
		DiCon maintains an Employee Stock Option Plan and an Employee Stock Purchase Plan as a means of motivating its employees to make a tangible contribution towards achieving its corporate objectives. In September 2002, DiCon suspended the sale of DiCon shares to employees under the Employee Stock Purchase Plan.
		Critical Accounting Policies and Estimates
		The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires estimates and judgments that affect the reported amounts of assets and liabilities, net sales and expenses, and the related disclosures. Estimates are based on historical experience, knowledge of economic and market factors and various other assumptions that the Company believes to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The following critical accounting policies are affected by significant estimates, assumptions and judgments used in the preparation of the Company’s consolidated financial statements.
		Revenue recognition
		The Company recognizes revenue upon shipment of the product provided that persuasive evidence of a final agreement exists, delivery has occurred, the selling price is fixed or determinable and collectibility is reasonably assured. Revenue associated with contract-related cancellation payments from customers is not recognized until a formal agreement is signed or a purchase order issued by the customer covering such payments and the collectibility of the cancellation payments is determined to be probable. The Company records provisions against gross revenue for estimated product returns and allowances in the period when the related revenue is recorded. Should actual product returns and allowances exceed the Company’s estimates, additional reductions to revenue would result.
		Allowances for doubtful accounts
		The Company performs ongoing credit evaluations of its customers. Allowances for doubtful accounts for estimated losses are maintained resulting from the inability or unwillingness of customers to make required payments. When the Company becomes aware that a specific customer is unable to meet its financial obligations, such as bankruptcy or deterioration in the customer’s operating results or financial position, the Company records a specific allowance to reflect the level of credit risk in the customer’s outstanding receivable balance. The Company is not able to predict changes in the financial condition of customers, and if circumstances related to the Company’s customers deteriorate, estimates of the recoverability of trade receivables could be materially affected and the Company may be required to record additional allowances. Alternatively, if the Company provides for more allowances than needed, the Company may reverse a portion of such provisions in future periods based on actual collection experience.

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		Warranty accrual
		The Company normally provides warranties for its products for one year. The Company provides reserves for the estimated cost of product warranties at the time revenue is recognized. Because the Company’s products are manufactured, in most cases, to customer specifications and their acceptance is based on meeting those specifications, the Company historically has experienced minimal warranty costs. Estimates of the costs of warranty obligations are based on the Company’s historical experience of known product failure rates, use of materials and service delivery costs incurred in correcting product failures. In addition, from time to time, specific warranty accruals may be made if unforeseen technical problems arise. Should the Company’s actual experience relative to these factors differ from estimates, the Company may be required to record additional warranty reserves. Alternatively, if the Company provides more reserves than needed, the Company may reverse a portion of such provisions in future periods.
		Inventory valuation
		The Company regularly assesses the valuation of inventories and writes down those inventories that are obsolete or in excess of forecasted usage to their estimated realizable value. Estimates of realizable value are based upon the Company’s analyses and assumptions including, but not limited to, forecasted sales levels by product, expected product lifecycle, product development plans and future demand requirements. If market conditions are less favorable than the Company’s forecast or actual demand from customers is lower than the Company’s estimates, the Company may be required to record additional inventory write-downs. If demand is higher than expected, the Company may sell inventories that had previously been written down. Inventories are valued at the lower of cost or market using the first-in, first-out (FIFO) method. Cost is determined using standard cost, which approximates actual cost.
		Property, plant and equipment
		The Company evaluates the carrying value of property, plant and equipment whenever certain events or changes in circumstances indicate that the carrying amount may not be recoverable. Such events or circumstances include, but are not limited to, a prolonged industry downturn, a significant decline in the Company’s market value, or significant reductions in projected future cash flows. In assessing the recoverability of property, plant and equipment, the Company compares the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, the Company writes down such assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows using a discount rate based upon the Company’s weighted average cost of capital. Significant judgments and assumptions are required in the forecast of future operating results used in the preparation of the estimated future cash flows, including long-term forecasts of the amounts and timing of overall market growth and the Company’s percentage of that market, groupings of assets, discount rate and terminal growth rates. Changes in these estimates could have a material adverse effect on the assessment of property, plant and equipment, thereby requiring the Company to write down the assets.
		Deferred taxes
		The Company regularly assesses the likelihood that deferred tax assets will be recovered from future taxable income. If necessary, the Company records a valuation allowance to reduce deferred tax assets to the amount that the Company believes to be realizable. The Company considers projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance. If it is determined that the Company will not realize all or part of deferred tax assets, an adjustment to the deferred tax asset will be charged to earnings in the period such determination is made.
		Financial Results
		Three Months Ended September 30, 2003 Compared with Three Months Ended September 30, 2002
		Net Sales
		Net sales declined 30.9% from $5.4 million for the quarter ended September 30, 2002 to $3.7 million for the quarter ended September 30, 2003. This decline reflects the overall decline in the demand for fiberoptic components and test equipment by telecommunications equipment vendors, the Company’s primary customers, as well as increased competition for the remaining business opportunities. It is still unclear when an upturn in demand might occur.

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		In the quarter ended September 30, 2003, the Company recorded no revenue from cancellations of prior supply agreements with customers compared with $1.2 million in cancellation revenue from this source in the same period of the prior year. This revenue represents actual cash payments received during that quarter.
		The fiberoptic communications industry is characterized by dynamic technological changes. Specific products may have a relatively short product life, even though basic product designs may have a substantial life. Generally, customers expect prices to decline steadily. During the current period of significant excess capacity, the pressure to reduce average selling prices may even be greater. DiCon seeks to offset this trend through new product introductions with higher average selling prices and through aggressive programs to improve manufacturing yields and cost reductions. There is no certainty that these programs will be successful to offset the pricing pressure from customers in the future. For the quarter ended September 30, 2003, the declining revenues were due both to a decline in selling prices and to decline in the volume of goods shipped.
		Sales to different geographic areas may fluctuate from period to period depending on various factors such as new system development, purchase cycle and price. Net sales to customers outside North America represented 48% of total net sales for the quarter ended September 30,2003, as compared to 23% for the quarter ended September 30, 2002, respectively.
		As of September 30, 2003 and 2002, the Company experienced the following concentrations with sales.

		Sales to DiCon’s leading customers vary significantly from year to year and DiCon does not have the ability to predict future sales to these customers. However, if the downturn in the telecommunications industry continues, DiCon expects telecommunications carriers to continue their current levels of capital spending, which may further affect DiCon’s sales.
		Cost of Goods Sold and Gross Margin
		Costs of goods sold declined 15.8% from $5.4 million in the quarter ended September 30, 2002, to $4.6 million in the quarter ended September 30, 2003. Gross margin as a percentage of net sales was negative 23.1% in the quarter ended September 30, 2003, compared to negative 1.0% in the quarter ended September 30, 2002. The decrease in gross margin was primarily attributable to the $1.2 million that was recorded from the cancellation of prior supply agreements with customers in the quarter ended September 30, 2002 as compared to zero in the same period of the current year. The Company scrapped $37,000 and $672,000 of materials for the quarter ended September 30, 2003 and, 2002 respectively. For the quarter ended September 30, 2003, the Company wrote off impaired inventory cost of $414,000.
		Gross margin can be affected by a number of factors, including product mix, customer mix, applications mix, product demand, pricing pressures, manufacturing constraints, higher costs resulting from new production facilities, and product yield. Considering these factors, gross margin fluctuations are difficult to predict and there can be no assurance that DiCon will achieve or maintain gross margin percentages at historical levels in future periods and DiCon expects losses to continue in future periods if market demand stays at the current level.
		Operating Expenses
		Selling, General and Administrative Expenses
		Selling, general and administrative (“SG&A”) expense was $1.3 million in the quarter ended September 30, 2003, compared to $1.8 million in the quarter ended September 30, 2002. The decrease in SG&A was the result of reduction in personnel and other expenses.

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		Research and Development Expenses
		Research and development (“R&D”) expense was $1.6 million in the quarter ended September 30, 2003, compared to $3.4 million in quarter ended September 30, 2002. The decrease in R&D spending reflects the cost reductions resulting from further consolidation of product development programs and workforce reductions. Future expenditures are expected to fluctuate both in absolute dollars and as a percentage of revenue based on the need to invest in new R & D in order to remain competitive in this rapidly changing industry.
		Other Income (Expense)
		Other income (expense) composed of interest expense, net, loss on disposal of fixed assets and others, was $0.3 million in the quarter ended September 30, 2003, compared to expenses of $1.1 million for the quarter ended September 30, 2002. The reduction of expenses is primarily attributable to decreased interest expenses associated with DiCon’s real estate loan and equipment loan as well as reduced imputed interest on required payments under the terms of the conversion of the Phantom Stock Plan to the Employee Stock Option Plan.
		Loss Before Income Tax Benefit
		The Company reported a net loss before income tax benefit of $4.1 million for the current quarter compared to $6.4 million for the same quarter in the prior year.
		Income Tax Benefit
		For the quarter ended September 30, 2002, the Company recorded $3.5 million of income tax benefit. The Company had sufficient income for federal income tax purposes in prior years to carryback the anticipated losses from that year, and to receive a refund. Thus, the Company accrued an income tax receivable for this amount which was received in full in June 2003. California state income taxes may not be carried back to prior years. The losses for California purposes may result in lower taxes paid in the future, depending on the then current tax laws for California.
		Due to uncertainty surrounding the realization of favorable tax attributes in future tax returns, the Company recorded a valuation allowance against its net operating losses and credits at March 31, 2003. The Company’s income tax benefit at September 30, 2003 of $0.3 million is composed of a decrease in the net deferred tax liability arising from temporary differences between the financial reporting and tax bases of assets and liabilities. Management regularly evaluates the recoverability of the deferred tax asset and the level of the valuation allowance. At such time as it is determined that it is more likely than not that the deferred tax asset will be realizable, the valuation allowance will be reduced.
		For the three months ended September 30, 2003, the effective tax rate was (7.5)% compared to (54.3)% for the same period in the prior year. The tax rate for each period is the result of the consolidation of tax provision of the US operations with that of the Taiwan operations of Global Fiberoptics, and can vary substantially from period to period depending on the relative performance of each operation.
		Six Months Ended September 30, 2003 Compared with Six Months Ended September 30, 2002
		Net Sales
		Net sales declined 37.4% from $11.9 million for the six months ended September 30, 2002 to $7.5 million for the six months ended September 30, 2003. This decline reflects the overall decline in the demand for fiberoptic components and test equipment by telecommunications equipment vendors, the Company’s primary customers, as well as increased competition for the remaining business opportunities. It is still unclear when an upturn in demand might occur.
		In the six months ended September 30, 2003, the Company recorded no revenue from cancellations of prior supply agreements with customers compared with $1.2 million in cancellation revenue from this source in the same period of the prior year. This revenue represents actual cash payments received during that period.
		The fiberoptic communications industry is characterized by dynamic technological changes. Specific products may have a relatively short product life, even though basic product designs may have a substantial life. Generally, customers expect prices to decline steadily. During the current period of significant excess capacity, the pressure to reduce average selling prices may even

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		be greater. DiCon seeks to offset this trend through new product introductions with higher average selling prices and through aggressive programs to improve manufacturing yields and cost reductions. There is no certainty that these programs will be successful to offset the pricing pressure from customers in the future. For the six months ended September 30, 2003, the declining revenues were due both to a decline in selling prices and to decline in the volume of goods shipped.
		Sales to different geographic areas may fluctuate from period to period depending on various factors such as new system development, purchase cycle and price. Net sales to customers outside North America represented 50% of total net sales for the six months ended September 30, 2003, as compared to 27% for the six months ended September 30, 2002, respectively.
		As of September 30, 2003 and 2002, the Company experienced the following concentrations with sales.

		Sales to DiCon’s leading customers vary significantly from year to year and DiCon does not have the ability to predict future sales to these customers. However, if the downturn in the telecommunications industry continues, DiCon expects telecommunications carriers to continue their current levels of capital spending, which may further affect DiCon’s sales.
		Cost of Goods Sold and Gross Margin
		Costs of goods sold declined 23.4% from $11.9 million in the six months ended September 30, 2002, to $9.1 million in the six months ended September 30, 2003. Gross margin as a percentage of net sales was negative 22.4% in the six months ended September 30, 2003, compared to zero in the six months ended September 30, 2002. The decrease in gross margin was primarily attributable to the $1.2 million that was recorded from the cancellation of prior supply agreements with customers in the six months ended September 30, 2002 as compared to zero in the same period of the current year. The Company scrapped $0.3 million and $0.7 million of materials for the six months ended September 30, 2003 and 2002 respectively. For the six months ended September 30, 2003, the Company wrote off impaired inventory cost of $0.6 million.
		Gross margin can be affected by a number of factors, including product mix, customer mix, applications mix, product demand, pricing pressures, manufacturing constraints, higher costs resulting from new production facilities, and product yield. Considering these factors, gross margin fluctuations are difficult to predict and there can be no assurance that DiCon will achieve or maintain gross margin percentages at historical levels in future periods and DiCon expects losses to continue in future periods if market demand stays at the current level.
		Operating Expenses
		Selling, General and Administrative Expenses
		Selling, general and administrative (“SG&A”) expense was $2.8 million for the six months ended September 30, 2003, compared to $4.8 million for the six months ended September 30, 2002. The decrease in SG&A was the result of reduction in personnel and other expenses.
		Research and Development Expenses
		Research and development (“R&D”) expense was $3.4 million for the six months ended September 30, 2003, compared to $9.0 million for six months ended September 30, 2002. The decrease in R&D spending reflects the cost reductions resulting from further consolidation of product development programs and workforce reductions. Future expenditures are expected to fluctuate both in absolute dollars and as a percentage of revenue based on the need to invest in new R&D in order to remain competitive in this rapidly changing industry.

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		Other Income (Expense)
		Other income (expense) composed of interest expense, net, loss on disposal of fixed assets and others, was approximately $0.5 million for the six months ended September 30, 2003, compared to expenses of $1.9 million for the six months ended September 30, 2002. The reduction of expenses is primarily attributable to decreased interest expenses associated with DiCon’s real estate loan and equipment loan as well as reduced imputed interest on required payments under the terms of the conversion of the Phantom Stock Plan to the Employee Stock Option Plan.
		Loss Before Income Tax Benefit
		The Company reported loss before income tax benefit for the six months ended September 30, 2003 has been reduced to $8.3 million compared to $15.7 million for the same six months in the prior year.
		Income Tax Benefit
		For the six months ended September 30, 2002, the Company recorded $6.5 million of income tax benefit. The Company had sufficient income for federal income tax purposes in prior years to carryback the anticipated losses from that year, and to receive a refund. Thus, the Company accrued an income tax receivable for this amount which was received in full in June 2003. California state income taxes may not be carried back to prior years. The losses for California purposes may result in lower taxes paid in the future, depending on the then current tax laws for California.
		Due to uncertainty surrounding the realization of favorable tax attributes in future tax returns, the Company recorded a valuation allowance against its net operating losses and credits at March 31, 2003. The Company’s income tax benefit at September 30, 2003 of approximately $0.6 million is composed of a decrease in the net deferred tax liability arising from temporary differences between the financial reporting and tax bases of assets and liabilities. Management regularly evaluates the recoverability of the deferred tax asset and the level of the valuation allowance. At such time as it is determined that it is more likely than not that the deferred tax asset will be realizable, the valuation allowance will be reduced.
		For the six months ended September 30, 2003, the effective tax rate was (7.0)% compared to (41.5)% for the same period in the prior year. The tax rate for each period is the result of the consolidation of tax provision of the US operations with that of the Taiwan operations of Global Fiberoptics, and can vary substantially from period to period depending on the relative performance of each operation.
		Liquidity and Capital Resources
		Net cash provided by operations of $11.6 million increased at September 30, 2003 from a cash outflow of $2.3 million for the six months ended September 30, 2002. The increase is primarily due to an income tax refund of $15.3 million offset by the net loss for the six months ended September 30, 2003. Accounts receivable were lower in the six months ended September 30, 2003, due to a decline in net sales. Inventory levels were lower primarily as a result of lower purchase and production volumes, a write down of inventory to the lower of cost or market and due to the excess and obsolence inventory provision.
		Net cash from operations may continue to be negative unless the business climate for the Company improves or the Company is able to substantially reduce operating costs. If sales remain at current levels or decline further and the Company is unable to reduce its spending rates substantially, the Company will continue to use cash for operating expenses and may suffer adverse consequences at some future date.
		Cash used in investing activities increased from $8.0 million for the six months ended September 30, 2002 to $13.6 million in the current period. This is primarily the result of efforts to increase earnings on working capital by investing in certificates of deposits with maturities in excess of 90 days and mutual funds of $14.5 million during the six months ended September 30, 2003 as compared to $6.8 million for the six months ended September 31, 2002. All certificates mature in one year or less. Additionally, the Company sold approximately $1.0 million of marketable securities during the current period.
		For the six months ended September 30, 2002, the Company made a long-term investment of $0.5 million for a minority interest in a firm in Taiwan. Purchases of equipment declined from $1.5 million in the six months ended September 30, 2002 to approximately $34,000 in the same six months this year.