ALLIANCE FIBER OPTIC PRODUCTS INC - FORM 10-Q

Attached files

file	filename
EX-31.1 - RULE 13A-14(A) CERTIFICATION OF CHIEF EXECUTIVE OFFICER - ALLIANCE FIBER OPTIC PRODUCTS INC	exhibit31-1.htm
EX-32.1 - STATEMENT OF CHIEF EXECUTIVE OFFICER UNDER SECTION 906 - ALLIANCE FIBER OPTIC PRODUCTS INC	exhibit32-1.htm
EX-32.2 - STATEMENT OF ACTING CHIEF FINANCIAL OFFICER UNDER SECTION 906 - ALLIANCE FIBER OPTIC PRODUCTS INC	exhibit32-2.htm
EXCEL - IDEA: XBRL DOCUMENT - ALLIANCE FIBER OPTIC PRODUCTS INC	Financial_Report.xls
EX-31.2 - RULE 13A-14(A) CERTIFICATION OF ACTING CHIEF FINANCIAL OFFICER - ALLIANCE FIBER OPTIC PRODUCTS INC	exhibit31-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________________

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

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

For the transition period from __________ to __________

Commission File Number 0-31857

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

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

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

(408) 736-6900
(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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated Filer o	Non-accelerated filer o	Smaller reporting company þ
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

On October 31, 2011, 8,893,515 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

ALLIANCE FIBER OPTIC PRODUCTS, INC.

FORM 10-Q

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2011

INDEX

	Page
PART I: FINANCIAL INFORMATION	1
ITEM 1: FINANCIAL STATEMENTS	1
Condensed Consolidated Balance Sheets	1
Condensed Consolidated Statements of Operations	2
Condensed Consolidated Statements of Cash Flows	3
Notes to Condensed Consolidated Financial Statements	4
ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS	12
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	17
ITEM 4: CONTROLS AND PROCEDURES	17
PART II: OTHER INFORMATION	18
ITEM 1A: RISK FACTORS	18
ITEM 6: EXHIBITS	28
SIGNATURE	29

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

ALLIANCE FIBER OPTIC PRODUCTS, INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)

	September 30,			December 31,
	2011			2010
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	14,992		$	8,040
Short-term investments		22,012			37,320
Accounts receivable, net		7,843			7,224
Inventories, net		7,482			7,439
Prepaid expense and other current assets		656			733
Total current assets		52,985			60,756

Long-term investments		10,054			-
Property and equipment, net		7,717			7,523
Other assets		172			170

Total assets	$	70,928		$	68,449

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	4,321		$	4,931
Accrued expenses		3,316			4,633
Current portion of bank loan		101			104
Total current liabilities		7,738			9,668

Long-term liabilities:
Bank loan		147			231
Other long-term liabilities		550			546
Total long term liabilities		697			777
Total liabilities		8,435			10,445

Commitments and contingencies (Note 8)

Stockholders' equity:
Common stock, $0.001 par value: 20,000,000 shares authorized;
8,893,515 and 8,793,636 shares issued and outstanding at
September 30, 2011 and December 31, 2010.		9			9
Additional paid-in-capital		114,813			113,707
Accumulated deficit		(54,060	)		(57,784	)
Accumulated other comprehensive income		1,731			2,072

Stockholders' equity		62,493			58,004

Total liabilities and stockholders' equity	$	70,928		$	68,449

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011			2010
Revenues	$	11,778	$	13,276	$	31,883		$	33,768
Cost of revenues		7,963		8,563		21,580			22,309
Gross profit		3,815		4,713		10,303			11,459
Operating expenses:
Research and development		834		882		2,356			2,461
Sales and marketing		595		643		1,711			1,840
General and administrative		1,052		978		3,095			2,882
Total operating expenses		2,481		2,503		7,162			7,183
Income from operations		1,334		2,210		3,141			4,276
Interest and other income, net		149		102		452			358
Net income before tax		1,483		2,312		3,593			4,634
Income tax (benefit) expense		29		248		(131	)		323
Net income	$	1,454	$	2,064	$	3,724		$	4,311
Net income per share:
Basic	$	0.16	$	0.24	$	0.42		$	0.50
Diluted	$	0.16	$	0.23	$	0.41		$	0.49
Shares used in computing net income per share:
Basic		8,883		8,575		8,853			8,537
Diluted		9,040		8,826		9,119			8,734
Included in costs and expenses above:
Stock based compensation charges
Cost of revenue	$	28	$	28	$	74		$	62
Research and development		29		11		48			23
Sales and marketing		63		13		117			23
General and administrative		139		35		274			63
Total	$	259	$	87	$	513		$	171

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

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

	Nine Months Ended September 30,
	2011			2010
Cash flows from operating activities:
Net Income	$	3,724		$	4,311
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization		1,131			791
Loss on disposal of property and equipment		6			4
Amortization of stock-based compensation		513			171
Provision for inventory		(176	)		67
Changes in assets and liabilities:
Accounts receivable		(620	)		(3,120	)
Inventories		133			(2,205	)
Prepaid expenses and other assets		77			(293	)
Other assets		(2	)		69
Accounts payable		(611	)		2,790
Accrued expenses		(1,317	)		665
Other long-term liabilities		5			49
Net cash provided by operating activities		2,863			3,299

Cash flows from investing activities:
Purchase of short-term investments		(12,341	)		(19,353	)
Proceeds from sales and maturities of short-term investments		27,636			23,298
Purchase of long-term investments		(10,054	)		-
Purchase of property and equipment		(1,304	)		(3,044	)
Net cash provided by investing activities		3,937			901

Cash flows from financing activities:
Proceeds from issuance of common stock under ESPP		210			118
Proceeds from the exercise of stock options		383			265
Repayment of bank borrowings		(68	)		(90	)
Net cash provided by financing activities		525			293

Effect of exchange rate changes on cash and cash equivalents		(373	)		269
Net increase in cash and cash equivalents		6,952			4,762
Cash and cash equivalents at beginning of period		8,040			8,525
Cash and cash equivalents at end of period	$	14,992		$	13,287

Supplemental disclosure of cash flow information:
Cash paid for interest	$	(6	)	$	(8	)

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

ALLIANCE FIBER OPTIC PRODUCTS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Summary of Significant Accounting Policies

The Company

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

Basis of Presentation

The accompanying condensed consolidated balance sheet as of December 31, 2010, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of September 30, 2011 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and include the accounts of Alliance Fiber Optic Products, Inc. and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the SEC on March 18, 2011. The unaudited condensed consolidated financial statements as of September 30, 2011, and for the three and nine months ended September 30, 2011 and 2010, reflect, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial information set forth herein. The results of operations for the interim periods are not necessarily indicative of the results to be expected for any subsequent interim period or for an entire year.

There have been no significant changes in the Company’s critical accounting policies during the nine months ended September 30, 2011 as compared to what was previously disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2010.

Revenue Recognition

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

Allowance for Doubtful Accounts

Allowances are provided for estimated returns and potential uncollectable trade receivables. Provisions for return allowances are recorded at the time revenue is recognized based on our historical returns, current economic trends and changes in customer demand. Such allowances are adjusted periodically to reflect actual and anticipated experience. We also identify specific accounts considered to have a high risk of uncollectibility and reserve the full amount. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist primarily of market rate accounts, corporate bonds, certificates of deposit, and commercial paper.

Short-Term and Long-Term Investments

The Company generally invests its excess cash in certificates of deposit, corporate bonds, and commercial paper. Such investments are made in accordance with the Company’s investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates.

Concentrations of Risk

Our connectivity products contributed 73.6% and 65.00% of our revenues for the three months ended September 30, 2011 and 2010, respectively. Our optical passive products contributed 26.4% and 35.0% of our revenues for the three months ended September 30, 2011 and 2010, respectively.

Our connectivity products contributed 75.6% and 68.5% of our revenues for the nine months ended September 30, 2011 and 2010, respectively. Our optical passive products contributed 24.4% and 31.5% of our revenues for the nine months ended September 30, 2011 and 2010, respectively.

In the three months ended September 30, 2011 and 2010, our top 10 customers comprised 68.6% and 68.7% of our revenues, respectively. For the three months ended September 30, 2011, two customers accounted for 13.8% and 11.7% of our total revenues, respectively. Amounts due from these customers were $1.2 million and $1.0 million, respectively, at September 30, 2011. For the three months ended September 30, 2010, two customers accounted for 16.7% and 16.3% of our total revenues, respectively. Amounts due from these customers were $1.8 million and $1.9 million, respectively, at September 30, 2010.

In the nine months ended September 30, 2011 and 2010, our top 10 customers comprised 63.6% and 69.2% of our revenues, respectively. For the nine months ended September 30, 2011, one customer accounted for 14.8% of our revenues. For the nine months ended September 30, 2010, three customers accounted for 15.2%, 15.2% and 10.2% of our revenues, respectively.

2. Recent Accounting Pronouncements and Accounting Changes

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance to amend the disclosure requirements related to fair value measurements. The guidance will add new requirements for disclosures into and out of Levels 1 and 2 fair value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. It also clarifies existing fair value disclosures about the level of disaggregation, inputs, and valuation techniques. The Company adopted the guidance effective January 1, 2011, as required. The adoption of the new guidance did not have a material effect on the Company’s consolidated financial position or results of operations.

In June 2011, the FASB issued guidance amending the presentation requirements for comprehensive income. For public entities, this guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 with early adoption permitted. Upon adoption, The Company will have the option to report total comprehensive income, including components of net income and components of other comprehensive income, as a single continuous statement or in two separate but consecutive statements. The Company does not anticipate the adoption of this guidance will have a material impact on our consolidated financial statements.

3. Stock-based Compensation

The Accounting Standards Codification (“ASC”) 718 requires companies to record compensation expense for stock options measured at fair value, on the date of grant, using an option-pricing model. The fair value of stock options granted and stock purchased pursuant to the Employee Stock Purchased Plan (“ESPP”) prior to June 30, 2010 was determined using the Binomial Lattice Model. The Company adopted the Black-Scholes valuation model for stock options granted and stock purchased pursuant to the ESPP after June 30, 2010. The Company believes that the Black-Scholes model is more appropriate in determining fair value of its stock-based compensation and does not differ materially from the previous valuation model used.

At September 30, 2011, the Company had one stock-based compensation plan, the 2000 Stock Incentive Plan, which is described below.

In November 2000, the Company adopted its 2000 Stock Incentive Plan under which 1,500,000 shares of common stock were reserved for issuance to eligible employees, directors and consultants upon exercise of stock options and stock purchase rights. The plan was amended and restated in 2010 to, among other things, extend the term under which awards may be granted under the plan until March 17, 2020, eliminate a 10 million share ceiling on the aggregate number of shares of common stock that may be issued under the plan, and to include certain qualifying performance criteria and annual award limits so that awards granted under the plan qualify as “performance-based compensation" under the requirements of Section 162(m) of the Internal Revenue Code of 1986, as amended.

Under the 2000 Stock Incentive Plan, participants may be granted restricted stock units (“RSUs”), representing an unfunded, unsecured right to receive a Company common share on the date specified in the recipient’s award. The RSUs granted under the plan generally vest over two years at a rate of 50 percent per year or five years at a rate of 20 percent per year. The Company recognizes compensation expense on a straight-line basis over the two-year and five-year vesting term of each award.

Options granted under the 2000 Stock Incentive Plan generally vest over four years and are exercisable for not more than ten years. However, most options granted in the past four years have been fully vested at the time of grant. Options are exercisable for not more than ten years.

The following information relates to stock option activity for the nine months ended September 30, 2011:

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
Options	Shares		Price		Life	Value
Outstanding at December 31, 2010	920,040		$	7.27
Granted	-			-
Exercised	(75,100	)		5.10
Forfeited	(18,060	)		16.71
Outstanding at September 30, 2011	826,880		$	7.26	5.19 Years	$	781,279
Vested and expected to vest at September 30, 2011	817,877		$	7.25	5.15 Years	$	780,725
Exercisable at September 30, 2011	677,058		$	7.09	4.37 Years	$	770,667

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of fiscal 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2011. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised was $0.09 million and $0.3 million for the three and nine months ended September 30, 2011, respectively. The total intrinsic value of options exercised for the three and nine months ended September 30, 2010 was de minimis.

No options were granted during the three months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, there was $0.5 million of total unrecognized compensation cost related to share-based compensation arrangements granted under the plan. The compensation cost is expected to be realized over four years.

Cash received from option exercises during the three and nine months ended September 30, 2011 was $0.1 million and $0.4 million, respectively, and is included within the financing activities section in the accompanying condensed consolidated statements of cash flows.

During the nine months ended September 30, 2011, a total of 24,789 shares were issued under the employee stock purchase plan and cash received from the purchases were $0.2 million. The compensation expense recorded in the quarter ended September 30, 2011 was approximately $0.04 million. As of September 30, 2011, there was $0.01 million of unrecognized compensation cost related to the ESPP which is expected to be realized over the next month.

During the nine months ended September 30, 2011, the Company granted 273,000 RSUs with a total grant-date fair value of $2.5 million. The resulting compensation expense recorded in the quarter ended September 30, 2011 was approximately $0.2 million. There was $2.2 million of total unrecognized compensation cost related to RSUs granted under the Plan, of which $0.5 million is expected to be realized over two years and $1.7 million is expected to be realized over five years.

The following table summarizes employee stock-based compensation expense resulting from the stock options, RSUs, and the ESPP (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Included in cost of revenue	$	28	$	28	$	74	$	62
Included in operating expenses:
Research and development		29		11		48		23
Sales and marketing		63		13		117		23
General and administrative		139		35		274		63
Total		231		59		439		109
Total stock-based compensation expense	$	259	$	87	$	513	$	171

4. Inventories, net (in thousands)

	September 30,		December 31,
	2011		2010
Inventories:
Finished goods	$	2,496	$	2,211
Work-in-process		2,623		2,713
Raw materials		2,363		2,515
	$	7,482	$	7,439

5. Net Income Per Share

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Numerator:
Net income	$	1,454	$	2,064	$	3,724	$	4,311
Denominator:
Shares used in computing net income per share:
Basic		8,883		8,575		8,853		8,537
Diluted		9,040		8,826		9,119		8,734
Net income per share:
Basic	$	0.16	$	0.24	$	0.42	$	0.51
Diluted	$	0.16	$	0.23	$	0.41	$	0.49

The total number of shares excluded from the calculation of diluted net income per share is as follows (in thousands), because the effect would be anti-dilutive:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2011	2010	2011	2010
Antidilutive stock options and restricted stock units
not included in income per share calculation	-	203	-	179

6. Comprehensive Income

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

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

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011			2010
Net income	$	1,454		$	2,064	$	3,724		$	4,311
Cumulative translation adjustments		(914	)		358		(328	)		421
Unrealized gain (loss) on investments		2			43		(13	)		16
Total comprehensive income	$	542		$	2,465	$	3,383		$	4,748

7. Income Taxes

The Company adopted ASC 740, Accounting for Uncertainty in Income Taxes, on January 1, 2007. It is the Company's accounting policy to record income tax interest and penalties in the income tax provision. The Company did not have any material unrecognized tax benefits or uncertain tax positions at September 30, 2011.

8. Commitments and Contingencies

Litigation:

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

Indemnification and Product Warranty:

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

The Company generally warrants products against defects in materials and workmanship and non-conformance to specifications for varying lengths of time. If there is a material increase in customer claims compared with historical experience, or if costs of servicing warranty claims are greater than expected, the Company may record a charge against cost of revenues. The Company accrued $0.02 million for warranty reserves at each of September 30, 2011 and 2010.

Operating Leases:

The Company leases office space under long-term operating leases expiring at various dates through 2016.

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

Years ending December 31:
2011 (remainning three months of the year)	$	171
2012		661
2013		383
2014		337
2015		211
Thereafter		18
Total	$	1,781

9. Bank Loans

In November 2004, the Company entered into a ten-year loan of $0.5 million in Taiwan with an interest rate of 2.3% for the first two years and 3.6% for the following years. In November 2006, the Company entered into a seven-year loan of $0.2 million in Taiwan with an interest rate of 2.8%. Both loans are secured by the Company’s building in Taiwan. In September 2007, the Company also entered a five-year equipment loan of $0.1 million with an interest rate of 3.68%.

Payments due under the Company’s bank loans as of September 30, 2010 were as follows (in thousands):

Years ending December 31,
2011		27
2012		100
2013		79
2014		51
Total payment		257
Less: Amounts representing interest		(9	)
Present value of net remaining payments		248
Less: current portion		(101	)
Long-term portion	$	147

10. Related Party Transactions

As of September 30, 2011, Foxconn Holding Limited was a holder of 17.99% of the Company’s common stock, based on share ownership information set forth in a Schedule 13G filed by Foxconn Holding Limited on January 4, 2002. The Company sells products to and purchases raw materials from Hon Hai Precision Company Limited (“Hon Hai”), who is the parent company of Foxconn Holding Limited, in the normal course of business. These transactions were made at prices and terms consistent with those with unrelated third parties. There were no sales of products to Hon Hai for the three months ended September 30, 2011. Sales of products to Hon Hai were $0.02 million for the nine months ended September 30, 2011. There were no sales of products to Hon Hai for the three and nine months ended September 30, 2010. Amounts due from Hon Hai were de miniums at September 30, 2011 and 2010 respectively. Purchases of raw materials from Hon Hai were $0.3 million and $0.9 million for the three and nine months ended September 30, 2011, respectively. Purchases of raw materials from Hon Hai were $0.9 million and $2.5 million for the three and nine months ended September 30, 2010, respectively. Amounts due to Hon Hai were $0.4 million and $0.9 million at September 30, 2011 and 2010 respectively.

11. Fair Value of Financial instruments

Effective January 1, 2008, the Company adopted ASC 820 which provides a definition of fair value, establishes a hierarchy for measuring fair value under generally accepted accounting principles, and requires certain disclosures about fair values used in the financial statements. ASC 820 does not extend the use of fair value beyond what is currently required by other pronouncements, and it does not pertain to stock-based compensation under ASC 718, Share-Based Payments or to leases under ASC 840, Accounting for Leases.

In February 2008, FASB ASC 820 was issued. This FASB Staff Position provides a one year deferral of the effective date of ASC 820 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company has adopted the provisions of ASC 820 with respect to financial assets and liabilities only.

ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company measures the following financial assets at fair value on a recurring basis. The fair values of these financial assets at September 30, 2011 and December 31, 2010 (in thousands) were as follows:

			in Active		Other		Significant
	Balance at		Markets for		Observable		Unobservable
	September 30,		Identical Assets		Inputs		Inputs
	2011		(Level 1)		(level 2)		(Level 3)
Cash equivalents:
Money market mutual funds	$	13,998	$	13,998	$	-	$	-
Marketable Securities:
Time deposits		21,560		21,560		-		-
Corporate bonds		452		-		452		-
Long-term investments:
Time deposits		10,054		10,054		-		-
Total	$	46,065	$	45,612	$	452	$	-

	Fair Value Measurements at
	Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
	Balance at		Markets for		Observable		Unobservable
	December 31,		Identical Assets		Inputs		Inputs
	2010		(Level 1)		(level 2)		(Level 3)
Cash equivalents:
Money market mutual funds	$	5,194	$	5,194	$	-	$	-
Marketable Securities:
Time deposits		21,578		21,578		-		-
Commercial paper		2,994		-		2,994		-
Corporate bonds		12,748		-		12,748		-
Total	$	42,514	$	26,772	$	15,742	$	-

As of September 30, 201, the Company held investments in corporate bonds, certificates of deposit, and money market securities. The Company’s cash and cash equivalents are comprised of investments with original maturities of 90 days or less from the date of purchase. The Company’s short-term investments are comprised of corporate bonds and certificates of deposit with original maturities of 91 days or more from the date of purchase. The Company’s long-term investment is comprised of certificates of deposit with original maturities of 365 days or more from the date of purchase.

12. Geographic Segment Information

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

The following is a summary of the Company’s revenues generated from geographic segments, revenues generated by product lines and identifiable assets located in these segments (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Revenues
North America	$	6,495	$	5,594	$	17,544	$	15,584
Europe		2,221		3,914		5,509		8,899
Asia		3,062		3,768		8,830		9,285
	$	11,778	$	13,276	$	31,883	$	33,768

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Revenues
Connectivity Products	$	8,665	$	8,630	$	24,098	$	23,145
Optical Passive Products		3,113		4,646		7,785		10,623
	$	11,778	$	13,276	$	31,883	$	33,768

	September 30,		December 31,
	2011		2010
Property and Equipment
United States	$	98	$	79
Taiwan		3,434		3,589
China		4,185		3,855
	$	7,717	$	7,523

13. Subsequent Event

We evaluated subsequent events through the time of the filing of this report on Form 10-Q. We are not aware of any significant events that occurred subsequent to the balance sheet date prior to the filing of this report that would have a material impact on our condensed consolidated financial statements.

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

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

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

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, bad debts, inventories, asset impairments, income taxes, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values for assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

For additional information regarding our critical accounting policies and estimates, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2010.

Overview

We were founded in December 1995 and commenced operations to design, manufacture and market fiber optic interconnect products, which we call our connectivity products. We started selling our optical passive products in July 2000. Since their introduction, sales of optical passive products have fluctuated with the overall market for these products.

Our connectivity products contributed revenues of $8.7 million, or 73.6% and $8.6 million, or 65.0% for the three months ended September 30, 2011 and 2010, respectively. Our optical passive products contributed revenues of $3.1 million, or 26.4% and $4.7 million, or 35.0% for the three months ended September 30, 2011 and 2010, respectively.

Our connectivity products contributed revenues of $24.1 million, or 75.6% and $23.2 million, or 68.5% for the nine months ended September 30, 2011 and 2010, respectively. Our optical passive products contributed revenues of $7.8 million, or 24.4% and $10.6 million, or 31.5% for the nine months ended September 30, 2011 and 2010, respectively.

In the three months ended September 30, 2011 and 2010, our top 10 customers comprised 68.6% and 68.7% of our revenues, respectively. For the three months ended September 30, 2011, two customers accounted for 13.8% and 11.7% of our total revenues. For the three months ended September 30, 2010, two customers accounted for 16.7% and 16.3% of our total revenues.

In the nine months ended September 30, 2011 and 2010, our top 10 customers comprised 63.6% and 69.2% of our revenues, respectively. For the nine months ended September 30, 2011, one customer accounted for 14.8% of our total revenue. For the nine months ended September 30, 2010, three customers accounted for 15.2%, 15.2% and 10.2% of our total revenues, respectively.

We market and sell our products predominantly through our direct sales force.

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

changes in manufacturing volume;
costs incurred in establishing additional manufacturing lines and facilities;
inventory write-downs and impairment charges related to manufacturing assets;
mix of products sold;
changes in our pricing and pricing from our competitors;
mix of sales channels through which our products are sold; and
mix of domestic and international sales.

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

Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as costs associated with trade shows, promotional activities and travel expenses. We intend to continue to invest in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. However, we cannot be certain that our expenditures will result in higher revenues. In addition, we believe that our future success depends upon establishing successful relationships with a variety of key customers.

General and administrative expenses consist primarily of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting support.

Results of Operations

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

	Three Months Ended September 30,		Nine Months Ended September 30,
	2011	2010	2011			2010
Revenues	100.0%	100.0%		100.0%		100.0%
Cost of revenues	67.6	64.5		67.7		66.0
Gross profit	32.4	35.5		32.3		34.0
Operating expenses:
Research and development	7.1	6.6		7.4		7.3
Sales and marketing	5.0	4.8		5.3		5.5
General and administrative	9.0	7.4		9.7		8.5
Total operating expenses	21.1	18.8		22.4		21.3

Income from operations	11.3	16.7		9.9		12.7
Interest and other income, net	1.3	0.7		1.4		1.0
Net income before tax	12.6	17.4		11.3		13.7
Income tax	0.3	1.9		(0.4	)	1.0
Net income	12.3%	15.5%		11.7%		12.7%

Revenues. Revenues were $11.8 million and $13.3 million for the three months ended September 30, 2011 and 2010, respectively. Revenues decreased 11.3% in the quarter ended September 30, 2011 from the same period in 2010. Revenues were $31.9 million and $33.8 million for the nine months ended September 30, 2011 and 2010, respectively. Revenues decreased 5.6% in the nine months ended September 30, 2011 from the same period in 2010. The decrease for the three and nine months ended September 30, 2011 was mainly due to decreased orders from our existing customers and lower volume shipments of telecom and datacom applications related products.

Cost of Revenues. Cost of revenues was $8.0 million and $8.6 million for the three months ended September 30, 2011 and 2010, respectively. Cost of revenues as a percentage of revenues increased to 67.6% for the three months ended September 30, 2011 from 64.5% for the three months ended September 30, 2010. Cost of revenues was $21.6 million and $22.3 million for the nine months ended September 30, 2011 and 2010, respectively. Cost of revenues as a percentage of revenues increased to 67.7% for the nine months ended September 30, 2011 from 66.0% for the nine months ended September 30, 2010. The higher percentage cost of revenues for the three and nine months ended September 30, 2011 resulted from decreased factory utilization due to lower revenues.

Gross Profit. Gross profit decreased to $3.8 million, or 32.4% of revenues, for the three months ended September 30, 2011 from $4.7 million, or 35.5% of revenues, for the same period in 2010. Gross profit decreased to $10.3 million, or 32.3% of revenues, for the nine months ended September 30, 2010 from $11.5 million, or 34.0% of revenues, for the same period in 2010. For the three and nine months ended September 30, 2011, the lower gross profit was due to the lower utilization of our factories as a result of decreased volume shipments to our customers. We expect our gross profit as a percentage of revenues to improve in the event of higher production volumes, which we anticipate will result in improved absorption of overhead expenses. However, decreasing average selling prices will negatively impact our gross profit and may offset benefits, if any, from improved absorption.

Research and Development Expenses. Research and development expenses decreased to $0.8 million for the three months ended September 30, 2011 from $0.9 million for the same period in 2010. Research and development expenses decreased to $2.4 million for the nine months ended September 30, 2011 from $2.5 million for the same period in 2010. The lower research and development expenses were due to lower capital investments for new product development.

As a percentage of revenues, research and development expenses increased to 7.1% in the three months ended September 30, 2011 from 6.6% for the same period in 2010. As a percentage of revenues, research and development expenses increased to 7.4% in the nine months ended September 30, 2011 from 7.3% for the same period in 2010. The higher research and development expenses as a percentage of revenues were mainly due to decreased revenue levels. We expect research and development expenses will remain relatively flat in the next quarter.

Sales and Marketing Expenses. Sales and marketing expenses remained at $0.6 million for the three months ended September 30, 2011 and 2010, respectively. Sales and marketing expenses decreased to $1.7 million for the nine months ended September 30, 2011 from $1.8 million for the same period in 2010.

As a percentage of revenues, sales and marketing expenses increased to 5.0% in the three months ended September 30, 2011 from 4.8% for the same period in 2010. As a percentage of revenues, sales and marketing expenses decreased to 5.3% in the nine months ended September 30, 2011 from 5.5% for the same period in 2010. The higher sales and marketing expenses as a percentage of revenues was mainly due to decreased revenue levels. We expect sales and marketing expenses will remain relatively flat in the next quarter.

General and Administrative Expenses. General and administrative expenses increased to $1.1 million for the three months ended September 30, 2011 from $1.0 million for the same period in 2010. General and administrative expenses increased to $3.1 million for the nine months ended September 30, 2011 from $2.9 million for the same period in 2010. The higher general and administrative expenses were mainly due to higher stock based compensation charges.

As a percentage of revenues, general and administrative expenses increased to 9.0% in the three months ended September 30, 2011 from 7.4% for the same period in 2010. As a percentage of revenues, general and administrative expenses increased to 9.7% in the nine months ended September 30, 2011 from 8.5% for the same period in 2010. The higher general and administrative expenses as a percentage of revenues was mainly due to decreased revenue levels. We expect general and administrative expenses will remain relatively flat in the next quarter.

Stock-Based Compensation. Total stock-based compensation increased to approximately $259,000 for the three months ended September 30, 2011 from approximately $87,000 for the same period in 2010. Total stock-based compensation increased to approximately $513,000 for the nine months ended September 30, 2011 from approximately $171,000 for the same period in 2010. This increase was due to restricted stock units granted in June 2011 and resulted in higher stock-based compensation expense.

Interest and Other Income, Net. Interest and other income, net, remained at $0.1 million for the three months ended September 30, 2011 and 2010, respectively. Interest and other income, net, was $0.5 million and $0.4 million for the nine months ended September 30, 2011 and 2010, respectively. These amounts consisted primarily of interest income which fluctuated based on cash balances and changes in interest rates.

Income Tax Expense. Income tax expense was approximately $0.03 million and $0.25 million for the three months ended September 30, 2011 and 2010, respectively. Income tax benefit was $0.1 million and income tax expense was $0.3 million for the nine months ended September 30, 2011 and 2010, respectively. The credit for the nine months ended September 30, 2011 was due to the reversal of an over-accrual for California State tax in 2010.

Liquidity and Capital Resources

At September 30, 2011, we had cash and cash equivalents of $15.0 million and short-term investments of $22.0 million. During the quarter ended June 30, 2011, we also moved $10.0 million from short-term investments to long-term investments comprised of a certificate of deposit. Long-term investments at September 30, 2011 were $10.1 million.

Net cash provided by operating activities was $2.9 million for the nine months ended September 30, 2011. The increase in net cash provided by operating activities was primarily due to net income of $3.7 million and contribution from adjustment for non-cash charges, including depreciation and stock based compensation of $1.6 million. These were offset by a $1.3 million in decrease in accrued expenses, a $0.6 million increase in accounts receivable and a $0.6 million decrease in accounts payable. Net cash provided by operating activities was $3.3 million for the nine months ended September 30, 2010. Net cash provided by operating activities was primarily due to net income of $4.3 million, an increase in accounts payable and other liabilities of $3.5 million, and contribution from adjustment for non-cash charges, including depreciation and stock based compensation of $1.0 million. These were offset by a $3.1 million increase in accounts receivable and a $2.2 million increase in inventory.

Cash provided by investing activities was $3.9 million for the nine months ended September 30, 2011. This resulted from $15.3 million in net proceeds from short-term investments and $10.1 million in purchases of long-term investments. We also used $1.3 million on equipment purchases. Cash provided by investing activities was $0.9 million for the nine months ended September 30, 2010. This resulted from $3.9 million in net proceeds from short-term investments and $3.0 million spending on equipment purchases.

Cash provided by financing activities was $0.5 million and $0.3 million for the nine months ended September 30, 2011 and 2010, respectively. Net cash provided by financing activities was primarily due to proceeds from the exercise of options to purchase our common stock and the sale of our common stock through our Employee Stock Purchase Plan, which was offset in part by repayment of bank borrowings.

We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, our future growth, including any potential acquisitions, may require additional funding. If cash generated from operations is insufficient to satisfy our long-term liquidity requirements, we may need to raise capital through additional equity or debt financings, additional credit facilities, strategic relationships or other arrangements. If additional funds are raised through the issuance of securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of any debt facility could impose restrictions on our operations. The sale of additional equity or debt securities could result in additional dilution to our stockholders, and additional financing may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of our planned product development and marketing efforts. Strategic arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies or products. Our failure to raise capital when needed could harm our business, financial condition and operating results.

Off Balance Sheet Arrangements

We did not have any off-balance sheet arrangements at September 30, 2011.

Contractual Obligations

Our long-term debt obligations are for principal and interest on mortgage and equipment loans from financial institutions in Taiwan.

In July 2004, we moved into our corporate headquarters in Sunnyvale, California. The lease has a six-year term commencing on July 22, 2004. In June 2010, we renewed the lease for an 18,088 square foot facility in the same building, which lease will expire in January 2016.

In Taiwan, we lease a total of approximately 38,800 square feet in one facility located in Tu-Cheng City, Taiwan. This lease expires at various times from January 2012 to December 2013. In December 2000, the Company purchased approximately 8,200 square feet of space immediately adjacent to its leased facility for $0.8 million, bringing the total square footage to approximately 47,000 square feet.

We lease a 132,993 square foot facility in Shenzhen, China which lease will expire in October 2014.

Recent Accounting Pronouncements

See Note 2 of our Notes to Unaudited Condensed Consolidated Financial Statements included with this Quarterly Report on Form 10-Q for information on recent accounting pronouncements.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4: CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Our disclosure controls and procedures have been designed to meet reasonable assurance standards. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Acting Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

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

PART II: OTHER INFORMATION

ITEM 1A: RISK FACTORS

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

We had net income of approximately $1.5 million and $2.1 million in the third quarter of fiscal 2011 and 2010, respectively. Although we generated a profit in the third quarter of fiscal 2011 and 2010, we may not be able to sustain profitability in the future. Although our cash and cash equivalents increased in the third quarter of fiscal 2011, our cash flows may be negative again in the future as we continue to invest in our business. As of September 30, 2011, we had an accumulated deficit of approximately $54.1 million.

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

Our connectivity products have historically represented a significant part of our revenues, and if we are unsuccessful in commercially selling our optical passive products, our business will be seriously harmed.

Sales of our connectivity products accounted for over 73.6% of our revenues in the quarter ended September 30, 2011 and a majority of our historical revenues. We expect to substantially depend on these products for the majority of our near-term revenues. We have in the past, and may in the future experience declines in average selling prices. Any significant decline in the price of, or demand for, these products, or failure to increase their market acceptance, would seriously harm our business. In addition, we believe that our future growth and a significant portion of our future revenues will depend on the commercial success of our optical passive products, which we began shipping commercially in July 2000. Demand for these products has fluctuated over the past few years, declining sharply starting in mid fiscal 2001 and then increasing beginning in 2003. If demand for these products does not continue to increase and our target customers do not continue to adopt and purchase our optical passive products, our revenues may decline and we may have to write-off additional inventory that is currently on our books.

Continuing weak general economic or business conditions may have a negative impact on our business.

Continuing concerns over inflation, deflation, another recession, energy costs, geopolitical issues, the availability and cost of credit, Federal budget proposals, unemployment, global economic stability, the U.S. mortgage market and an uncertain real estate market in the U.S. have contributed to increased volatility and diminished expectations for the global economy and expectations of slower global economic growth going forward. These factors, combined with volatile oil prices, declining business and consumer confidence, a volatile stock market and increased unemployment, have precipitated an economic slowdown and recession. If the economic climate in the U.S. and abroad does not improve or continues to deteriorate, our business, including our customers and our suppliers, could be negatively affected, resulting in a negative impact on our revenues.

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

In the quarters ended September 30, 2011 and 2010, our top 10 customers comprised 68.6% and 68.7% of our revenues, respectively. In the nine months ended September 30, 2011 and 2010, our top 10 customers comprised 63.6% and 69.2% of our revenues, respectively. Two customers accounted for 13.8% and 11.7% of our total revenues for the three months ended September 30, 2011. One customer accounted for 14.8% of our total revenues for the nine months ended September 30, 2011. Two customers accounted for 16.7% and 16.3% of our total revenues for the three months ended September 30, 2010. Three customers accounted for 15.2%, 15.2% and 10.2% of our total revenues for the nine months ended September 30, 2010.

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

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

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

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

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

customer unwillingness to implement our products;
any delays or difficulties that we may incur in completing the development and introduction of our planned products or product enhancements;
the success of our customers;
excess inventory in the telecommunications industry;
new product introductions by our competitors;
any failure of our products to perform as expected; or
any difficulty we may incur in meeting customers’ delivery requirements or product specifications.

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

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

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

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

The market for fiber optic components is intensely competitive. We believe that our principal competitors are the major manufacturers of optical components and integrated modules, including vendors selling to third parties and business divisions within communications equipment suppliers. Our principal competitors in the components market include Oclaro Corp., DiCon Fiberoptics, Inc., JDS Uniphase Corp., Oplink Communications Inc., Senko Advanced Components and Tyco Electronics Corporation. We believe that we primarily compete with diversified suppliers for the majority of our product line and to a lesser extent with niche companies that offer a more limited product line. Competitors in any portion of our business may also rapidly become competitors in other portions of our business.

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

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

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

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

As of September 30, 2011, we had a total of 33 full-time employees in Sunnyvale, California, 317 full-time employees in Taiwan, and 866 full-time employees in China. Matching the scale of our operations with demand fluctuations, combined with the challenges of expanding and managing geographically dispersed operations, has placed, and will continue to place, a significant strain on our management and resources. To manage the expected fluctuations in our operations and personnel, we will be required to:

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

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

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

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

The development of new or enhanced fiber optic products is a complex and uncertain process. We may experience difficulties in design, manufacturing, marketing and other areas that could delay or prevent the development, introduction or marketing of new products and enhancements. Development costs and expenses are incurred before we generate revenues from sales of products resulting from these efforts. Our total research and development expenses were approximately $0.8 million and $0.9 million for the three months ended September 30, 2011 and 2010, respectively. Our total research and development expenses were approximately $2.4 million and $2.5 million for the nine months ended September 30, 2011 and 2010, respectively. While we expect that our research and development expenses will remain relatively flat in the last quarter of 2011, we may in the future make additional investments in research and development and these investments could be substantial.

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

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

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

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

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

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

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

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

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

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

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

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

We depend on a limited number of third parties to supply key materials, components and equipment, such as ferrules, optical filters and lenses, and if we are not able to obtain sufficient quantities of these items at acceptable prices, our ability to fill orders would be limited and our operating results could be harmed.

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

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

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

We are exposed to risks and increased expenses as a result of legislation requiring companies to evaluate internal controls over financial reporting.

Although we will not have to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002 until we become an accelerated filer, we are still required to perform an assessment of our internal control over financial reporting and to disclose management’s assessment of the same under Section 404(a) of Sarbanes-Oxley. We have implemented an ongoing program to perform the system and process evaluation and testing we believe to be necessary to comply with this requirement, however, we cannot assure you that we will be successful in our efforts. In the event that our chief executive officer, acting chief financial officer or, when applicable, our independent registered public accounting firm, determines that our internal control over financial reporting is not effective as defined under Section 404(a), investor perceptions of our company may be negatively affected and this could cause a decline in our stock price.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The occurrence of any one or more of the foregoing factors could negatively impact our revenues.

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

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

the education of potential end-user customers and network service providers about the benefits of optical networks; and
the continued growth of the metropolitan, last mile, and enterprise access segments of the communications network.

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

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

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

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

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

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

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

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

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

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

Although we are not aware of any intellectual property lawsuits filed against us, we may be a party to litigation regarding intellectual property in the future. We may not prevail in any such actions, given their complex technical issues and inherent uncertainties. Insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. If there is a successful claim of infringement or we fail to develop non-infringing technology or license the proprietary rights on a timely basis, our business could be harmed.

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

Our primary manufacturing operation is located in Tu-Cheng City, Taiwan, an active earthquake fault zone. This region has experienced large earthquakes in the past and may likely experience them in the future. In September 2001, a typhoon hit Taiwan causing businesses, including our manufacturing facility, and the financial markets to close for two days. A large earthquake or typhoon in Taiwan could disrupt our manufacturing operation in Taiwan for an extended period of time, which would limit our ability to supply our products to our customers in sufficient quantities on a timely basis, harming our customer relationships.

ITEM 6: EXHIBITS

Exhibits

Exhibit Number		Title
31.1		Rule 13a-14(a) certification of Chief Executive Officer
31.2		Rule 13a-14(a) certification of Acting Chief Financial Officer
32.1*		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
32.2*		Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
101.INS**		XBRL Taxonomy Instance Document
101.SCH**		XBRL Taxonomy Schema Document
101.PRE**		XBRL Taxonomy Presentation Linkbase Document
101.LAB**		XBRL Taxonomy Label Linkbase Document
101.CAL**		XBRL Taxonomy Calculation Linkbase Document
101.DEF**		XBRL Taxonomy Definition Linkbase document

____________________

* In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 34-47986, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed “filed” for purposes of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

** In accordance with Rule 406T of Regulation S-T, the information furnished in these exhibits will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act.

SIGNATURE

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

Dated: November 10, 2011

ALLIANCE FIBER OPTIC PRODUCTS, INC.


By	/s/ Anita K. Ho
Anita K. Ho
Acting Chief Financial Officer
(Principal Financial and Accounting Officer and Duly
Authorized Signatory)

Alliance Fiber Optic Products, Inc.
Exhibit Index

Exhibit Number		Title
31.1		Rule 13a-14(a) certification of Chief Executive Officer
31.2		Rule 13a-14(a) certification of Acting Chief Financial Officer
32.1*		Statement of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
32.2*		Statement of Acting Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350).
101.INS**		XBRL Taxonomy Instance Document
101.SCH**		XBRL Taxonomy Schema Document
101.PRE**		XBRL Taxonomy Presentation Linkbase Document
101.LAB**		XBRL Taxonomy Label Linkbase Document
101.CAL**		XBRL Taxonomy Calculation Linkbase Document
101.DEF**		XBRL Taxonomy Definition Linkbase document

____________________

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