ZHONE TECHNOLOGIES INC (Form: 10-Q, Received: 05/14/2004 16:44:10)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the Quarterly period ended March 31, 2004

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

For the transition period from to

000-32743

(Commission File Number)

ZHONE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)


Delaware		22-3509099
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

7001 Oakport Street Oakland, California		94621
(Address of principal executive offices)		(Zip code)

(510) 777-7000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

As of April 30, 2004, there were 78,127,000 shares of the Registrant’s Common Stock issued and outstanding.

Zhone Technologies, Inc.

FORM 10-Q

Quarterly Period Ended March 31, 2004

Table of Contents


Part I.	Financial Information
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets at March 31, 2004 and December 31, 2003	2
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and March 31, 2003	3
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and March 31, 2003	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36

Part II.	Other Information
Item 1.	Legal Proceedings	37
Item 2.	Changes in Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	38
Item 4.	Submission of Matters to a Vote of Security Holders	38
Item 5.	Other Information	38
Item 6.	Exhibits and Reports on Form 8-K	38
	Signature	40

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except par value)


	March 31, 2004			December 31, 2003
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	45,096		$	32,547
Short-term investments		44,888			65,709
Accounts receivable, net of allowances for sales returns and doubtful accounts of $2,679 and $3,505, respectively		13,470			10,693
Inventories		28,419			24,281
Prepaid expenses and other current assets		2,949			3,905

Total current assets		134,822			137,135
Property and equipment, net		22,238			22,585
Goodwill		100,337			100,337
Other acquisition-related intangible assets, net		11,102			12,877
Restricted cash		622			622
Other assets		996			1,013

Total assets	$	270,117		$	274,569

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	19,276		$	19,998
Line of credit		14,500			4,800
Current portion of long-term debt		878			1,351
Accrued and other liabilities		22,279			28,685

Total current liabilities		56,933			54,834
Long-term debt, less current portion		31,803			32,040
Other long-term liabilities		678			816

Total liabilities		89,414			87,690

Stockholders’ equity:
Common stock, $0.001 par value. Authorized 900,000 shares; issued and outstanding 78,108 and 76,629 shares as of March 31, 2004 and December 31, 2003, respectively		78			77
Additional paid-in capital		794,082			787,567
Notes receivable from stockholders		(550	)		(550	)
Deferred compensation		(3,716	)		(4,444	)
Other comprehensive loss		(49	)		(14	)
Accumulated deficit		(609,142	)		(595,757	)

Total stockholders’ equity		180,703			186,879

Total liabilities and stockholders’ equity	$	270,117		$	274,569

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Operations

(In thousands, except per share data)


	Three Months Ended March 31,
	2004			2003
Net revenue	$	21,033		$	17,075
Cost of revenue		11,898			9,748
Stock-based compensation		82			(445	)

Gross profit		9,053			7,772

Operating expenses:
Research and product development (excluding non-cash stock-based compensation expense of $216 and $(1,263))		5,953			5,744
Sales and marketing (excluding non-cash stock-based compensation expense of $159 and $(1,052))		4,682			4,277
General and administrative (excluding non-cash stock-based compensation expense of $153 and $(255))		2,482			765
Purchased in-process research and development		6,185			—
Stock-based compensation		528			(2,570	)
Amortization and impairment of intangible assets		2,078			1,784

Total operating expenses		21,908			10,000

Operating loss		(12,855	)		(2,228	)
Other income (expense), net		(434	)		(533	)

Loss before income taxes		(13,289	)		(2,761	)
Income tax provision		96			41

Net loss		(13,385	)		(2,802	)
Accretion on preferred stock (Note 5)		—			(10,618	)

Net loss applicable to holders of common stock	$	(13,385	)	$	(13,420	)

Basic and diluted net loss per share applicable to holders of common stock	$	(0.17	)	$	(2.07	)
Weighted average shares outstanding used to compute basic and diluted net loss per share applicable to holders of common stock		77,266			6,490

All per share amounts have been retroactively adjusted to reflect the one-for-ten reverse split of common stock and the effect of the Tellium merger. (See Note 1(b)).

See accompanying notes to condensed consolidated financial statements.

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

(In thousands)


	Three months ended March 31,
	2004			2003
Cash flows from operating activities:
Net loss	$	(13,385	)	$	(2,802	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,331			2,225
Stock-based compensation		610			(3,015	)
Purchased in-process research and development		6,185			—
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(2,777	)		6,647
Inventories		(4,138	)		(235	)
Prepaid expenses and other current assets		956			(157	)
Other assets		17			(68	)
Accounts payable		(722	)		(1,584	)
Accrued liabilities and other		(6,484	)		(4,430	)

Net cash used in operating activities		(17,407	)		(3,419	)

Cash flows from investing activities:
Purchases of property and equipment		(66	)		(16	)
Purchases of short-term and other investments		(48,966	)		—
Proceeds from sale and maturities of short-term investments		69,790			—
Cash payments related to acquisitions		(650	)		—

Net cash provided by (used in) investing activities		20,108			(16	)

Cash flows from financing activities:
Net borrowings (payments) under credit facilities		9,700			(2,639	)
Proceeds from issuance of common stock and warrants, net of repurchases		896			7
Repayment of debt		(710	)		(1,157	)

Net cash provided by (used in) financing activities		9,886			(3,789	)

Effect of exchange rate changes on cash		(38	)		14

Net increase (decrease) in cash and cash equivalents		12,549			(7,210	)
Cash and cash equivalents at beginning of period		32,547			10,614

Cash and cash equivalents at end of period	$	45,096		$	3,404

Supplemental disclosures of cash flow information:
Non-cash investing and financing activities:
Common stock issued for acquisition	$	5,738		$	—
Series B redeemable convertible preferred stock issued for acquisition		—			10,125

See accompanying notes to condensed consolidated financial statements.

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)

Organization and Summary of Significant Accounting Policies

(a)

Description of Business

Zhone Technologies, Inc. and subsidiaries (“the Company”) designs, develops and markets telecommunications hardware and software products for network service providers. The Company has developed an integrated hardware and software architecture designed to simplify the way network service providers deliver communication services to their subscribers. The Company’s products enable service providers to use their existing networks to deliver voice, video, data, and entertainment services to their customers. The Company was incorporated under the laws of the state of Delaware in June 1999. The Company began operations in September 1999 and is headquartered in Oakland, California.

(b)

Basis of Presentation

The condensed consolidated financial statements are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the current interim period are not necessarily indicative of results to be expected for the current year or any other period. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2003.

In July 2002, in conjunction with the Company’s equity restructuring, the Company’s Board of Directors approved a reverse stock split of the Company’s common stock at a ratio of one-for-ten (the “Reverse Split”), causing each outstanding share of common stock to convert automatically into one-tenth of a share of common stock. In November 2003, the Company consummated its merger with Tellium, Inc. (“Tellium”). As a result of the merger with Tellium, stockholders of Zhone prior to the merger received 0.47 shares of Tellium common stock for each outstanding share of Zhone common stock, following the conversion of all outstanding shares of Zhone preferred stock into Zhone common stock. Immediately following the exchange, the combined company was renamed Zhone.

For accounting purposes, the merger with Tellium was treated as a reverse merger, in which Zhone was treated as the acquirer based on factors including the relative voting rights, board control, and senior management composition. The financial statements of the combined company after the merger reflect the financial results of Zhone on a historical basis after giving effect to the merger exchange ratio to historical share-related data. The results of operations for Tellium were included in Zhone’s results of operations from the effective date of the merger.

Stockholders’ equity has been restated to give retroactive recognition to the Reverse Split and the effect of the Tellium merger for all periods presented by reclassifying the excess par value resulting from the reduced number of shares from common stock to paid-in capital. All references to preferred share, common share and per common share amounts for all periods presented have been retroactively restated to reflect the Reverse Split and the effect of the Tellium merger.

(c)

Use of Estimates

The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

(d)

Revenue Recognition

The Company recognizes revenue when the earnings process is complete. The Company recognizes product revenue upon shipment of product under contractual terms which transfer title to customers upon shipment, under normal credit terms, or under sales-type leases, net of estimated sales returns and allowances at the time of shipment. Revenue is deferred if there are significant post-delivery obligations, if collection is not considered reasonably assured at the time of sale, or if the fees are not fixed or determinable. When significant post-delivery obligations exist, revenue is deferred until such

obligations are fulfilled. The Company’s arrangements generally do not have any significant post-delivery obligations. The Company offers products and services such as support, education and training, hardware upgrades and extended warranty coverage. For multiple element revenue arrangements, the Company establishes the fair value of these products and services based primarily on sales prices when the products and services are sold separately. When collectibility is not reasonably assured, revenue is recognized when cash is collected. Revenue from education services and support services is recognized over the contract term or as the service is performed. The Company makes certain sales to product distributors. These customers are given certain privileges to return a portion of inventory. The Company recognizes revenue on sales to distributors that have contractual return rights when the products have been sold by the distributors, unless there is sufficient customer specific sales and sales returns history to support revenue recognition upon shipment. Revenue from sales of software products is recognized provided that a purchase order has been received, the software has been shipped, collection of the resulting receivable is probable, and the amount of the related fees is fixed or determinable. To date, revenue from software transactions and sales-type leases has not been significant. The Company accrues for warranty costs, sales returns, and other allowances at the time of shipment based on historical experience and expected future costs.

(e)

Allowances for Sales Returns and Doubtful Accounts

The Company has an allowance for sales returns for estimated future product returns related to current period product revenue. The Company bases its allowance on periodic assessment of historical trends in product return rates and current approved returned products. If the actual future returns were to deviate from the historical data on which the reserve had been established, the Company’s revenue could be adversely affected.

The Company has an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments. The Company bases its allowance on periodic assessment of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement reviews, and historical collection trends. Additional allowances may be required if the liquidity or financial condition of its customers were to deteriorate.

(f)

Inventories

Inventories are stated at the lower of cost or market, with cost being determined using the first-in, first-out (FIFO) method. In assessing the net realizable value of inventories, the Company is required to make judgments as to future demand requirements and compare these with the current or committed inventory levels. Once inventory has been written down to its estimated net realizable value, its carrying value cannot be increased due to subsequent changes in demand forecasts. To the extent that a severe decline in forecasted demand occurs, or the Company experiences a higher incidence of inventory obsolescence due to rapidly changing technology and customer requirements, the Company may incur significant charges for excess inventory.

(g)

Concentration of Risk

The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, Internet service providers, wireless carriers, and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts. For the three months ended March 31, 2004, sales to two customers represented 11% and 10% of net revenue, respectively. For the three months ended March 31, 2003, sales to one customer represented 18% of net revenue. As of March 31, 2004, the Company had accounts receivable balances from three customers individually representing 24%, 16% and 10% of accounts receivable, respectively. As of December 31, 2003, the Company had accounts receivable balances from two customers individually representing 31% and 11% of accounts receivable, respectively.

(h)

Accounting for Stock-Based Compensation

The Company has elected to account for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”) and related interpretations. Under this method, compensation expense is recorded on the date of grant only if the current fair value exceeds the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation , established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123, as amended.

For the three months ended March 31, 2004 and 2003, the fair value of the Company’s stock-based awards to employees was estimated using the following weighted average assumptions: expected option life of 4.0 years; dividend yield of 0%; risk-free interest rate of 3.0% and 4.5%, respectively; and volatility of 95% and 0%, respectively. Prior to entering into its merger agreement with Tellium, Inc. in July 2003, the Company used the minimum value option pricing model for privately-held companies, which does not consider the impact of stock price volatility.

The following table illustrates the effect on net loss and net loss per share if the fair-value-based method had been applied to all outstanding and unvested awards in each period (in thousands, except per share data):


	Three months ended March 31,
	2004			2003
Net loss, as reported	$	(13,385	)	$	(13,420	)

Add: Stock-based compensation expense included in reported net loss		610			(3,015	)
Deduct: Total stock-based compensation benefit (expense) determined under fair value method for all awards		(1,861	)		3,335

Pro forma net loss	$	(14,636	)	$	(13,100	)

Loss per share applicable to holders of common stock:
As reported – basic and diluted	$	(0.17	)	$	(2.07	)

Pro forma – basic and diluted	$	(0.19	)	$	(2.02	)

(i)

Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities .” In December 2003, the FASB issued a revision to FIN 46 (“FIN 46R”). FIN 46R requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46R are effective immediately for all new arrangements entered into after December 31, 2003. The Company does not have any financial interests in variable interest entities created prior to December 31, 2003, for which the provisions of FIN 46R became effective on January 1, 2004. The adoption of FIN 46R did not have a material impact on the Company’s consolidated financial statements.

(2)

Acquisitions

Gluon

In February 2004, the Company acquired the assets of Gluon Networks, Inc. (“Gluon”) in exchange for total consideration of $6.49 million, consisting of common stock valued at $5.74 million, $0.65 million of cash and $0.1 million of acquisition related costs. One of our directors is a partner of a venture capital firm which is a major stockholder of Zhone, and which was also a major stockholder of Gluon. The transaction was accounted for as an asset acquisition rather than a business combination, since only assets were acquired, which consisted primarily of Gluon’s intellectual property. Gluon was a development stage company that had developed a product for customer trials but had not generated any revenue to date. The Company agreed to acquire Gluon’s intellectual property and hired approximately ten of the former Gluon employees. The Company intends to incorporate elements of the Gluon technology into its future product offerings but does not anticipate generating material revenue from such products until the second half of 2005.

The purchase price for the Gluon transaction was allocated to purchased in-process research and development - $6.19 million, and acquired workforce - $0.3 million. The amount allocated to purchased in-process research and development was charged to expense during the first quarter of 2004, because technological feasibility had not been established and no future alternative uses for the technology existed. The estimated fair value of the purchased in-process research and development was determined using a discounted cash flow model, based on a discount rate which took into consideration the stage of completion and risks associated with developing the technology. Because the transaction did not constitute a business combination, no goodwill was recorded and a portion of the purchase price was allocated to the acquired workforce, which will be amortized over a two year period.

Tellium

In November 2003, the Company completed the acquisition of Tellium in exchange for total consideration of approximately $173.3 million, consisting of common stock valued at $119.4 million, options and warrants to purchase common stock valued at $7.9 million, assumed liabilities of $42.8 million, and acquisition costs of $3.2 million. The transaction was treated as a reverse merger for accounting purposes, in which the Company was treated as the acquirer based on factors including the relative voting rights, board control, and senior management composition. The purchase price was allocated to the fair values of the assets acquired as follows: net tangible assets - $144.4 million, goodwill - $25.7 million and deferred compensation - $3.1 million. The Company recorded severance and facility exit costs for the Tellium acquisition in accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination”. A rollforward of the EITF 95-3 reserve activity was comprised as follows (in thousands):


	Severance			Facility Exit Costs			Total
Balance at December 31, 2003	$	3,242		$	2,372		$	5,614
Cash payments		(2,982	)		(1,379	)		(4,361	)

Balance at March 31, 2004	$	260		$	993		$	1,253

The remaining costs accrued under EITF 95-3 are expected to be paid within the next nine months.

(3)

Long-lived Assets, Goodwill and Other Acquisition-Related Intangible Assets

As of January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets . SFAS No. 142 requires that goodwill no longer be amortized, but should be tested for impairment at least annually. The Company completed its transitional and first annual goodwill impairment test as of January 2002 and November 2002, respectively. As the Company has determined that it operates in a single segment with one operating unit, the fair value of its reporting unit was performed at the Company level using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies’ data. As of November 2003, the Company performed the annual goodwill impairment test using the market approach, reflecting the fact that the Company’s stock was publicly traded following the consummation of the Tellium merger. At March 31, 2004 and December 31, 2003, the Company had goodwill with a carrying value of $100.3 million. No goodwill impairment charges have been recorded since the initial adoption of SFAS No. 142.

In accordance with SFAS No. 144, the Company reviews long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable

based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.

The Company estimated the fair value of its long-lived assets based on a combination of the market, income and replacement cost approaches. In the application of the impairment testing, the Company was required to make estimates of future operating trends and resulting cash flows and judgments on discount rates and other variables. Actual future results and other assumed variables could differ from these estimates.

Details of the Company’s acquisition-related intangible assets are as follows:


	March 31, 2004
	Gross Amount		Accumulated Amortization			Net		Weighted Average Useful Life
			(in thousands)					(in years)
Developed technology	$	35,596	$	(30,706	)	$	4,890	3.7
Core technology		12,104		(10,289	)		1,815	5.0
Others		11,312		(6,915	)		4,397	3.6

Total	$	59,012	$	(47,910	)	$	11,102


	December 31, 2003
	Gross Amount		Accumulated Amortization			Net		Weighted Average Useful Life
			(in thousands)					(in years)
Developed technology	$	35,596	$	(29,907	)	$	5,689	3.7
Core technology		12,104		(9,683	)		2,421	5.0
Others		11,008		(6,241	)		4,767	3.6

Total	$	58,708	$	(45,831	)	$	12,877

Amortization expense of acquisition-related intangible assets was $2.1 million and $1.8 million for the three months ended March 31, 2004 and 2003, respectively.

Estimated amortization expense for the future periods ending December 31 is as follows: 2004 (remainder of year) - $6.3 million, 2005 - $4.6 million, and 2006 - $0.3 million.

The changes in the carrying amount of goodwill are as follows (in thousands):


	Three months ended March 31,
	2004		2003
Beginning balance	$	100,337	$	70,828
Goodwill acquired		—		4,232

Ending balance	$	100,337	$	75,060

(4)

Inventories

Inventories as of March 31, 2004 and December 31, 2003 are as follows (in thousands):


	March 31, 2004		December 31, 2003
Inventories:
Raw materials	$	22,128	$	19,681
Work in process		4,603		3,088
Finished goods		1,688		1,512

	$	28,419	$	24,281

(5)

Redeemable Convertible Preferred Stock

During the three months ended March 31, 2003, the Company had Series AA and Series B redeemable convertible preferred stock outstanding, and was recording accretion relating to this preferred stock as described below. There were no shares of preferred stock outstanding during the three months ended March 31, 2004. All outstanding shares of preferred stock were converted to common stock prior to the consummation of the Tellium merger in November 2003.

Prior to April 17, 2003, the Company’s Series AA and Series B redeemable convertible preferred stock had contained a redemption feature, such that holders of the redeemable convertible preferred stock could require the Company to redeem the preferred stock at, or any time after, November 1, 2004, 2005, and 2006, in three annual installments, that number of shares of redeemable convertible preferred stock equal to not less than 33.3%, 66.7%, and 100%, respectively. On April 17, 2003, the terms of the redeemable convertible preferred stock were changed to eliminate the redemption feature. Upon the elimination of the redemption feature, the convertible preferred stock was reclassified to stockholders’ equity.

Prior to April 17, 2003, the Company was accreting the redeemable convertible preferred stock to its stated redemption price. The Company accreted, by charging paid in capital, $12.7 million on all outstanding Series AA and Series B redeemable convertible preferred stock through April 17, 2003, which was reflected as an increase in the carrying value of the preferred stock. Upon the elimination of the redemption feature for the Series AA and Series B preferred shares, the Company stopped recording accretion on the convertible preferred stock. The accretion of the redemption value of the redeemable convertible preferred stock for the three months ended March 31, 2003 was $10.6 million.

(6)

Net Loss Per Share

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


	Three months ended March 31,
	2004			2003
Numerator:
Net loss	$	(13,385	)	$	(2,802	)
Accretion on preferred stock		—			(10,618	)

Net loss applicable to holders of common stock	$	(13,385	)	$	(13,420	)

Denominator:
Weighted average common stock outstanding		77,456			7,293
Adjustment for common stock issued subject to repurchase		(190	)		(803	)

Denominator for basic and diluted calculation		77,266			6,490

Basic and diluted net loss per share applicable to holders of common stock	$	(0.17	)	$	(2.07	)

The following table sets forth potential common stock that is not included in the diluted net loss per share calculation above because their effect would be antidilutive for the periods indicated (in thousands, except exercise price data):


	Three Months Ended March 31, 2004	Weighted Average Exercise price
Weighted average common stock issued subject to repurchase	190	$	1.84
Warrants	337		47.40
Outstanding stock options granted	4,653		4.26

	5,180


	Three Months Ended March 31, 2003	Weighted Average Exercise price
Convertible Preferred stock	38,996		N/M
Weighted average common stock issued subject to repurchase	803	$	2.11
Warrants	78		29.97
Outstanding stock options granted	1,548		1.45

	41,426

(7)

Comprehensive Loss

The components of comprehensive loss, net of tax, for the three months ended March 31, 2004 and 2003 were as follows (in thousands):


	Three Months Ended March 31,
	2004			2003
Net loss	$	(13,385	)	$	(13,420	)
Change in unrealized loss on investments		3			—
Foreign currency translation adjustments		(38	)		14

Total comprehensive loss	$	(13,420	)	$	(13,406	)

(8)

Commitments and Contingencies

Leases

The Company has entered into operating leases for certain office space and equipment, some of which contain renewal options. The Company has options to purchase the leased assets at the end of the lease terms.

Future minimum lease payments under all non-cancelable operating leases with terms in excess of one year are as follows (in thousands):


	Operating leases
Year ending December 31:
2004 (remainder of year)	$	4,785
2005		1,113
2006		425
2007		342

Total minimum lease payments	$	6,665

Warranty Costs

The Company accrues for warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally one year from the date of shipment.

The following table summarizes the activity related to the product warranty liability for the three months ended March 31, 2004 and 2003 (in thousands):


	Three Months Ended March 31,
	2004			2003
Beginning balance	$	5,856		$	6,040
Charged to operations		51			190
Warranty reserve from acquired companies		—			1,537
Reductions		(352	)		(618	)

Ending balance	$	5,555		$	7,149

The Company depends on sole source and limited source suppliers for several key components and contract manufacturing. If the Company was unable to obtain these components on a timely basis, the Company would be unable to meet its customers’ product delivery requirements which could adversely impact operating results.

The Company has agreements with various contract manufacturers which include inventory repurchase commitments on excess material. The Company has recorded a liability of $4.6 million related to these arrangements as of March 31, 2004 and December 31, 2003.

Letters of Credit

The Company has issued letters of credit to ensure its performance or payment to third parties in accordance with specified terms and conditions, which amounted to $0.6 million as of March 31, 2004. The Company has recorded restricted cash equal to the amount outstanding under these letters of credit.

Legal Proceedings

The Company is involved in various litigation matters relating to the operations of Tellium prior to the merger as described below.

In July 2002, Corning Incorporated filed a Demand for Arbitration arising out of a dispute in connection with Tellium’s October 2000 merger with Astarte Fiber Networks, Inc. Corning alleges that Astarte and Tellium, as successor-in-interest to Astarte, fraudulently induced Corning to enter into a contract, breached that contract, and breached warranties presented in that contract. The Demand for Arbitration was subsequently amended to add a claim for unjust enrichment. Corning seeks an award of $38 million, plus expenses and interest. Tellium filed a response with the American Arbitration Association that they are not a proper party to the dispute. A third party to the Demand has also responded to the American Arbitration Association that Tellium is not relevant to the dispute. The arbiters have been empanelled, and a preliminary hearing was held on February 27, 2003. At the preliminary hearing, Tellium made a motion to dismiss the suit against the Company for failure to state a viable claim as to Tellium, and the arbiters set a briefing schedule on the motion. The parties completed briefing on July 18, 2003. On September 17, 2003, the arbiters denied Tellium’s motion to dismiss, with a suggestion that Tellium refile its motion on the close of discovery. The parties have also commenced some discovery, including requests for documents, written interrogatories, and depositions. On October 28, 2003, Tellium commenced in the United States District Court for the Southern District of New York an action for a declaratory judgment that Tellium is not a proper party to the arbitration. Tellium’s action seeks to have the arbitration stayed and Corning enjoined from pursuing arbitration any further against Tellium. On January 28, 2004, the arbiters stayed all proceedings against Tellium, but the arbitration continues as to Astarte. It is too early in the dispute process to determine what impact, if any, this dispute will have upon the Company’s business, financial condition, or results of operations. The Company intends to vigorously defend the claims made in any legal proceedings that may result and pursue any possible counterclaims against Corning, Astarte, and other parties associated with the claims.

actions and equitable relief as may be permitted by law or equity. On May 19, 2003, a consolidated amended complaint representing all of the actions was filed. On August 4, 2003, Tellium and its underwriters filed motions to dismiss the complaint. On April 1, 2004, the Court issued its decision granting Tellium’s and the underwriters’ motions to dismiss, while allowing plaintiffs an opportunity to seek leave to file a further amended complaint. The Company anticipates opposing that motion and moving to have the further amended complaint dismissed with prejudice. It remains too early in the legal process to determine what impact, if any, these suits will have upon the Company’s business, financial condition, or results of operations. The Company intends to continue vigorously defending against the claims made in these actions.

On January 8, 2003 and January 27, 2003, two shareholder derivative complaints were filed on behalf of Tellium in the Superior Court of New Jersey. These complaints were made by plaintiffs who purport to be Tellium shareholders on behalf of Tellium, alleging, among other things, that Tellium directors breached their fiduciary duties to the company by engaging in stock transactions with individuals associated with Qwest, and in making materially misleading statements regarding Tellium’s relationship with Qwest. The actions seek damages in an unspecified amount, including imposition of a constructive trust in favor of Tellium for the amount of profits allegedly received through stock sales, disgorgement of proceeds in connection with the stock option exercises, damages allegedly sustained by Tellium in connection with alleged breaches of fiduciary duties, costs, and expenses incurred in connection with the actions. These cases have been stayed by the court pending the resolution of motions to dismiss in the above-referenced federal court securities actions. It is too early in the legal process to determine what impact, if any, these suits will have upon the Company’s business, financial condition, or results of operations. The Company intends to vigorously defend the claims made in these actions, which have been consolidated.

The Denver, Colorado regional office of the SEC is conducting two investigations titled In the Matter of Qwest Communications International, Inc. and In the Matter of Issuers Related to Qwest . The first of these investigations does not involve any allegation of wrongful conduct on the part of Tellium. In connection with the second investigation, the SEC is examining various transactions and business relationships involving Qwest and eleven companies having a vendor relationship with Qwest, including Tellium. This investigation, insofar as it relates to Tellium, appears to focus generally on whether Tellium’s transactions and relationships with Qwest were appropriately disclosed in Tellium’s public filings and other public statements. In addition, the United States Attorney in Denver is conducting an investigation involving Qwest, including Qwest’s relationships with certain of its vendors, including Tellium. In connection with that investigation, the U.S. Attorney has sought documents and information from Tellium and has sought interviews and/or grand jury testimony from persons associated or formerly associated with Tellium, including certain of its officers. The U.S. Attorney has indicated that, while aspects of its investigation are in an early stage, neither Tellium nor any of the Company’s current or former officers or employees is a target of the investigation. The Company is cooperating fully with these investigations. The Company is not able, at this time, to say when the SEC or U.S. Attorney investigations will be completed and resolved, or what the ultimate outcome with respect to the Company will be. These investigations could result in substantial costs and a diversion of management’s attention and may have a material and adverse effect on the Company’s business, financial condition, and results of operations.

The Company is subject to other legal proceedings, claims and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s results of operations or financial position.

(9)

Segment Information

Zhone designs, develops and markets telecommunications hardware and software products for network service providers. The Company derives substantially all of its revenues from the sales of the Zhone product family. The Company’s chief operating decision maker is the Company’s chief executive officer, or CEO. The CEO reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. The Company has determined that it has operated within one discrete reportable business segment since inception. The Company is required to disclose certain information about geographic concentrations and revenue by product family.


	Three Months ended March 31,
	2004		2003
	(in thousands)
Revenue:
North America	$	17,791	$	15,717
International		3,242		1,358

Total revenue	$	21,033	$	17,075


	Three Months ended March 31,
	2004		2003
	(in thousands)
Revenue by Product Family:
SLMS	$	9,636	$	7,074
MUX		5,080		6,444
DLC		6,317		3,557

Total revenue	$	21,033	$	17,075

(10)

Subsequent Events

In April 2004, the Company announced a definitive agreement to acquire Sorrento Networks Corporation (“Sorrento”). Under the terms of the agreement, the Company will issue 0.9 of a share of common stock for each outstanding share of Sorrento common stock, and will assume options and warrants to purchase Sorrento common stock, with appropriate adjustments based on the merger exchange ratio. Based on a preliminary valuation, the Company would issue approximately 14.7 million shares of common stock and would assume approximately 5.4 million options and warrants to purchase common stock, and the total value of the transaction would be approximately $97.7 million. One of our directors is a partner of a venture capital firm which is a major stockholder of Zhone, and also holds warrants to purchase Sorrento common stock. The proposed merger is subject to regulatory and stockholder approvals and other closing conditions, and is currently expected to close during the second or third quarter of 2004.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report. In addition to historical information, this report contains forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. We use words such as “anticipate”, “believe”, “could”, “estimate”, “expect”, “intend”, “may”, “should”, “will”, “would” and similar expressions to identify forward-looking statements. Factors that might cause such a difference include, but are not limited to, the rate of product purchases by current and prospective customers, general economic conditions, conditions specific to the telecommunications and related industries, new product introductions and enhancements by us and our competitors, competition, manufacturing and sourcing risks. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified below, under “Risk Factors” and elsewhere herein. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

OVERVIEW

We were founded in 1999 to offer network service providers a simplified, comprehensive architectural approach to delivering services over their access networks.

We have developed hardware and software that simplify the way network service providers deliver communication services to their subscribers. Our Single Line Multi-Service Architecture, or SLMS ^{^™} , is a simplified network architecture that provides broadband and narrowband services over a scalable next-generation local-loop infrastructure. SLMS is designed to extend the speed, reliability and cost-efficiencies currently achieved in the core of the communications network to business and consumer subscribers. Our products enable service providers to use their existing networks to deliver voice, data, video, and entertainment services to their customers. We have designed our products to interoperate with different types of wiring and equipment already deployed in service providers’ networks.

Our Zhone Management System, or ZMS ^{^™} , provides the software tools necessary to manage all of the products, services and subscribers in a SLMS network. ZMS is a single management tool that enables network service providers to allow instant delivery and upgrade of network services. In addition, ZMS is capable of interfacing with and managing other vendors equipment already deployed in service providers’ networks.

We currently have products in three categories: the SLMS product family; the digital loop carrier, or DLC, product family and the multiplexer, or MUX, product family.

We believe that we have assembled the employee base, technological breadth and market presence to provide a simple yet comprehensive set of solutions to the complex problems encountered by network service providers when delivering communications services to subscribers.

Since inception, we have incurred significant operating losses and have an accumulated deficit of $609.1 million at March 31, 2004. The global telecommunications market has deteriorated significantly over the last several years. Many of our customers and potential customers have reduced their capital spending during this period and many others have ceased operations. Additional capital spending reductions have continued due to continued uncertainties regarding the state of the global economy, network overcapacity, customer bankruptcies, network build-out delays and limited capital availability. In response to the challenging environment, we have taken the actions that we believe are necessary for our future success. In particular, we have significantly reduced our operating costs through workforce reductions and careful cost controls. We have also taken significant write-downs of inventory, intangible assets and property and equipment. Due to our restructuring activities and careful expense controls, our net loss decreased from $108.6 million in 2002 to $17.2 million in 2003. We do not expect any significant reductions in our overall workforce for at least through the period ending December 2004.

Going forward, our key objectives include the following:

•

Increasing revenue while continuing to carefully control costs;

•

Continued investments in strategic research and product development activities that will provide the maximum potential return on investment;

•

Minimizing consumption of our cash and short-term investments; and

•

Analyzing and pursuing strategic acquisitions that will allow us to expand our customer, technology and/or revenue base.

Basis of Presentation

In November 2003, we consummated our merger with Tellium. Tellium was the surviving entity under corporate law and following the merger its name was changed to Zhone Technologies, Inc. However, due to various factors, including the relative voting rights, board control, and senior management composition of the combined company, the transaction was treated as a reverse merger for accounting purposes, and Zhone was treated as the “acquirer”. As a result, the financial statements of the combined company after the merger reflect the financial results of Zhone on a historical basis after giving effect to the merger exchange ratio to historical share-related data. The results of operations for Tellium were included in the combined company’s results of operations from the effective date of the merger.

In July 2002, in conjunction with our equity restructuring, our Board of Directors approved a reverse stock split of our common stock at a ratio of one-for-ten (the “Reverse Split”), causing each outstanding share of common stock to convert automatically into one-tenth of a share of common stock. As a result of the merger with Tellium, stockholders of Zhone prior to the merger received 0.47 of a share of Tellium common stock for each outstanding share of Zhone common stock, following the conversion of all outstanding shares of our preferred stock into common stock.

In October 2003, in response to an inquiry from the SEC, we restated our consolidated financial statements and related disclosures for the year ended December 31, 2002 and for the quarters ended June 30, 2003 and March 31, 2003. All information, discussions and comparisons in this report reflect the restatement. The restatement reflected increased non-cash stock-based compensation expense resulting from a change in the estimated fair value of our common stock from $0.21 per share to $3.19 per share. We also adjusted the Series AA redeemable preferred stock to reflect a decrease in the estimated fair value from $170.7 million to $126.5 million, or $5.81 per share to $4.31 per share as of July 1, 2002.

Acquisitions

As of March 31, 2004, we had completed ten acquisitions of complementary companies, products or technologies to supplement our internal growth. To date, we have generated a significant amount of our revenue from sales of products obtained through acquisitions.

We are likely to acquire additional businesses, products and technologies in the future. In April 2004, we announced a definitive agreement to acquire Sorrento Networks Corporation in a transaction valued at approximately $97.7 million based on a preliminary valuation. If we complete additional acquisitions in the future, we could consume cash, incur substantial additional debt and other liabilities, incur amortization expenses related to acquired intangible assets or incur large write-offs related to impairment of goodwill and long-lived assets. In addition, future acquisitions may have a significant impact on our short term results of operations, materially impacting revenues or expenses and making period to period comparisons of our results of operations less meaningful.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of its financial condition and results of operations is based upon 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 management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The policies discussed below are considered by management to be critical because changes in such estimates can materially affect the amount of our reported net income or loss. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions.

Revenue Recognition

We recognize revenue when the earnings process is complete. We recognize product revenue upon shipment of product under contractual terms which transfer title to customers upon shipment, under normal credit terms, or under sales-type leases, net of estimated sales returns and allowances at the time of shipment. Revenue is deferred if there are significant post-delivery obligations, if collection is not considered reasonably assured at the time of sale, or if the fees are not fixed or determinable. When significant post-delivery obligations exist, revenue is deferred until such obligations are fulfilled. Our arrangements generally do not have any significant post delivery obligations. We offer products and services such as support, education and training, hardware upgrades and extended warranty coverage. For multiple element revenue arrangements, we establish the fair value of these products and services based primarily on sales prices when the products and services are sold separately. When collectibility is not reasonably assured, revenue is recognized when cash is collected. Revenue from education services and support services is recognized over the contract term or as the service is performed. We make certain sales to product distributors. These customers are given certain privileges to return a portion of inventory. We recognize revenue on sales to distributors that have contractual return rights when the products have been sold by the distributors, unless there is sufficient customer specific sales and sales return history to support revenue recognition upon shipment. Revenue from sales of software products is recognized provided that a purchase order has been received, the software has been shipped, collection of the resulting receivable is probable, and the amount of the related fees is fixed or determinable. To date, revenue from software transactions and sales-type leases has not been significant. We accrue for warranty costs, sales returns, and other allowances at the time of shipment based on historical experience and expected future costs.

Allowances for Sales Returns and Doubtful Accounts

We record an allowance for sales returns for estimated future product returns related to current period product revenue. The allowance for sales returns is recorded as a reduction of revenue and an allowance against our accounts receivable. We base our allowance for sales returns on periodic assessments of historical trends in product return rates and current approved returned products. If the actual future returns were to deviate from the historical data on which the reserve had been established, our future revenue could be adversely affected.

We record an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments for amounts owed to us. We base our allowance on periodic assessments of our customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement reviews, and historical collection trends. Additional allowances may be required in the future if the liquidity or financial condition of our customers were to deteriorate, resulting in an impairment in their ability to make payments.

Valuation of Long-Lived Assets, including Goodwill and Other Acquisition-Related Intangible Assets

Our long-lived assets consist primarily of goodwill, other acquisition-related intangible assets and property and equipment. We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Such events or circumstances include, but are not limited to, a significant decrease in the benefits realized from the acquired business, difficulty and delays in integrating the business or a significant change in the operations of the acquired business or use of an asset. Goodwill and other acquisition-related intangible assets not subject to amortization are tested annually for impairment using a two-step approach, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value.

We estimate the fair value of our long-lived assets based on a combination of the market, income and replacement cost approaches. In the application of the impairment testing, we are required to make estimates of future operating trends and resulting cash flows and judgments on discount rates and other variables. Actual future results and other assumed variables could differ from these estimates.

As of March 31, 2004, we have $100.3 million of goodwill, $11.1 million of other acquisition-related intangible assets and $22.2 million of property and equipment. Other acquisition-related intangible assets are comprised mainly of technology in place and customer relationships. Many of the entities acquired by us do not have significant tangible assets, as a result, a significant portion of

the purchase price is typically allocated to intangible assets and goodwill. Our future operating performance will be impacted by the future amortization of intangible assets, potential charges related to purchased in-process research and development for future acquisitions, and potential impairment charges related to goodwill. Accordingly, the allocation of the purchase price of the acquired companies to intangible assets and goodwill has a significant impact on our future operating results. The allocation process requires management to make significant estimates and assumptions, including estimates of future cash flows expected to be generated by the acquired assets and the appropriate discount rate for these cash flows. Should different conditions prevail, we would have to perform an impairment review that might result in material write-downs of intangible assets and/or goodwill. Other factors we consider important which could trigger an impairment review, include, but are not limited to, significant changes in the manner of use of our acquired assets, significant changes in the strategy for our overall business or significant negative economic trends. If this evaluation indicates that the value of an intangible asset or long-lived asset may be impaired, an assessment of the recoverability of the net carrying value of the asset over its remaining useful life is made. If this assessment indicates that the cost of an intangible asset or long-lived asset is not recoverable, based on the estimated undiscounted future cash flows or other comparable market valuations of the entity or technology acquired over the remaining amortization or depreciation period, the net carrying value of the related intangible asset or long-lived asset will be reduced to fair value and the remaining amortization or depreciation period may be adjusted. For example, we recorded significant impairment charges during 2001, including $41.7 million related to goodwill and other acquired intangibles. In addition, in the fourth quarter of 2002, we recorded approximately $50.8 million of impairment in property, plant and equipment and other assets. Due to uncertain market conditions and potential changes in our strategy and product portfolio, it is possible that forecasts used to support our intangible assets may change in the future, which could result in additional non-cash charges that would adversely affect our results of operations and financial condition.

Restructuring Charges

During the years ended December 31, 2002 and 2001, we recorded charges of $4.5 million and $5.1 million, respectively, in connection with our restructuring programs. These restructuring charges were comprised primarily of: (i) severance and related charges; (ii) facilities and lease cancellations and (iii) write-offs of abandoned equipment. We accounted for each of these costs in accordance with relevant accounting literature as summarized in SEC Staff Accounting Bulletin No. 100, Restructuring and Impairment Charges, Emerging Issues Task Force (“EITF”) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring) and EITF Issue No. 88-10, Costs Associated with Lease Modification or Termination . There were no restructuring charges recorded during the year ended December 31, 2003 or the three months ended March 31, 2004.

Any such costs incurred in the future will be recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities or SFAS No. 112, Employers Accounting for Post Employment Benefits, and any write-off of abandoned equipment will be accounted for in accordance with SFAS No. 144 , Accounting for the Impairment or Disposal of Long Lived Assets.

Actual costs relative to these estimates, along with other estimates made by management in connection with our restructuring programs, may vary significantly depending, in part, on factors that may be beyond our control. We review the status of any ongoing restructuring activities on a quarterly basis and, if appropriate, record changes to our restructuring obligations in current operations based on our most current estimates.

RESULTS OF OPERATIONS

We list in the tables below the historical condensed consolidated statement of operations as a percentage of revenue for the periods indicated.


	Three Months Ended March 31
	2004		2003
Net revenue	100	%	100	%
Cost of revenue	57	%	54	%

Gross profit	43	%	46	%
Operating expenses:
Research and product development	28	%	34	%
Sales and marketing	22	%	25	%
General and administrative	12	%	4	%
Purchased in-process research and development	29	%	0	%
Stock-based compensation	3	%	(15	)%
Amortization and impairment of intangible assets	10	%	10	%

Total operating expenses	104	%	59	%

Operating loss	(61	)%	(13	)%
Other income (expense), net	(2	)%	(3	)%

Loss before income taxes	(63	)%	(16	)%
Income tax provision	(1	)%	0	%

Net loss	(64	)%	(16	)%

Revenue

Information about our revenue for products and services for the three months ended March 31, 2004 and 2003 is summarized below (in millions):


	Three Months Ended March 31,
	2004		2003		Increase (Decrease)		% change
Products	$	19.1	$	15.2	$	3.9	26	%
Services		1.9		1.9		—	(1	)%

Total	$	21.0	$	17.1	$	3.9	23	%

Information about our revenue for North America and International markets for the three months ended March 31, 2004 and 2003 is summarized below (in millions):


	Three Months Ended March 31,
	2004		2003		Increase (Decrease)		% change
North America	$	17.8	$	15.7	$	2.1	13	%
International		3.2		1.4		1.8	139	%

Total	$	21.0	$	17.1	$	3.9	23	%

Information about our revenue by product line for the three months ended March 31, 2004 and 2003 is summarized below (in millions):


	Three Months Ended March 31,
	2004		2003		Increase (Decrease)			% change
SLMS	$	9.6	$	7.1	$	2.5		36	%
MUX		5.1		6.4		(1.3	)	(21	)%
DLC		6.3		3.6		2.7		78	%

	$	21.0	$	17.1	$	3.9		23	%

For the three months ended March 31, 2004, total revenue increased 23% or $3.9 million to $21.0 million from $17.1 million for the same period last year. For the three months ended March 31, 2004, product revenue increased by 26% or $3.9 million from the same period last year, due to stabilizing demand for our products compared to the same period last year, in which revenue had declined significantly on a sequential basis from the fourth quarter of 2002. Service revenue decreased modestly for the three months ended March 31, 2004 compared to the same period last year. For the three months ended March 31, 2004, international revenue increased by $1.8 million to $3.2 million compared to $1.4 million for the same period last year. The increase in international revenue was due to sales to one customer in Asia during the period that represented an unusually high purchase volume.

Revenue for our SLMS product family increased by 36%, or $2.5 million, for the three months ended March 31, 2004 as compared to the same period last year. The increase in SLMS revenue was primarily attributable to the one customer in Asia as described above. Revenue for our DLC product family increased by 78%, or $2.7 million for the three months ended March 31, 2004 as compared to the same period last year. Revenue for our MUX product line declined by 21% or $1.3 million for the three months ended March 31, 2004 as compared to the same period last year.

While we anticipate focusing our sales and marketing efforts on our SLMS product family in 2004, revenue from the DLC and MUX product families is expected to continue to represent a significant percentage of total revenue, given the current trends in service provider capital spending, which tend to focus more on supporting legacy type revenue generating activities rather than investing in newer, more technologically advanced types of products. We expect that over time, the product mix will continue to shift towards next generation products in SLMS, with MUX and DLC revenues remaining flat or declining as a percentage of total revenues. However in any given quarter, revenue from the MUX and DLC product lines may fluctuate significantly, due to seasonal and other variations in the purchasing patterns for the major customers of these products.

Two customers accounted for 11% and 10% of total revenue, respectively, for the three months ended March 31, 2004. One customer accounted for 18% of total revenue for the three months ended March 31, 2003. No other customer accounted for 10% or more of total revenue in either period. Although our largest customers have varied over time, we anticipate that our results of operations in any given period will continue to depend to a great extent on sales to a small number of large accounts. As a result, our revenue for any quarter may be subject to significant volatility based upon changes in orders from one or a small number of key customers.

Cost of Revenue

For the three months ended March 31, 2004, cost of revenue increased $2.7 million to $12.0 million compared to $9.3 million for the same period last year. Total cost of revenue was 57% of revenue for the three months ended March 31, 2004, compared to 54% of revenue for the same period last year. Cost of revenue was higher as a percentage of revenue for the three months ended March 31, 2004 due primarily to the effect on cost of revenue of stock-based compensation expense. During the three months ended March 31, 2003, cost of revenue included a net benefit relating to stock-based compensation of $445,000, compared to a net expense in the same period of the current year of $82,000. The impact of this difference was approximately 3% of revenue. The net benefit in the prior year period resulted from a reversal of stock-based compensation due to the forfeiture of unvested shares which exceeded the amortization of deferred compensation in that period.

Cost of revenue for the three months ended March 31, 2004 was negatively impacted by excess inventory charges and a shift in product mix towards a higher percentage of lower margin DLC products. This effect was offset by the favorable impact of the revenue transaction with the one customer in Asia as described above, for which the inventory had been previously written down. We currently expect that cost of revenue will continue to be approximately 57% of revenue for the three months ending June 30, 2004.

Research and Product Development Expenses

For the three months ended March 31, 2004, research and development expenses increased by $0.2 million to $5.9 million, compared to $5.7 million for the same period last year. The modest increase was primarily due to higher compensation related expenses.

Sales and Marketing Expenses

For the three months ended March 31, 2004, sales and marketing expenses increased by $0.4 million to $4.7 million, compared to $4.3 million for the same period last year. The increase was primarily due to higher commissions, customer service and marketing related expenses driven by the overall increase in revenue.

General and Administrative Expenses

For the three months ended March 31, 2004, general and administrative expenses increased by $1.7 million to $2.5 million, compared to $0.8 million for the same period last year. The significant increase was primarily due to charges related to lease terminations for two excess facilities and increased costs associated with being an SEC registrant.

Purchased In-Process Research and Development Expense

During the three months ended March 31, 2004, we recorded a charge of $6.2 million for purchased in-process research and development expense relating to the acquisition of the assets of Gluon Networks. The amount was charged to expense because technological feasibility had not been established and no future alternative uses for the technology existed. The estimated fair value of the purchased in-process research and development was determined using a discounted cash flow model, based on a discount rate which took into consideration the stage of completion and risks associated with developing the technology. No charges for purchased in-process research and development were recorded in the same period last year.

Stock-Based Compensation Expense

Stock-based compensation expense was $0.6 million for the three months ended March 31, 2004, compared to a benefit of $3.0 million for the same period last year. Stock-based compensation expense primarily resulted from the difference between the fair value of our common stock and the exercise price for stock options granted to employees on the date of grant. We amortize the resulting deferred compensation over the vesting periods of the applicable options using an accelerated method, which can result in a net credit to stock-based compensation expense during a particular period, if the amount reversed due to the forfeiture of unvested shares exceeds the amortization of deferred compensation. During the three months ended March 31, 2003, the amount reversed due to the forfeiture of unvested shares exceeded the amortization of deferred compensation, resulting in a net benefit of $3.0 million.

For the three month periods ended March 31, 2004 and 2003, stock-based compensation expense consisted of (in thousands):


	Three Months Ended
	March 31, 2004			March 31, 2003
Amortization of deferred compensation	$	678		$	2,073
Benefit due to reversal of previously recorded stock-based compensation expense on forfeited shares		(7	)		(5,092	)
Compensation expense (benefit) relating to non-employees		(61	)		1
Compensation expense relating to exchange of stock options		—			3

	$	610		$	(3,015	)

Amortization and Impairment of Intangibles

For the three months ended March 31, 2004 amortization of intangibles increased by $0.3 million compared to the same period last year, due to the acquisitions of eLuminant in February 2003 and Gluon in February 2004.

Other Income (Expense), Net

For the three months ended March 31, 2004, other income (expense), net decreased by $0.1 million compared to $0.5 million for the same period last year. The detail is as follows (in thousands):


	Three Months Ended March 31,
	2004			2003
Interest expense	$	(899	)	$	(1,014	)
Interest income		394			50
Other income (expense)		71			431

	$	(434	)	$	(533	)

Interest expense decreased for the three months ended March 31, 2004 as compared to the same period last year due primarily to a decrease in the amount of average outstanding borrowings. Interest income increased for the three months ended March 31, 2004 as compared to the same period last year due primarily to higher average balances of cash and short-term investments.

Liquidity and Capital Resources

Historically, we have financed our operations through private sales of capital stock and borrowings under various debt arrangements. Following the completion of our merger with Tellium, Inc. in November 2003, in which our common stock became publicly traded, we expect to finance our operations through a combination of our existing cash, cash equivalents and short-term investments, available credit facilities, and sales of equity and debt instruments, based on our operating requirements and market conditions.

At March 31, 2004, cash, cash equivalents and short-term investments, all of which are available to fund current operations, were $90.0 million. This amount includes cash and cash equivalents of $45.1 million, as compared with $32.5 million at December 31, 2003. The increase in cash and cash equivalents of $12.6 million was attributable to cash provided by investing activities of $20.1 million and cash provided by financing activities of $9.9 million offset by cash used in operating activities of $17.4 million.

Net cash provided by investing activities consisted primarily of net maturities of short-term investments of $20.8 million. Net cash provided by financing activities consisted primarily of net borrowings under our line of credit of $9.7 million. Net cash used in operating activities consisted of the net loss of $13.4 million, adjusted for non-cash charges totaling $9.1 million and changes in operating assets and liabilities totaling $13.1 million. The most significant components of the changes in operating assets and liabilities were a decrease in accrued expenses of $6.5 million and an increase in inventories of $4.1 million.

As a result of the financial demands of major network deployments and the difficulty in accessing capital markets, network service providers continue to request financing assistance from their suppliers. From time to time we may provide or commit to extend credit or credit support to our customers. This financing may include extending credit to customers or guaranteeing the indebtedness of customers to third parties. Depending upon market conditions, we may seek to factor these arrangements to financial institutions and investors to free up our capital and reduce the amount of our financial commitments for such arrangements. Our ability to provide customer financing is limited and depends upon a number of factors, including our capital structure, the level of our available credit and our ability to factor commitments to third parties. Any extension of financing to our customers will limit the capital that we have available for other uses. Currently, we do not have any significant customer financing related commitments.

Currently, our primary source of liquidity comes from our cash and cash equivalents and short-term investments, which totaled $90.0 million at March 31, 2004, and our line of credit agreement, under which $14.5 million was outstanding at March 31, 2004, and an additional $7.1 million was committed as security for obligations under our secured real estate loan facility and other letters of credit. In February 2004, we entered into a new line of credit agreement with the same financial institution that had provided our previous working capital financing. The new line of credit agreement has a maximum credit limit of $25.0 million with no borrowing base restrictions. Borrowings under the line of credit agreement bear interest at the financial institution’s prime rate or LIBOR plus 2.9%, at the election of the borrower.

Our short-term investments are classified as available-for-sale and consist of securities that are readily convertible to cash, including certificates of deposits, commercial paper and government securities, with original maturities at the date of acquisition ranging from 90 days to one year. At current revenue levels, we anticipate that some portion of our existing cash and cash equivalents and investments will continue to be consumed by operations.

In March 2004, we filed a Form S-3 Registration Statement which will allow us to sell, from time to time, up to $100 million of our common stock or other securities. Although we may use this multi-purpose shelf registration to raise additional capital, there can be no certainty as to when or if we may offer any securities under the shelf registration or what the terms of any such offering would be.

Our accounts receivable, while not considered a primary source of liquidity, represents a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. At March 31, 2004, three customers represented 24%, 16% and 10%, respectively, of our total accounts receivable balance. Our fixed commitments for cash expenditures consist primarily of payments under operating leases, inventory purchase commitments, and payments of principal and interest for debt obligations. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities, inventory purchase commitments and debt. We currently intend to fund our operations for the foreseeable future using our existing cash, cash equivalents and investments and liquidity available under our line of credit agreement.

Based on our current plans and business conditions, we believe that our existing cash, cash equivalents and investments and available credit facilities will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months.

Contractual Commitments and Off-Balance Sheet Arrangements

At March 31, 2004, our future contractual commitments by fiscal year were as follows (in thousands):


	Total		Remainder of 2004		2005		2006		2007
Operating leases	$	6,665	$	4,785	$	1,113	$	425	$	342
Debt		32,681		644		934		31,103		—
Inventory purchase commitments		4,574		4,574		—		—		—

Total future contractual commitments	$	43,920	$	10,003	$	2,047	$	31,528	$	342

The amounts shown above represent off-balance sheet arrangements to the extent that a liability is not already recorded on our balance sheet. For operating lease commitments, a liability is generally not recorded on our balance sheet unless the facility represents an excess facility for which an estimate of the facility exit costs has been recorded on our balance sheet. Payments made under operating leases will be treated as rent expense for the facilities currently being utilized. For debt obligations, the amounts shown above represent the scheduled principal repayments, but not the associated interest payments which may vary based on changes in market interest rates. At March 31, 2004, the interest rate on our outstanding debt obligations was 8.0%. Inventory purchase commitments represent the amount of excess inventory purchase commitments that have been recorded on our balance sheet at March 31, 2004.

We also had commitments under outstanding letters of credit totaling $0.6 million at March 31, 2004. We have recorded restricted cash on our balance sheet equal to the amount outstanding under these letters of credit.

RISK FACTORS

You should carefully consider the following risk factors, in addition to the other information set forth in this report, before making any investment decisions regarding our company. Each of these risk factors could adversely affect our business, financial condition and results of operations.

We have entered into a merger agreement with Sorrento Networks Corporation. Failure to complete the merger with Sorrento could have a material adverse effect on our business, financial condition, and results of operations.

We have entered into a merger agreement with Sorrento, which is subject to the approval of the stockholders of both Zhone and Sorrento. There can be no assurance that the merger will occur or, if it does, what effect it will have on our business, financial condition, and results of operations. Completion of the merger is subject to several closing conditions, including obtaining requisite regulatory and stockholder approvals. In addition, Sorrento is required to have a minimum closing cash balance of $5 million after payment of all legal, accounting, banking, severance and bonus obligations, and must secure the election of the holders of at least 75% of its outstanding PIPE warrants to receive warrants to purchase Zhone common stock in the merger in exchange for their PIPE warrants. Zhone and Sorrento may be unable to obtain such approvals on a timely basis or at all. If the merger with Sorrento is not completed, we could suffer a number of consequences that would adversely affect our business, including:

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the diversion of management’s attention from our day-to-day business and the unavoidable disruption of our employees and our relationships with customers as a result of efforts relating to the merger;

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uncertainties relating to the anticipated merger may detract from our ability to grow revenues and minimize costs, which, in turn, may lead to a loss of market position;

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the significant expenses we have incurred and will continue to incur in connection with the proposed transaction, and;

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the possibility that termination of the merger agreement under some circumstances would require us to reimburse expenses incurred by Sorrento up to $1 million.

We may not achieve the benefits we expect from the merger with Sorrento, which may have a material adverse effect on the combined company’s business, financial condition, and results of operations.

The combined company will need to overcome significant challenges in order to realize any benefits or synergies from the merger, including timely, efficient and successful execution of a number of post-merger strategies, including:

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combining the operations of the two companies;

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integrating and managing the combined company;

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retaining and assimilating the key personnel of each company;

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retaining existing customers of both companies;

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retaining strategic partners of each company; and

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creating and maintaining uniform standards, controls, procedures, policies, and information.

The execution of these post-merger strategies will involve considerable risks and may not be successful. These risks include:

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the potential disruption of the combined company’s ongoing business and distraction of its management;

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unanticipated expenses and potential delays related to integration of technology and other resources of the two companies;

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the significant expenses the combined company will incur in connection with the proposed transaction;

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the impairment of relationships with employees, suppliers, and customers as a result of any integration of new management personnel; and

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potential unknown liabilities associated with the merger and the combined operations.

Failure to overcome these risks or any other problems encountered in connection with the merger could slow the growth of the combined company or lower the quality of its services, which could reduce customer demand and have a material adverse effect on our business, financial condition and results of operations.

We have incurred significant losses to date and expect that we will continue to incur losses in the foreseeable future. If we fail to generate sufficient revenue to achieve or sustain profitability, our stock price could decline.

We have incurred significant losses to date and expect that we will to continue to incur losses in the foreseeable future. Our net losses for 2003 and 2002 were $17.2 million and $108.6 million, respectively. Our net loss for the three months ended March 31, 2004 was $13.4 million, and we had an accumulated deficit of $609.1 million at March 31, 2004.

We have not generated positive cash flow from operations since inception, and expect this trend to continue for the foreseeable future. We have significant fixed expenses and expect that we will continue to incur substantial manufacturing, research and product development, sales and marketing, customer support, administrative and other expenses in connection with the ongoing development of the business. In addition, we may be required to spend more on research and product development than originally budgeted to respond to industry trends. We may also incur significant new costs related to possible acquisitions and the integration of new technologies. Further, as 2004 is the first full year that we will be subject to SEC reporting obligations and given the increased costs associated with compliance with the Sarbanes-Oxley Act of 2002, we are likely to incur increased expenses related to regulatory and legal compliance. We may not be able to adequately control costs and expenses or achieve or maintain adequate operating margins. As a result, our ability to achieve and sustain profitability will depend on our ability to generate and sustain substantially higher revenue while maintaining reasonable cost and expense levels. If we fail to generate sufficient revenue to achieve or sustain profitability, we will continue to incur substantial operating losses and our stock price could decline.

We have been, and may continue to be, adversely affected by recent unfavorable developments in the communications industry, world events and the economy in general.

Our customers and potential customers continue to experience a severe economic slowdown that has led to significant decreases in their revenues. For most of the last five years, the markets for our equipment have been influenced by the entry into the communications services business of a substantial number of new telecommunications companies. In the United States, this was due largely to changes in the regulatory environment, in particular those brought about by the Telecommunications Act of 1996. These new companies raised significant amounts of capital, much of which they invested in new equipment, causing acceleration in the growth of the markets for telecommunications equipment. More recently, there has been a reversal of this trend, including the failure of a large number of the new entrants and a sharp contraction of the availability of capital to the industry. This industry trend has been compounded by the slowing not only of the U.S. economy, but the economies in virtually all of the countries in which we market our products. This, in turn, has caused a substantial reduction in demand for our equipment.

The continuing acts and threats of terrorism and the geo-political uncertainties in other continents are also having an adverse effect on the U.S. economy and could possibly induce or accelerate the advent of a more severe economic downturn. The U.S. government’s political, social and economic policies and policy changes as a result of these circumstances could have consequences that we cannot predict, including causing further weaknesses in the economy. The long-term impact of these events on our business is uncertain. Additionally, the amount of debt incurred by our customers, and the continued reductions in capital spending, puts the businesses of certain of our customers and potential customers in jeopardy. As a result, our operating results and financial condition could be materially adversely affected.

Capital constraints in the telecommunications industry could restrict the ability of our customers to buy our products.

As a result of the economic slowdown affecting the telecommunications industry and the technology industry in general, our customers and potential customers have significantly reduced the rate of their capital expenditures, and as result, our revenue declined by 26% from 2002 to 2003. The reduction of capital equipment acquisition budgets or the inability of our current and prospective customers to obtain capital could cause them to reduce or discontinue purchase of our products, and as a result we could experience reduced revenues and our operating results could be adversely impacted. In addition, many of the current and prospective customers for our products are emerging companies with limited operating histories. These companies require substantial capital for the development, construction and expansion of their businesses. Neither equity nor debt financing may be available to these companies on favorable terms, if at all. To the extent that these companies are unable to obtain the financing they need, our ability to make future

sales to these customers and realize revenue from any such sales could be harmed. In addition, to the extent we choose to provide financing to these prospective customers, we will be subject to additional financial risk which could cause our expenses to increase.

Our future operating results are difficult to predict due to our limited operating history.

We began operations in September 1999. Although we expect that our internally developed Single Line Multi-Service, or SLMS, product line will account for a substantial portion of our revenue in the future, to date we have generated a significant portion of our revenue from sales of product lines that we acquired from other companies. Due to our limited operating history, we have difficulty accurately forecasting our revenue, and we have limited historical financial data upon which to base our operating expense budgets. Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are outside of our control. The primary factors that may affect our results of operations include the following:

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commercial acceptance of our SLMS products;

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fluctuations in demand for network access products;

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new product introductions, enhancements or announcements by our competitors;

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the length and variability of the sales cycles for our products;

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the timing and size of sales of our products;

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our customers’ ability to finance their purchase of our products as well as their own operations;

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our ability to forecast demand for our products;

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the ability of our company and our contract manufacturers to attain and maintain production volumes and quality levels for our products;

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our ability to obtain sufficient supplies of sole or limited source components;

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changes in our pricing policies or the pricing policies of our competitors;

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increases in the prices of the components we purchase, or quality problems associated with these components;

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our ability to develop, introduce and ship new products and product enhancements that meet customer requirements in a timely manner;

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the timing and magnitude of prototype expenses;

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unanticipated changes in regulatory requirements which may require us to redesign portions of our products;

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our ability to attract and retain key personnel;

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our sales of common stock or other securities in the future;

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costs related to acquisitions of technologies or businesses; and

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general economic conditions as well as those specific to the communications, Internet and related industries.

If demand for our SLMS products does not develop, then our results of operations and financial condition will be adversely affected.

Our future revenue depends significantly on our ability to successfully develop, enhance and market our SLMS products to the network service provider market. Most network service providers have made substantial investments in their current infrastructure, and they may elect to remain with their current architectures or to adopt new architectures, such as SLMS, in limited stages or over extended periods of time. A decision by a customer to purchase our SLMS products will involve a significant capital investment. We will need to convince these service providers of the benefits of our products for future upgrades or expansions. We do not know

whether a viable market for our SLMS products will develop or be sustainable. If this market does not develop or develops more slowly than we expect, our business, financial condition and results of operations will be seriously harmed.

Our target customer base is concentrated, and the loss of one or more of our customers could harm our business.

The target customers for our products are network service providers that operate voice, data and video communications networks. There are a limited number of potential customers in our target market. During the three months ended March 31, 2004, two customers accounted for 11% and 10% of our revenue, respectively. During the year ended December 31, 2003, two customers accounted for approximately 17% and 11% of our revenue, respectively. A significant portion of our future revenue will depend on sales of our products to a limited number of customers. Any failure of one or more customers to purchase products from us for any reason, including any downturn in their businesses, would seriously harm our business, financial condition and results of operations.

Acquisitions are an important part of our strategy, and any strategic acquisitions or investments we make could disrupt our business and seriously harm our financial condition.

As of March 31, 2004, we have acquired ten companies or product lines, and we are likely to acquire additional businesses, products or technologies in the future. In April 2004, we announced a definitive agreement to acquire Sorrento Networks Corporation. On an ongoing basis, we expect to consider acquisitions of, or investments in, complementary companies, products or technologies to supplement our internal growth. In the future, we may encounter difficulties identifying and acquiring suitable acquisition candidates on reasonable terms.

If we do complete future acquisitions, we could:

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issue stock that would dilute our current stockholders’ percentage ownership;

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consume cash;

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incur substantial debt;

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assume liabilities;

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increase our ongoing operating expenses and level of fixed costs;

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record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;

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incur amortization expenses related to certain intangible assets;

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incur large and immediate write-offs; or

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become subject to litigation.

Any acquisitions or investments that we make in the future will involve numerous risks, including:

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problems combining the acquired operations, technologies or products;

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unanticipated costs;

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diversion of management’s time and attention from our existing business;

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adverse effects on existing business relationships with suppliers and customers;

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risks associated with entering markets in which we have no or limited prior experience; and

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potential loss of key employees, particularly those of acquired companies.

We do not know whether we will be able to successfully integrate the businesses, products, technologies or personnel that we might acquire in the future or that any strategic investments we make will meet our financial or other investment objectives. Any failure to do so could seriously harm our business, financial condition and results of operations.

The market we serve is highly competitive and, as a relatively early stage company, we may not be able to compete successfully.

Competition in the communications equipment market is intense. We are aware of many companies in related markets that address particular aspects of the features and functions that our products will provide. Currently, our primary competitors include large equipment companies, such as Advanced Fibre Communications, Alcatel, and Lucent Technologies. We also may face competition from other large communications equipment companies or other companies with significant market presence and financial resources that may enter our market in the future. In addition, a number of new public and private companies have announced plans for new products to address the same network needs that our products address, both domestically and abroad. Some of these companies may have lower cost structures than us.

Many of our competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, sales and marketing resources than we do and may be able to undertake more extensive marketing efforts, adopt more aggressive pricing policies and provide more customer financing than we can. Moreover, our competitors may foresee the course of market developments more accurately than we do and could develop new technologies that render our products less valuable or obsolete.

In our markets, competitive factors include:

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performance;

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reliability and scalability;

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ease of installation and use;

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interoperability with existing products;

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upgradeability;

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geographic footprints for products;

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ability to provide customer financing;

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breadth of services;

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price;

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technical support and customer service; and

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brand recognition.

If we are unable to compete successfully against our current and future competitors, we may have difficulty obtaining customers, and we could experience price reductions, order cancellations, increased expenses and reduced gross margins, any of which would harm our business, financial condition and results of operations.

The long and variable sales cycles for our products may cause revenue and operating results to vary significantly from quarter to quarter.

The target customers for our products have substantial and complex networks that they traditionally expand in large increments on a periodic basis. Accordingly, our marketing efforts are largely focused on prospective customers that may purchase our products as part of a large-scale network deployment. Our target customers typically require a lengthy evaluation, testing and product qualification process. Throughout this process, we are often required to spend considerable time and incur significant expense educating and providing information to prospective customers about the uses and features of our products. Even after a company makes the final decision to purchase our products, it may deploy our products slowly. The timing of deployment of our products varies widely, and depends on a number of factors, including:

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our customers’ skill sets;

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geographic density of potential subscribers;

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the degree of configuration necessary to deploy our products; and

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our customers’ ability to finance their purchase of our products as well as their operations.

As a result of any of these factors, our revenue and operating results may vary significantly from quarter to quarter.

The success of our business depends on our executive officers and key employees, and the loss of the services of one or more of them could harm our business.

Our future success depends upon the continued services of our executive officers and other key engineering, manufacturing, operations, sales, marketing and support personnel who have critical industry experience and relationships that we rely on to build our business, including Morteza Ejabat, our co-founder, Chairman and Chief Executive Officer, Jeanette Symons, our Chief Technical Officer, and Kirk Misaka, our Chief Financial Officer. The loss of the services of any of our key employees, including Mr. Ejabat, Ms. Symons and Mr. Misaka, could delay the development and production of our products and negatively impact our ability to maintain customer relationships, which would harm our business, financial condition and results of operations.

If we are unable to successfully manage and expand our international operations, our business could be harmed.

We currently have international operations consisting of sales, technical support and marketing teams in various locations worldwide. We expect to continue expanding our international operations in the future. The successful management and expansion of our international operations requires significant human and financial resources. Further, our international operations may be subject to certain risks and challenges that could harm our operating results, including:

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expenses associated with developing and customizing our products for foreign countries;

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unexpected changes in regulatory requirements, taxes, trade laws and tariffs;

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fluctuations in currency exchange rates;

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longer sales cycles for our products;

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greater difficulty in accounts receivable collection and longer collection periods;

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difficulties and costs of staffing and managing foreign operations;

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reduced protection for intellectual property rights;

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potentially adverse tax consequences; and

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changes in a country’s or region’s political and economic conditions.

Any of these factors could harm our existing international operations and business or impair our ability to continue expanding into international markets.

We have significant debt obligations, which could adversely affect our business, operating results and financial condition.

As of March 31, 2004, we had approximately $31.8 million in long-term debt. You should be aware that this level of debt could materially and adversely affect us in a number of ways, including:

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limiting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes;

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limiting our flexibility to plan for, or react to, changes in our business or market conditions;

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requiring us to use a significant portion of any future cash flow from operations to repay or service the debt, thereby reducing the amount of cash available for other purposes;

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making us more highly leveraged than some of our competitors, which may place us at a competitive disadvantage; and

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making us more vulnerable to the impact of adverse economic and industry conditions and increases in interest rates.

We cannot assure you that we will generate sufficient cash flow or be able to borrow funds in amounts sufficient to enable us to service our debt or to meet our working capital and capital expenditures requirements. If we are unable to generate sufficient cash flow from operations or to borrow sufficient funds to service our debt, due to borrowing base restrictions or otherwise, we may be required to sell assets, reduce capital expenditures, refinance all or a portion of existing debt or obtain additional financing. We cannot assure you that we will be able to engage in any of these actions on reasonable terms, if at all.

Because our products are complex and will be deployed in complex environments, our products may have defects that we discover only after full deployment, which could seriously harm our business.

Our products are complex and are designed to be deployed in large quantities across complex networks. Because of the nature of these products, they can only be fully tested when completely deployed in large networks with high amounts of traffic. Our customers may discover errors or defects in our hardware or software, or our products may not operate as expected, after they have been fully deployed. If we are unable to fix defects or other problems that may be identified after full deployment, we could experience:

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loss of revenue and market share;

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loss of existing customers;

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failure to attract new customers or achieve market acceptance;

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diversion of development resources;

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increased service and warranty costs;

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legal actions by our customers; and

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increased insurance costs.

Defects, integration issues or other performance problems in our products could also result in financial or other damages to our customers. Our customers could seek damages for related losses from us, which could seriously harm our business, financial condition and results of operations. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly and would put a strain on our management and resources. The occurrence of any of these problems would seriously harm our business, financial condition and results of operations.

If we fail to enhance our existing products or develop and introduce new products that meet changing customer requirements and technological advances, our ability to sell our products would be materially adversely affected.

Our target markets are characterized by rapid technological advances, evolving industry standards, changes in end-user requirements, frequent new product introductions and changes in communications offerings from network service providers. Our future success will significantly depend on our ability to anticipate or adapt to such changes and to offer, on a timely and cost-effective basis, products that meet changing customer demands and industry standards. We may not have sufficient resources to successfully and accurately anticipate technological and market trends, manage long development cycles or develop, introduce and market new products and enhancements. We currently license technology, and from time to time, we may be required to license additional technology from third parties to sell or develop our products and product enhancements. We cannot assure you that our existing and future third-party licenses will be available to us on commercially reasonable terms, if at all. Our inability to maintain or obtain any third-party license required to sell or develop our products and product enhancements could require us to obtain substitute technology of lower quality or performance standards or at greater cost. If we are not able to develop new products or enhancements to existing products on a timely and cost-effective basis, or if our new products or enhancements fail to achieve market acceptance, our business, financial condition and results of operations would be materially adversely affected.

The communications industry is subject to government regulations, which could harm our business.

The Federal Communications Commission, or FCC, has jurisdiction over the entire communications industry in the United States and, as a result, our existing and future products and our customers’ products are subject to FCC rules and regulations. Current and future FCC rules and regulations affecting communications services could negatively affect our business. The uncertainty associated with future FCC decisions may result in network service providers delaying decisions regarding expenditures for equipment for broadband services. In addition, international regulatory bodies establish standards that may govern our products in foreign markets. Domestic and international regulatory requirements could result in postponements or cancellations of product orders, which would harm our business, financial condition and results of operations. Further, we cannot be certain that we will be successful in obtaining or maintaining any regulatory approvals that may, in the future, be required to operate our business.

We face certain litigation risks.

We are a party to lawsuits and claims in the normal course of our business. In addition, we are currently involved in several litigation matters which we inherited as a result of our acquisition of Tellium. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition. For additional information regarding certain of the lawsuits in which we are involved, see Part II, Item 1—“Legal Proceedings”.

Our business will be adversely affected if we are unable to protect our intellectual property rights from third-party challenges.

We rely on a combination of copyrights, patents, trademarks and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners and control access to and distribution of our software, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our technology is difficult, and we do not know whether the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.

In the future we may become involved in disputes over intellectual property, which could subject us to significant liability, divert the time and attention of our management and prevent us from selling our products.

We or our customers may be party to litigation in the future to protect our intellectual property or to respond to allegations that we infringe others’ intellectual property. We may receive in the future communications from third parties inquiring about their interest in licensing certain intellectual property to us or more generally identifying intellectual property that may be the basis of a future infringement claim. We have received letters from Lucent Technologies stating that many of our products are using technology covered by or related to Lucent patents and inviting us to discuss a licensing arrangement with Lucent. To date, no lawsuit or other formal action has been filed by Lucent. However, we cannot assure you that we would be successful in defending against any Lucent infringement claims. To the extent we are not successful in defending such claims, we may be subject to substantial damages (including possible treble damages and attorneys’ fees).

If any party accuses us of infringing upon its proprietary rights, we would have to defend ourselves and possibly our customers against the alleged infringement. We cannot assure you that we would prevail in any intellectual property litigation, given its complex technical issues and inherent uncertainties. If we are unsuccessful in any such litigation, we could be subject to significant liability for damages and loss of our proprietary rights. Intellectual property litigation, regardless of its outcome, would likely be time consuming and expensive to resolve. Any such litigation could force us to stop selling, incorporating or using our products that include the challenged intellectual property, or redesign those products that use the technology. In addition, if a party accuses us of infringing upon its proprietary rights, we may have to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all. Any of these results could have a material adverse effect on our business, financial condition and results of operations.

We rely on contract manufacturers for a significant portion of our manufacturing requirements.

Through the third quarter of 2003, we utilized Solectron for the majority of our manufacturing requirements for all product lines. During the fourth quarter of 2003, we transitioned the manufacturing of certain product lines to another contract manufacturer, and for another product line, transitioned the manufacturing process internally. We continue to use Solectron to manufacture certain product lines under the terms of an agreement which expired in March 2004. While we have become somewhat less dependent on Solectron for our manufacturing requirements, we expect to continue to rely on contract manufacturers to fulfill a significant portion of our product manufacturing requirements.

Any manufacturing disruption could impair our ability to fulfill orders. Our future success will depend, in significant part, on our ability to have Solectron or other contract manufacturers produce our products cost-effectively and in sufficient volumes. We face a number of risks associated with this dependence on third-party manufacturers including:

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reduced control over delivery schedules;

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the potential lack of adequate capacity during periods of excess demand;

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manufacturing yields and costs;

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quality assurance;

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increases in prices; and

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the potential misappropriation of our intellectual property.

We have no long-term contracts or arrangements with any of our vendors that guarantee product availability, the continuation of particular payment terms or the extension of credit limits. We have experienced in the past, and may experience in the future, problems with our contract manufacturers, such as inferior quality, insufficient quantities and late delivery of products. To date, these problems have not materially adversely affected us. We may not be able to obtain additional volume purchase or manufacturing arrangements on terms that we consider acceptable, if at all. If we enter into a high-volume or long-term supply arrangement and subsequently decide that we cannot use the products or services provided for in the agreement, our business will be harmed. We cannot assure you that we will be able to effectively manage our relationship with our contract manufacturers, or that these manufacturers will meet our future requirements for timely delivery of products of sufficient quality or quantity. Any of these difficulties could harm our relationships with customers and cause us to lose orders.

While our existing contract with Solectron expired in March 2004, we continue to use Solectron to manufacture products under the terms of the expired agreement. If we are unable to continue to use Solectron for these manufacturing requirements, then we may be required to manufacture the products produced under this agreement internally or find another outside contract manufacturer. If we fail to successfully transition manufacturing operations in-house or fail to locate and qualify suitable manufacturing candidates capable of satisfying our product specifications or quantity requirements, then we may experience product shortages and, as a result, be unable to fulfill customer orders accurately and timely which could negatively affect our customer relationships and operating results. Further, new third-party manufacturers may encounter difficulties in the manufacture of our products resulting in product delivery delays.

We depend on sole or limited source suppliers for several key components. If we are unable to obtain these components on a timely basis, we will be unable to meet our customers’ product delivery requirements, which would harm our business.

We currently purchase several key components from single or limited sources pursuant to limited term supply contracts. If any of our sole or limited source suppliers experiences capacity constraints, work stoppages or any other reduction or disruption in output, they may be unable to meet our delivery schedule. Our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable prices, refuse to sell their products or components to us at any price or be unable to obtain or have difficulty obtaining components for their products from their suppliers.

In these events, we could be forced to commence a time consuming and difficult process of identifying and qualifying an alternative supplier of the key components. There is no guarantee that such a search would be successful. If we do not receive critical components from our suppliers in a timely manner, we will be unable to meet our customers’ product delivery requirements. Any failure to meet a customer’s delivery requirements could harm our reputation and decrease our sales, which would harm our business, financial condition and results of operations.

If we fail to attract and retain qualified personnel, our business might be harmed.

Our future success will depend in large part upon our ability to identify, attract and retain qualified individuals, particularly research and development and customer service engineers and sales and marketing personnel. Our products are generally of a highly technical nature, and therefore require a sophisticated sales effort targeted at several key people within each prospective customer’s organization. Our target customers are large network service providers that require high levels of service and support from our customer service engineers and our sales and marketing personnel. Competition for these employees in our industry and in the San Francisco Bay Area in particular, as well as other areas in which we recruit, may be intense, and we may not be successful in attracting or retaining these personnel. If we are not able to hire the kind and number of research and development, sales and marketing and customer service personnel required to support our product offerings and customers, we may not reach the level of

sales necessary to achieve profitability or may be impaired from meeting existing customer demands, either of which could materially harm our business.

Our business will suffer if we fail to properly manage our growth and continually improve our internal controls and systems.

We have expanded our operations rapidly since our inception. The number of our employees has grown from eight as of September 30, 1999 to 237 as of March 31, 2004. As our business grows, we expect to increase the scope of our operations and the number of our employees. Our ability to successfully offer our products and implement our business plan in a rapidly evolving market requires an effective planning and management process. To manage our growth properly, we must:

•

hire, train, manage and retain qualified personnel, including engineers and research and development personnel;

•

carefully manage and expand our manufacturing relationships and related controls and reporting systems;

•

effectively manage multiple relationships with our customers, suppliers and other third parties;

•

implement additional operational and financial controls, reporting and financial systems and procedures; and

•

successfully integrate employees of acquired companies.

Failure to do any of the above in an efficient and timely manner could seriously harm our business, financial condition and results of operations.

If we are unable to obtain additional capital to fund our existing and future operations, we may be required to reduce the scope of our planned product development and marketing and sales efforts, which would harm our business, financial condition and results of operations.

The development and marketing of new products and the expansion of our direct sales operation and associated support personnel requires a significant commitment of resources. We may continue to incur significant operating losses or expend significant amounts of capital if:

•

the market for our products develops more slowly than anticipated;

•

we fail to establish market share or generate revenue at anticipated levels;

•

our capital expenditure forecasts change or prove inaccurate; or

•

we fail to respond to unforeseen challenges or take advantage of unanticipated opportunities.

As a result, we may need to raise substantial additional capital. Additional capital, if required, may not be available on acceptable terms, or at all. If additional capital is raised through the issuance of debt securities, the terms of such debt could impose financial or other restrictions on our operations. If we are unable to obtain additional capital or are required to obtain additional capital on terms that are not favorable to us, we may be required to reduce the scope of our planned product development and sales and marketing efforts, which would harm our business, financial condition and results of operations.

Your ability to influence key transactions, including changes of control, may be limited by significant insider ownership, provisions of our charter documents and provisions of Delaware law.

At March 31, 2004, our executive officers, directors and entities affiliated with them beneficially owned, in the aggregate, approximately 42% of our outstanding common stock. These stockholders, if acting together, will be able to influence significantly all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. Circumstances may arise in which the interests of these stockholders could conflict with the interests of our other stockholders. These stockholders could delay or prevent a change in control of our company even if such a transaction would be beneficial to our other stockholders. In addition, provisions of our amended and restated certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to certain stockholders.

Our stockholders will incur dilution as a result of the exercise of outstanding options and warrants and any future sale of equity or equity-linked debt securities.

The exercise of outstanding options and warrants and the future sale of any equity or equity-linked debt securities, including any additional securities issued in connection with acquisitions or in connection with our shelf registration statement, will result in dilution to our then-existing stockholders. Any dilution resulting from the future sale of equity or equity-linked debt securities will be more substantial if the price paid for such securities is less than the price paid by our then-existing stockholders for our outstanding capital stock.

We do not plan to pay dividends in the foreseeable future.

We do not anticipate paying cash dividends to our stockholders in the foreseeable future. We expect to retain future earnings, if any, for the future operation and expansion of the business. In addition, our ability to pay dividends may be limited by any applicable restrictions under our debt and credit agreements. Accordingly, our stockholders must rely on sales of their capital stock after price appreciation, which may never occur, as the only way to realize a return on their investment.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Cash, Cash Equivalents and Short-Term Investments

Cash, cash equivalents and short-term investments consisted of the following as of March 31, 2004 and December 31, 2003 (in thousands):


	March 31, 2004		December 31, 2003
Cash and short-term investments:
Cash and cash equivalents	$	45,096	$	32,547
Short-term investments		44,888		65,709

	$	89,984	$	98,256

Concentration of Credit Risk

Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. Cash and cash equivalents consist principally of demand deposit and money market accounts, commercial paper, and debt securities of domestic municipalities with credit ratings of AA or better. Cash and cash equivalents are principally held with various domestic financial institutions with high-credit standing. As of March 31, 2004, we had accounts receivable balances from three customers individually representing 24%, 16% and 10% of accounts receivable, respectively.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and long-term debt. We do not use derivative financial instruments in our investment portfolio. We do not hold financial instruments for trading or speculative purposes. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt instruments of high credit quality and relatively short average maturities. Our cash and cash equivalents and short-term investments are not subject to material interest rate risk due to their short maturities. Under our investment policy, short-term investments have a maximum maturity of one year from the date of acquisition, and the average maturity of the portfolio cannot exceed six months. Due to the relatively short maturity of the portfolio, a 10% increase in market interest rates at March 31, 2004 would decrease the fair value of the portfolio by less than $0.1 million.

Foreign Currency Risk

We transact business in various foreign countries. Substantially all of our assets are located in the United States. We have product development activities in Canada and sales operations throughout Europe, Asia, the Middle East and Latin America. Accordingly, our operating results are also exposed to changes in exchange rates between the U.S. dollar and those currencies. Since inception, we have not hedged any of our local currency cash flows. While our financial results to date have not been materially affected by any changes in currency exchange rates, devaluation of the U.S. dollar against these currencies may affect our future operating results.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during our first fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

The Company is involved in various litigation matters relating to the operations of Tellium prior to the merger as described below.

On various dates between approximately December 10, 2002 and February 27, 2003, numerous class-action securities complaints were filed against Tellium in the United States District Court, District of New Jersey. These complaints allege, among other things, that Tellium and its then-current directors and executive officers and its underwriter violated the Securities Act of 1933 by making false and misleading statements preceding its initial public offering and in its registration statement prospectus relating to the securities offered in the initial public offering. The complaints further allege that these parties violated the Securities Exchange Act of 1934 by acting recklessly or intentionally in making the alleged misstatements. The actions seek damages in an unspecified amount, including compensatory damages, costs, and expenses incurred in connection with the actions and equitable relief as may be permitted by law or equity. On May 19, 2003, a consolidated amended complaint representing all of the actions was filed. On August 4, 2003, Tellium and its underwriters filed motions to dismiss the complaint. On April 1, 2004, the Court issued its decision granting Tellium’s and the underwriters’ motions to dismiss, while allowing plaintiffs an opportunity to seek leave to file a further amended complaint. The Company anticipates opposing that motion and moving to have the further amended complaint dismissed with prejudice. It remains too early in the legal process to determine what impact, if any, these suits will have upon the Company’s business, financial condition, or results of operations. The Company intends to continue vigorously defending against the claims made in these actions.

The U.S. Attorney has indicated that, while aspects of its investigation are in an early stage, neither Tellium nor any of the Company’s current or former officers or employees is a target of the investigation. The Company is cooperating fully with these investigations. The Company is not able, at this time, to say when the SEC or U.S. Attorney investigations will be completed and resolved, or what the ultimate outcome with respect to the Company will be. These investigations could result in substantial costs and a diversion of management’s attention and may have a material and adverse effect on the Company’s business, financial condition, and results of operations.

Item 2.

Changes in Securities and Use of Proceeds

In February 2004, the Company issued 1.0 million shares of unregistered common stock valued at $5.74 million to Gluon Networks in connection with the acquisition of its assets. The issuance was deemed exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) in reliance on Regulation D of the Securities Act.

In March 2004, the Company issued 10,000 shares of unregistered common stock to one entity as a charitable contribution. The issuance was deemed exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

In April 2004, the Company filed a Registration Statement on Form S-3 which will, when declared effective, register the shares issued to the former Gluon stockholders and the shares issued as a charitable contribution as described above.

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits and Reports on Form 8-K

(a)

Exhibits (1)


Exhibit		Description

2.1	(2)	Agreement and Plan of Reorganization, dated as of December 7, 2000, by and among ZTI, Xybridge Technologies Acquisition Corporation and Xybridge Technologies, Inc.

2.2	(2)	Purchase and Sale Agreement, dated as of August 24, 2001, by and among ZTI, and Nortel Networks Corporation.

2.3	(2)	Agreement and Plan of Merger, dated as of June 18, 2002, by and among ZTI, VCI Acquisition Corporation and Vpacket Communications, Inc.

2.4	(2)	Stock Purchase and Sale Agreement, dated as of February 14, 2003, by and among ZTI and NEC eLuminant Technologies, Inc.

2.5	(3)	Agreement and Plan of Merger, dated as of July 27, 2003, by and among Registrant, Zebra Acquisition Corp. and ZTI.

3.1	(4)	Amended and Restated Certificate of Incorporation dated May 22, 2001.

3.2		Certificate of Amendment of Certificate of Incorporation dated November 13, 2003.

3.3		Certificate of Ownership and Merger dated November 13, 2003.

3.4	(4)	Amended and Restated Bylaws.

4.1		Form of Second Restated Rights Agreement dated November 13, 2003.

10.1	(2)	Employment Agreement, dated as of October 20, 1999, by and between ZTI and Mory Ejabat, Registrant’s Chairman and Chief Executive Officer.

10.2	(2)	Employment Agreement, dated as of October 20, 1999, by and between ZTI and Jeanette Symons, Registrant’s Chief Technology Officer and Vice President, Engineering.



10.3	(2)	Restricted Stock Purchase Agreement, dated as of July 1, 2002, by and between ZTI and Mory Ejabat.

10.4	(2)	Restricted Stock Purchase Agreement, dated as of July 1, 2002, by and between ZTI and Jeanette Symons.

10.5	(2)	Promissory Note and Pledge Agreement, dated as of July 11, 2002, by and between ZTI and Mory Ejabat.

10.6	(2)	Promissory Note and Pledge Agreement, dated as of July 11, 2002, by and between ZTI and Jeanette Symons.

10.7	(2)	Strategic Alliance Agreement, dated as of March 13, 2000, by and between ZTI and Solectron Corporation.

10.8	(2)	Form of Asset Purchase Agreement by and between ZTI and Solectron Corporation.

10.9	(2)	Supply Agreement, dated as of March 13, 2000, by and between ZTI and Solectron Corporation.

10.10	(2)	Loan and Security Agreement, dated as of March 30, 2001, by and between ZTI and Fremont Investment and Loan.

10.11	(2)	Pledge and Assignment of Cash Collateral Account, dated as of March 30, 2001, by and between ZTI and Fremont Investment and Loan.

10.12	(2)	Secured Promissory Note, dated as of March 30, 2001, by and between ZTI and Fremont Investment and Loan.

10.13	(2)	Purchase and Sale Agreement with Repurchase Options, dated as of January 20, 2000, by and between ZTI and the Redevelopment Agency of the City of Oakland.

10.14	(2)	1999 Stock Option Plan, as amended.

10.15	(4)	Amended and Restated 1997 Employee Stock Incentive Plan.

10.16	(4)	2001 Stock Incentive Plan.

10.17	(5)	2002 Employee Stock Purchase Plan.

10.18	(6)	Amended and Restated Special 2001 Stock Incentive Plan.

10.19	(7)	2002 Stock Incentive Plan.

10.20		Form of Indemnification Agreement by and between Registrant and Registrant’s directors and officers.

10.21		Amended and Restated Loan and Security Agreement, dated as of February 24, 2004, by and between Registrant and Silicon Valley Bank.

21.1		List of Subsidiaries of the Registrant

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certification of Chief Executive Officer and Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	The exhibit list previously filed with the Registrant’s Annual Report on Form 10-K for the period ending December 31, 2003 (except for Exhibits 23.1, 24.1, 31.1, 31.2 and 32 thereto) is hereby restated as follows.

(2)	Incorporated by reference to ZTI Merger Subsidiary III, Inc.’s Report on Form 10 filed with the Commission on April 30, 2003.

(3)	Incorporated by reference from the Form 8-K filed on July 28, 2003.

(4)	Incorporated by reference from the Registration Statement filed on Form S-1, Registration No. 333-46362, as amended.

(5)	Incorporated by reference from the Registration Statement filed on Form S-8, filed with the Commission on May 21, 2002.

(6)	Incorporated by reference from the Quarterly Report filed on Form 10-Q for the period ended June 30, 2002, filed with the Commission on August 15, 2002.

(7)	Incorporated by reference from the Registration Statement filed on Form S-8, filed with the Commission on August 28, 2002.

(b)

Reports on Form 8-K

On February 3, 2004, the Company filed a current report on Form 8-K related to its financial results for the quarter ended December 31, 2003.

On February 6, 2004, the Company filed a current report on Form 8-K/A relating to a change in accountants which resulted from the merger with Tellium.

SIGNATURE

Pursuant to the requirements of Section 12 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.


	Z HONE T ECHNOLOGIES , I NC .

Date: May 14, 2004	By:	/s/ M ORTEZA E JABAT

	Name:	Morteza Ejabat
	Title:	Chief Executive Officer

EXHIBIT 3.2

CERTIFICATE OF AMENDMENT

CERTIFICATE OF INCORPORATION

TELLIUM, INC.

(a Delaware Corporation)

Pursuant to Section 242 of the General

Corporation Law of the State of Delaware

Tellium, Inc., a corporation organized and existing under the laws of Delaware, does hereby certify that:

FIRST: The name of the corporation is Tellium, Inc. (the “Corporation”).

SECOND: The original Certificate of Incorporation of the Corporation (the “Certificate”) was filed with the Secretary of State of the State of Delaware on April 21, 1997 under the name MWD, Inc.

THIRD: The Corporation hereby amends the Certificate, as heretofore amended, by adding a new paragraph to Article IV to be located at the end of Article IV and entitled “Reclassification” (the “Amendment”) to read as follows:

(C) Reclassification. Immediately upon the effectiveness of the Certificate of Amendment adding this paragraph (C) to Article IV of the Amended and Restated Certificate of Incorporation of the Corporation (the “Effective Date”), each four (4) shares of the Corporation’s Common Stock, par value $.001 per share, issued and outstanding immediately prior to the Effective Date (the “Old Common Stock”), shall automatically and without any action on the part of the holder thereof be reclassified, combined and changed into one (1) share of the Corporation’s Common Stock, subject to the treatment of fractional share interests as described below. Each holder of a certificate or certificates, which immediately prior to the Effective Date represented outstanding shares of the Old Common Stock (the “Old Certificates,” whether one or more), shall be entitled to receive, upon surrender of such Old Certificates to the Corporation for cancellation, a certificate, or certificates (the “New Certificates,” whether one or more) representing the number of whole shares of Common Stock

into which and for which the shares of the Old Common Stock formerly represented by such Old Certificates so surrendered are reclassified under the terms hereof. From and after the Effective Date, the Old Certificates shall represent only (i) the number of shares of Common Stock into which the shares of the Old Common Stock represented thereby were reclassified and (ii) the right to receive New Certificates pursuant to the provisions hereof. No certificates or scrip representing fractional share interests in the New Common Stock will be issued, and no such fractional share interests will entitle the holder thereof to vote, or to any rights of a shareholder of the Corporation. In lieu of any fractional shares, each holder who would otherwise be entitled to a fractional share shall be entitled to receive an amount in cash, without interest, equal to such fraction multiplied by the average closing price per share of the Common Stock on the Nasdaq Small Cap Market for the ten most recent trading days prior to the Effective Date. If more than one Old Certificate shall be surrendered for the account of the same stockholder, the number of full shares of Common Stock for which New Certificates shall be issued shall be computed on the basis of the aggregate number of shares represented by the Old Certificates so surrendered. If any New Certificate is to be issued in a name other than that in which the Old Certificates surrendered for exchange are issued, the Old Certificates so surrendered shall be properly endorsed and otherwise in proper form for transfer, and the person or persons requesting such exchange shall affix any requisite stock transfer tax stamps to the Old Certificates surrendered, or provide funds for their purchase, or establish to the satisfaction of the Corporation that such taxes are not payable.

FOURTH: The foregoing amendment has been duly adopted in accordance with Section 242 of the Delaware General Corporation Law (“DGCL”).

FIFTH: This Certificate of Amendment shall not become effective until, and shall become effective at, 4:00 p.m. on November 13, 2003.

IN WITNESS WHEREOF, the undersigned has caused this Certificate of Amendment to be signed by its duly authorized officer this 13 ^th day of November, 2003


TELLIUM, INC.

By:		/s/ Michael J. Losch
Name:		Michael J. Losch
Title:		CFO, Secretary and Treasurer

EXHIBIT 3.3

CERTIFICATE OF OWNERSHIP AND MERGER

Merging

SAFARI MERGER SUB, INC.

(a Delaware corporation)

Into

TELLIUM, INC.

(a Delaware corporation)

Pursuant to Section 253 of the General

Corporation Law of Delaware

Tellium, Inc. (the “Company”), a corporation organized and existing under the laws of Delaware, does hereby certify that:

FIRST: The Company was incorporated on the 21st day of April, 1997, pursuant to the Delaware General Corporation Law (the “DGCL”), the provisions of which permit the merger of a subsidiary corporation organized and existing under the laws of said State into a parent corporation organized and existing under the laws of said State.

SECOND: The Company owns all of the outstanding shares of the common stock, par value $0.01 per share, of Safari Merger Sub, Inc. (“Safari”), a corporation incorporated on the 5 ^th day of November, 2003, pursuant to the DGCL, and having no class of capital stock outstanding other than said common stock.

THIRD: The Company, by the following resolutions of the Board of Directors, adopted on November 7, 2003 and filed with the minutes of the Board, determined to merge Safari into the Company:

RESOLVED, Safari shall be merged with and into the Company (the “Merger”) with the Company being the surviving corporation of the Merger (the “Surviving Corporation”) and assuming all of Safari’s liabilities and obligations;

FURTHER RESOLVED, that the Merger shall be effective upon the date and time specified in the Certificate of Ownership and Merger filed with the Secretary of State of Delaware;

FURTHER RESOLVED, that the Certificate of Incorporation of the Company, as in effect at the effective time of the Merger, shall be the Certificate of Incorporation of the Surviving Corporation, with such amendments set forth herein;

FURTHER RESOLVED, that at the effective time of the Merger, the name of the Company shall be changed to Zhone Technologies, Inc. and ARTICLE I of the Certificate of Incorporation of the Company shall be amended to read as follows:

ARTICLE I

NAME

The name of the corporation is Zhone Technologies, Inc. (the “Corporation”).

FURTHER RESOLVED, that, at the effective time of the Merger and without any action on the part of the Company or Safari, all of the issued and outstanding shares of capital stock of Safari shall be canceled and the shares of capital stock of the Company outstanding immediately prior to the effective time of the Merger shall continue as shares of capital stock of the Surviving Corporation;

FURTHER RESOLVED, that the Bylaws of the Company, as in effect at the effective time of the Merger, shall be the Bylaws of the Surviving Corporation;

FURTHER RESOLVED, at the effective time of the Merger, the directors of the Company shall continue as the directors of the Surviving Corporation, until their successors are duly elected or appointed and qualified in the manner provided by the Certificate of Incorporation and Bylaws of the Surviving Corporation, or as otherwise provided by law;

FURTHER RESOLVED, at the effective time of the Merger, the officers of the Company shall continue in their respective offices as officers of the Surviving Corporation, until their respective successors are duly elected or appointed and qualified in the manner provided by the Certificate of Incorporation and Bylaws of the Surviving Corporation, or as otherwise provided by law; and

FURTHER RESOLVED, that the officers of the Company be, and each of them hereby is, authorized and empowered in the name and on behalf of the Company to execute, acknowledge and file with the Secretary of State of Delaware the Certificate of Ownership and Merger setting forth a copy of the resolutions to so merge Safari into the Company and to assume its obligations, and to so change the name of the Company, and the date of adoption thereof, and to execute, acknowledge, file and deliver such other documents and to take such other actions as they may deem necessary or appropriate to effect the Merger and said change of name.

FOURTH: This Certificate of Ownership and Merger, and the Merger provided for herein, shall not become effective until, and shall become effective at, 4:02 p.m. on November 13, 2003.

IN WITNESS WHEREOF, the undersigned has caused this Certificate of Ownership and Merger to be signed by its duly authorized officer this 13th day of November, 2003.


TELLIUM, INC.

By:		/s/ Mory Ejabat
Name:		Mory Ejabat
Title:		CEO

EXHIBIT 4.1

ZHONE TECHNOLOGIES, INC.

SECOND RESTATED RIGHTS AGREEMENT

THIS SECOND RESTATED RIGHTS AGREEMENT is entered into as of November 13, 2003, by and among Zhone Technologies, Inc., a Delaware corporation (the “Company”), the undersigned holders of Series AA Preferred Stock (the “Series AA Preferred Stockholders”) and Series B Preferred Stock (the “Series B Preferred Stockholders”) of the Company (collectively, the “Preferred Stockholders”), and Mory Ejabat, Jeanette Symons and Robert Dahl (each a “Founder” and collectively, the “Founders”).

RECITALS :

A. The Company has entered into an Agreement and Plan of Merger, dated as of July 27, 2003 (the “Merger Agreement”), by and among the Company, Tellium, Inc. (“Tellium”) and Zebra Acquisition Corp. (“Merger Sub”), providing for, among other things, the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving as a wholly owned subsidiary of Tellium.

B. Upon the consummation of the Merger, which is expected to occur on the date of this Agreement (the “Merger Closing Date”), each share of Common Stock and Preferred Stock of the Company will be converted into the right to receive a certain number of shares of Common Stock of Tellium according to a formula set forth in the Merger Agreement.

C. Immediately following the Merger, the name of Tellium will be changed to Zhone Technologies, Inc. (hereinafter the “Company” shall refer to Zhone Technologies, Inc. after the Merger (formerly Tellium, Inc.)).

D. Following the consummation of the Merger and the name change as described above, Zhone will be a publicly-traded company with shares listed on the Nasdaq National Market and subject to the public reporting obligations set forth in the Securities Exchange Act of 1934. As a result, the parties to this Agreement agree that the Merger shall be considered to be a “Qualified IPO”, as that term was defined in the Restated Rights Agreement, dated as of February 12, 2003, by and among the Company and the other parties thereto.

E. The parties desire to amend and restate this Rights Agreement, as provided herein, to clarify the rights and obligations of the parties with respect to the Company following the Merger.

AGREEMENT :

NOW, THEREFORE, in consideration of the foregoing and of the mutual promises and covenants contained herein, the parties agree as follows:

1. Registration Rights .

1.1 Definitions . As used in this Agreement, the following terms shall have the following respective meanings:

(a) The terms “register,” “registered” and “registration” refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act of 1933, as amended (the “Securities Act”), and the declaration or ordering of the effectiveness of such registration statement.

(b) The term “Registrable Securities” means (i) any and all shares of Common Stock of the Company issued or issuable in connection with the Merger to the former holders of Preferred Stock of Zhone, including warrants and options exercisable therefor or convertible securities convertible thereunto, (ii) except for Sections 1.1(d), 1.2, 1.4, 1.9 and 2.1, the Founder Shares (as defined in subsection (e) below), (iii) stock issued in lieu of the securities referred to in (i) and (ii) above in any reorganization or (iv) stock issued in respect of the stock referred to in (i), (ii) and (iii) above and this clause (iv) as a result of a stock split, stock dividend, recapitalization or the like (collectively, a “Recapitalization Event”), but excluding any such Common Stock that has been (i) registered under the Securities Act pursuant to an effective registration statement for resale of securities filed thereunder and disposed of in accordance with the registration statement covering them, (ii) subject to Section 1.10, disposed of pursuant to an exemption to the registration requirements under the Securities Act or (iii) publicly sold pursuant to Rule 144 or Rule 145 under the Securities Act.

(c) The terms “Holder” or “Holders” mean(s) any person or persons to whom Registrable Securities were originally issued or qualifying transferees under subsection 1.10 hereof who hold Registrable Securities.

(d) The term “Initiating Holders” means any Holder or Holders of twenty percent (20%) or greater of the Registrable Securities then held by the Holders.

(e) The term “Founder Shares” shall mean any and all shares of Common Stock of the Company issued to the Founders in connection with the Merger, but excluding any such Common Stock that has been (i) registered under the Securities Act pursuant to an effective registration statement for resale of securities filed thereunder and disposed of in accordance with the registration statement covering them, (ii) subject to Section 1.10, disposed of pursuant to an exemption to the registration requirements under the Securities Act or (iii) publicly sold pursuant to Rule 144 or Rule 145 under the Securities Act.

(f) The term “SEC” means the Securities and Exchange Commission.

(g) The term “Registration Expenses” shall mean all expenses incurred by the Company in complying with any single registration effected pursuant to subsections 1.2, 1.3 and 1.4 hereof, including, without limitation, all registration, qualification and filing fees, printing expenses, escrow fees, fees and disbursements of counsel for the Company, reasonable fees and expenses of one special counsel for all selling stockholders up to One Hundred Fifty Thousand Dollars ($150,000), blue sky fees and expenses, and the expense of any special audits incident to or required by any such registration (but excluding the compensation of regular employees of the Company which shall be paid in any event by the Company).

(h) The term “Material Adverse Change” shall mean any change, effect or circumstance that, individually or when taken together with all other such changes, effects or circumstances, has or is reasonably likely to have, any material adverse effect on the assets, liabilities, operations, business, competitive position, prospects, results of operations or condition (financial or otherwise) of the Company and its subsidiaries taken as a whole; provided , however that none of the following shall be deemed to constitute a Material Adverse Change: any change, effect or circumstance that results from conditions affecting the U.S. economy or the world economy.

(i) The term “Person” means any natural person, partnership (whether limited or general), limited liability company, trust, estate, association, corporation, custodian, nominee or any other individual or entity in its own or any representative entity.

1.2 Demand Registration .

(a) Request for Registration . In case the Company shall receive from Initiating Holders a written request that the Company effect any registration, qualification or compliance with respect to Registrable Securities with an anticipated aggregate offering price before deduction of standard underwriting discounts and commissions, in excess of Five Million Dollars ($5,000,000), the Company will:

(i) promptly give written notice of the proposed registration, qualification or compliance to all other Holders; and

(ii) as soon as practicable, use its best efforts to effect all such registrations, qualifications and compliances (including, without limitation, the execution of an undertaking to file post-effective amendments, appropriate qualifications under the applicable blue sky or other state securities laws and appropriate compliance with exemptive regulations issued under the Securities Act and any other governmental requirements or regulations) as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Initiating Holder’s or Initiating Holders’ Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any Holder or Holders joining in such request as are specified in a written request given within thirty (30) days after receipt of such written notice from the Company; provided, that the Company shall not be obligated to take any action to effect such registration, qualification or compliance pursuant to this subsection 1.2:

(A) at any time prior to six (6) months following the Merger Closing Date;

(B) in any particular jurisdiction in which the Company would be required to execute a general qualification or compliance unless the Company is already subject to service in such jurisdiction and except as required by the Securities Act; or

(C) after the Company has effected two (2) such registrations pursuant to this subsection 1.2(a) and such registrations have been declared or ordered effective.

Subject to the foregoing clauses (A) through (C), the Company shall file a registration statement covering the Registrable Securities so requested to be registered as soon as practical, but in any event within ninety (90) days after receipt of the request or requests of the Initiating Holders; provided, however, that if the Company shall furnish to such Initiating Holders a certificate signed by the President of the Company stating that in the good faith judgment of the Board of Directors it would be detrimental to the Company and its stockholders for such registration statement to be filed at the date filing would be required and it is therefore essential to defer the filing of such registration statement, the Company shall have an additional period of not more than sixty (60) days after the expiration of the initial ninety (90) day period within which to file such registration statement; provided, that the Company may not use this right more than once in any twelve (12) month period. The Company shall use its best efforts to cause such registration statement to remain effective for at least one hundred twenty (120) days, or until the distribution described in the registration statement has been completed, whichever occurs first. In the event the Company does not perform its obligations set forth in the preceding sentence, then such registration shall not be deemed effected for the purposes of the limitations set forth in Section 1.2(a)(ii)(C).

(b) Underwriting . If the Initiating Holders intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as part of their request made pursuant to subsection 1.2 and the Company shall include such information in the written notice referred to in subsection 1.2(a)(i). In such event, the underwriter shall be selected by a majority in interest of the Initiating Holders and shall be reasonably acceptable to the Company. The right of any Holder to registration pursuant to subsection 1.2 shall be conditioned upon such Holder’s participation in such underwriting and the inclusion of such Holder’s Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such Holder) to the extent provided herein. The Company shall (together with all Holders proposing to distribute their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters. Notwithstanding any other provision of this subsection 1.2, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, the Initiating Holders shall so advise all Holders participating in the registration, and the number of shares of Registrable Securities that may be included in the registration and underwriting shall be allocated among all such Holders thereof in proportion, as nearly as practicable, to the respective amounts of Registrable Securities held by such Holders. If any Holder disapproves of the terms of the underwriting, such Holder may elect to withdraw therefrom by written notice to the Company, the underwriter and the Initiating Holders. Any Registrable Securities which are excluded from the underwriting by reason of the underwriter’s marketing limitation or withdrawn from such underwriting shall be withdrawn from such registration.

(c) Company Shares . If the managing underwriter has not limited the number of Registrable Securities to be underwritten, the Company may include securities for its own account or for the account of others in such registration if the managing underwriter so agrees and if the number of Registrable Securities which would otherwise have been included in such registration and underwriting will not thereby be limited.

1.3 Company Registration .

(a) Registration . If at any time or from time to time, the Company shall determine to register any of its securities, for its own account or the account of any of its stockholders (other than a registration (A) on Form S-1 or S-8 or successor forms relating solely to employee stock option or purchase plans, (B) on Form S-4 relating solely to an SEC Rule 145 transaction or (C) a registration on any other form or successor forms the use of which is not appropriate for the sale of Registrable Securities), the Company will:

(i) promptly give to each Holder written notice thereof; and

(ii) include in such registration (and compliance), and in any underwriting involved therein, all the Registrable Securities specified in a written request or requests, made within twenty (20) days after receipt of such written notice from the Company by any Holder or Holders, except as set forth in subsection 1.3(b) below.

(b) Underwriting . If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise the Holders as a part of the written notice given pursuant to subsection 1.3(a)(i). In such event the right of any Holder to registration pursuant to subsection 1.3 shall be conditioned upon such Holder’s participation in such underwriting and the inclusion of such Holder’s Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company and the other stockholders distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company. Notwithstanding any other provision of this subsection 1.3, if the underwriter determines that marketing factors require a limitation of the number of shares to be underwritten, the underwriter may limit the number of Registrable Securities to be included in the registration and underwriting; provided , however in no event shall the amount of Registrable Securities of the Holders included in the offering be reduced below thirty percent (30%) of the total amount of securities included in such offering, unless the Holders holding a majority of the Registrable Securities consent in writing to such a reduction. In the event of a cutback by the managing underwriter of the number of Registrable Securities to be included in the registration and underwriting, the Company shall advise all Holders of Registrable Securities which would otherwise be registered and underwritten pursuant hereto, and the number of shares of Registrable Securities that may be included in the registration and underwriting shall be allocated first among all of such Holders, excluding the Holders of Founder Shares, in proportion, as nearly as practicable, to the respective amounts of Registrable Securities held by such Holders as of the date of the notice pursuant to subsection 1.3(a)(i). If, after such Holders participate to the full extent they desire in such registration and underwriting, the managing underwriter determines that additional shares of Registrable Securities may be included, the number of such shares shall be allocated among all of the Holders of Founder Shares in proportion, as nearly as practicable, to the respective amounts of Registrable Securities held by such Holders of Founder Shares. If any Holder disapproves of the terms of the underwriting, he or she may elect to

withdraw therefrom by written notice to the Company and the underwriter. Any Registrable Securities excluded or withdrawn from such underwriting shall be withdrawn from such registration.

1.4 Form S-3 . In addition to the rights and obligations set forth in subsections 1.2 and 1.3 above, if Initiating Holders request that the Company file a registration statement on Form S-3 (or any successor to Form S-3) for a public offering of Registrable Securities, and the Company is then a registrant entitled to use Form S-3 to register shares for such an offering, the Company will: (i) promptly give written notice of the proposed registration, qualification or compliance to all other Holders; and (ii) as soon as practicable, use its best efforts to effect all such registrations, qualifications and compliances (including, without limitation, the execution of an undertaking to file post-effective amendments, appropriate qualifications under the applicable blue sky or other state securities laws and appropriate compliance with exemptive regulations issued under the Securities Act and any other governmental requirements or regulations) as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Initiating Holder’s or Initiating Holders’ Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any Holder or Holders joining in such request as are specified in a written request given within thirty (30) days after receipt of such written notice from the Company. The Company shall use its best efforts to cause such registration statement to remain effective for at least one hundred twenty (120) days, or until the distribution described in the registration statement has been completed, whichever occurs first; provided, however the Company shall not be required to effect a registration pursuant to this subsection 1.4:

(a) at any time prior to six (6) months following the Merger Closing Date;

(b) in any particular jurisdiction in which the Company would be required to execute a general consent to service of process in effecting such registration, qualification or compliance, unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act;

(c) if the Company, within ten (10) days of the receipt of the request of the Initiating Holders, gives notice of its bona fide intention to effect the filing of a registration statement with the SEC within forty-five (45) days of receipt of such request (other than with respect to a registration statement relating to a Rule 145 transaction, an offering solely to employees or any other registration which is not appropriate for the registration of Registrable Securities);

(d) during a period of ninety (90) days following the effective date of any registration statement filed under the Securities Act (other than with respect to a registration statement relating to a Rule 145 transaction, an offering solely to employees or any other registration which is not appropriate for the registration of Registrable Securities);

(e) if the Company has effected two (2) registrations pursuant to this subsection 1.4 within the previous twelve (12) months, provided, however , in the event the Company does not exercise best efforts to cause a registration statement to remain effective for at least one hundred twenty (120) days, or until the distribution is completed, whichever occurs first, then such registration shall not be deemed effected for the purposes of the limitations of this Section 1.4(d); or

(f) if the Company shall furnish to such Initiating Holders a certificate signed by the President of the Company stating that in the good faith judgment of the Board of Directors of the Company, it would be detrimental to the Company and its stockholders for such registration statement to be filed on or before the date filing would be required and it is therefore essential to defer the filing of such registration statement, in which case the Company shall have the right to defer such filing for a period of not more than ninety (90) days after the furnishing of such a certificate of deferral, provided that the Company may not defer such filing pursuant to this subsection 1.4 more than once in any twelve (12) month period.

In the event such Initiating Holders propose to offer the shares of Registrable Securities pursuant to this subsection 1.4 by means of an underwriting, the proposed underwriter(s) shall be selected by a majority in interest of the Initiating Holders and shall be reasonably acceptable to the Company. In such event, the right of any Holder to registration pursuant to subsection 1.4 shall be conditioned upon such Holder’s participation in such underwriting and the inclusion of such Holder’s Registrable Securities in the underwriting (unless otherwise mutually agreed by a majority in interest of the Initiating Holders and such Holder) to the extent provided herein. The Company shall (together with all Holders proposing to distribute their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters. Notwithstanding any other provision of this subsection 1.4, if the underwriter advises the Initiating Holders in writing that marketing factors require a limitation of the number of shares to be underwritten, the Initiating Holders shall so advise all Holders participating in the registration, and the number of shares of Registrable Securities that may be included in the registration and underwriting shall be allocated among all such Holders thereof in proportion, as nearly as practicable, to the respective amounts of Registrable Securities held by such Holders. If any Holder disapproves of the terms of the underwriting, such Holder may elect to withdraw therefrom by written notice to the Company, the underwriter and the Initiating Holders. Any Registrable Securities which are excluded from the underwriting by reason of the underwriter’s marketing limitation or withdrawn from such underwriting shall be withdrawn from such registration.

1.5 Expenses of Registration . All Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to this Section 1 shall be borne by the Company except as follows:

(a) The Company shall not be required to pay for Registration Expenses of any registration proceeding begun pursuant to subsection 1.2, the request for which has been subsequently withdrawn by the Initiating Holders, in which latter such case, such expenses shall be borne pro rata by the Holders requesting such withdrawal. Notwithstanding the foregoing, the Company shall be required to pay for Registration Expenses of any registration proceeding begun pursuant to subsection 1.2 if the request for such registration proceeding has been withdrawn (i) by the Initiating Holders at the Company’s request, (ii) due to the occurrence of a Material Adverse Change or (iii) when the Initiating Holders agree to forfeit one (1) other registration for which the Company would be obligated to pay expenses.

(b) The Company shall not be required to pay fees or disbursements of legal counsel other than the fees and disbursements of one special counsel selected by a majority of the participating Holders.

(c) The Company shall not be required to pay Registration Expenses for more than two (2) registrations pursuant to subsection 1.2.

(d) The Company shall not be required to pay Registration Expenses for more than six (6) registrations pursuant to subsection 1.4.

(e) The Company shall not be required to pay underwriters’ fees, discounts or commissions relating to Registrable Securities.

1.6 Registration Procedures . In the case of each registration, qualification or compliance effected by the Company pursuant to this Rights Agreement, the Company will keep each Holder participating therein advised in writing as to the initiation of each registration, qualification and compliance and as to the completion thereof. Except as otherwise provided in subsection 1.5, at its expense the Company will:

(a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities (drafts of which shall be provided to the Holders for the sole purpose of confirming the accuracy of the information therein relating to each such Holder) and use its best efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective for up to one hundred twenty (120) days.

(b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement (drafts of which shall be provided to the Holders for the sole purpose of confirming the accuracy of the information therein relating to each such Holder).

(c) Furnish to the Holders such numbers of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them.

(d) Use its best efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders, provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions.

(e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter of such offering. Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement.

(f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing.

1.7 Indemnification .

(a) The Company will indemnify each Holder of Registrable Securities and each of its officers, directors, members and partners, and each Person controlling any such Person, with respect to which such registration, qualification or compliance has been effected pursuant to this Rights Agreement, and each underwriter, broker or dealer, if any, and each Person who controls any underwriter, broker or dealer of the Registrable Securities held by or issuable to such Holder, against all claims, losses, expenses, damages and liabilities (or actions in respect thereto) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any prospectus, offering circular or other document (including any related registration statement, notification or the like) incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statement therein not misleading, or any violation or alleged violation by the Company of the Securities Act, the Securities Exchange Act of 1934, as amended (“Exchange Act”), or any state securities law applicable to the Company or any rule or regulation promulgated under the Securities Act, the Exchange Act or any such state law and relating to action or inaction required of the Company in connection with any such registration, qualification of compliance, and will reimburse each such Holder, each of its officers, directors, members and partners, and each Person controlling any such Person, each such underwriter, broker or dealer and each Person who controls any such underwriter, broker or dealer, within a reasonable amount of time after incurred for any reasonable legal and any other expenses incurred in connection with investigating, defending or settling any such claim, loss, damage, liability or action; provided, however, that the indemnity agreement contained in this subsection 1.7(a) shall not apply to amounts paid in settlement of any such claim, loss, damage, liability, or action if such settlement is effected without the consent of the Company (which consent shall not be unreasonably withheld); and provided, further that the Company will not be liable in any such case to the extent that any such claim, loss, damage or liability arises out of or is based solely on any untrue statement or omission based upon written information furnished to the Company by an instrument duly executed by such Holder or underwriter, broker or dealer specifically for use therein.

(b) Each Holder will, if Registrable Securities held by or issuable to such Holder are included in the securities as to which such registration, qualification or compliance is being effected, indemnify the Company, each of its directors and officers, each underwriter, broker or dealer, if any, of the Company’s securities covered by such a registration statement, each person who controls the Company within the meaning of the Securities Act, and each other such Holder, each of its officers, directors, members and partners and each Person controlling such Person, against all claims, losses, expenses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other

document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company, such Holders, such directors, officers, partners, members, Persons or underwriters, brokers or dealers for any reasonable legal or any other expenses incurred in connection with investigating, defending or settling any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document in reliance solely upon and in conformity with written information furnished to the Company by the Holder in an instrument duly executed by such Holder specifically for use therein; provided, however that the indemnity agreement contained in this subsection 1.7(b) shall not apply to amounts paid in settlement of any such claim, loss, damage, liability or action if such settlement is effected without the consent of the Holder (which consent shall not be unreasonably withheld); and provided, further that the total amount for which any Holder shall be liable under this subsection 1.7(b) shall not in any event exceed the aggregate net proceeds received by such Holder from the sale of Registrable Securities held by such Holder in such registration.

(c) Each party entitled to indemnification under this subsection 1.7 (the “Indemnified Party”) shall give notice to the party required to provide indemnification (the “Indemnifying Party”) promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom; provided , that counsel for the Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not be unreasonably withheld), and the Indemnified Party may participate in such defense at such party’s expense; and provided, further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations hereunder, unless such failure resulted in prejudice to the Indemnifying Party; and provided, further that an Indemnified Party (together with all other Indemnified Parties which may be represented without conflict by one counsel) shall have the right to retain one separate counsel, with the fees and expenses to be paid by the Indemnifying Party, if representation of such Indemnified Party by the counsel retained by the Indemnifying Party would be inappropriate due to actual or potential differing interests between such Indemnified Party and any other party represented by such counsel in such proceeding. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation.

(d) If the indemnification provided for in this Section 1.7 is held by a court of competent jurisdiction to be unavailable to an Indemnified Party with respect to any losses, claims, damages or liabilities referred to herein, the Indemnifying Party, in lieu of indemnifying such Indemnified Party thereunder, shall to the extent permitted by applicable law contribute to the amount paid or payable by such Indemnified Party as a result of such loss, claim, damage or liability in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party on the one hand and of the Indemnified Party on the other in connection with the violation(s) that resulted in such loss, claim, damage or liability, as well as any other relevant equitable considerations. The relative fault of the Indemnifying Party and of the Indemnified

Party shall be determined by a court of law by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the Indemnifying Party or by the Indemnified Party and the parties’ relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission; provided , that in no event shall any contribution by a Holder hereunder exceed the net proceeds received from the offering by such Holder.

(e) The obligations of the Company and Holders under this Section 1.7 shall survive completion of any offering of Registrable Securities in a registration statement and the termination of this Agreement. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation.

1.8 Information by Holder . Any Holder or Holders of Registrable Securities included in any registration shall promptly furnish to the Company such information regarding such Holder or Holders and the distribution proposed by such Holder or Holders as the Company may request in writing and as shall be required in connection with any registration, qualification or compliance referred to herein.

1.9 Rule 144 Reporting . With a view to making available to Holders the benefits of certain rules and regulations of the SEC which may permit the sale of the Registrable Securities to the public without registration, the Company agrees at all times to:

(a) make and keep public information available, as those terms are understood and defined in SEC Rule 144;

(b) file with the SEC in a timely manner all reports and other documents required of the Company under the Securities Act and the Exchange Act; and

(c) so long as a Holder owns any Registrable Securities, to furnish to such Holder forthwith upon request a written statement by the Company as to its compliance with the reporting requirements of said Rule 144, and of the Securities Act and the Exchange Act, a copy of the most recent annual or quarterly report of the Company, and such other reports and documents so filed by the Company as the Holder may reasonably request in complying with any rule or regulation of the SEC allowing the Holder to sell any such securities without registration.

1.10 Transfer of Registration Rights . Holders’ rights to cause the Company to register their securities and keep information available, granted to them by the Company under Section 1, may be assigned by any Holder upon the (i) sale or transfer by such Holder to a transferee of any portion of the Registrable Securities held by such Holder in excess of 100,000 shares of Common Stock (as adjusted for any Recapitalization Event), (ii) transfer of Registrable Securities to an affiliated partnership or other entity or to an affiliate or an associate of such Holder or (iii) transfer of any portion of the Registrable Securities held by such Holder to any other Holder; provided, that the Company is given written notice by such Holder at the time of or within a reasonable time after said transfer, stating the name and address of said transferee and

identifying the securities with respect to which such registration rights are being assigned, and further provided that said transferee shall agree to become subject to the obligations of the transferring party hereunder.

1.11 Limitations on Subsequent Registration Rights . From and after the date hereof, the Company shall not, without the prior written consent of the Holders of not less than a majority of the Registrable Securities held by all of the Holders then outstanding, enter into any agreement with any holder or prospective holder of any securities of the Company which would allow such holder or prospective holder to demand any registration or include such securities in any registration filed under subsections 1.2, 1.3 or 1.4 hereof if such inclusion would adversely affect the rights of any Holder under such subsections.

1.12 Termination of Registration Rights . No Holder shall be entitled to exercise any right provided for in this Section 1 after seven (7) years following the Merger Closing Date; provided, however, that a Holder’s rights provided for in this Section 1 shall terminate earlier when such Holder may sell all its shares in a three (3) month period under Rule 144 of the Securities Act (without reference to Rule 144(k)).

2. General .

2.1 Waivers and Amendments . With the written consent of the record or beneficial holders of at least sixty six and two-thirds percent (66K%) of the Registrable Securities, the obligations of the Company and the rights of the parties under this Agreement may be waived (either generally or in a particular instance, either retroactively or prospectively, and either for a specified period of time or indefinitely), and with the same consent the Company, when authorized by resolution of its Board of Directors, may enter into a supplementary agreement for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Agreement; provided, however that no modification, amendment or waiver of this Agreement shall adversely affect any Preferred Stockholder in a way different than any other Preferred Stockholder without the first Preferred Stockholder’s written consent; provided, further, however that no such modification, amendment or waiver shall reduce the aforesaid percentage of Registrable Securities without the consent of all of the Holders of the Registrable Securities. Upon the effectuation of each such waiver, consent, agreement of amendment or modification, the Company shall promptly give written notice thereof to the record holders of the Registrable Securities who have not previously consented thereto in writing.

2.2 Governing Law . This Agreement shall be governed in all respects by the laws of the State of Delaware as such laws are applied to agreements between Delaware residents entered into and to be performed entirely within Delaware.

2.3 Successors and Assigns . Except as otherwise expressly provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors, assigns, heirs, executors and administrators of the parties hereto. Upon the closing of the Merger, all of the rights and obligations of the Company under this Agreement shall become rights and obligations of Tellium, which shall be renamed “Zhone Technologies, Inc.” immediately following the closing of the Merger.

2.4 Entire Agreement . Notwithstanding the provisions of section 4 of that certain Affiliate Agreement, dated on or about the closing date of the Merger, between Tellium, Inc. and certain of the parties to this Agreement, this Agreement constitutes the full and entire understanding and agreement between the parties with regard to the subjects hereof, and this Agreement shall supersede and cancel all prior agreements between the parties hereto with regard to the subject matter hereof.

2.5 Notices, etc . All notices, requests, consents and other communications under this Agreement shall be in writing and shall be delivered by hand or fax or sent by a nationally recognized overnight courier service with written verification of receipt:

If to the Company:

Zhone Technologies, Inc.

7001 Oakport Street

Oakland, California 94621

Attention: President

(fax no. 510-777-7001)

with a copy to:

Gray Cary Ware & Freidenrich LLP

400 Hamilton Avenue

Palo Alto, California 94301-1825

Attention: Peter M. Astiz, Esq.

(fax no. 650-833-2001)

If to a Preferred Stockholder:

At such address or addresses as may have been furnished to the Company in writing by such Preferred Stockholder.

Notices provided in accordance with this Section 2.5 shall be deemed delivered upon actual receipt.

2.6 Severability . In case any provision of this Agreement shall be invalid, illegal, or unenforceable, the validity, legality and enforceability of the remaining provisions of this Agreement shall not in any way be affected or impaired thereby.

2.7 Titles and Subtitles . The titles of the sections and subsections of this Agreement are for convenience of reference only and are not to be considered in construing this Agreement.

2.8 Counterparts . This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one instrument.

2.9 Attorney’s Fees . In the event that any dispute among the Company, any or all Founders and any or all Preferred Stockholders should result in arbitration, the arbitrator may award to one or more of the Prevailing Persons such reasonable attorney fees, costs and expenses, as determined by the arbitrator. Any judgment or order enforcing such arbitration may, in the discretion of the court entering such judgment or order, contain a specific provision providing for the recovery of attorney fees and costs incurred in enforcing such judgment or order and an award of prejudgment interest from the date of the breach at the maximum rate of interest allowed by law. For the purposes of this Section 2.9, “attorney fees” shall include, without limitation, attorney fees incurred in arbitration, post-arbitration order or judgment motions, contempt proceedings, garnishment, levy, and debtor and third party examinations, discovery and bankruptcy litigation. For purposes of this Section 2.9, “Prevailing Person” shall mean any person who is determined by the arbitrator in the proceeding to have prevailed or who prevails by dismissal, default or otherwise.

2.10 Binding Arbitration . The Company, each Founder and each Preferred Stockholder agree that any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by binding arbitration, and judgment upon the final award may be entered in any court having jurisdiction. The arbitration shall be in Palo Alto, California and in accordance with the Comprehensive Arbitration Rules and Procedures (“Rules”) of the Judicial Arbitration and Mediation Services/Endispute in San Francisco, California. Except as otherwise provided in Section 2.9 (“Attorney’s Fees”) of this Agreement, all fees and expenses of the arbitration shall be borne by the parties equally.

A single arbitrator shall be selected according to the Rules within thirty (30) days of submission of the dispute to the arbitrator. The arbitrator shall conduct the arbitration in accordance with the California Evidence Code. The parties shall allow and participate in discovery in accordance with the California Rules of Civil Procedure for a period of sixty (60) days after the filing of an answer or other responsive pleading. All issues regarding compliance with discovery requests shall be decided by the arbitrator. Any party may seek the arbitrator’s permission to take any additional deposition which is necessary to preserve the testimony of a witness who either is, or may become, outside the subpoena power of the arbitrator or otherwise unavailable to testify in the arbitration.

The arbitrator shall have the power to enter any award that could be entered by a Judge of the Superior Court of the State of California sitting without a jury, and only such power, except that the arbitrator shall not have the power to award punitive damages, treble damages or any other damages that do not represent actual damages, even if permitted under the laws of the State of California or any other applicable law.

The parties hereby agree to the Optional Appeal Procedure provided for in the Rules. The final arbitration award may be enforced in any court having jurisdiction over the parties and the subject matter of the arbitration. Notwithstanding the foregoing, the Company, each Founder and each Preferred Stockholder irrevocably submit to the non-exclusive jurisdiction of the Superior Court of the State of California, Santa Clara County, and the United States District Court for the Northern District of California, Branch nearest to Palo Alto, California, in any action to enforce an arbitration award.

The Company, each Founder and each Preferred Stockholder further agree that personal jurisdiction over it may be effected by service of process by registered or certified mail addressed as provided in Section 2.5 of this Agreement, and that when so made shall be as if served upon it personally within the State of California.

[Signatures to Follow]

IN WITNESS WHEREOF, the parties hereby have executed this Agreement on the date first above written.


C OMPANY :

Zhone Technologies, Inc.

By:		/s/ Mory Ejabat
		Mory Ejabat,
		Chief Executive Officer

ACKNOWLEDGED AND AGREED

Tellium, Inc.

By:

C OUNTERPART S IGNATURE P AGE

Z HONE T ECHNOLOGIES , I NC .

S ECOND R ESTATED R IGHTS A GREEMENT

FOUNDERS

Please print your name and sign to the right.

Name (Please Print):

Signature:

C OUNTERPART S IGNATURE P AGE

Z HONE T ECHNOLOGIES , I NC .

R ESTATED R IGHTS A GREEMENT

PREFERRED STOCKHOLDER

If entity:


Please print the legal name of the organization and have an authorized person sign to the right.	Name of Organization:

	By:
		Name (Please Print)

	Title:
If individual:

Please print your name and sign to the right.
	Name (Please Print):



	Signature:

EXHIBIT 10.20

INDEMNITY AGREEMENT

This Indemnity Agreement, dated as of , 200 , is made by and between Zhone Technologies, Inc., a Delaware corporation (the “ Company ”), and (the “ Indemnitee ”).

RECITALS

A. The Company is aware that competent and experienced persons are increasingly reluctant to serve as directors, officers or agents of corporations unless they are protected by comprehensive liability insurance or indemnification, due to increased exposure to litigation costs and risks resulting from their service to such corporations, and due to the fact that the exposure frequently bears no reasonable relationship to the compensation of such directors, officers and other agents.

B. The statutes and judicial decisions regarding the duties of directors and officers are often difficult to apply, ambiguous, or conflicting, and therefore fail to provide such directors, officers and agents with adequate, reliable knowledge of legal risks to which they are exposed or information regarding the proper course of action to take.

C. Plaintiffs often seek damages in such large amounts and the costs of litigation may be so enormous (whether or not the case is meritorious), that the defense and/or settlement of such litigation is often beyond the personal resources of directors, officers and other agents.

D. The Company believes that it is unfair for its directors, officers and agents and the directors, officers and agents of its subsidiaries to assume the risk of huge judgments and other expenses which may occur in cases in which the director, officer or agent received no personal profit and in cases where the director, officer or agent was not culpable.

E. The Company recognizes that the issues in controversy in litigation against a director, officer or agent of a corporation such as the Company or its subsidiaries are often related to the knowledge, motives and intent of such director, officer or agent, that he is usually the only witness with knowledge of the essential facts and exculpating circumstances regarding such matters, and that the long period of time which usually elapses before the trial or other disposition of such litigation often extends beyond the time that the director, officer or agent can reasonably recall such matters; and may extend beyond the normal time for retirement for such director, officer or agent with the result that he, after retirement or in the event of his death, his spouse, heirs, executors or administrators, may be faced with limited ability and undue hardship in maintaining an adequate defense, which may discourage such a director, officer or agent from serving in that position.

F. Based upon their experience as business managers, the Board of Directors of the Company (the “ Board ”) has concluded that, to retain and attract talented and experienced individuals to serve as directors, officers and agents of the Company and its subsidiaries and to

encourage such individuals to take the business risks necessary for the success of the Company and its subsidiaries, it is necessary for the Company to contractually indemnify its directors, officers and agents and the directors, officers and agents of its subsidiaries, and to assume for itself maximum liability for expenses and damages in connection with claims against such directors, officers and agents in connection with their service to the Company and its subsidiaries, and has further concluded that the failure to provide such contractual indemnification could result in great harm to the Company and its subsidiaries and the Company’s stockholders.

G. Section 145 of the General Corporation Law of Delaware, under which the Company is organized (“ Section 145 ”), empowers the Company to indemnify its directors, officers, employees and agents by agreement and to indemnify persons who serve, at the request of the Company, as the directors, officers, employees or agents of other corporations or enterprises, and expressly provides that the indemnification provided by Section 145 is not exclusive.

H. The Company desires and has requested the Indemnitee to serve or continue to serve as a director, officer or agent of the Company and/or one or more subsidiaries of the Company free from undue concern for claims for damages arising out of or related to such services to the Company and/or one or more subsidiaries of the Company.

I. Indemnitee is willing to serve, or to continue to serve, the Company and/or one or more subsidiaries of the Company, provided that he is furnished the indemnity provided for herein.

AGREEMENT

NOW, THEREFORE, the parties hereto, intending to be legally bound, hereby agree as follows:

1. Definitions .

(a) Agent . For the purposes of this Agreement, “agent” of the Company means any person who is or was a director, officer, employee or other agent of the Company or a subsidiary of the Company; or is or was serving at the request of, for the convenience of, or to represent the interests of the Company or a subsidiary of the Company as a director, officer, employee or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise; or was a director, officer, employee or agent of a foreign or domestic corporation which was a predecessor corporation of the Company or a subsidiary of the Company, or was a director, officer, employee or agent of another enterprise at the request of, for the convenience of, or to represent the interests of such predecessor corporation.

(b) Expenses . For purposes of this Agreement, “expenses” include all out-of-pocket costs of any type or nature whatsoever (including, without limitation, all attorneys’ fees and related disbursements), actually and reasonably incurred by the Indemnitee in connection with either the investigation, defense or appeal of a proceeding or establishing or enforcing a right to indemnification under this Agreement or Section 145 or otherwise; provided, however, that “expenses” shall not include any judgments, fines, ERISA excise taxes or penalties, or amounts paid in settlement of a proceeding.

(c) Proceeding . For the purposes of this Agreement, “proceeding” means any threatened, pending, or completed action, suit or other proceeding, whether civil, criminal, administrative, or investigative.

(d) Subsidiary . For purposes of this Agreement, “subsidiary” means any corporation of which more than 50% of the outstanding voting securities is owned directly or indirectly by the Company, by the Company and one or more other subsidiaries, or by one or more other subsidiaries.

2. Agreement to Serve . The Indemnitee agrees to serve and/or continue to serve as agent of the Company, at its will (or under separate agreement, if such agreement exists), in the capacity Indemnitee currently serves as an agent of the Company, so long as he is duly appointed or elected and qualified in accordance with the applicable provisions of the Bylaws of the Company or any subsidiary of the Company or until such time as he tenders his resignation in writing; provided, however, that nothing contained in this Agreement is intended to create any right to continued employment by Indemnitee.

3. Liability Insurance .

(a) Maintenance of D&O Insurance . The Company hereby covenants and agrees that, so long as the Indemnitee shall continue to serve as an agent of the Company and thereafter so long as the Indemnitee shall be subject to any possible proceeding by reason of the fact that the Indemnitee was an agent of the Company, the Company, subject to Section 3(c), shall promptly obtain and maintain in full force and effect directors’ and officers’ liability insurance (“ D&O Insurance ”) in reasonable amounts from established and reputable insurers.

(b) Rights and Benefits . In all policies of D&O Insurance, the Indemnitee shall be named as an insured in such a manner as to provide the Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company’s directors, if the Indemnitee is a director; or of the Company’s officers, if the Indemnitee is not a director of the Company but is an officer; or of the Company’s key employees, if the Indemnitee is not a director or officer but is a key employee.

(c) Limitation on Required Maintenance of D&O Insurance . Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain D&O Insurance if the Company determines in good faith that such insurance is not reasonably available, the premium costs for such insurance are disproportionate to the amount of coverage provided, the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or the Indemnitee is covered by similar insurance maintained by a subsidiary of the Company.

4. Mandatory Indemnification . Subject to Section 9 below, the Company shall indemnify the Indemnitee as follows:

(a) Successful Defense . To the extent the Indemnitee has been successful on the merits or otherwise in defense of any proceeding (including, without limitation, an action by

or in the right of the Company) to which the Indemnitee was a party by reason of the fact that he is or was an agent of the Company at any time, against all expenses of any type whatsoever actually and reasonably incurred by him in connection with the investigation, defense or appeal of such proceeding.

(b) Third Party Actions . If the Indemnitee is a person who was or is a party or is threatened to be made a party to any proceeding (other than an action by or in the right of the Company) by reason of the fact that he is or was an agent of the Company, or by reason of anything done or not done by him in any such capacity, the Company shall indemnify the Indemnitee against any and all expenses and liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes and penalties, and amounts paid in settlement) actually and reasonably incurred by him in connection with the investigation, defense, settlement or appeal of such proceeding, provided the Indemnitee acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and its stockholders, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful.

(c) Derivative Actions . If the Indemnitee is a person who was or is a party or is threatened to be made a party to any proceeding by or in the right of the Company by reason of the fact that he is or was an agent of the Company, or by reason of anything done or not done by him in any such capacity, the Company shall indemnify the Indemnitee against all expenses actually and reasonably incurred by him in connection with the investigation, defense, settlement, or appeal of such proceeding, provided the Indemnitee acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and its stockholders; except that no indemnification under this subsection 4(c) shall be made in respect to any claim, issue or matter as to which such person shall have been finally adjudged to be liable to the Company by a court of competent jurisdiction unless and only to the extent that the court in which such proceeding was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such amounts which the court shall deem proper.

(d) Actions where Indemnitee is Deceased . If the Indemnitee is a person who was or is a party or is threatened to be made a party to any proceeding by reason of the fact that he is or was an agent of the Company, or by reason of anything done or not done by him in any such capacity, and if prior to, during the pendency of after completion of such proceeding Indemnitee becomes deceased, the Company shall indemnify the Indemnitee’s heirs, executors and administrators against any and all expenses and liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes and penalties, and amounts paid in settlement) actually and reasonably incurred to the extent Indemnitee would have been entitled to indemnification pursuant to Sections 4(a), 4(b), or 4(c) above were Indemnitee still alive.

(e) Notwithstanding the foregoing, the Company shall not be obligated to indemnify the Indemnitee for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes and penalties, and amounts paid in settlement) for which payment is actually made to or on behalf of Indemnitee under a valid and collectible insurance policy of D&O Insurance, or under a valid and enforceable indemnity clause, by-law or agreement.

5. Partial Indemnification . If the Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of any expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes and penalties, and amounts paid in settlement) incurred by him in the investigation, defense, settlement or appeal of a proceeding, but not entitled, however, to indemnification for all of the total amount hereof, the Company shall nevertheless indemnify the Indemnitee for such total amount except as to the portion hereof to which the Indemnitee is not entitled.

6. Mandatory Advancement of Expenses . Subject to Section 8(a) below, the Company shall advance all expenses reasonably incurred by the Indemnitee in connection with the investigation, defense, settlement or appeal of any proceeding to which the Indemnitee is a party or is threatened to be made a party by reason of the fact that the Indemnitee is or was an agent of the Company. Indemnitee hereby undertakes to repay such amounts advanced only if, and to the extent that, it shall be determined ultimately that the Indemnitee is not entitled to be indemnified by the Company as authorized hereby. The advances to be made hereunder shall be paid by the Company to the Indemnitee within twenty (20) days following delivery of a written request therefor by the Indemnitee to the Company.

7. Notice and Other Indemnification Procedures .

(a) Promptly after receipt by the Indemnitee of notice of the commencement of or the threat of commencement of any proceeding, the Indemnitee shall, if the Indemnitee believes that indemnification with respect thereto may be sought from the Company under this Agreement, notify the Company of the commencement or threat of commencement thereof.

(b) If, at the time of the receipt of a notice of the commencement of a proceeding pursuant to Section 7(a) hereof, the Company has D&O Insurance in effect, the Company shall give prompt notice of the commencement of such proceeding to the insurers in accordance with the procedures set forth in the respective policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such proceeding in accordance with the terms of such policies.

(c) In the event the Company shall be obligated to pay the expenses of any proceeding against the Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such proceeding, with counsel approved by the Indemnitee, upon the delivery to the Indemnitee of written notice of its election so to do. After delivery of such notice, approval of such counsel by the Indemnitee and the retention of such counsel by the Company, the Company will not be liable to the Indemnitee under this Agreement for any fees of counsel subsequently incurred by the Indemnitee with respect to the same proceeding, provided that (i) the Indemnitee shall have the right to employ his counsel in any such proceeding at the Indemnitee’s expense; and (ii) if (A) the employment of counsel by the Indemnitee has been previously authorized by the Company, (B) the Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and the Indemnitee in the conduct of any such defense, or (C) the Company shall not, in fact, have employed counsel to assume the defense of such proceeding, then the fees and expenses of Indemnitee’s counsel shall be paid by the Company.

8. Exceptions . Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement:

(a) Claims Initiated by Indemnitee . to indemnify or advance expenses to the Indemnitee with respect to proceedings or claims initiated or brought voluntarily by the Indemnitee and not by way of defense, unless (i) such indemnification is expressly required to be made by law, (ii) the proceeding was authorized by the Board, (iii) such indemnification is provided by the Company, in its sole discretion, pursuant to the powers vested in the Company under the General Corporation Law of Delaware or (iv) the proceeding is brought to establish or enforce a right to indemnification under this Agreement or any other statute or law or otherwise as required under Section 145;

(b) Lack of Good Faith . to indemnify the Indemnitee for any expenses incurred by the Indemnitee with respect to any proceeding instituted by the Indemnitee to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in such proceeding was not made in good faith or was frivolous; or

(c) Unauthorized Settlements . to indemnify the Indemnitee under this Agreement for any amounts paid in settlement of a proceeding unless the Company consents to such settlement, which consent shall not be unreasonably withheld.

9. Non-exclusivity . The provisions for indemnification and advancement of expenses set forth in this Agreement shall not be deemed exclusive of any other rights which the Indemnitee may have under any provision of law, the Company’s Certificate of Incorporation, as may be amended from time to time, or Bylaws, the vote of the Company’s stockholders or disinterested directors, other agreements, or otherwise, both as to action in his official capacity and to action in another capacity while occupying his position as an agent of the Company, and the Indemnitee’s rights hereunder shall continue after the Indemnitee has ceased acting as an agent of the Company and shall inure to the benefit of the heirs, executors and administrators of the Indemnitee.

10. Enforcement . Any right to indemnification or advances granted by this Agreement to Indemnitee shall be enforceable by or on behalf of Indemnitee in any court of competent jurisdiction if (i) the claim for indemnification or advances is denied, in whole or in part, or (ii) no disposition of such claim is made within ninety (90) days of request therefor. Indemnitee, in such enforcement action, if successful in whole or in part, shall be entitled to be paid also the expense of prosecuting his claim. It shall be a defense to any action for which a claim for indemnification is made under this Agreement (other than an action brought to enforce a claim for expenses pursuant to Section 6 hereof, provided that the required undertaking has been tendered to the Company) that Indemnitee is not entitled to indemnification because of the limitations set forth in Sections 4 and 8 hereof. Neither the failure of the Company (including its Board of Directors or its stockholders) to have made a determination prior to the commencement of such enforcement action that indemnification of Indemnitee is proper in the circumstances, nor an actual determination by the Company (including its Board of Directors or its stockholders) that such indemnification is improper, shall be a defense to the action or create a presumption that Indemnitee is not entitled to indemnification under this Agreement or otherwise.

11. Subrogation . In the event the Company is obligated to make a payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery under an insurance policy or any other indemnity agreement covering the Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable the Company effectively to bring suit to enforce such rights.

12. Survival of Rights .

(a) All agreements and obligations of the Company contained herein shall continue during the period Indemnitee is an agent of the Company and shall continue thereafter so long as Indemnitee shall be subject to any possible claim or threatened, pending or completed action, suit or proceeding, whether civil, criminal, arbitrational, administrative or investigative, by reason of the fact that Indemnitee was serving in the capacity referred to herein.

(b) The Company shall require any successor to the Company (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets of the Company, expressly to assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place.

13. Interpretation of Agreement . It is understood that the parties hereto intend this Agreement to be interpreted and enforced so as to provide indemnification to the Indemnitee to the fullest extent permitted by law including those circumstances in which indemnification would otherwise be discretionary.

14. Severability . If any provision or provisions of this Agreement shall be held to be invalid, illegal or unenforceable for any reason whatsoever, (i) the validity, legality and enforceability of the remaining provisions of the Agreement (including without limitation, all portions of any paragraphs of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall not in any way be affected or impaired thereby, and (ii) to the fullest extent possible, the provisions of this Agreement (including, without limitation, all portions of any paragraph of this Agreement containing any such provision held to be invalid, illegal or unenforceable, that are not themselves invalid, illegal or unenforceable) shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable and to give effect to Section 13 hereof.

15. Modification and Waiver . No supplement, modification or amendment of this Agreement shall be binding unless executed in writing by both of the parties hereto. No waiver of any of the provisions of this Agreement shall be deemed or shall constitute a waiver of any other provisions hereof (whether or not similar) nor shall such waiver constitute a continuing waiver.

16. Notice . All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed duly given (i) if delivered by hand and receipted for by the party addressee or (ii) if mailed by certified or registered mail with postage prepaid, on the third business day after the mailing date. Addresses for notice to either party are as shown on the signature page of this Agreement, or as subsequently modified by written notice.

17. Governing Law . This Agreement shall be governed exclusively by and construed according to the laws of the State of Delaware as applied to contracts between Delaware residents entered into and to be performed entirely within Delaware.

The parties hereto have entered into this Indemnity Agreement effective as of the date first above written.


THE COMPANY:

ZHONE TECHNOLOGIES, INC.

By
Title

Address		7001 Oakport Street Oakland CA 94621 Attn: Corporate Secretary

INDEMNITEE:


[Name]

Address

Exhibit 10.21

Silicon Valley Bank

Amended and Restated Loan and Security Agreement


Borrowers:		ZTI Merger Subsidiary III, Inc.
		(formerly known as Zhone Technologies, Inc.)

		Zhone Technologies, Inc.
		(formerly known as Tellium, Inc.)

Address:		7001 Oakport St.
		Oakland, California 94621

Date:		February 24, 2004

THIS AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT (“Loan Agreement” or “Agreement”) is entered into on the above date between SILICON VALLEY BANK (“Silicon”), whose address is 3003 Tasman Drive, Santa Clara, California 95054 and the borrowers named above (jointly and severally, the “Borrower”), whose chief executive office is located at the above address (“Borrower’s Address”). The Schedule to this Agreement (the “Schedule”) shall for all purposes be deemed to be a part of this Agreement, and the same is an integral part of this Agreement. (Definitions of certain terms used in this Agreement are set forth in Section 8 below.)

This Loan Agreement amends and restates in its entirety the Loan and Security Agreement between Silicon and ZTI Merger Subsidiary III, Inc. dated as of December 30, 2002 (as previously amended, the “Prior Loan Agreement”), in order to add Zhone Technologies, Inc. as a Borrower thereunder, and to modify the terms of the Prior Loan Agreement as herein set forth.

1. LOANS.

1.1 Loans. Silicon will make loans to Borrower (the “Loans”), in amounts up to the amounts (the “Credit Limit”) shown on the Schedule, provided no Default or Event of Default has occurred and is continuing.

1.2 Interest. All Loans and all other monetary Obligations shall bear interest at the rate shown on the Schedule, except where expressly set forth to the contrary in this Agreement. Interest shall be payable monthly, on the last day of the month. Interest may, in Silicon’s discretion, be charged to Borrower’s loan account, and the same shall thereafter bear interest at the same rate as the other Loans. Silicon may, in its discretion, charge interest to Borrower’s Deposit Accounts maintained with Silicon.

1.3 Overadvances. If at any time or for any reason the total of all outstanding Loans and all other monetary Obligations under or in connection with this Agreement exceeds the Credit Limit (an “Overadvance”), Borrower shall pay the amount of the excess to Silicon, within one Business Day following notice thereof from Silicon to Borrower. Without limiting Borrower’s obligation to repay to Silicon the amount of any Overadvance, Borrower agrees to pay Silicon interest on the outstanding amount of any Overadvance, on demand, at the Default Rate.

1.4 Fees. Borrower shall pay Silicon the fees shown on the Schedule, which are in addition to all interest and other sums payable to Silicon and are not refundable.

1.5 Loan Requests. To obtain a Loan, Borrower shall make a request to Silicon by facsimile or telephone. Loan requests received after 12:00 Noon will not be considered by Silicon until the next Business Day. Silicon may rely on any telephone request for a Loan given by a person whom Silicon believes is an authorized representative of Borrower, and Borrower will indemnify Silicon for any loss Silicon suffers as a result of that reliance.

1.6 Letters of Credit. At the request of Borrower, Silicon may, in its good faith business judgment, issue or arrange for the issuance of letters of credit for the account of Borrower, in each case in form and substance satisfactory to Silicon in its sole discretion (collectively, “Letters of Credit”). Letters of Credit issued under the Prior Loan Agreement constitute “Letters of Credit” for all purposes of this Agreement and shall be governed by this Agreement. The aggregate face amount of all Letters of Credit from time to time outstanding shall not exceed the amount shown on the Schedule (the “Letter of Credit Sublimit”), and shall be reserved against Loans which would otherwise be available hereunder, and in the event at any time there are insufficient Loans available to Borrower for such reserve, Borrower shall deposit and maintain with Silicon cash collateral in an amount at all times equal to such deficiency, which shall be held as Collateral for all purposes of this Agreement. Borrower shall pay all bank charges (including charges of Silicon) for the issuance of Letters of Credit, together with the customary fee Silicon’s letter of credit department shall charge in connection with the issuance of the Letters of Credit (which shall be 1.5% per annum). Any payment by Silicon under or in connection with a Letter of Credit shall constitute a Loan hereunder on the date such payment is made. Each Letter of Credit shall have an expiry date not more than one hundred and eighty days days after the Maturity Date, but Borrower’s obligation to reimburse Silicon for any sums due on or in connection with the Letters of Credit outstanding after the Maturity Date will be secured by cash on terms acceptable to Silicon at all times after the Maturity Date. Borrower hereby agrees to indemnify and hold Silicon harmless from any loss, cost, expense, or liability, including payments made by Silicon, expenses, and reasonable attorneys’ fees incurred by Silicon arising out of or in connection with any Letters of Credit other than those arising from Silicon’s gross negligence or wilful misconduct. Borrower agrees to be bound by Silicon’s interpretations of any Letter of Credit issued by Silicon for Borrower’s account, and Borrower understands and agrees that Silicon shall not be liable for any error, negligence, or mistake, whether of omission or commission, in following Borrower’s instructions or those contained in the Letters of Credit or any modifications, amendments, or supplements thereto. The provisions of this Loan Agreement, as it pertains to Letters of Credit, and any other Loan Documents relating to Letters of Credit are cumulative.

2. SECURITY INTEREST.

To secure the payment and performance of all of the Obligations when due, Borrower hereby grants to Silicon a security interest in all of the following (collectively, the “Collateral”): all right, title and interest of Borrower in and to all of the following, whether now owned or hereafter arising or acquired and wherever located: all Accounts; all Inventory; all Equipment; all Deposit Accounts; all General Intangibles (including without limitation all Intellectual Property); all Investment Property; all Other Property; and any and all claims, rights and interests in any of the above, and all guaranties and security for any of the above, and all substitutions and replacements for, additions, accessions, attachments, accessories, and improvements to, and proceeds (including proceeds of any insurance policies, proceeds of proceeds and claims against third parties) of, any and all of the above, and all Borrower’s books relating to any and all of the above.

Notwithstanding the foregoing, the security interest granted herein does not extend to, and the term “Collateral” does not include, the following: (A) more than 65% of the presently existing and hereafter arising issued and outstanding shares of capital stock owned by Borrower of any foreign subsidiary which shares entitle the holder thereof to vote for directors or any other matter; and (B) any license or rights under any contract or rights as lessee of any equipment or software, to the extent that (i) the grant of a security interest therein would be contrary to applicable law, or (ii) such license or contract or lease prohibits the grant of a security interest therein (but only to the extent such prohibition is enforceable under applicable law). Except as disclosed on Exhibit 1 hereto, Borrower represents and warrants to Silicon that it is not presently a party to, nor is it bound by, any material in-bound software license relating to its SLMS, access node or IMACS product lines (which Borrower represents are all of its material product lines) which prohibits Borrower from granting a security interest therein to Silicon (to the extent such prohibition is enforceable under applicable law). Borrower shall not, hereafter, without Silicon’s prior written consent, enter into any material in-bound software license relating to its SLMS, access node or IMACAS product lines which prohibits Borrower from granting a security interest therein to Silicon (to the extent such prohibition is enforceable under applicable law), unless Borrower uses commercially reasonable efforts to have such prohibition removed, and in the event Borrower is not successful in having such prohibition removed, Borrower shall give prompt written notice thereof to Silicon.

3. REPRESENTATIONS, WARRANTIES AND COVENANTS OF BORROWER.

In order to induce Silicon to enter into this Agreement and to make Loans, Borrower represents and warrants to Silicon as follows, and Borrower covenants that the following representations will continue to be true, and that Borrower will at all times comply with all of the following covenants, throughout the term of this Agreement and until all Obligations (other than contingent indemnification obligations) have been paid and performed in full:

3.1 Corporate Existence and Authority. Borrower is and will continue to be, duly organized, validly existing and in good standing under the laws of the State of Delaware. Borrower is and will continue to be qualified and licensed to do business

-2-

in all jurisdictions in which any failure to do so would reasonably be expected to result in a Material Adverse Change. The execution, delivery and performance by Borrower of this Agreement, and all other documents contemplated hereby (i) have been duly and validly authorized, (ii) are enforceable against Borrower in accordance with their terms (except as enforcement may be limited by equitable principles and by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to creditors’ rights generally), and (iii) do not violate Borrower’s Certificate of Incorporation, or Borrower’s by-laws, or any law or any material agreement or instrument which is binding upon Borrower or its property, and (iv) do not constitute grounds for acceleration of any material indebtedness or obligation under any agreement or instrument which is binding upon Borrower or its property.

3.2 Name; Trade Names and Styles. The name of Borrower set forth in the heading to this Agreement is its correct name. Borrower has provided Silicon with all prior names of Borrower and all of Borrower’s present and prior trade names. Borrower shall give Silicon 30 days’ prior written notice before changing its corporate name. Borrower has complied, and will in the future comply, in all material respects, with all laws relating to the conduct of business under a fictitious business name, except where the failure to so comply would not reasonably be expected to result in a Material Adverse Change.

3.3 Place of Business; Location of Collateral. The address set forth in the heading to this Agreement is Borrower’s chief executive office. Borrower will give Silicon written notice of a change in its chief executive office, within 30 days after such change.

3.4 Title to Collateral; Perfection; Permitted Liens.

(a) Borrower is now, and will at all times in the future be, the sole owner of all the Collateral, except for licensed property rights and items of Equipment and related software which are leased to Borrower. The Collateral now is and will remain free and clear of any and all liens, charges, security interests, encumbrances and adverse claims, except for Permitted Liens. Silicon now has, and will continue to have, a first-priority perfected and enforceable security interest in all of the Collateral, subject only to the Permitted Liens, and Borrower will at all times defend the Collateral against all encumbrances (other than Permitted Liens) and adverse claims of others (other than Permitted Liens).

(b) [intentionally omitted]

(c) In the event that Borrower shall at any time after the date hereof have any commercial tort claims against others, which it is asserting or intends to assert, and in which the potential recovery exceeds $500,000, Borrower shall promptly notify Silicon thereof in writing and provide Silicon with such information regarding the same as Silicon shall request (unless providing such information would waive the Borrower’s attorney-client privilege). Such notification to Silicon shall constitute a grant of a security interest in the commercial tort claim and all proceeds thereof to Silicon, and Borrower shall execute and deliver all such documents and take all such actions as Silicon shall reasonably request in connection therewith.

3.5 Maintenance of Collateral. Borrower will maintain the Collateral consisting of tangible personal property in good working condition (ordinary wear and tear excepted), and Borrower will not use the Collateral for any unlawful purpose. Borrower will immediately advise Silicon in writing of any material loss or damage to the Collateral.

3.6 Books and Records. Borrower has maintained and will maintain at Borrower’s Address complete and accurate books and records, comprising an accounting system in accordance with GAAP.

3.7 Financial Condition, Statements and Reports. All financial statements now or in the future delivered to Silicon have been, and will be, prepared in conformity with GAAP and now and in the future will fairly present the results of operations and financial condition of Borrower, in accordance with GAAP, at the times and for the periods therein stated. Between the last date covered by any such statement provided to Silicon and the date hereof, there has been no Material Adverse Change.

3.8 Tax Returns and Payments; Pension Contributions. Borrower has timely filed, and will timely file, all required tax returns and reports, and Borrower has timely paid, and will timely pay, all foreign, federal, state and local taxes, assessments, deposits and contributions now or in the future owed by Borrower. Borrower may, however, defer payment of any contested taxes, provided that Borrower (i) in good faith contests Borrower’s obligation to pay the taxes by appropriate proceedings promptly and diligently instituted and conducted, (ii) notifies Silicon in writing of the commencement of, and any material development in, the proceedings, and (iii) posts bonds or takes any other steps required to keep the contested taxes from becoming a lien upon any of the Collateral. Borrower is unaware of any claims or adjustments proposed for any of Borrower’s prior tax years which could result in additional taxes becoming due and payable by Borrower. Borrower has paid, and shall continue to pay all amounts necessary to fund all present and future pension, profit sharing and deferred compensation plans in accordance with their terms, and Borrower has not and will not withdraw from participation in, permit partial or complete termination of, or permit the occurrence of any other event with respect to, any such plan which could reasonably be expected to result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency.

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3.9 Compliance with Law. Borrower has, to the best of its knowledge, complied, and will comply, in all material respects, with all provisions of all foreign, federal, state and local laws and regulations applicable to Borrower, including, but not limited to, those relating to Borrower’s ownership of real or personal property, the conduct and licensing of Borrower’s business, and all environmental matters.

3.10 Litigation. There is no claim, suit, litigation, proceeding or investigation pending or (to best of Borrower’s knowledge) threatened against or affecting Borrower in any court or before any governmental agency (or any basis therefor known to Borrower) which could reasonably be expected to result, either separately or in the aggregate, in any Material Adverse Change. Borrower will promptly inform Silicon in writing of any claim, proceeding, litigation or investigation in the future threatened or instituted against Borrower involving any uninsured claim or claims involving $1,000,000 or more in the aggregate asserted in any fiscal year, or which could reasonably be expected to result, either separately or in the aggregate, in a Material Adverse Change.

3.11 Use of Proceeds. All proceeds of all Loans shall be used solely for lawful business purposes. Borrower is not purchasing or carrying any “margin stock” (as defined in Regulation U of the Board of Governors of the Federal Reserve System) and no part of the proceeds of any Loan will be used to purchase or carry any “margin stock” or to extend credit to others for the purpose of purchasing or carrying any “margin stock.”

4. [intentionally omitted]

5. ADDITIONAL DUTIES OF BORROWER.

5.1 Financial and Other Covenants. Borrower shall at all times, during the term of this Agreement and thereafter while any Obligations (other than contingent indemnification obligations) are outstanding, comply with the financial and other covenants set forth in the Schedule.

5.2 Insurance. Borrower shall, at all times insure all of the tangible personal property Collateral and carry such other business insurance, with insurers reasonably acceptable to Silicon, in such form and amounts as Silicon may reasonably require and that are customary and in accordance with standard practices for Borrower’s industry and locations, and Borrower shall provide evidence of such insurance to Silicon. All such insurance policies shall name Silicon as an additional loss payee (subject to the rights of the holders of Permitted Liens holding claims senior to Silicon), and shall contain a lenders loss payee endorsement in form reasonably acceptable to Silicon. Upon receipt of the proceeds of any such insurance, subject to the rights of the holders of Permitted Liens holding claims senior to Silicon, Silicon shall apply such proceeds in reduction of the Obligations as Silicon shall determine in its good faith business judgment, except that, provided no Default or Event of Default has occurred and is continuing, Silicon shall release to Borrower insurance proceeds from each event of loss totaling less than $1,000,000, which shall be used by Borrower for ordinary business purposes or, as applicable, the replacement of Equipment with respect to which the insurance proceeds were paid. Silicon may require reasonable assurance that the insurance proceeds so released will be so used. If Borrower fails to provide or pay for any insurance, Silicon may, but is not obligated to, obtain the same at Borrower’s expense, to the extent necessary to protect Silicon’s interest in the Collateral and upon prompt written notice to Borrower. Borrower shall promptly deliver to Silicon copies of all material reports made to insurance companies.

5.3 Reports. Borrower, at its expense, shall provide Silicon with the written reports set forth in the Schedule, and such other written reports with respect to Borrower (including budgets, sales projections, operating plans and other financial documentation), as Silicon shall from time to time specify in its good faith business judgment. Borrower shall give Silicon written notice of the following within 30 days after the same are consummated: (i) any merger between Borrower or any of its present or future subsidiaries and any third party, and (ii) any acquisition of assets outside the ordinary course of business for consideration having a value in excess of $5,000,000.

5.4 Access to Collateral, Books and Records . After the occurrence and during the continuance of an Event of Default, on one Business Day’s notice, Silicon, or its agents, shall have the right to inspect the Collateral, and the right to audit and copy Borrower’s books and records. Silicon shall take reasonable steps to keep confidential all information obtained in any such inspection or audit and will exercise the same degree of care that it exercises for its own proprietary information, but Silicon shall have the right to disclose any such information to its auditors, regulatory agencies, and attorneys, and pursuant to any subpoena or other legal process. The foregoing inspections and audits after the occurrence and during the continuance of an Event of Default shall be at Borrower’s expense.

5.5 Negative Covenants. Except as may be permitted in the Schedule, Borrower shall not, without Silicon’s prior written consent (which shall be a matter of its good faith business judgment), do any of the following:

(i) merge or consolidate with another corporation or entity if (A) the Borrower is not the surviving entity in the merger or consolidation, or (B) before, or after giving effect to the merger or consolidation a Default or Event of Default has occurred or would occur; or

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(ii) acquire any assets outside the ordinary course of business if before, or after giving effect to the acquisition a Default or Event of Default has occurred or would occur; or

(iii) sell or transfer any Collateral, except for (A) the sale of finished Inventory in the ordinary course of Borrower’s business, (B) the sale of obsolete or unneeded Equipment in the ordinary course of business; (C) non-exclusive licenses and similar non-exclusive arrangements for the use of the property of Borrower in the ordinary course of business; (D) transfers consisting of the granting of Permitted Liens or the making of Permitted Investments or the liquidation of Permitted Investments; (E) transfers consisting of the payment of operating expenses in the ordinary course of business; and (F) transfers of Inventory and Equipment to Borrower’s contract manufacturers in the ordinary course of Borrower’s business; or

(iv) engage in or permit any of its subsidiaries to engage in any business other than the businesses currently engaged in by Borrower or its subsidiaries or reasonably related thereto

(v) dissolve or elect to dissolve.

Transactions permitted by the foregoing provisions of this Section are only permitted if no Default or Event of Default would occur as a result of such transaction.

5.6 Litigation Cooperation. Should any third-party suit or proceeding be instituted by or against Silicon with respect to any Collateral or relating to Borrower, Borrower shall, without expense to Silicon, make available Borrower and its officers, employees and agents and Borrower’s books and records, to the extent that Silicon may deem them reasonably necessary in order to prosecute or defend any such suit or proceeding.

5.7 Further Assurances. Borrower agrees, at its expense, on request by Silicon, to execute all documents and take all actions, as Silicon, may, in its good faith business judgment, deem necessary or useful in order to perfect and maintain Silicon’s perfected first-priority security interest in the Collateral (subject to Permitted Liens), and in order to fully consummate the transactions contemplated by this Agreement.

6. TERM.

6.1 Maturity Date. This Agreement shall continue in effect until the maturity date set forth on the Schedule (the “Maturity Date”), subject to Section 6.3 below.

6.2 Early Termination. This Agreement may be terminated prior to the Maturity Date as follows: (i) by Borrower, effective three Business Days after written notice of termination is given to Silicon; or (ii) by Silicon at any time after the occurrence and during the continuance of an Event of Default, without notice, effective immediately.

6.3 Payment of Obligations. On the Maturity Date or on any earlier effective date of termination, Borrower shall pay and perform in full all outstanding Loans and other Obligations, whether evidenced by installment notes or otherwise, and whether or not all or any part of such Obligations are otherwise then due and payable. Without limiting the generality of the foregoing, if on the Maturity Date, or on any earlier effective date of termination, there are any outstanding Letters of Credit issued by Silicon or issued by another institution based upon an application, guarantee, indemnity or similar agreement on the part of Silicon, then on such date Borrower shall provide to Silicon cash collateral in an amount equal to 105% of the face amount of all such Letters of Credit plus all interest, fees and cost due or to become due in connection therewith (as estimated by Silicon in its good faith business judgment), to secure all of the Obligations relating to said Letters of Credit, pursuant to Silicon’s then standard form cash pledge agreement. Notwithstanding any termination of this Agreement, all of Silicon’s security interests in all of the Collateral and all of the terms and provisions of this Agreement shall continue in full force and effect until all Obligations (other than contingent indemnification obligations) have been paid and performed in full; provided that Silicon may, in its sole discretion, refuse to make any further Loans after termination. No termination shall in any way affect or impair any right or remedy of Silicon, nor shall any such termination relieve Borrower of any Obligation to Silicon, until all of the Obligations (other than contingent indemnification obligations) have been paid and performed in full. Upon payment and performance in full of all the Obligations (other than contingent indemnification obligations) and termination of this Agreement, Silicon shall promptly terminate its financing statements with respect to the Borrower and deliver to Borrower such other documents as may be required to fully terminate Silicon’s security interests.

7. EVENTS OF DEFAULT AND REMEDIES.

7.1 Events of Default. The occurrence of any of the following events shall constitute an “Event of Default” under this Agreement, and Borrower shall give Silicon immediate written notice thereof: (a) Any warranty, representation, statement, report or certificate made or delivered to Silicon by Borrower or any of Borrower’s officers, employees or agents, now or in the future, shall be untrue or misleading in a material respect when made or deemed to be made; or (b) Borrower shall fail to pay when due any Loan or any interest thereon or any other monetary Obligation within two Business Days after the date due; or (c) the total Loans and other Obligations outstanding at any time shall exceed the Credit Limit and Borrower shall fail to pay the excess to Silicon within the time set forth in Section 1.3 hereof; or (d) Borrower shall fail to comply with any of

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the financial covenants set forth in the Schedule, or shall fail to perform any other non-monetary Obligation which by its nature cannot be cured; or (e) Borrower shall fail to perform any other non-monetary Obligation, which failure is not cured within 10 days after it occurs, or if the default cannot by its nature be cured within 10 days, the default is not cured within a reasonable time after it has occurred not to exceed 30 days; or (f) any levy, assessment, attachment, seizure, lien or encumbrance (other than a Permitted Lien) is made on all or any part of the Collateral which is not cured within 10 days after the Borrower has notice of the same or in the exercise of reasonable diligence should have had notice of the same; or (g) any event of default occurs under any obligation secured by a Permitted Lien that gives the holder thereof the right to accelerate indebtedness of more than $400,000, which is not cured within any applicable cure period or waived in writing by the holder of the Permitted Lien; provided, however, that the Event of Default under this Section 7.1(g) caused by the occurrence of an event of default under such other agreement shall be cured or waived for purposes of this Agreement upon Silicon receiving written notice of such cure or waiver of the default under such other agreement, if at the time of such cure or waiver (i) Silicon has not declared an Event of Default under this Agreement and exercised any rights with respect thereto, and (ii) any such cure or waiver does not result in an Event of Default under any other provision of this Agreement, and (iii) in connection with any such cure or waiver, the terms of any agreement with such third party are not modified or amended in any manner which are in the good faith judgment of Silicon materially less advantageous to Borrower; or (h) Borrower breaches any material contract or obligation, which has resulted or may reasonably be expected to result in a Material Adverse Change; or (i) Dissolution, termination of existence, insolvency or business failure of Borrower; or appointment of a receiver, trustee or custodian, for all or any part of the property of, assignment for the benefit of creditors by, or the commencement of any proceeding by Borrower under any reorganization, bankruptcy, insolvency, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, now or in the future in effect; or (j) the commencement of any proceeding against Borrower or any Material Guarantor under any reorganization, bankruptcy, insolvency, arrangement, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction, now or in the future in effect, which is not cured by the dismissal thereof within 30 days after the date commenced; or (k) revocation or termination of, or limitation or denial of liability upon, any guaranty of the Obligations by a Material Guarantor or any attempt to do any of the foregoing, or commencement of proceedings by any Material Guarantor of any of the Obligations under any bankruptcy or insolvency law; or (l) revocation or termination of, or limitation or denial of liability upon, any pledge of any certificate of deposit, securities or other property or asset of any kind pledged by any by a Material Guarantor to secure any or all of the Obligations, or any attempt to do any of the foregoing, or commencement of proceedings by or against any by a Material Guarantor under any bankruptcy or insolvency law; or (m) Borrower makes any payment on account of any indebtedness or obligation which has been subordinated to the Obligations other than as permitted in the applicable subordination agreement, or if any Person who has subordinated such indebtedness or obligations terminates or in any way limits his subordination agreement; or (n) without the prior written consent of Silicon, any Person or group of affiliated Persons shall acquire more than 50% of the outstanding shares of stock of Borrower, in one or more transactions; or (o) Borrower shall generally not pay its debts as they become due, or Borrower shall conceal, remove or transfer any part of its property, with intent to hinder, delay or defraud its creditors, or make or suffer any transfer of any of its property which may be fraudulent under any bankruptcy, fraudulent conveyance or similar law; or (p) Silicon shall give written notice to Borrower that, in its good faith business judgment, a Material Adverse Change has occurred. Silicon may cease making any Loans hereunder during any of the above cure periods, and thereafter if an Event of Default has occurred and is continuing.

7.2 Remedies. Upon the occurrence and during the continuance of any Event of Default, and at any time thereafter, Silicon, at its option, and without notice or demand of any kind (all of which are hereby expressly waived by Borrower), may do any one or more of the following: (a) Cease making Loans or otherwise extending credit to Borrower under this Agreement or any other Loan Document; (b) Accelerate and declare all or any part of the Obligations to be immediately due, payable, and performable, notwithstanding any deferred or installment payments allowed by any instrument evidencing or relating to any Obligation; (c) Take possession of any or all of the Collateral wherever it may be found, and for that purpose Borrower hereby authorizes Silicon without judicial process to enter onto any of Borrower’s premises without interference to search for, take possession of, keep, store, or remove any of the Collateral, and remain on the premises or cause a custodian to remain on the premises in exclusive control thereof, without charge for so long as Silicon deems it necessary, in its good faith business judgment, in order to complete the enforcement of its rights under this Agreement or any other agreement; provided, however, that should Silicon seek to take possession of any of the Collateral by court process, Borrower hereby irrevocably waives: (i) any bond and any surety or security relating thereto required by any statute, court rule or otherwise as an incident to such possession; (ii) any demand for possession prior to the commencement of any suit or action to recover possession thereof; and (iii) any requirement that Silicon retain possession of, and not dispose of, any such Collateral until after trial or final judgment; (d) Require Borrower to assemble any or all of the Collateral and make it available to Silicon at places designated by Silicon which are reasonably convenient to Silicon and Borrower, and to remove the Collateral to such locations as Silicon may deem advisable; (e) Complete the processing, manufacturing or repair of any Collateral prior to a disposition thereof and, for such purpose and for the purpose of removal, Silicon shall have the right to use Borrower’s premises, vehicles, hoists, lifts, cranes, and other Equipment and all other property without charge; (f) Sell, lease or otherwise dispose of any of the Collateral, in its condition at the time Silicon obtains possession of it or after further manufacturing, processing or repair, at one or more public and/or private sales, in lots or in bulk, for cash, exchange or other

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property, or on credit, and to adjourn any such sale from time to time without notice other than oral announcement at the time scheduled for sale. Silicon shall have the right to conduct such disposition on Borrower’s premises without charge, for such time or times as Silicon deems reasonable, or on Silicon’s premises, or elsewhere and the Collateral need not be located at the place of disposition. Silicon may directly or through any affiliated company purchase or lease any Collateral at any such public disposition, and if permissible under applicable law, at any private disposition. Any sale or other disposition of Collateral shall not relieve Borrower of any liability Borrower may have if any Collateral is defective as to title or physical condition or otherwise at the time of sale; (g) Demand payment of, and collect any Accounts and General Intangibles comprising Collateral and, in connection therewith, Borrower irrevocably authorizes Silicon to endorse or sign Borrower’s name on all collections, receipts, instruments and other documents, to take possession of and open mail addressed to Borrower and remove therefrom payments made with respect to any item of the Collateral or proceeds thereof, and, in Silicon’s good faith business judgment, to grant extensions of time to pay, compromise claims and settle Accounts and the like for less than face value; (h) Offset against any sums in any of Borrower’s general, special or other Deposit Accounts with Silicon against any or all of the Obligations; and (i) Demand and receive possession of any of Borrower’s federal and state income tax returns and the books and records utilized in the preparation thereof or referring thereto. All reasonable attorneys’ fees, expenses, costs, liabilities and obligations incurred by Silicon with respect to the foregoing shall be added to and become part of the Obligations, shall be due on demand, and shall bear interest at a rate equal to the highest interest rate applicable to any of the Obligations. Without limiting any of Silicon’s rights and remedies, from and after the occurrence and during the continuance of any Event of Default, the interest rate applicable to the Obligations shall be increased by an additional four percent per annum (the “Default Rate”). Silicon will not deliver to any person any notice of exclusive control, any entitlement order, or other directions or instructions pursuant to any control agreement or similar agreement providing for control of any Collateral, unless an Event of Default has occurred and is continuing hereunder.

7.3 Standards for Determining Commercial Reasonableness. Borrower and Silicon agree that a sale or other disposition (collectively, “sale”) of any Collateral which complies with the following standards will conclusively be deemed to be commercially reasonable: (i) Notice of the sale is given to Borrower at least ten days prior to the sale, and, in the case of a public sale, notice of the sale is published at least five days before the sale in a newspaper of general circulation in the county where the sale is to be conducted; (ii) Notice of the sale describes the collateral in general, non-specific terms; (iii) The sale is conducted at a place designated by Silicon, with or without the Collateral being present; (iv) The sale commences at any time between 8:00 a.m. and 6:00 p.m; (v) Payment of the purchase price in cash or by cashier’s check or wire transfer is required; (vi) With respect to any sale of any of the Collateral, Silicon may (but is not obligated to) direct any prospective purchaser to ascertain directly from Borrower any and all information concerning the same. Silicon shall be free to employ other methods of noticing and selling the Collateral, in its discretion, if they are commercially reasonable.

7.4 Power of Attorney. Upon the occurrence and during the continuance of any Event of Default, without limiting Silicon’s other rights and remedies, Borrower grants to Silicon an irrevocable power of attorney coupled with an interest, authorizing and permitting Silicon (acting through any of its employees, attorneys or agents) at any time, at its option, but without obligation, with or without notice to Borrower, and at Borrower’s expense, to do any or all of the following, in Borrower’s name or otherwise, but Silicon agrees that if it exercises any right hereunder, it will do so in good faith and in a commercially reasonable manner: (a) Execute on behalf of Borrower any documents that Silicon may, in its good faith business judgment, deem advisable in order to perfect and maintain Silicon’s security interest in the Collateral, or in order to exercise a right of Borrower or Silicon, or in order to fully consummate all the transactions contemplated under this Agreement, and all other Loan Documents; (b) Execute on behalf of Borrower, any invoices relating to any Account, any draft against any Account Debtor and any notice to any Account Debtor, any proof of claim in bankruptcy, any Notice of Lien, claim of mechanic’s, materialman’s or other lien, or assignment or satisfaction of mechanic’s, materialman’s or other lien; (c) Take control in any manner of any cash or non-cash items of payment or proceeds of Collateral; endorse the name of Borrower upon any instruments, or documents, evidence of payment or Collateral that may come into Silicon’s possession; (d) Endorse all checks and other forms of remittances received by Silicon; (e) Pay, contest or settle any lien, charge, encumbrance, security interest and adverse claim in or to any of the Collateral, or any judgment based thereon, or otherwise take any action to terminate or discharge the same; (f) Grant extensions of time to pay, compromise claims and settle Accounts and General Intangibles for less than face value and execute all releases and other documents in connection therewith; (g) Pay any sums required on account of Borrower’s taxes or to secure the release of any liens therefor, or both; (h) Settle and adjust, and give releases of, any insurance claim that relates to any of the Collateral and obtain payment therefor; (i) Instruct any third party having custody or control of any books or records belonging to, or relating to, Borrower to give Silicon the same rights of access and other rights with respect thereto as Silicon has under this Agreement; and (j) Take any action or pay any sum required of Borrower pursuant to this Agreement and any other Loan Documents. Any and all reasonable sums paid and any and all reasonable costs, expenses, liabilities, obligations and attorneys’ fees incurred by Silicon with respect to the foregoing shall be added to and become part of the Obligations, shall be payable on demand, and shall bear interest at a rate equal to the highest interest rate applicable to any of the Obligations. In no event shall Silicon’s rights under the foregoing power of attorney or any of Silicon’s other rights under this Agreement be deemed to indicate that Silicon is in control of the business, management or properties of Borrower.

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7.5 Application of Proceeds. All proceeds realized as the result of any sale of the Collateral shall be applied by Silicon first to the reasonable costs, expenses, liabilities, obligations and attorneys’ fees incurred by Silicon in the exercise of its rights under this Agreement, second to the interest due upon any of the Obligations, and third to the principal of the Obligations, in such order as Silicon shall determine in its sole discretion. Any surplus shall be paid to Borrower or other persons legally entitled thereto; Borrower shall remain liable to Silicon for any deficiency. If, Silicon, in its good faith business judgment, directly or indirectly enters into a deferred payment or other credit transaction with any purchaser at any sale of Collateral, Silicon shall have the option, exercisable at any time, in its good faith business judgment, of either reducing the Obligations by the principal amount of purchase price or deferring the reduction of the Obligations until the actual receipt by Silicon of the cash therefor.

7.6 Remedies Cumulative. In addition to the rights and remedies set forth in this Agreement, Silicon shall have all the other rights and remedies accorded a secured party under the California Uniform Commercial Code and under all other applicable laws, and under any other instrument or agreement now or in the future entered into between Silicon and Borrower, and all of such rights and remedies are cumulative and none is exclusive. Exercise or partial exercise by Silicon of one or more of its rights or remedies shall not be deemed an election, nor bar Silicon from subsequent exercise or partial exercise of any other rights or remedies. The failure or delay of Silicon to exercise any rights or remedies shall not operate as a waiver thereof, but all rights and remedies shall continue in full force and effect until all of the Obligations have been fully paid and performed.

8. Definitions. As used in this Agreement, the following terms have the following meanings:

“ Account Debtor ” means the obligor on an Account.

“ Accounts ” means all present and future “accounts” as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation all accounts receivable and other sums owing to Borrower.

“ Affiliate ” means, with respect to any Person, a relative, partner, shareholder, director, officer, or employee of such Person, or any parent or subsidiary of such Person, or any Person controlling, controlled by or under common control with such Person.

“ Business Day ” means a day on which Silicon is open for business.

“ Cash Equivalents” means marketable securities and short-term investments in accordance with the Investment Policy of the Borrower’s Board of Directors, a copy of which is attached hereto as Exhibit 3, and any amendments to said Investment Policy which are consented to in writing by Silicon in its good faith business judgment.

“ Code ” means the Uniform Commercial Code as adopted and in effect in the State of California from time to time.

“ Collateral ” has the meaning set forth in Section 2 above.

“ continuing ” and “ during the continuance of ” when used with reference to a Default or Event of Default means that the Default or Event of Default has occurred and has not been either waived in writing by Silicon or cured within any applicable cure period.

“ Default ” means any event which with notice or passage of time or both, would constitute an Event of Default.

“ Default Rate ” has the meaning set forth in Section 7.2 above.

“ Deposit Accounts ” means all present and future “deposit accounts” as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation all general and special bank accounts, demand accounts, checking accounts, savings accounts and certificates of deposit.

“ Equipment ” means all present and future “equipment” as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation all machinery, fixtures, goods, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing.

“ Event of Default ” means any of the events set forth in Section 7.1 of this Agreement.

“ GAAP ” means generally accepted accounting principles consistently applied.

“ General Intangibles ” means all present and future “general intangibles” as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation all Intellectual Property, payment intangibles, royalties, contract rights, goodwill, franchise agreements, purchase orders, customer lists, route lists, telephone numbers, domain names, claims, income tax refunds, security and other deposits, options to purchase or sell real or personal property, rights in all litigation presently or hereafter pending (whether in contract, tort or otherwise), insurance policies (including without limitation key man, property damage, and business interruption insurance), payments of insurance and rights to payment of any kind.

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“ good faith business judgment ” means honesty in fact and good faith (as defined in Section 1201 of the Code) in the exercise of Silicon’s business judgment.

“ Guarantor ” means any present or future guarantor of all or any part of the Obligations, and “ Material Guarantor ” means any Guarantor other than a Guarantor which, at the pertinent time, has less than $200,000 in tangible assets and less than $1,000,000 in fair market value of total assets.

“ including ” means including (but not limited to).

“ Intellectual Property ” means all present and future (a) copyrights, copyright rights, copyright applications, copyright registrations and like protections in each work of authorship and derivative work thereof, whether published or unpublished, (b) trade secret rights, including all rights to unpatented inventions and know-how, and confidential information; (c) mask work or similar rights available for the protection of semiconductor chips; (d) patents, patent applications and like protections including without limitation improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same; (e) trademarks, servicemarks, trade styles, and trade names, whether or not any of the foregoing are registered, and all applications to register and registrations of the same and like protections, and the entire goodwill of the business of Borrower connected with and symbolized by any such trademarks; (f) computer software and computer software products; (g) designs and design rights; (h) technology; (i) all claims for damages by way of past, present and future infringement of any of the rights included above; (j) all licenses or other rights to use any property or rights of a type described above.

“ Inventory ” means all present and future “inventory” as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation all merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products, including without limitation such inventory as is temporarily out of Borrower’s custody or possession or in transit and including any returned goods and any documents of title representing any of the above.

“ Investment Property ” means all present and future investment property, securities, stocks, bonds, debentures, debt securities, partnership interests, limited liability company interests, options, security entitlements, securities accounts, commodity contracts, commodity accounts, and all financial assets held in any securities account or otherwise, and all options and warrants to purchase any of the foregoing, wherever located, and all other securities of every kind, whether certificated or uncertificated.

“ Loan Documents ” means, collectively, this Agreement, and all other present and future documents, instruments and agreements between Silicon and Borrower, including, but not limited to those relating to this Agreement, and all amendments and modifications thereto and replacements therefor.

“ Material Adverse Change ” means any of the following: (i) a material adverse change in the business, operations, or financial or other condition of the Borrower, or (ii) a material impairment of the prospect of repayment of any portion of the Obligations; or (iii) a material impairment of the value or priority of Silicon’s security interests in the Collateral.

“ Obligations ” means all present and future Loans, advances, debts, liabilities, obligations, guaranties, covenants, duties and indebtedness at any time owing by Borrower to Silicon, whether evidenced by this Agreement or any note or other instrument or document, or otherwise, whether arising from an extension of credit, opening of a letter of credit, banker’s acceptance, loan, guaranty, indemnification or otherwise, whether direct or indirect (including, without limitation, those acquired by assignment and any participation by Silicon in Borrower’s debts owing to others), absolute or contingent, due or to become due, including, without limitation, all interest, charges, expenses, fees, attorney’s fees, expert witness fees, audit fees, letter of credit fees, collateral monitoring fees, closing fees, facility fees, termination fees, minimum interest charges and any other sums chargeable to Borrower under this Agreement or under any other Loan Documents.

“ Other Property ” means the following as defined in the California Uniform Commercial Code in effect on the date hereof with such additions to such term as may hereafter be made, and all rights relating thereto: all present and future “commercial tort claims” (including without limitation any commercial tort claims), “documents”, “instruments”, “promissory notes”, “chattel paper”, “letters of credit”, “letter-of-credit rights”, “fixtures”, “farm products” and “money”; and all other goods and personal property of every kind, tangible and intangible, whether or not governed by the California Uniform Commercial Code.

“ Parent ” shall mean Zhone Technologies, Inc.

“ Permitted Investments ” are:

(a) Investments shown on Exhibit 2 and existing on the effective date hereof;

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(b) (i) marketable direct obligations issued or unconditionally guaranteed by the United States or its agency or any State maturing within 1 year from its acquisition, (ii) commercial paper maturing no more than 1 year after its creation and having the highest rating from either Standard & Poor’s Ratings Service (“S&P”) or Moody’s Investors Service, Inc. (“Moody’s”), (iii) Silicon’s certificates of deposit issued maturing no more than 1 year after issue, (iv) Investments permitted by Borrower’s investment policy, as amended from time to time, provided that such investment policy (and such amendments thereto) has been approved by Silicon in writing (which approval shall not be unreasonably withheld, conditioned or delayed);

(c) Investments consisting of the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business;

(d) Investments consisting of (i) compensation of employees, officers, directors and consultants so long as the Board of Directors of Borrower determines that such compensation is reasonable and in the best interests of Borrower; (ii) travel advances and employee relocation loans and other employee advances in the ordinary course of business, and (iii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower pursuant to employee stock purchase plan and employee stock option plan agreements approved by Borrower’s Board of Directors, in an aggregate amount not to exceed $1,000,000 at any time outstanding;

(e) Investments (including debt obligations) received in connection with the bankruptcy or reorganization of customers or suppliers and in settlement of delinquent obligations of, and other disputes with, customers or suppliers arising in the ordinary course of business;

(f) Investments consisting of notes receivable of, or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates, in the ordinary course of business;

(g) Strategic investments in customers, vendors, suppliers and other Persons in the same industries as Borrower and its Subsidiaries, including the exercise of warrants to purchase capital stock of such Persons in an aggregate amount not to exceed $500,000 per year;

(h) Deposit and investment accounts of Borrower in which Silicon has a Lien prior to any other Lien (other than Liens securing fees and expenses of the depository or investment intermediary); and

(i) loans or investments in consolidated subsidiaries from time to time in an amount sufficient to fund operating expenses of said subsidiaries.

“ Permitted Liens ” means the following: (i) purchase money security interests in specific items of Equipment and related software; (ii) leases of specific items of Equipment and related software; (iii) liens for taxes not yet delinquent or being contested in good faith and for which adequate reserves have been made, and as to which there is no lien on any of the Collateral; (iv) additional security interests and liens consented to in writing by Silicon, which consent may be withheld in its good faith business judgment; (v) security interests being terminated substantially concurrently with this Agreement; (vi) liens of materialmen, mechanics, warehousemen, carriers, or other similar liens arising in the ordinary course of business and securing obligations which are not delinquent; (vii) non-exclusive licenses or sublicenses granted in the ordinary course of Borrower’s business and any interest or title of a licensor or under any license or sublicense to Borrower; (viii) liens in a total amount not to exceed $1,000,000 on earnest money deposits required under a letter of intent or purchase agreement which are in connection with transactions permitted by this Agreement and are consented to by Silicon in its good faith business judgment, provided such funds are at all times kept in a segregated escrow account; (ix) liens to secure non-delinquent payment of workers’ compensation, unemployment insurance, old-age pensions, social security and other like obligations incurred in the ordinary course of business; (x) liens on insurance proceeds in favor of insurance companies granted solely as security for financed premiums, provided such Liens are confined to such premiums and further, provided, the aggregate amount of such liens does not at any time exceed $1,000,000; (xi) liens on escrowed cash in an aggregate amount not exceeding $1,000,000, representing a portion of the proceeds of sales or transactions permitted by this Agreement, established to satisfy contingent post closing obligations that Borrower owes (including earn-outs, indemnities and working capital adjustments) so long as such Liens are disclosed in writing to Silicon at or prior to the date they arise; (xii) leases or subleases granted in the ordinary course of Borrower’s business, including in connection with Borrower’s leased premises or leased property; (xiii) [intentionally omitted]; (xv) liens incurred in connection with the extension, renewal or refinancing of the indebtedness secured by liens of the type described above in clauses (i) or (ii) above, provided that any extension, renewal or replacement lien is limited to the property encumbered by the existing lien and the principal amount of the indebtedness being extended, renewed or refinanced does not increase; (xiv) Liens in favor of customs and revenue authorities which secure payment of customs duties in connection with the importation of goods; (xv) governmental liens in connection with progress payments made on government contracts which are limited to the Inventory being sold pursuant to such government contract; (xvi) a security interest in the Collateral in favor of CIT Venture Leasing Fund, LLC and CIT Technology Financing Services, Inc., provided the same is subject to a subordination agreement in favor of Silicon in form acceptable to Silicon in its good faith business judgment. Silicon will have the right to require, as a condition to its

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consent under subparagraph (iv) above, that the holder of the additional security interest or lien sign an intercreditor agreement on Silicon’s then standard form, acknowledge that the security interest is subordinate to the security interest in favor of Silicon, and agree not to take any action to enforce its subordinate security interest so long as any Obligations remain outstanding, and that Borrower agree that any uncured default in any obligation secured by the subordinate security interest shall also constitute an Event of Default under this Agreement.

“ Person ” means any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, government, or any agency or political division thereof, or any other entity.

“ ZTI ” shall mean ZTI Merger Subsidiary III, Inc.

Other Terms . All accounting terms used in this Agreement, unless otherwise indicated, shall have the meanings given to such terms in accordance with GAAP, consistently applied. All other terms contained in this Agreement, unless otherwise indicated, shall have the meanings provided by the Code, to the extent such terms are defined therein.

9. GENERAL PROVISIONS.

9.1 Interest Computation. In computing interest on the Obligations, all checks, wire transfers and other items of payment received by Silicon (including proceeds of Accounts and payment of the Obligations in full) shall be deemed applied by Silicon on account of the Obligations on receipt by Silicon of immediately available funds, and, for purposes of the foregoing, any such funds received after 12:00 Noon on any day shall be deemed received on the next Business Day, provided that sums received by wire transfer will be applied on the date of receipt. Silicon shall not, however, be required to credit Borrower’s account for the amount of any item of payment which is unsatisfactory to Silicon in its good faith business judgment, and Silicon may charge Borrower’s loan account for the amount of any item of payment which is returned to Silicon unpaid.

9.2 Application of Payments. All payments with respect to the Obligations may be applied, and in Silicon’s good faith business judgment reversed and re-applied, to the Obligations, in such order and manner as Silicon shall determine in its good faith business judgment.

9.3 Charges to Accounts. Silicon may, in its discretion, require that Borrower pay monetary Obligations in cash to Silicon, or charge them to Borrower’s Loan account, in which event they will bear interest at the same rate applicable to the Loans. Silicon may also, in its discretion, charge any monetary Obligations to Borrower’s Deposit Accounts maintained with Silicon.

9.4 Monthly Accountings. Silicon shall provide Borrower monthly with an account of advances, charges, expenses and payments made pursuant to this Agreement. Such account shall be deemed correct, accurate and binding on Borrower and an account stated (except for reverses and reapplications of payments made and corrections of errors discovered by Silicon), unless Borrower notifies Silicon in writing to the contrary within 60 days after such account is rendered, describing the nature of any alleged errors or omissions.

9.5 Notices. All notices to be given under this Agreement shall be in writing and shall be given either personally or by reputable private delivery service or by regular first-class mail, or certified mail return receipt requested, addressed to Silicon or Borrower at the addresses shown in the heading to this Agreement, or at any other address designated in writing by one party to the other party. Notices to Silicon shall be directed to the Commercial Finance Division, to the attention of the Division Manager or the Division Credit Manager. All notices shall be deemed to have been given upon delivery in the case of notices personally delivered, or at the expiration of one Business Day following delivery to the private delivery service, or two Business Days following the deposit thereof in the United States mail, with postage prepaid.

9.6 Severability. Should any provision of this Agreement be held by any court of competent jurisdiction to be void or unenforceable, such defect shall not affect the remainder of this Agreement, which shall continue in full force and effect.

9.7 Integration. This Agreement and such other written agreements, documents and instruments as may be executed in connection herewith are the final, entire and complete agreement between Borrower and Silicon and supersede all prior and contemporaneous negotiations and oral representations and agreements, all of which are merged and integrated in this Agreement. There are no oral understandings, representations or agreements between the parties which are not set forth in this Agreement or in other written agreements signed by the parties in connection herewith.

9.8 Waivers; Indemnity. The failure of Silicon at any time or times to require Borrower to strictly comply with any of the provisions of this Agreement or any other Loan Document shall not waive or diminish any right of Silicon later to demand and receive strict compliance therewith. Any waiver of any default shall not waive or affect any other default, whether prior or subsequent, and whether or not similar. None of the provisions of this Agreement or any other Loan Document shall be deemed to have been waived by any act or knowledge of Silicon or its agents or employees, but only by a specific written waiver signed by an authorized officer of Silicon and delivered to Borrower. Borrower waives the benefit of all statutes of

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limitations relating to any of the Obligations or this Agreement or any other Loan Document, and Borrower waives demand, protest, notice of protest and notice of default or dishonor, notice of payment and nonpayment, release, compromise, settlement, extension or renewal of any commercial paper, instrument, account, General Intangible, document or guaranty at any time held by Silicon on which Borrower is or may in any way be liable, and notice of any action taken by Silicon, unless expressly required by this Agreement. Borrower hereby agrees to indemnify Silicon and its affiliates, subsidiaries, parent, directors, officers, employees, agents, and attorneys, and to hold them harmless from and against any and all claims, debts, liabilities, demands, obligations, actions, causes of action, penalties, costs and expenses (including reasonable attorneys’ fees), of every kind, which they may sustain or incur based upon or arising out of any of the Obligations, or any relationship or agreement between Silicon and Borrower, or any other matter, relating to Borrower or the Obligations; provided that this indemnity shall not extend to damages proximately caused by the indemnitee’s own gross negligence or willful misconduct. Notwithstanding any provision in this Agreement to the contrary, the indemnity agreement set forth in this Section shall survive any termination of this Agreement and shall for all purposes continue in full force and effect.

9.9 No Liability for Ordinary Negligence . Neither Silicon, nor any of its directors, officers, employees, agents, attorneys or any other Person affiliated with or representing Silicon shall be liable for any claims, demands, losses or damages, of any kind whatsoever, made, claimed, incurred or suffered by Borrower or any other party through the ordinary negligence of Silicon, or any of its directors, officers, employees, agents, attorneys or any other Person affiliated with or representing Silicon, but nothing herein shall relieve Silicon from liability for its own gross negligence or willful misconduct.

9.10 Amendment. The terms and provisions of this Agreement may not be waived or amended, except in a writing executed by Borrower and a duly authorized officer of Silicon.

9.11 Time of Essence. Time is of the essence in the performance by Borrower of each and every obligation under this Agreement.

9.12 Attorneys’ Fees and Costs. Borrower shall reimburse Silicon for all reasonable attorneys’ fees and all filing, recording, search, title insurance, appraisal, audit, and other reasonable costs incurred by Silicon, pursuant to, or in connection with, or relating to this Agreement (whether or not a lawsuit is filed), including, but not limited to, any reasonable attorneys’ fees and costs Silicon incurs in order to do the following: prepare and negotiate this Agreement and all present and future documents relating to this Agreement; obtain legal advice in connection with this Agreement or Borrower; enforce, or seek to enforce, any of its rights; prosecute actions against, or defend actions by, Account Debtors; commence, intervene in, or defend any action or proceeding; initiate any complaint to be relieved of the automatic stay in bankruptcy; file or prosecute any probate claim, bankruptcy claim, third-party claim, or other claim; examine, audit, copy, and inspect any of the Collateral or any of Borrower’s books and records; protect, obtain possession of, lease, dispose of, or otherwise enforce Silicon’s security interest in, the Collateral; and otherwise represent Silicon in any litigation relating to Borrower. In satisfying Borrower’s obligation hereunder to reimburse Silicon for attorneys fees, Borrower may, for convenience, issue checks directly to Silicon’s attorneys, Levy, Small & Lallas, but Borrower acknowledges and agrees that Levy, Small & Lallas is representing only Silicon and not Borrower in connection with this Agreement. If either Silicon or Borrower files any lawsuit against the other predicated on a breach of this Agreement, the prevailing party in such action shall be entitled to recover its reasonable costs and attorneys’ fees, including (but not limited to) reasonable attorneys’ fees and costs incurred in the enforcement of, execution upon or defense of any order, decree, award or judgment. All attorneys’ fees and costs to which Silicon may be entitled pursuant to this Paragraph shall immediately become part of Borrower’s Obligations, shall be due on demand, and shall bear interest at a rate equal to the highest interest rate applicable to any of the Obligations.

9.13 Benefit of Agreement. The provisions of this Agreement shall be binding upon and inure to the benefit of the respective successors, assigns, heirs, beneficiaries and representatives of Borrower and Silicon; provided, however, that Borrower may not assign or transfer any of its rights under this Agreement without the prior written consent of Silicon, and any prohibited assignment shall be void. No consent by Silicon to any assignment shall release Borrower from its liability for the Obligations.

9.14 Joint and Several Liability. If Borrower consists of more than one Person, their liability shall be joint and several, and the compromise of any claim with, or the release of, any Borrower shall not constitute a compromise with, or a release of, any other Borrower.

9.15 Limitation of Actions. Any claim or cause of action by Borrower against Silicon, its directors, officers, employees, agents, accountants or attorneys, based upon, arising from, or relating to this Loan Agreement, or any other Loan Document, or any other transaction contemplated hereby or thereby or relating hereto or thereto, or any other matter, cause or thing whatsoever, occurred, done, omitted or suffered to be done by Silicon, its directors, officers, employees, agents, accountants or attorneys, shall be barred unless asserted by Borrower by the commencement of an action or proceeding in a court of competent jurisdiction by the filing of a complaint within one year after the first act, occurrence or omission upon which such claim or cause of action, or any part thereof, is based, and the service of a summons and complaint on an officer of Silicon, or on any other person authorized to accept service on behalf of Silicon, within thirty (30) days thereafter. Borrower

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agrees that such one-year period is a reasonable and sufficient time for Borrower to investigate and act upon any such claim or cause of action. The one-year period provided herein shall not be waived, tolled, or extended except by the written consent of Silicon in its sole discretion. This provision shall survive any termination of this Loan Agreement or any other Loan Document.

9.16 Paragraph Headings; Construction. Paragraph headings are only used in this Agreement for convenience. Borrower and Silicon acknowledge that the headings may not describe completely the subject matter of the applicable paragraph, and the headings shall not be used in any manner to construe, limit, define or interpret any term or provision of this Agreement. This Agreement has been fully reviewed and negotiated between the parties and no uncertainty or ambiguity in any term or provision of this Agreement shall be construed strictly against Silicon or Borrower under any rule of construction or otherwise.

9.17 Governing Law; Jurisdiction; Venue. This Agreement and all acts and transactions hereunder and all rights and obligations of Silicon and Borrower shall be governed by the laws of the State of California. As a material part of the consideration to Silicon to enter into this Agreement, Borrower (i) agrees that all actions and proceedings relating directly or indirectly to this Agreement shall, at Silicon’s option, be litigated in courts located within California, and that the exclusive venue therefor shall be Santa Clara County; (ii) consents to the jurisdiction and venue of any such court and consents to service of process in any such action or proceeding by personal delivery or any other method permitted by law; and (iii) waives any and all rights Borrower may have to object to the jurisdiction of any such court, or to transfer or change the venue of any such action or proceeding.

9.18 Mutual Waiver of Jury Trial. BORROWER AND SILICON EACH HEREBY WAIVE THE RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED UPON, ARISING OUT OF, OR IN ANY WAY RELATING TO, THIS AGREEMENT OR ANY OTHER PRESENT OR FUTURE INSTRUMENT OR AGREEMENT BETWEEN SILICON AND BORROWER, OR ANY CONDUCT, ACTS OR OMISSIONS OF SILICON OR BORROWER OR ANY OF THEIR DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, ATTORNEYS OR ANY OTHER PERSONS AFFILIATED WITH SILICON OR BORROWER, IN ALL OF THE FOREGOING CASES, WHETHER SOUNDING IN CONTRACT OR TORT OR OTHERWISE.


Borrower:		Silicon:

ZHONE TECHNOLOGIES, INC.		SILICON VALLEY BANK

By	/s/ Kirk Misaka	By	/s/ Patrick J. O’Donnell
	President or Vice President	Title	Vice President

Borrower:

ZTI MERGER SUBSIDIARY III, INC.

By	/s/ Kirk Misaka
	President or Vice President

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Silicon Valley Bank

Schedule to

Amended and Restated Loan and Security Agreement


Borrowers:		ZTI Merger Subsidiary III, Inc.
		(formerly known as Zhone Technologies, Inc.)

		Zhone Technologies, Inc.
		(formerly known as Tellium, Inc.)

Date:		February 24, 2004

This Schedule forms an integral part of the Amended and Restated Loan and Security Agreement between Silicon Valley Bank and the above-borrower of even date.


1. CREDIT LIMIT

(Section 1.1):		Loans (the “Loans”) in amount not to exceed $25,000,000 in the aggregate at any time outstanding.

Sublimits—Overall Limit		The following Letter of Credit Sublimit, Cash Management Sublimit and FX Sublimit shall be applicable during the term of this Agreement, provided, however, that notwithstanding anything herein to the contrary, the total of the Letter of Credit Sublimit, the Cash Management Sublimit and the FX Sublimit under this Agreement shall not at any time exceed a total of $25,000,000 (the “Overall Sublimit”).

Letter of Credit Sublimit (Section 1.6):		$25,000,000, subject to the Overall Sublimit.

Cash Management Services and Reserves:		Subject to the Overall Sublimit, Borrower may use up to $25,000,000 (the “Cash Management Sublimit”) of Loans available hereunder for Silicon’s Cash Management Services (as defined below), including, merchant services, business credit card, ACH and other services identified in the cash management services agreement related to such service (the “Cash Management Services”). Silicon may, in its sole discretion, reserve against Loans which would otherwise be available hereunder such sums as Silicon shall determine in its good faith business judgment in connection with the Cash Management Services, and Silicon may charge to Borrower’s Loan account, any amounts that may become due or owing to Silicon in connection with the Cash Management Services. Borrower agrees to execute and deliver to Silicon all standard form applications and agreements of Silicon in



		connection with the Cash Management Services, and, without limiting any of the terms of such applications and agreements, Borrower will pay all standard fees and charges of Silicon in connection with the Cash Management Services. The Cash Management Services shall terminate on the Maturity Date.

FX Sublimit:		$25,000,000, subject to the Overall Sublimit.

		Borrower may enter into foreign exchange forward contracts with Silicon, on its standard forms, under which Borrower commits to purchase from or sell to Silicon a set amount of foreign currency more than one business day after the contract date (the “FX Forward Contracts”); provided that (1) at the time the FX Forward Contract is entered into Borrower has Loans available to it under this Agreement in an amount at least equal to 10% of the amount of the FX Forward Contract; (2) the total FX Forward Contracts at any one time outstanding may not exceed 10 times the amount of the FX Sublimit set forth above. Silicon shall have the right to withhold, from the Loans otherwise available to Borrower under this Agreement, a reserve (which shall be in addition to all other reserves) in an amount equal to 10% of the total FX Forward Contracts from time to time outstanding, and in the event at any time there are insufficient Loans available to Borrower for such reserve, Borrower shall deposit and maintain with Silicon cash collateral in an amount at all times equal to such deficiency, which shall be held as Collateral for all purposes of this Agreement, until such time as there exist sufficient Loans available to Borrower for such reserve at which time such cash collateral shall be released. Silicon may, in its discretion, terminate the FX Forward Contracts at any time that an Event of Default occurs and is continuing. Borrower shall execute all standard form applications and agreements of Silicon in connection with the FX Forward Contracts, and without limiting any of the terms of such applications and agreements, Borrower shall pay all standard fees and charges of Silicon in connection with the FX Forward Contracts.

2. INTEREST RATE (Section 1.2):.


		As set forth in the Libor Supplement being executed concurrently.

3. FEES (Section 1.4):


Loan Fee:		$150,000. Said fee is fully earned on the date hereof, is in addition to all interest and other fees and is non-refundable.


4. MATURITY DATE
(Section 6.1):		364 days from the date of this Agreement (the “Maturity Date”).


5. FINANCIAL COVENANTS
(Section 5.1):

		Borrower shall comply with each of the following covenants:

Adjusted Quick Ratio:		As of the end of each month, Borrower shall maintain a ratio of

		(i) unrestricted cash and Cash Equivalents, as shown on Borrower’s balance sheet, plus Borrower’s accounts receivable (net of allowance for doubtful accounts and other deductions in accordance with GAAP),

		TO

		(ii) Borrower’s current liabilities (including without limitation outstanding Loans), minus accrued liabilities under GAAP, plus the amount of all Letters of Credit outstanding,

		of not less than 2.0 to 1.0 .

Remaining Months Liquidity:		As of the end of each month, Borrower shall maintain a total of unrestricted cash and Cash Equivalents, as shown on Borrower’s balance sheet, minus all outstanding Loans and Letters of Credit in an amount greater than 6.0 times the average monthly net loss (if any) incurred by Borrower for the immediately preceding three months, determined in accordance with GAAP, net of amortization and depreciation and non-cash, stock-based compensation.


6. REPORTING.
(Section 5.3):
		Borrower shall provide Silicon with the following:

		1. Monthly unaudited financial statements, as soon as available, and in any event within thirty days after the end of each month, together with a report as to any material liabilities which are “other liabilities” rather than “accrued liabilities” and which are included in the line item “Accrued and other liabilities” on Borrower’s balance sheet.



		2. Monthly Compliance Certificates, within thirty days after the end of each month, in such form as Silicon shall reasonably specify, signed by the Chief Financial Officer of Borrower, certifying that as of the end of such month Borrower was in full compliance with all of the terms and conditions of this Agreement, and setting forth calculations showing compliance with the financial covenants set forth in this Agreement and such other information as Silicon shall reasonably request, including, without limitation, a statement that at the end of such month there were no held checks.

		3. Annual operating budgets (including income statements, balance sheets and cash flow statements, by month) for the upcoming fiscal year of Borrower within thirty days prior to the end of each fiscal year of Borrower.

		4. Annual financial statements, as soon as available, and in any event within 120 days following the end of Borrower’s fiscal year, certified by, and with an unqualified opinion of, independent certified public accountants acceptable to Silicon.


7. ADDITIONAL PROVISIONS

		(1) Banking Relationship. Borrower shall at all times maintain its primary operating accounts with Silicon, and without limiting the generality of the foregoing, Borrower shall, at all times, maintain on deposit with Silicon an amount not less than the lesser of (i) $50,000,000, or (ii) 85% of Borrower’s total unrestricted cash, Cash Equivalents and other investments. As to any Deposit Accounts and investment accounts maintained with another institution, Borrower shall cause such institution, within 30 days after the date of this Agreement, to enter into a control agreement in form acceptable to Silicon in its good faith business judgment in order to perfect Silicon’s first-priority security interest in said Deposit Accounts and investment accounts.

		(2) Exim Agreement. The Loan and Security Agreement (Exim Program) between Silicon and ZTI dated December 30, 2002 is hereby terminated without penalty. There are presently no loans outstanding thereunder.

		(3) Cross-corporate Guaranties. Each Borrower shall concurrently execute and deliver to Silicon a Cross-Corporate Continuing Guaranty, in form and substance satisfactory to Silicon, in order to guarantee all Obligations of the other Borrower in favor of Silicon.



		(4) Subsidiary Guaranties. Borrower has caused the following companies (the “Domestic Subsidiaries”) to execute and deliver to Silicon Continuing Guaranties with respect to all of the Obligations of ZTI and Security Agreements and related documentation with respect to all of their assets:

		(1) CAG Technologies, Inc.

		(2) Optaphone Systems, Inc.

		(3) Premisys Communications, Inc.

		(4) Vpacket Communications, Inc.

		(5) Xybridge Technologies, Inc.

		(6) Zhone Merger Subsidiary I, Inc.

		(7) Zhone Merger Subsidiary II, Inc.

		(8) Zhone Technologies International, Inc.

		(9) ZTI Merger Subsidiary, Inc.

		(10) eLuminant Technologies, Inc. (formerly NEC eLuminant Technologies, Inc.)

		Borrower shall concurrently cause all of the Domestic Subsidiaries to execute and deliver a Continuing Guaranty with respect to the Parent, on the same terms and conditions as the existing Continuing Guaranty with respect to ZTI. Borrower represents and warrants that the Domestic Subsidiaries are all of its domestic subsidiaries as of the date hereof, except for Zhone Technologies Campus, LLC, which Borrower represents and warrants is a special purpose limited liability company whose sole asset is real property utilized by Borrower and which is not permitted to guaranty the obligations of the Borrower under its agreement with its lender. In the event, in the future, the Borrower creates or acquires any additional domestic subsidiaries, Borrower shall likewise promptly cause such additional domestic subsidiaries to execute and deliver to Silicon Continuing Guaranties with respect to all of the Obligations and Security Agreements and related documentation with respect to all of their assets, the same form, and certified resolutions or other evidence of authority with respect to the execution and delivery of such Guaranties and Security Agreements. Throughout the term of this Agreement Borrower shall cause the Guaranties and Security Agreements referred to in this Section to continue in full force and effect.

		(5) Sherwood Trust Financing Statement. Borrower represents and warrants that (i) Borrower’s subsidiary, Optaphone Systems,


		Inc. (“Optaphone”), was acquired by Borrower in 2000, and (ii) the UCC-1 Financing Statement filed in the Office of the California Secretary of State in favor of Sherwood Trust with respect to Optaphone Systems, Ltd., a Texas limited partnership (File No. 0123660795, filed August 21, 2001) does not encumber any of Borrower’s or any of its subsidiaries’ (including Optaphone’s) assets and does not pertain to Borrower or any of its subsidiaries (including Optaphone).


Borrower:		Silicon:

ZHONE TECHNOLOGIES, INC.		SILICON VALLEY BANK

By	/s/ Kirk Misaka	By	/s/ Patrick J. O’Donnell
	President or Vice President	Title	Vice President

Borrower:

ZTI MERGER SUBSIDIARY III, INC.

By	/s/ Kirk Misaka
	President or Vice President

EXHIBIT 21.1

SUBSIDIARIES OF ZHONE TECHNOLOGIES, INC.

Zhone Technologies, Inc. Canada

Zhone Technologies International, Inc. Delaware

Zhone Technologies Campus, LLC California

Zhone International Ltd. Cayman Islands

Zhone Technologies Australia PTY LTD Australia

Zhone Technologies BV Netherlands

Zhone Technologies De Argentina SRL Argentina

Zhone Technologies do Brasil LTDA Brazil

Zhone Technologies GMBH Germany

Zhone Technologies KK Japan

Zhone Technologies Ltd. United Kingdom

Zhone Technologies Limited Hong Kong

Zhone Technologies Pte. Ltd. Singapore

Zhone Technologies S. de R.L. de C.V. Mexico

Zhone Technologies SRL Italy

Zhone Merger Subsidiary I, Inc. Delaware

Zhone Merger Subsidiary II, Inc. Delaware

ZTI Merger Subsidiary, Inc. Delaware

ZTI Merger Subsidiary III, Inc. Delaware

CAG Technologies, Inc. California

OptaPhone Systems, Inc. California

Premisys Communications, Inc. Delaware

Premisys Communications Ltd. United Kingdom

Simpulan Mutiara Sdn. Bhd. Malaysia

Vpacket Communications, Inc. California

Xybridge Technologies, Inc. Texas

Eluminant Technologies, Inc. Delaware

Zhone Technologies Finance, Inc. Delaware

Astarte Fiber Networks, Inc., Colorado

Tellium (UK) Limited United Kingdom

Tellium International, LLC, Delaware

Tellium Global Sales & Services, LLC, Delaware

Tellium Benelux, B.V.B.A., Belgium

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Morteza Ejabat, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Zhone Technologies, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report.

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

May 14, 2004

/s/ M ORTEZA E JABAT

Morteza Ejabat, Chief Executive Officer

EXHIBIT 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Kirk Misaka, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Zhone Technologies, Inc.;

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

May 14, 2004

/s/ K IRK M ISAKA

Kirk Misaka, Chief Financial Officer

Exhibit 32

CERTIFICATION

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.ss.1350, as adopted), Morteza Ejabat, Chief Executive Officer of Zhone Technologies, Inc. (the “Company”), and Kirk Misaka, Chief Financial Officer of the Company, each hereby certify that, to the best of their knowledge:

1. The Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, to which this Certification is attached as Exhibit 32 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

In Witness Whereof, the undersigned have set their hands hereto as of the 14 ^th day of May, 2004.



/s/ M ORTEZA E JABAT				/s/ K IRK M ISAKA

Chief Executive Officer				Chief Financial Officer