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 ARS and associated Rights, 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, economic stability, 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.

This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K, its Consolidated Financial Statement and the notes thereto, for the year ended December 31, 2008.

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

Critical Accounting Policies and Estimates

Stock-based Compensation Expense

On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including employee stock options and employee stock purchases pursuant to our Employee Stock Purchase Plan ("ESPP") based on estimated fair values. We adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our 2006 fiscal year.

Stock-based compensation expense recognized under SFAS 123(R) for the three and six months ended June 30, 2009 was $0.02 million and $0.05 million, respectively, determined by the Binomial Lattice valuation model, and represents stock-based compensation expense related to our employee stock purchase plan. As of June 30, 2009, there was no unrecognized compensation cost related to non-vested share-based compensation arrangements under the Company's stock option plan.

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, 2008.

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 introduction, sales of optical passive products have fluctuated with the overall market for these products.

Our connectivity products contributed revenues of $4.5 million and $6.7 million for the three months ended June 30, 2009 and 2008, respectively. Our optical passive products contributed revenues of $3.2 million and $3.6 million for the three months ended June 30, 2009 and 2008, respectively. Our connectivity products contributed 57.3% and 64.2% of our revenues for the six months ended June 30, 2009 and 2008, respectively. Our optical passive products contributed 42.7% and 35.8% of our revenues for the six months ended June 30, 2009 and 2008, respectively.

In the three months ended June 30, 2009 and 2008, our top 10 customers comprised 64.6% and 67.6% of our revenues, respectively. For the three months ended June 30, 2009, two customers accounted for 17.5% and 17.2% of our total revenues. For the three months ended June 30, 2008, two customers accounted for 18.0% and 10.9% of our total revenues. We market and sell our products predominantly through our direct sales force.

In the six months ended June 30, 2009 and 2008, our top 10 customers comprised 66.6% and 66.0% of our revenues, respectively. For the six months ended June 30, 2009, two customers each accounted for 19.1% of our total revenues. For the six months ended June 30, 2008, two customers accounted for 19.2% and 10.0% of our total revenues, respectively.

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

· changes in manufacturing volume;

· costs incurred in establishing additional manufacturing lines and facilities;

· inventory write-downs and 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          Six Months
                                     Ended June 30,       Ended June 30,
                                     2009      2008       2009      2008
Revenues                             100.0%    100.0%     100.0%    100.0%
Cost of revenues                       68.9      68.5       69.4      68.6
   Gross profit                        31.1      31.5       30.6      31.4

Operating expenses
   Research and development             9.8       8.7        9.7       9.1
   Sales and marketing                  7.5       6.2        7.9       6.7
   General and administrative          10.0       8.7       10.5       9.0
     Total operating expenses          27.3      23.6       28.1      24.8

Income from operations                  3.8       7.9        2.5       6.6
Interest and other income, net          2.2       2.7        2.6       3.4
Net income                             6.0%     10.6%       5.1%     10.0%

Revenues. Revenues were $7.7 million and $10.3 million for the three months ended June 30, 2009 and 2008, respectively. Revenues decreased 25.2% in the three months ended June 30, 2009 from the same period in 2008. Revenues were $15.4 million and $19.7 million for the six months ended June 30, 2009 and 2008, respectively. Revenues decreased 22.1% in the six months ended June 30, 2009 from the same period in 2008. The decrease for the three and six months ended June 30, 2009 was mainly due to reduced orders from our customers as a result of an industry wide slow down due to macro economic conditions. Declines in average selling prices were a secondary cause of the decrease in revenues and resulted from pricing pressure from customers, competitive pricing by other suppliers and general product maturity. We expect we may experience similar levels of average selling prices decline in the future.

Cost of Revenues. Cost of revenues was $5.3 million and $7.1 million for the three months ended June 30, 2009 and 2008, respectively. Cost of revenues as a percentage of revenues increased to 68.9% for the three months ended June 30, 2009 from 68.5% for the three months ended June 30, 2008. Cost of revenues was $10.7 million and $13.5 million for the six months ended June 30, 2009 and 2008, respectively. Cost of revenues as a percentage of revenues increased to 69.4% for the six months ended June 30, 2009 from 68.6% for the six months ended June 30, 2008. The higher cost of revenues as a percentage of revenues for the period ended June 30, 2009 was due to the lower sales of connectivity products, which have higher gross margins.

Gross Profit. Gross profit decreased in dollars to $2.4 million, or 31.1% of revenues, for the three months ended June 30, 2009 from $3.3 million, or 31.5% of revenues, for the same period in 2008. Gross profit decreased to $4.7 million, or 30.6% of revenues, for the six months ended June 30, 2009 from $6.2 million, or 31.4% of revenues, for the same period in 2008. For the three and six months ended June 30, 2009, the lower gross profit was due to the lower utilization of our factories as a result of decreased volume shipments to our customers. Declines in average selling prices were offset by cost improvements other than utilization, including material purchase prices and yield and cycle time improvements.

Research and Development Expenses. Research and development expenses decreased to $0.8 million for the three months ended June 30, 2009 from $0.9 million for the same period in 2008. Research and development expenses decreased to $1.5 million for the six months ended June 30, 2009 from $1.8 million for the same period in 2008. The decrease was primarily due to costs control and fewer products in development.

As a percentage of revenues, research and development expenses increased to 9.8% in the three months ended June 30, 2009 from 8.7% for the same period in 2008. As a percentage of revenues, research and development expenses increased to 9.7% in the six months ended June 30, 2009 from 9.1% for the same period in 2008. The higher research and development expenses as a percentage of revenues was mainly due to decreased revenue levels. We expect research and development expenses on our product development efforts to increase in the near term as we intend to continue to invest in our research and product development efforts.

Sales and Marketing Expenses. Sales and marketing expenses remained at $0.6 million for the three months ended June 30, 2009 and 2008, respectively. Sales and marketing expenses decreased to $1.2 million for the six months ended June 30, 2009 from $1.3 million for the same period in 2008. As a percentage of revenues, sales and marketing expenses increased to 7.5% in the three months ended June 30, 2009 from 6.2% for the same period in 2008.

As a percentage of revenues, sales and marketing expenses increased to 7.9% in the six months ended June 30, 2009 from 6.7% for the same period in 2008. 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 two quarters.

General and Administrative Expenses. General and administrative expenses decreased to $0.8 million for the three months ended June 30, 2009 from $0.9 million for the same period in 2008. General and administrative expenses decreased to $1.6 million for the six months ended June 30, 2009 from $1.8 million for the same period in 2008.

As a percentage of revenues, general and administrative expenses increased to 10.0% in the three months ended June 30, 2009 from 8.7% for the same period in 2008. As a percentage of revenues, general and administrative expenses increased to 10.5% in the six months ended June 30, 2009 from 9.0% for the same period in 2008. The higher general and administrative expenses as a percentage of revenue was mainly due to decreased revenue levels. We expect general and administrative expenses will increase due to higher fees and costs associated with compliance with laws and regulations such as the Sarbanes-Oxley Act of 2002 and the regulations promulgated thereunder.

Stock-Based Compensation. Total stock-based compensation decreased to $22,000 for the three months ended June 30, 2009 from $46,000 for the same period in 2008. Total stock-based compensation decreased to $50,000 for the six months ended June 30, 2009 from $97,000 for the same period in 2008. These decreases were because the majority of options granted in the past three years were fully vested at the time of grant.

Interest and Other Income, Net. Interest and other income, net, was $0.2 million and $0.3 million for the three months ended June 30, 2009 and 2008, respectively. Interest and other income, net, was $0.4 million and $0.7 million for the six months ended June 30, 2009 and 2008, respectively.

Income Tax Expense. Income tax expense was approximately $0.03 million and $0.02 million for the three months ended June 30, 2009 and 2008, respectively. Income tax expense was approximately $0.04 million and $0.08 million for the six months ended June 30, 2009 and 2008, respectively. During the first quarter of 2008, we paid $0.05 million income tax for the year ended December 31, 2007.

Liquidity and Capital Resources

At June 30, 2009, we had cash and cash equivalents of $7.3 million and short-term investments of $31.6 million, which includes our ARS of $14.4 million. We also hold $1.8 million of ARS Rights in other current assets. On June 30, 2009, we reclassified $16.2 million of ARS and the related ARS Right from long-term to current assets. The ARS and associated Rights are not saleable by us at the date hereof. Accordingly, we do not consider the ARS or the Rights as sources of liquidity at this time.

Net cash provided by operating activities was $0.7 million for the six months ended June 30, 2009. The increase in net cash provided by operating activities was primarily due to net income of $0.7 million. Additionally, cash used for accounts payable of $0.6 million, accounts receivable of $0.4 million, prepaid expenses of $0.2 million, and accrued liabilities of $0.2 million, offset cash provided by decreases in inventory of $0.9 million, and depreciation and amortization of $0.5 million.

Net cash provided by operating activities was $0.9 million for the six months ended June 30, 2008. Net cash provided by operating activities was primarily due to net income of $1.9 million, an increase in accounts payable of $0.9 million, and total depreciation and amortization expenses of $0.6 million, which was offset by a $1.3 million increase in accounts receivable, a $0.4 million decrease in inventory provision and a $0.6 million increase in inventory.

Cash used in investing activities was $5.5 million for the six months ended June 30, 2009. This resulted from $5.2 million in net purchases of short-term investments and reclassification of long-term investments to short-term investments. We also used $0.3 million cash on equipment purchases. Cash provided by investing activities was $10.0 million for the six months ended June 30, 2008. This resulted from $10.4 million in net proceeds from sales of short-term investments offset by $0.5 million spending on equipment purchases.

Cash provided by financing activities was $0.05 million and $0.3 for the six months ended June 30, 2009 and 2008, respectively, and was comprised of proceeds from the exercise of options to purchase our common stock and the sale of our common stock through our Employee Stock Purchase Plan. Cash used in financing activities was $0.08 million each for the six months ended June 30, 2009 and 2008, respectively, and was used for 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.

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 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 May 2010 to December 2011. In December 2000, the Company purchased approximately 8,200 square feet of space immediately adjacent to the leased facility for $0.8 million, bringing the total square footage to approximately 47,000 square feet.

In July 2007, we renewed the lease for our 62,000 square foot facility in the Shenzhen area of China, which will expire in July 2012. In February 2007, we entered into a lease for an 8,200 square feet facility in Shenzhen, which lease will expire in January 2012.

In August 2009, we expanded our facility in the Shenzhen area of China. We replaced the existing two leases with a new lease for a 132,993 square foot facility in Shenzhen, which lease will expire in October 2014.