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

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

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

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 ☑ No ☐

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 ☑ No ☐

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 (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

On April 20, 2016, 15,803,585 shares of the registrant’s Common Stock, $0.001 par value per share, were outstanding.

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

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

ALLIANCE FIBER OPTIC PRODUCTS, INC.
Condensed Consolidated Statements of Operations and Comprehensive Income (loss)

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

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.

The accompanying condensed consolidated balance sheet as of December 31, 2015, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements as of and for the three months ended March 31, 2016 and 2015 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, 2015. The unaudited condensed consolidated financial statements as of March 31, 2016, and for the three months ended March 31, 2016 and 2015, 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 three months ended March 31, 2016 as compared to those disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2015.

The Company recognizes revenue upon shipment of its products to customers, provided that it has 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 products, the Company has no obligation to provide any modification or customization upgrades, enhancements or post contract customer support.

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 historical returns, current economic trends and changes in customer demand. Such allowances are adjusted periodically to reflect actual and anticipated experience. The Company also identifies specific accounts considered to have a high risk of uncollectibility and records an allowance for the full amount. Material differences may result in the amount and timing of revenue for any period than if management had made different judgments or utilized different estimates.

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 money market accounts, corporate bonds and certificates of deposit.

The Company generally invests its excess cash in certificates of deposit and corporate bonds. 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.

Connectivity products contributed 71.9% and 79.7% of the Company’s revenues for the three months ended March 31, 2016 and 2015, respectively. The Company’s optical passive products contributed 28.1% and 20.3% of the Company’s revenues for the three months ended March 31, 2016 and 2015, respectively.

In the three month ended March 31, 2016 and 2015, the Company’s 10 largest customers comprised 62.2% and 77.9% of the Company’s revenues, respectively. One customer accounted for 10.7% and 45.1% of the Company’s revenues for the three months ended March 31, 2016 and 2015, respectively. The amount due from this customer was $0.7 million at March 31, 2016.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, "Leases (Topic 842)". The amendments under this pronouncement will change the way all leases with a duration of one year of more are treated. Under this guidance, lessees will be required to capitalize virtually all leases on the balance sheet as a right-of-use asset and an associated financing lease liability or capital lease liability. The right-of-use asset represents the lessee’s right to use, or control the use of, a specified asset for the specified lease term. The lease liability represents the lessee’s obligation to make lease payments arising from the lease, measured on a discounted basis. Based on certain characteristics, leases are classified as financing leases or operating leases. Financing lease liabilities, those that contain provisions similar to capitalized leases, are amortized like capital leases are under current accounting, as amortization expense and interest expense in the statement of operations. Operating lease liabilities are amortized on a straight-line basis over the life of the lease as lease expense in the statement of operations. This update is effective for annual reporting periods, and interim periods within those reporting periods, beginning after December 15, 2018. The Company is currently evaluating the impact this standard will have on its policies and procedures pertaining to its existing and future lease arrangements, disclosure requirements and on its consolidated financial statements.

In July 2015, FASB issued new accounting guidance on simplifying the measurement of inventory which requires that inventory within the scope of the guidance be measured at the lower of cost and net realizable value. Prior to the issuance of the standard, inventory was measured at the lower of cost or market (where market was defined as replacement cost, with a ceiling of net realizable value and floor of net realizable value less a normal profit margin). The accounting guidance is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2015, the FASB issued guidance which eliminates the concept of extraordinary items in an entity’s income statement. The changes in ASU 2015-01 are effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2014, FASB issued a new accounting standard which requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern for each annual and interim reporting period and to provide related footnote disclosures in certain circumstances. The accounting standard is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued a new financial accounting standard which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance. The accounting standard is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the impact of this accounting standard on its consolidated financial statements.

Stock Repurchase Program. On August 24, 2015, the Company announced a program to repurchase up to $25.0 million worth of the Company’s outstanding common stock. On November 20, 2015, the Company increased the program by $10 million. Repurchases under the program may be made in open market and privately negotiated transactions in compliance with Securities and Exchange Commission Rule 10b-18, subject to market conditions, applicable legal requirements and other factors. The Company was not required to repurchase any amount of common stock in any period and the program could be modified or suspended at any time. For the year ended December 31, 2015, an aggregate of 2,196,632 shares of common stock had been repurchased under the program and the repurchased program was closed as of December 31, 2015. There were no shares repurchased during the three months ended March 31, 2016.

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 Purchase Plan (“ESPP”) was determined using the Black-Scholes Model.

Pursuant to the Company’s 2000 Stock Incentive Plan (the ”2000 Plan”), participants may be granted restricted stock units (“RSUs”), representing an unfunded, unsecured right to receive shares of the Company’s common stock 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, over three years at a rate of 33.3 percent per year, over four years at a rate of 25 percent per year or over five years at a rate of 20 percent per year. The Company recognizes compensation expense on a straight-line basis over the vesting term of each award.

Options granted under the 2000 Plan generally vest over four years. Options have a ten year contractual term.

The following information relates to stock option activity for the three months ended March 31, 2016:

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 first quarter of fiscal 2016 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 March 31, 2016. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised during the three months ended March 31, 2016 and 2015 was $0.01 million and $0.3 million, respectively.

Cash received from option exercises was $0.02 million and $0.1 million during the three months ended March 31, 2016 and 2015, respectively. Such amounts are included within the financing activities section in the accompanying condensed consolidated statements of cash flows.

No options were granted during the three months ended March 31, 2016. 60,000 RSUs were granted during the three months ended March 31, 2016, which RSUs vest as to one half of the shares on each of January 1, 2017 and 2018. At March 31, 2016, there was $6.2 million of unrecognized compensation cost related to stock options and RSUs, all of which is expected to be realized over three years.

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

	Three Months Ended March 31,
	2016		2015
Included in cost of revenue	$	103	$	121
Included in operating expenses:
Research and development		67		46
Selling, marketing and administrative		707		329
Total		774		375
Total stock-based compensation expense	$	877	$	496

	March 31,		December 31,
	2016		2015
Inventories
Finished goods	$	3,257	$	3,438
Work-in-process		4,793		4,409
Raw materials		3,855		3,072
	$	11,905	$	10,919

The inventory balances shown above are presented net of an allowance for excess and obsolete inventories of $1.4 million at each of March 31, 2016 and December 31, 2015.

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.

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 March 31,
	2016			2015
Numerator:
Net (loss) income	$	(536	)	$	3,558
Denominator:
Shares used in computing net (loss) income per share:
Basic		15,789			17,872
Diluted		15,789			18,296
Net (loss) income per share:
Basic	$	(0.03	)	$	0.20
Diluted	$	(0.03	)	$	0.19

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 (loss) income and comprehensive (loss) income for the Company is due to foreign exchange translations adjustments and unrealized gain (loss) on available-for-sale securities.

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

The Company is subject to income tax in both the United States and various foreign jurisdictions. The effective tax rate is also affected by the taxable earnings in foreign jurisdictions with various different statutory tax rates. The Company reviews its expected annual effective income tax rates and makes changes on a quarterly basis as necessary based on certain factors such as forecasted annual operating income and valuation of deferred tax assets. The Company recorded an income tax benefit in 2016 to reflect the net loss incurred during the three months ended March 31, 2016.

The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. In making such determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.

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. See Note 13 for information with respect to litigation after the date of the financial statements.

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 March 31, 2016, 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 $0.09 million and $0.07 million for warranty reserves at March 31, 2016 and December 31, 2015.

The Company leases office space under long-term operating leases expiring at various dates through 2019.

The Company’s aggregate future minimum facility lease payments as of March 31, 2016 were as follows (in thousands):

Years ending December 31:
2016 (remaining nine months of the year)	$	820
2017		647
2018		419
2019		367
Total	$	2,253

As of March 31, 2016, and based on information filed with the Securities and Exchange Commission in March 2016, Foxconn Holding Limited (“Foxconn”) and Hon Hai Precision Industry Co. Ltd. (“Hon Hai”) held 13.74% of the Company’s common stock. In the normal course of business, the Company sells products to and purchases raw materials from Hon Hai, who is the parent company of Foxconn. These transactions were made at prices and terms consistent with those of unrelated third parties.

Sales to Hon Hai were $0.001 million for the three months ended March 31, 2016. No sales to Hon Hai were made in the three months ended March 31, 2015. Purchases of raw materials from Hon Hai were $0.3 million and $0.5 million in the three months ended March 31, 2016 and 2015, respectively. The amount due from Hon Hai was $0.001 million as of March 31, 2016. No amount was due from Hon Hai as of December 31, 2015. Amounts due to Hon Hai were $0.4 million and $0.3 million at March 31, 2016 and December 31, 2015, respectively.

U.S. GAAP defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact a purchase or sale and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability.

The Company uses a fair value hierarchy established by U.S. GAAP that established a three-tiered fair value hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable to prioritize inputs used to measure fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is available and significant to the fair value measurement. Those tiers are defined as follows:

In accordance with the U.S. GAAP Codification Topic 820, the following table represents the fair value hierarchy for the Company’s financial assets (investments) measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in thousands):

	Fair Value Measurements at
	Reporting Date Using
			Quoted Prices		Significant
			in Active		Other		Significant
	Balance at		Markets for		Observable		Unobservable
	March 31,		Identical Assets		Inputs		Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	115	$	115	$	-	$	-
Marketable Securities:
Time deposits		7,977		7,977		-		-
Corporate bonds		5,158		-		5,158		-
Long-term investments:
Time deposits		10,868		10,868		-		-
Total	$	24,118	$	18,960	$	5,158	$	-

	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
	2015		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	281	$	281	$	-	$	-
Marketable Securities:
Time deposits		12,825		12,825		-		-
Corporate bonds		5,006		-		5,006		-
Long-term investments:
Time deposits		10,821		10,821		-		-
Total	$	28,933	$	23,927	$	5,006	$	-

As of March 31, 2016 and December 31, 2015, the Company held investments in corporate bonds, certificates of deposit, and money market securities. The Company’s cash and cash equivalents consist of investments with original maturities of 90 days or less from the date of purchase. The Company’s short-term investments consist 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 investments consist of certificates of deposit with original maturities of 365 days or more from the date of purchase.

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 by geographic segments, revenues generated by product lines and identifiable assets located in these segments (in thousands):

	Three Months Ended March 31,
	2016		2015
Revenues
North America	$	5,386	$	15,535
Europe		2,266		2,861
Asia		4,833		3,267
	$	12,485	$	21,663

	Three Months Ended March 31,
	2016		2015
Revenues
Connectivity Products	$	8,978	$	17,263
Optical Passive Products		3,507		4,400
	$	12,485	$	21,663

	March 31,		December 31,
	2016		2015
Property and Equipment. Net
United States	$	199	$	191
Taiwan		8,891		9,016
China		6,942		6,976
	$	16,032	$	16,183

On April 7, 2016, Corning Incorporated, (“Parent”) a New York corporation, Apricot Merger Company, a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”), and the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”). Pursuant to the Merger Agreement, Parent caused Merger Sub to commence, on April 21, 2016, a tender offer (the “Offer”) to purchase all of the issued and outstanding shares of the Company’s common stock, $0.001 par value and the related rights to purchase shares of Series A Preferred Stock (the “Shares”), at a price of $18.50 per share (the “Offer Price”). Consummation of the Offer is subject to various conditions set forth in the Merger Agreement, including, but not limited to (i) at least a majority of Shares being tendered in the Offer and (ii) the satisfaction or waiver by Merger Sub of certain other customary conditions and requirements set forth in the Merger Agreement. The Offer expires at 12:00 midnight, New York City (end of day) time on Thursday, May 19, 2016 unless the Offer is extended in accordance with the terms of the Merger Agreement.

Pursuant to the Merger Agreement, as of the effective time of the Merger (the “Effective Time”), Merger Sub will merge with and into the Company with the Company surviving as a wholly-owned subsidiary of Parent (the “Merger”). In the Merger, each Share that is not tendered and accepted pursuant to the Offer (other than the Shares held in treasury, Shares held directly or indirectly by Parent or its subsidiaries, and Shares as to which appraisal rights have been perfected in accordance with applicable law) will be cancelled and converted into the right to receive the Offer Price, on the terms and conditions set forth in the Merger Agreement.

Pursuant to the terms of the Merger Agreement, at the Effective Time, each outstanding and unexercised option to purchase Shares to the extent vested as of the Effective Time (each, a ‘‘Vested Option’’) will be cancelled and converted into the right to a payment in cash of an amount equal to the product of (a) the total number of Shares subject to such Vested Option immediately prior to such cancellation and (b) the excess, if any, of the Offer Price over the exercise price per Share of such Vested Option immediately prior to such cancellation, less any applicable tax withholding. Any Vested Option with an exercise price per Share in excess of the Offer Price will be cancelled without any consideration due in exchange.

Pursuant to the terms of the Merger Agreement, at the Effective Time, each RSU to the extent it is vested and outstanding as of the Effective Time (each, a ‘‘Vested RSU’’) will be cancelled and exchanged for the right to a payment in cash of an amount equal to the product of (a) the total number of Shares subject to such Vested RSU immediately prior to such cancellation and (b) the Offer Price, less any applicable tax withholding.

Pursuant to the terms of the Merger Agreement, at the Effective Time, each outstanding and unexercised option to purchase Shares to the extent unvested as of the Effective Time (each, an ‘‘Unvested Option’’) will be assumed by Parent and converted into an option to purchase that number of shares of common stock of Parent as is determined by multiplying the number of Shares that were subject to such Unvested Option immediately prior to the Effective Time by the ‘‘conversion ratio’’ (as defined below), at a per Share exercise price as is determined by dividing the per Share exercise price of such Unvested Option as in effect immediately prior to the Effective Time by such conversion ratio and rounding the resulting exercise price up to the nearest whole cent. The resulting option to purchase shares of common stock of Parent will be subject to the same vesting terms and conditions as in effect immediately prior to the Effective Time. The ‘‘conversion ratio’’ means a fraction having a numerator equal to the Offer Price and a denominator equal to the average closing sales price of Parent’s common stock as reported on the New York Stock Exchange for the ten consecutive trading day period ending (and including) the second trading day prior to the Effective Time.

Pursuant to the terms of the Merger Agreement, at the Effective Time, each RSU that is outstanding and unvested as of the Effective Time (each, an ‘‘Unvested RSU’’) will be assumed by Parent and converted into an award with the same vesting terms and conditions entitling the holder to a payment in cash of an amount equal to the product of (a) the total number of Shares subject to such Unvested RSU immediately prior to such conversion and (b) the Offer Price, less any applicable tax withholding.

On April 22, 2016, a complaint captioned Stephen Bushansky v. Alliance Fiber Optic Products, Inc., et al. Case No. 16-CV-294245 was filed in the Superior Court of California, County of Santa Clara naming as defendants the Company, its Board of Directors, Corning and Merger Sub. This action purports to be a class action brought by a stockholder alleging, among other things, that the Company’s Board of Directors breached their fiduciary duties by approving the Merger Agreement, and that the Company, Corning and Merger Sub aided and abetted these alleged breaches of fiduciary duty. The complaint seeks, among other things, either to enjoin the proposed transaction or to rescind the transaction in the event it is consummated.

On April 27, 2016, a complaint captioned Rudy Luck v. Alliance Fiber Optic Products, Inc., et al., Case No. 16-CV-294413 was filed in the Superior Court of California, County of Santa Clara naming as defendants the Company, its Board of Directors, Corning and Apricot. Similarly to the Bushansky action referenced above, this action purports to be a class action brought by a stockholder alleging, among other things, that the Company’s Board of Directors breached their fiduciary duties by approving the Merger Agreement, and that Corning and Merger Sub aided and abetted these alleged breaches of fiduciary duty. The complaint seeks, among other things, either to enjoin the proposed transaction or to rescind the transaction in the event it is consummated.

The outcome of this litigation cannot be predicted with certainty; however, the Company believes that the actions are without merit and intends to defend them vigorously. A reasonable estimate of the amount of any possible loss or range of loss, if any, cannot be made at this time and, as such, the Company has not recorded an accrual for any possible loss.

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 the proposed merger and related litigation, our operating results, revenues, sources of revenues, cost of revenues, gross margin, profitability, the amount and mix of investments, expenditures and expenses, our liquidity and the adequacy of our capital resources, our uses of cash, the impact of the economic environment on our business, 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 ability to protect our intellectual property, the potential benefit of indemnification agreements, increases in the number of possible requests for licenses and patent infringement claims, our competitive position, sources of competition, consolidation in our industry, our international strategy, inventory management, our factory utilization levels, 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, judgments and assumptions on financial results. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected. These risks and uncertainties include, but are not limited to, those risks discussed elsewhere in this report, as well as risks related to the proposed merger and related litigation, risks related to the development of the metropolitan, last mile access, data center 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, risks associated with our international operations, cyber-security risks, fluctuations in demand for our products, declines in average selling prices, pricing pressure from customers or potential customers, development of new products by us and our competitors, increased competition, inability to obtain sufficient quantities of raw materials or components, 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 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. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

On April 7, 2016, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Corning Incorporated, (“Parent”) a New York corporation and Apricot Merger Company, a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”) Company. Pursuant to the Merger Agreement, Parent caused Merger Sub to commence, on April 21, 2016, a tender offer (the “Offer”) to purchase all of the issued and outstanding shares of our common stock, $0.001 par value and the related rights to purchase shares of Series A Preferred Stock (the “Shares”), at a price of $18.50 per share, net to the seller in cash without interest and subject to any required withholding taxes (the “Offer Price”). Consummation of the Offer is subject to various conditions set forth in the Merger Agreement, including, but not limited to (i) at least a majority of Shares being tendered in the Offer and (ii) the satisfaction or waiver by Merger Sub of certain other customary conditions and requirements set forth in the Merger Agreement. The Offer expires at 12:00 midnight, New York City (end of day) time on Thursday, May 19, 2016 unless the Offer is extended in accordance with the terms of the Merger Agreement.

Pursuant to the Merger Agreement, as of the effective time of the Merger (the “Effective Time”), Merger Sub will merge with and into our company with our company surviving as a wholly-owned subsidiary of Parent (the “Merger”). In the Merger, each Share that is not tendered and accepted pursuant to the Offer (other than the Shares held in treasury, Shares held directly or indirectly by Parent or its subsidiaries, and Shares as to which appraisal rights have been perfected in accordance with applicable law) will be cancelled and converted into the right to receive the Offer Price, on the terms and conditions set forth in the Merger Agreement.

Pursuant to the terms of the Merger Agreement, at the Effective Time, each restricted stock unit (“RSU”) to the extent it is vested and outstanding as of the Effective Time (each, a ‘‘Vested RSU’’) will be cancelled and exchanged for the right to a payment in cash of an amount equal to the product of (a) the total number of Shares subject to such Vested RSU immediately prior to such cancellation and (b) the Offer Price, less any applicable tax withholding.

The Merger Agreement provides that the Merger shall be effected as soon as practicable following the consummation of the Offer without stockholder approval pursuant to Section 251(h) of the Delaware General Corporation Law.

The Merger Agreement contains customary representations and warranties by Parent, Merger Sub and us. The Merger Agreement also contains customary covenants and agreements, including with respect to the operation of our business between signing and closing, restrictions on responses by us with respect to alternative transactions, governmental filings and approvals and other matters.

The Merger Agreement generally prohibits our solicitation of proposals relating to alternative business combination transactions and restricts our ability to furnish non-public information to, or participate in any discussions or negotiations with, any third party with respect to any such transaction, subject to certain limited exceptions.

The Merger Agreement includes a remedy of specific performance for us, Parent and Purchaser. The Merger Agreement also includes customary termination provisions for both us and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances, including termination by us to accept and enter into a definitive agreement with respect to an unsolicited superior proposal, we will be required to pay a termination fee of $10,541,022 (approximately 3.5% of the aggregate consideration) (the “Breakup Fee”). A superior proposal is a written proposal pursuant to which a third party would acquire, among other acquisition structures set forth in the Merger Agreement, 50.1% or more of the outstanding voting Shares or other equity interests or assets of our company on terms that our Board of Directors will have determined in good faith (after consultation with its independent financial advisor and its outside legal counsel) to be more favorable to our stockholders from a financial point of view and is reasonably capable of being consummated in accordance with the terms proposed taking into account relevant factors. Any such termination of the Merger Agreement by us is subject to certain conditions, including our compliance with certain procedures set forth in the Merger Agreement and a determination by our Board of Directors that the failure to take such action would be inconsistent with its fiduciary duties under applicable law, the entrance into a definitive agreement by us with a third party and payment of the Breakup Fee by us.

The foregoing description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of such agreement, which is filed as Exhibit 2.1 to our Current Report on Form 8-K filed with Securities and Exchange Commission, or SEC, on April 7, 2016 and incorporated herein by reference.

If the Merger is consummated, we will become a wholly-owned subsidiary of Parent. Accordingly, this Quarterly Report on Form 10-Q, which assumes we remain a standalone business, should be read with the understanding that should the Merger be completed, Parent will have the power to control the conduct of our business.

This shall not constitute an offer to sell or the solicitation of an offer to buy any shares of our common stock, nor shall there be any sale of such common stock in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. The offer is only being made through a Tender Offer Statement on Schedule TO filed with the SEC on April 21, 2016, which contains an offer to purchase, form of letter of transmittal and other documents relating to the Offer (collectively, the “ Offer Materials”), each having been filed with the SEC by Merger Sub and Parent. In addition, we filed with the SEC on April 21, 2016 a solicitation/recommendation statement on Schedule 14D-9 with respect to the Offer. Merger Sub and AFOP have mailed the Offer Materials and the Schedule 14D-9 to our stockholders. Investors and stockholders are urged to carefully read these documents and the other documents relating to the transactions contemplated by the Merger Agreement because these documents will contain important information relating to the Offer and related transactions. The Offer Materials and the Schedule 14D-9 are available at no cost on the SEC’s web site at www.sec.gov.

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

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, 2015.

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

Our connectivity products contributed revenues of $9.0 million, or 71.9%, and $17.3 million, or 79.7%, for the three months ended March 31, 2016 and 2015, respectively. Our optical passive products contributed revenues of $3.5 million, or 28.1%, and $4.4 million, or 20.3%, for the three months ended March 31, 2016 and 2015, respectively.

In the three months ended March 31, 2016 and 2015, our 10 largest customers comprised 62.2% and 77.9% of our total revenues, respectively. One customer accounted for 10.7% and 45.1% of our revenues for the three months ended March 31, 2016 and 2015, 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:

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, marketing, and administrative expenses consist of salaries, commissions and related expenses for personnel engaged in marketing, sales and technical support functions, as well as the costs associated with trade shows, promotional activities and travel expenses. It also consists of salaries and related expenses for executive, finance, administrative, accounting and human resources personnel, insurance and professional fees for legal and accounting support. We intend to continue to invest amounts similar to our spending levels in 2015 in our sales and marketing efforts, both domestically and internationally, in order to increase market awareness and to generate sales of our products. We expect administrative expenses will increase in absolute dollars to support our revenue growth, and as a result of cost associated with the proposed Merger and with compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

We cannot be certain that our expenditures will result in higher revenues. In addition, we believe our future success depends upon establishing and maintaining successful relationships with a variety of key customers.

We own all of the outstanding common stock of Transian Technology Ltd. Co., a Taiwan corporation, which we refer to as Alliance Fiber Optic Products Co. Ltd., through which we manufacture a majority of our connectivity products.

Through our wholly owned subsidiary, Unilite Limited, a British Virgin Islands limited liability company, we own 100% of Dong Yuan Optoelectronics Technology Ltd., a company formed under the laws of the People’s Republic of China. We refer to Dong Yuan as Alliance Fiber Optic Products China, which operates manufacturing facilities responsible for the production of a substantial majority of our filter-based and advanced product lines.

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

	Three Months Ended March 31,
	2016		2015
Revenues	100.0	%	100.0	%

Cost of revenues	70.4		59.4
Gross profit	29.6		40.6

Operating expenses:
Research and development	9.6		5.3
Selling, marketing and administrative	25.2		10.3
Total operating expenses	34.8		15.6

(Loss) Income from operations	(5.2	)	25.0
Interest and other income, net	0.8		0.9
Net (loss) income before tax	(4.4	%)	25.9	%
Benefit from (provision for) income taxes	0.1		(9.5	)
Net (loss) income	(4.3	%)	16.4	%

Revenues. Revenues were $12.5 million and $21.7 million for the three months ended March 31, 2016 and 2015, respectively. Revenues decreased 42.4% in the quarter ended March 31, 2016 from the same period in 2015, primarily due to a significant decrease in volume shipments of products to our largest customer, as well as decreases in shipment to other customers in telecom and datacom market applications.

Cost of Revenues. Cost of revenues was $8.8 million and $12.9 million for the three months ended March 31, 2016 and 2015, respectively. Cost of revenues as a percentage of revenues increased to 70.4% for the three months ended March 31, 2016 from 59.4% for the three months ended March 31, 2015. The lower cost of revenues and higher cost of revenues as a percentage of revenues for the three months ended March 31, 2016 resulted from higher fixed costs associated with lower sales, changes in the mix of products sold, and changes in the level of sales to customers.

Gross Profit. Gross profit decreased to $3.7 million, or 29.6% of revenues, for the three months ended March 31, 2016 from $8.8 million, or 40.6% of revenues, for the same period in 2015. The lower gross profit and percentage of gross profit were primarily due to the lower utilization of our factories due to decreased volume shipments of our products.

Research and Development Expenses. Research and development expenses were $1.2 million and $1.1 million for the three months ended March 31, 2016 and 2015, respectively. As a percentage of revenues, research and development expenses increased to 9.6% in the three months ended March 31, 2016 from 5.3% for the same period in 2015 as a result of decreased revenues and higher stock-based compensation expenses. We expect research and development expenses will increase as we intend to continue to invest in our research and product development efforts.

Sales, Marketing and Administrative Expenses. Sales, marketing and administrative expenses were $3.2 million and $2.2 million for the three months ended March 31, 2016 and 2015, respectively. As a percentage of revenues, sales and marketing expenses increased to 25.2% in the three months ended March 31, 2016 from 10.3% in the three months ended March 31, 2015 as a result of decreased revenues. The higher sales, marketing and administrative expenses were primarily due to higher stock-based compensation expenses and significant costs related to merger negotiations.

Stock-Based Compensation. Stock based compensation expense increased to $0.9 million for the three months ended March 31, 2016 from $0.5 million for the same period in 2015. This increase was due to stock options and RSUs granted in 2015 and 2016.

Interest and Other Income, Net. Interest and other income, net, was $0.1 million and $0.2 million for the three months ended March 31, 2016 and 2015, respectively. The decrease in interest income was due to cash used for the stock repurchase program in 2015.

Income Tax Benefit/Expense. Income tax benefit was $0.01 million for the three months ended March 31, 2016. Income tax expense was $2.1 million for the three months ended March 31, 2015. The income tax benefit was due to the net loss incurred in the three months ended March 31, 2016.

At March 31, 2016, we had $13.1 million of cash and cash equivalents, $13.1 million of short-term investments and long-term investments of $10.9 million.

Net cash provided by operating activities was $2.8 million for the three months ended March 31, 2016. Net cash provided by operating activities was primarily due to decrease in accounts receivable of $3.6 million, an increase in accounts payable of $1.1 million, contribution from adjustments for non-cash charges, including depreciation, and amortization and stock based compensation of $1.7 million, and a decrease in prepaid expenses of $0.6 million which was partially offset by a decrease in accrued expenses of $2.4 million, an increase in inventory of $0.9 million, and net loss of $0.5 million.

Net cash provided by operating activities was $2.6 million for the three months ended March 31, 2015. Net cash provided by operating activities was primarily due to net income of $3.6 million, a decrease in deferred tax assets of $1.2 million, an increase in accounts payable of $1.1 million, total depreciation and stock based compensation expenses of $1.2 million, and a $0.4 million increase in accrued expenses which was partially offset by a $3.4 million increase in accounts receivable, a $1.0 million increase in inventory, and a $0.4 million increase in prepaid expenses.

Net cash provided by investing activities was $4.2 million for the three months ended March 31, 2016. In the three months ended March 31, 2016, we received a net of $4.7 million from the sales of short-term investments, and we used $0.5 million to purchase equipment.

Net cash used in investing activities was $1.4 million for the three months ended March 31, 2015. In the three months ended March 31, 2015, we spent a net of $0.4 million for the purchase of short-term and long-term investments, and we used $1.0 million to purchase equipment.

Net cash provided by financing activities was $0.02 million for the three months ended March 31, 2016. Net cash provided by financing activities was from the exercise of options to purchase shares of our common stock.

Net cash used in financing activities was $3.9 million for the three months ended March 31, 2015. Net cash used in financing activities was primarily due to $4.0 million used to repurchase common stock pursuant to our stock repurchase program, which was offset by $0.1 million from the exercise of options to purchase shares of our common stock.

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 through potential acquisitions of other businesses, assets or technologies, 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, 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 also result in 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 funding, 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.

The lease on our corporate headquarters in Sunnyvale, California, had 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 expired in January 2016. In October 2015, we amended the lease to extend the term through July 31, 2017.

In Taiwan, we lease a total of 34,406 square feet in one facility located in Tu-Cheng City. This lease expires at various times from December 2016 to January 2017.

In China, we renewed the lease for our 132,993 square foot facility in Shenzhen, which will expire in October 2019. In December 2014, we entered into two lease agreements for our two new manufacturing facilities next to our facility in Shenzhen. Each facility has 55,285 square feet and both leases expire in December 2019.

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

We are exposed to risks associated with the translation of Taiwan (NT) and China (RMB) denominated financial results and accounts into U.S. dollars for financial reporting purposes. The carrying value of the assets and liabilities held in our Taiwan and China subsidiaries will be affected by fluctuations in the value of the U.S. dollar as compared to the NT and RMB. Changes in the value of the U.S. dollar as compared to the NT and RMB could have an adverse effect on our reported results of operations and financial condition. As the net positions of our unhedged foreign currency transactions fluctuate, our earnings might be negatively affected. In addition, the reported carrying value of our NT and RMB denominated assets and liabilities held in our Taiwan and China subsidiaries will be affected by fluctuations in the value of the U.S. dollar compared to the NT and RMB. As of March 31, 2016, we had a net asset balance, excluding intercompany payables and receivables, in our Taiwan and China subsidiaries denominated in NT and RMB. If the NT and RMB were to weaken 10 percent against the dollar, our net asset balance would decrease by approximately $1.0 million as of that date.

(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 at the reasonable assurance level.

(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.

Our proposed merger with a subsidiary of Corning Incorporated is subject to a number of conditions beyond our control. Failure to complete the merger could materially and adversely affect our future business, results of operations, financial condition and stock price.

On April 7, 2016, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Corning Incorporated, (“Corning” or “Parent”) a New York corporation, and Apricot Merger Company, a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Sub”). Pursuant to the Merger Agreement, Parent caused Merger Sub to commence on April 21, 2016, a tender offer (the “Offer”) to purchase all of the issued and outstanding shares of our common stock and the related rights to purchase shares of Series A Preferred Stock at a price of $18.50 per share, net to the seller in cash without interest and subject to any required withholding taxes (the “Offer Price”). Consummation of the Offer is subject to various conditions set forth in the Merger Agreement, including, but not limited to (i) at least a majority of Shares being tendered in the Offer and (ii) the satisfaction or waiver by Merger Sub of certain other customary conditions and requirements set forth in the Merger Agreement. Pursuant to the Merger Agreement, as of the effective time of the Merger, Merger Sub will merge with and into our company, with AFOP surviving as a wholly-owned subsidiary of Parent (the “Merger”).

We cannot predict whether and when the conditions will be satisfied. If one or more of these conditions is not satisfied, and as a result, we do not complete the Merger, or in the event the proposed Merger is not completed or is delayed for any other reason, our business, results of operations, financial condition and stock price may be harmed because:

The occurrence of these or other events individually or in combination could have a material adverse effect on our business, results of operations, financial condition and stock price.

In addition, our stock price may fluctuate significantly based on announcements by us, Corning or other third parties regarding the proposed Merger.

The Merger Agreement contains provisions that could discourage a potential competing acquiror.

The Merger Agreement contains “no solicitation” provisions that restrict our ability to solicit, initiate, or knowingly encourage, facilitate or induce third party proposals for the acquisition of our common stock or to pursue an unsolicited offer, subject to certain limited expections. In addition, Parent has an opportunity to modify the terms of the Merger in response to any competing acquisition proposals before our Board of Directors may withdraw or change its recommendation with respect to the Merger. Upon the termination of the Merger Agreement to pursue an alternative transaction, including in connection with a “superior proposal”, we will be required to pay $10.54 million as a termination fee. These provisions could discourage a potential third-party acquiror from considering or proposing an acquisition transaction, even if it were prepared to pay a higher per share price than what would be received in the Offer and the Merger. These provisions might also result in a potential third-party acquiror proposing to pay a lower price per share to our stockholders than it might otherwise have proposed to pay because of the added expense of the $10.54 million termination fee that may become payable. If the Merger Agreement is terminated and we determine to seek another business combination, we may not be able to negotiate a transaction with another party on terms comparable to, or better than, the terms of the Merger.

Our executive officers and directors have interests in the Offer and the Merger that may be different from, or in addition to, the interests of our stockholders generally.

Our executive officers and members of our Board of Directors may be deemed to have interests in the Offer and the Merger that may be different from or in addition to those of our stockholders, generally. These interests may create potential conflicts of interest. Our Board of Directors was aware of these potentially differing interests and considered them, among other matters, in evaluating and negotiating the Merger Agreement and in reaching its decision to approve the Merger Agreement and the transactions thereunder. These interests relate to or arise from, among other things:

●	the consideration to be received in respect of options to purchase Shares and restricted stock unit awards held by our executive officers and members of our Board of Directors;

●	the acceleration of vesting of equity awards held by our directors and our Chief Executive Officer in connection with the completion of the Merger; and

●	the right to continued indemnification and insurance coverage for our directors and executive officers following the completion of the Merger.

We are currently subject to class action lawsuits and may be subject to additional class action lawsuits relating to the Merger, which could materially adversely affect our business, financial condition, operating results and our ability to consummate the Merger.

Following the announcement that we had entered into the Merger Agreement with Parent and Merger Sub on April 7, 2016, on April 22, 2016, a complaint captioned Stephen Bushansky v. Alliance Fiber Optic Products, Inc., et al. Case No. 16-CV-294245 was filed in the Superior Court of California, County of Santa Clara naming as defendants our company, our Board of Directors, Corning and Merger Sub. This action purports to be a class action brought by a stockholder alleging, among other things, that our Board of Directors breached their fiduciary duties by approving the Merger Agreement, and that we, Corning and Merger Sub aided and abetted these alleged breaches of fiduciary duty. On April 27, 2016, a complaint captioned Rudy Luck v. Alliance Fiber Optic Products, Inc., et al., Case No. 16-CV-294413 was filed in the Superior Court of California, County of Santa Clara naming as defendants our company, our Board of Directors, Corning and Merger Sub. Similarly to the Bushansky action, this action purports to be a class action brought by a stockholder alleging, among other things, that our Board of Directors breached their fiduciary duties by approving the Merger Agreement, and that Corning and Merger Sub aided and abetted these alleged breaches of fiduciary duty. The complaints seek, among other things, either to enjoin the proposed transaction or to rescind the transaction in the event it is consummated. The outcome of this litigation cannot be predicted with certainty; however, we believe that the actions are without merit and intend to defend them vigorously.

We, our directors and officers, Corning and Merger Sub may be subject to additional class action lawsuits relating to the Merger and other additional lawsuits that may be filed. Such litigation is very common in connection with acquisitions of public companies, regardless of any merits related to the underlying acquisition. The costs of the defense of such lawsuits and other effects of such litigation could have an adverse effect on our business, financial condition and operating results.

In addition, one of the conditions to consummating the Merger is that no injunction or other order prohibiting or otherwise preventing the consummation of the Merger shall have been issued by any governmental entity of competent jurisdiction in the United States. Consequently, if any of the plaintiffs in these lawsuits or in any other subsequently filed similar lawsuits are successful in obtaining an injunction preventing the parties from consummating the Merger, such injunction may prevent the Merger from being completed in the expected timeframe, or at all.

We have obligations under certain circumstances to hold harmless and indemnify our directors and officers against judgments, fines, settlements and expenses related to claims against such directors and officers and otherwise to the fullest extent permitted under Delaware law and our bylaws and certificate of incorporation. Such obligations may apply to any potential litigation. However, an unfavorable outcome in any lawsuit related to the Merger could prevent or delay the consummation of the Merger and result in substantial costs to us.

We will incur significant costs in connection with the Merger, whether or not it is consummated.

We will incur substantial expenses related to the Merger, whether or not it is completed, including expenses related to litigation related to the proposed Merger. Through March 31, 2015, we have incurred substantial transaction costs and we anticipate incurring additional costs and expenses until completion of the Merger. In addition, we will incur investment banking fees of $2.7 million which are payable upon consummation of the Merger. Payment of these expenses by us as a standalone entity would adversely affect our operating results and financial condition and would likely adversely affect our stock price.

We have a history of losses, may experience future losses and may not be able to sustain profitability.

From inception through March 31, 2016, we had an accumulated deficit of $14.3 million. We incurred a net loss of $536,000 for the quarter ended March 31, 2016, and may incur additional losses in the future.

We continue to experience fluctuating demand for our products. If demand for our products declines, 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 continues to increase in the future, we may incur significant and increasing expenses for expansion of our manufacturing operations, research and development, sales and marketing, and administration, and in expanding our 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, we will need to generate and sustain substantially higher revenues while maintaining reasonable cost and expense levels, and our failure to do so may result in additional losses. We may not be able to achieve profitability in future periods, or maintain profitability on a quarterly or annual basis in the future.

We depend on a small number of customers for a significant portion of our revenues, and one customer accounted for approximately 11% and 45% of our revenues for the three months ended March 31, 2016 and 2015, respectively 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 three months ended March 31, 2016 and 2015, our 10 largest customers comprised 62.2% and 77.9% of our revenues, respectively. One customer accounted for 10.7% and 45.1% of our revenues for the three months ended March 31, 2016 and 2015, respectively.

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, to demand price concessions, or to alter their purchasing patterns in some other way. For example, our largest customer ordered fewer products in the third and fourth quarters of 2015 and the first quarter of 2016 than we expected, which had an adverse effect on our operating results. The loss of any significant customer, a significant reduction in sales we make to a customer, or any problems collecting receivables from one or more significant customers would likely harm our financial condition and results of operations. Changes in purchasing by these customers may also cause our operating results to fluctuate from period to period.

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

Sales of our connectivity products accounted for 71.9% and 79.7% of our revenues in the quarters ended March 31, 2016 and 2015, respectively, 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. 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.

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, the Federal deficit and credit rating, unemployment, global economic instability, slowing growth in China 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. These factors, combined with low oil prices, weak business and consumer confidence and a volatile stock market, have resulted in an economic slowdown. If the economic climate in the U.S. and abroad does not improve or deteriorates, our business, including our customers and our suppliers, could be negatively affected, resulting in a negative impact on our revenues.

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 demand for our products have caused our operating results to fluctuate. Because we incur operating expenses based on anticipated revenue levels; and a significant 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 elsewhere in this report, 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 Inc., JDS Uniphase Corp., Molex Inc., Senko Advanced Components and TE Connectivity. 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 greater resources to the development, promotion and sale of products, to negotiate lower prices on raw materials and components, or to deliver competitive products at lower prices.

Several of our existing and potential customers are also current and potential competitors of ours. These companies may develop or acquire additional competitive products or technologies in the future and subsequently reduce or cease their purchases from us. In light of the consolidation in the optical networking industry, we also believe that the size of suppliers will be an increasingly important part of a purchaser’s decision-making criteria in the future. We may not be able to compete successfully with existing or new competitors, 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 March 31, 2016, we had 33 full-time employees in Sunnyvale, California, 376 full-time employees in Taiwan, and 1,051 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;

●	comply with numerous laws, rules and regulations related to our business both domestically and outside the United States;

●	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 must continue to coordinate our domestic and international operations and maintain 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 China and manufacture many of our products there. Our facility in Taiwan 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. 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 design, manufacturing, marketing and other difficulties that could delay or prevent the development, introduction or marketing of new products and enhancements. Development costs and expenses are incurred before we generate revenues from sales of products resulting from these efforts. Our research and development expenses were $1.2 million and $1.1 million for the three months ended March 31, 2016 and 2015, respectively. We intend to continue to invest in our research and product development efforts, which could have a negative impact on our earnings in future periods.

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

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

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 continued 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 have experienced fluctuations in market demand due to overcapacity in our industry and an economy that is stymied by current financial and economic conditions, international terrorism, war and political instability.

The United States economy has experienced and continues to experience significant fluctuations in consumption and demand. We have in the past and may in the future experience decreases in 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 and economic 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 often experiences declining average selling prices, and declines in average selling prices of products could cause our gross margins to decline.

The optical networking component industry often experiences declining average selling prices as a result of increasing competition and from pricing pressures resulting in greater unit volume purchases as communication service providers continue to deploy fiber optic networks. We expect that average selling prices will continue to decrease over time in response to new product and technology introductions by us or 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.

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.

If we are unable to maintain effective internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our reported financial information and the market price of our common stock may be negatively affected.

As a public company, we are required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 which requires that we evaluate and determine the effectiveness of our internal control over financial reporting and provide a management report on our internal controls. 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. If we have a material weakness in our internal control over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, our management will be unable to conclude that our internal control over financial reporting is effective.

Our independent registered public accounting firm is also required to issue an attestation report on the effectiveness of our internal control over financial reporting on an annual basis. Even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may conclude that there are material weaknesses with respect to our internal controls or the level at which our internal controls are documented, designed, implemented or reviewed. If we are unable to conclude that our internal control over financial reporting is effective or if our auditors were to express an adverse opinion on the effectiveness of our internal control over financial reporting because we had one or more material weaknesses, investors could lose confidence in the accuracy and completeness of our financial disclosures, which could cause the price of our common stock to decline. Internal control deficiencies could also result in a restatement of our financial results.

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 Executive Vice President, Sales and Marketing; 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. 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, impair our operating results and harm our reputation. 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:

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 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, enterprise access, and datacenter 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:

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

Disclosure requirements relating to “conflict minerals” could increase our costs and limit the supply of certain metals that may be used in our products and affect our reputation with customers and stockholders.

As required under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), the Securities and Exchange Commission promulgated final rules regarding annual disclosures by public companies of their use of certain minerals and metals, known as “conflict minerals,” which are mined from the Democratic Republic of the Congo (DRC), and adjoining countries, and their efforts to prevent the sourcing of such conflict minerals from these countries. These rules require us to engage in due diligence efforts to ascertain and disclose the origin of some of the raw materials used in the production process. Annual disclosures are required no later than May 31 of each year. We have and will continue to incur costs associated with complying with these disclosure requirements, including due diligence to determine the sources of conflict minerals, if any, used in our products and other potential changes to our products, processes, or sources of supply as a consequence of such due diligence activities. These rules and our compliance procedures could adversely affect the supply and pricing of materials used in our products. Not all suppliers offer “conflict free” conflict minerals, so we cannot be certain that we will be able to obtain sufficient quantities of conflict free minerals from such suppliers or at competitive prices. Also, our reputation with our customers and stockholders could be damaged if we determine that certain of our products contain minerals not determined to be conflict free or if we are unable to sufficiently verify the origins of conflict minerals used in our products through the procedures we may implement. If we cannot determine that our products exclude conflict minerals sourced from the DRC or adjoining countries, some of our customers may discontinue, or materially reduce, purchases of our products, which could negatively affect our results of operations. In addition, our customers may require us to report to them on our conflict minerals compliance, and if we do not perform this function to a customer’s satisfaction, they may cease to do business with us.

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 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; policing the unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent the misappropriation or unauthorized use of our technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully as United States laws. Our competitors 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.

We have significant manufacturing operations in China, which exposes us to risks inherent in doing business in China.

A significant portion of our manufacturing is conducted at our facilities in Shenzhen, China, and we also conduct research and development-related activities in Shenzhen. Employee turnover in China is high due to the intensely competitive and fluid market for skilled labor. We will need to continue to hire appropriate personnel, obtain and retain required legal authorization to hire such personnel, and expend time and financial resources to hire and train such personnel. In addition, we believe that salary inflation rates for the skilled personnel we hire and seek to retain in China are likely to be higher than inflation rates elsewhere.

Operating in China subjects us to political, legal and economic risks. In particular, the political, legal and economic climate in China, both nationally and regionally, is fluid and unpredictable. Our ability to operate in China may be adversely affected by changes in Chinese laws and regulations such as those related to, among other things, taxation, import and export tariffs, environmental regulations, land use rights, intellectual property, currency controls, employee benefits and other matters. In addition, we may not obtain or retain the requisite legal permits to continue to operate in China, and costs or operational limitations may be imposed in connection with obtaining and complying with such permits.

We intend to continue to export the products manufactured at our facilities in China. Under current regulations, upon application and approval by the relevant governmental authorities, we will not be subject to certain Chinese taxes and will be exempt from certain duties on imported materials that are used in the manufacturing process and subsequently exported from China as finished products. However, Chinese trade regulations are in a state of flux, and we may become subject to other forms of taxation and duties in China or may be required to pay export fees in the future. In the event that we become subject to new taxation or export fees in China, our business and results of operations could be materially adversely affected.

We are subject to anti-corruption laws in the jurisdictions in which we operate, including the U.S. Foreign Corrupt Practices Act. Our failure to comply with these laws could result in penalties which could harm our reputation and have a material adverse effect on our business, results of operations and financial condition.

Because of our worldwide operations, we are subject to risks associated with compliance with applicable anti-corruption laws, including the U.S. Foreign Corrupt Practices Act, or FCPA, which generally prohibits U.S. companies and their employees and intermediaries from making payments to foreign officials for the purpose of obtaining or keeping business, securing an advantage, or directing business to another, and requires public companies to maintain accurate books and records and a system of internal accounting controls. Under the FCPA, U.S. companies may be held liable for actions taken by directors, officers, employees, agents, or other strategic or local partners or representatives. If we or our intermediaries fail to comply with the requirements of the FCPA or similar laws, governmental authorities in the United States and elsewhere could seek to impose civil and criminal fines and penalties which could have a material adverse effect on our business, results of operations and financial condition.

We are subject to complex taxation rules and practices, which may affect our results of operations.

As a multinational company, we are required to comply with increasingly complex taxation rules and practices in the U.S. and abroad. The development of our tax strategies requires expertise and may impact how we conduct our business. Our future effective tax rates could be unfavorably affected by changes in, or interpretations of, tax rules and regulations in the jurisdictions in which we do business, by lapses of the availability of the U.S. research and development tax credit or by changes in the valuation of our deferred tax assets and liabilities. Furthermore, we provide for certain tax liabilities that involve significant judgment. We are subject to the examination of our tax returns by federal, state and foreign tax authorities, which could focus on our intercompany transfer pricing methodology as well as other matters. If our tax strategies are ineffective or we are not in compliance with domestic and international tax laws, our financial position, operating results and cash flows could be adversely affected.

The distribution of any earnings of our foreign subsidiaries to the United States may be subject to United States income taxes, thus reducing our net income.

We hold a significant amount of cash and cash equivalents outside the United States in our foreign subsidiaries that may not be readily available to meet certain of our cash requirements in the United States. If we are unable to address our U.S. cash requirements through operations, through borrowings or from other sources of cash obtained at an acceptable cost, it may be necessary for us to consider repatriation of earnings that are deemed permanently reinvested, and we may be required to pay additional taxes under current tax laws, which could have a material effect on our results of operations and financial condition. We have not recorded a deferred tax liability of approximately $0.7 million related to U.S. federal and state income taxes and foreign withholding taxes on approximately $26.0 million of undistributed earnings of foreign subsidiaries indefinitely invested outside the United States. Except as required under U.S. tax law, we do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries that have not been previously taxed since we intend to invest such undistributed earnings outside of the U.S. Any such taxes would reduce our net income in the period in which these earnings are distributed. In addition, any significant change to the tax system in the U.S. or in other jurisdictions, including changes in the taxation of international income, could adversely affect our financial results.

We face risks associated with currency exchange rate fluctuations, which could adversely affect our operating results.

We are exposed to risks associated with the translation of Taiwan (NT) and China (RMB) denominated financial results and accounts into U.S. dollars for financial reporting purposes. The carrying value of the assets and liabilities held in our Taiwan and China subsidiaries will be affected by fluctuations in the value of the U.S. dollar as compared to the NT and RMB. Changes in the value of the U.S. dollar as compared to the NT and RMB could have an adverse effect on our reported results of operations and financial condition. As the net positions of our unhedged foreign currency transactions fluctuate, our earnings might be negatively affected. In addition, the reported carrying value of our NT and RMB denominated assets and liabilities held in our Taiwan and China subsidiaries will be affected by fluctuations in the value of the U.S. dollar compared to the NT and RMB. As of March 31, 2016, we had a net asset balance, excluding intercompany payables and receivables, in our Taiwan and China subsidiaries denominated in NT and RMB. If the NT and RMB were to weaken 10% against the dollar, our net asset balance would decrease by approximately $1.0 million as of this date. Although we have implemented hedging strategies designed to mitigate foreign currency risk, these strategies may not eliminate our exposure to foreign exchange rate fluctuations and involve costs and risks of their own, such as ongoing management time and expertise, external costs to implement the strategies and potential accounting implications.

* 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 Securities Exchange Act of 1934 (the “Exchange Act”). Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

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.

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

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PART I:	FINANCIAL INFORMATION		1
	ITEM 1:	FINANCIAL STATEMENTS	1
		Condensed Consolidated Balance Sheets	1
		Condensed Consolidated Statements of Operations and Comprehensive Income (loss)	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	13
	ITEM 3:	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	19
	ITEM 4:	CONTROLS AND PROCEDURES	20
PART II:	OTHER INFORMATION		21
	ITEM 1A: RISK FACTORS		21
	ITEM 6:	EXHIBITS	34
SIGNATURES			35

	March 31,			December 31,
	2016			2015
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	13,076		$	6,157
Short-term investments		13,135			17,831
Accounts receivable, net		8,988			12,547
Inventories, net		11,905			10,919
Deferred tax asset, net		3,848			3,848
Prepaid expenses and other current assets		1,683			2,121
Total current assets		52,635			53,423

Long-term investments		10,868			10,821
Property and equipment, net		16,032			16,183
Other assets		208			206
Total assets	$	79,743		$	80,633

Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	7,214		$	6,059
Accrued expenses		7,149			9,510
Total current liabilities		14,363			15,569

Other long-term liabilities		2,079			2,194
Total liabilities		16,442			17,763

Commitments and contingencies (Note 9)

Stockholders' equity:
Preferred stock, par value $0.001: 5,000,000 shares authorized:
no shares issued and outstanding at March 31, 2016 and
December 31, 2015		-			-
Common stock, $0.001 par value: 100,000,000 shares authorized;
15,791,585 and 15,786,785 shares issued and outstanding at
March 31, 2016 and December 31, 2015, respectively		16			16
Additional paid-in-capital		77,358			76,462
Accumulated deficit		(14,315	)		(13,779	)
Accumulated other comprehensive income		242			171

Stockholders' equity		63,301			62,870

Total liabilities and stockholders' equity	$	79,743		$	80,633

	Three Months Ended March 31,
	2016			2015
Cash flows from operating activities:
Net (loss) income	$	(536	)	$	3,558
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Depreciation and amortization		843			659
Loss on disposal of property and equipment		3			-
Stock-based compensation		877			496
Provision for (recovery of) inventory valuation		(46	)		139
Deferred taxes		-			1,168
Changes in assets and liabilities:
Accounts receivable		3,563			(3,354	)
Inventories		(823	)		(1,100	)
Prepaid expenses and other current assets		579			(388	)
Other assets		(5	)		(9	)
Accounts payable		1,071			1,104
Accrued expenses		(2,419	)		386
Other long-term liabilities		(296	)		(78	)
Net cash provided by operating activities		2,811			2,581

Cash flows from investing activities:
Purchase of short-term investments		(9,360	)		(31,847	)
Proceeds from sales and maturities of short-term investments		14,121			31,537
Purchase of long-term investments		(47	)		(46	)
Purchase of property and equipment		(479	)		(1,015	)
Net cash provided by (used in) investing activities		4,235			(1,371	)

Cash flows from financing activities:
Proceeds from the exercise of stock options		19			93
Repurchase of common stock		-			(3,986	)
Net cash provided by (used in) financing activities		19			(3,893	)

Effect of exchange rate changes on cash and cash equivalents		(146	)		341
Net increase (decrease) in cash and cash equivalents		6,919			(2,342	)
Cash and cash equivalents at beginning of period		6,157			22,723
Cash and cash equivalents at end of period	$	13,076		$	20,381

Supplemental disclosure of cash flow information:
Cash paid for income taxes	$	81		$	216

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
Options	Shares		Price		Life	Value
Outstanding at December 31, 2015	571,600		$	9.71
Granted	-			-
Exercised	(4,800	)		3.88
Forfeited	-			-
Outstanding at March 31, 2016	566,800		$	9.76	7.51 Years	$	2,894,971
Vested and expected to vest at March 31, 2016	566,800		$	9.76	7.51 Years	$	2,894,971
Exercisable at March 31, 2016	207,614		$	7.25	6.31 Years	$	1,577,556

	Level 1 —	inputs are quoted prices in active markets for identical assets or liabilities.
	Level 2 —	inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly.
	Level 3 —	inputs are unobservable and shall be used to the extent that observable inputs are not available in the overall fair value measurement.

●	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.

●	management’s and our employees’ attention may be diverted from our day-to-day operations as they focus on matters related to preparing for integration of our operations with those of Corning;

●	we could potentially lose key employees if such employees experience uncertainty about their future roles with us and decide to pursue other opportunities in light of the proposed Merger;

●	we could potentially lose customers or vendors, new customer or vendor contracts could be delayed or decreased and we may have difficulty hiring and retaining new employees;

●	we have agreed to restrictions in the Merger Agreement that limit how we conduct our business prior to the consummation of the Merger, including, among other things, restrictions on our ability to make certain capital expenditures, investments and acquisitions, sell, transfer or dispose of our assets, enter into material contracts outside of the ordinary course of business, amend our organizational documents and incur indebtedness. These restrictions may not be in our best interests as an independent company and may disrupt or otherwise adversely affect our business and our relationships with our customers, prevent us from pursuing otherwise attractive business opportunities, limit our ability to respond effectively to competitive pressures, industry developments and future opportunities, and otherwise harm our business, financial results and operations;

●	we have incurred and expect to continue to incur expenses related to the Merger, such as legal, financial advisory and accounting fees, and other expenses that are payable by us whether or not the proposed Merger is completed;

●	we may be required to pay a termination fee of approximately $10.54 million to Parent if the Merger Agreement is terminated under certain circumstances, which would negatively affect our financial results and liquidity;

●	activities related to the Merger and related uncertainties may lead to a loss of revenues and market position that we may not be able to regain if the proposed Merger does not occur; and

●	the failure to, or delays in, consummating the Merger may result in a negative impression of us with customers, potential customers or the investment community.

●	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 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.

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

Dated: May 2, 2016	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)