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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2003

OR

For the transition period from         to         .

Commission File Number: 000-32743

ZHONE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

7001 Oakport Drive

Oakland, CA 94621

(Address of principal executive office)

Registrant’s telephone number, including area code: (510) 777-7000

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK $0.001 PAR VALUE

(Title of class)

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x.

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 February 16, 2004 there were 78,020,000 shares outstanding of the registrant’s common stock, $0.001 par value. As of June 30, 2003, the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $68,451,000.

DOCUMENTS INCORPORATED BY REFERENCE

PART III—Portions of the definitive Proxy Statement for the 2004 Annual Meeting of Stockholders are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) to this Form 10-K.

PART I

ITEM 1.    BUSINESS

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements regarding our strategy, financial performance and revenue sources that involve a number of risks and uncertainties. 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, unanticipated regulatory changes, 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 from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified below, under “Risk Factors” and elsewhere in this report. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Zhone Technologies, Inc. (“Zhone”) was incorporated under the laws of the State of Delaware in June 1999, and completed its merger with Tellium, Inc. (“Tellium”) in November 2003. Following the merger, the combined company was renamed Zhone and its stock began trading on the NASDAQ National Market under the symbol “ZHNE”. Our principal executive offices are located at 7001 Oakport Drive, Oakland, California 94621. Our telephone number is (510) 777-7000, and our website address is www.zhone.com. The information on our website does not constitute part of this report. Investors can access the periodic report filings we make with the Securities and Exchange Commission, or SEC, on our website or at www.sec.gov.

Overview

We design, develop and market a complete line of telecommunications equipment for the local access network. Our products allow network service providers to offer voice, data and video services while optimizing bandwidth, reducing costs and speeding up provisioning. Our products enable network service providers to easily migrate from traditional circuit-based technology to packet-based networks while substantially reducing operating costs. Our products also allow service providers to add new subscriber services more quickly than is possible with conventional copper access solutions.

Background

Industry Background

Over the past decade, there has been a rapid growth of business and consumer network use resulting from file sharing, e-commerce, interactive television, video conferencing and telecommuting, wireless communications and a large increase in web content. This growth has resulted in levels of communications traffic that have severely taxed the capacity of conventional networks.

To meet the increasing demand for faster speed and more reliable communications services, equipment vendors have made significant investments in research and development resulting in tremendous advancements in new fiber optic technologies. These optical technologies have been successfully deployed between facilities of network service providers. However, the cost of deploying optical technologies is very high and network service providers have found fiber deployment cost-effective only in the core of the networks, where network service providers exchange traffic with each other.

Residential and most business subscribers generally have not been able to realize the same benefits from the new optical technologies. The vast majority of subscribers connect to communications networks via copper

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wires, commonly referred to as the local loop or the access network. As a result, there is an enormous disparity between bandwidth in the fiber optic core and the bandwidth at subscribers’ premises. The majority of today’s communications over the access network still occurs at 56 kilobits per second or slower on modem lines. In contrast, communications in the core of the network can travel at speeds up to 10 gigabits per second or 175,000 times faster.

Network operators have spent decades and invested billions of dollars building and maintaining today’s access networks. A complete replacement of these access networks with fiber optics would prove cost prohibitive. While several vendors have developed solutions that provide high speed fiber access, there have been few deployments to date. One problem with these solutions is that they are designed to replace existing copper deployments.

The Evolution of Multiple Access Networks

Recent challenges in the telecommunications industry have heightened network service provider requirements to maximize service revenues per subscriber while minimizing the cost of delivering these services. In order to compete, network service providers that have traditionally offered only voice services must expand their service offerings. This must be accomplished cost-effectively by eliminating the inefficiencies inherent in operating multiple single-purpose access networks for voice, data and video.

Cable operators have been aggressively upgrading their facilities for high-speed digital video services and have been successfully adding data and voice service capabilities in their networks. These networks allow cable operators to deliver packaged voice, data and video solutions over a single network into their markets. These cable operators are capturing significant revenues from voice and data services that could until recently be provided only by traditional network service providers.

As a result, network service providers are for the first time facing competition in their primary business. This new competition is being felt during a period in which network service providers have had to cut their capital expenditures dramatically, as they focus principally on sustaining current operations and revenues. Voice services remain the mainstay of economics and expertise for network service providers. The existing voice networks represent substantial investments in both facilities and skilled labor, and network service providers continue to focus on deriving value from these investments. In North America alone, this investment in voice networks represents an investment in the hundreds of billions of dollars.

Over the last thirty years, digital loop carriers, or DLCs, have represented a significant portion of network service providers’ capital expenditures to deliver voice services. DLCs are devices that allow a network service provider to combine signals from multiple customer telephone lines and transmit the calls as part of a single signal. The efficiencies gained from DLCs have the same impact as if the copper lines were substantially shortened which in turn allows for higher speed services with improved reliability. High-speed links are necessary in order for network service providers to deliver voice, data, video, and broadcast television services.

Network service providers today already rely on high speed DLC devices in order to compete with the cable companies for subscribers with multi-service offerings. However, most solutions available today are expensive and do not provide for migration from copper lines to advanced fiber networks or from today’s voice and data offerings to a more complete service offering capable of voice, data and video.

The Zhone Solution

We believe that we are the first company dedicated solely to developing the full spectrum of next-generation access network products. Our products are based upon our Single Line Multi Service, or SLMS, architecture. This new architecture was specifically developed to address the unmet challenges of delivering standards-based voice, data and video solutions. SLMS provides network service providers with flexibility and investment

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protection by supporting the most widely accepted media and technology protocols. Our products allow network 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.

Scalable, Multi-Service Integration Across the Access Network – SLMS simplifies the access network by consolidating new and existing services onto a single line; simplifying provisioning and operations; ensuring quality of service and reliability; and reducing time required to provision services.

Copper to Fiber Migration Flexibility – SLMS preserves network service providers’ investments in existing copper wire networks while providing the flexibility to cost-effectively migrate to fiber as warranted, with seamless in-service transitions and very high densities for optimal deployment options.

Protect the Value of Existing Subscriber Assets – SLMS protects the value of residential and commercial subscribers’ investments in equipment, inside wiring, and applications, minimizing transition impact and subscriber attrition.

Standards-Based Interoperability – SLMS provides the flexibility to deploy services over the most cost-effective infrastructure for each service area, whether copper or fiber using the most widely accepted technology protocols, and with required integration and industry-standard interfaces.

Full Remote Management of the Entire Access Network – SLMS provides substantial cost and time savings in service creation, configuration, fault detection and resolution, and enables new service billing and subscriber self-configuration options. Remote software upgrade procedures ensure ease of support.

The Zhone Strategy

Our strategy is to combine internal development with acquisitions of established access equipment vendors to achieve the “critical mass” required of telecommunications equipment providers. Today our products deliver services to over 300 service providers on six continents, including eight of the top ten network service providers in North America.

Key elements of our strategy include:

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Products

Our products provide the framework around which we are designing and developing high speed, communications software and equipment for the access network. All of the products listed below are currently available and shipping. Our products span three distinct areas:

SLMS Products

Our SLMS products address three areas of customer requirements. The Zhone Management System, or ZMS, product provides the software tools necessary to manage all of the component hardware as well as subscribers and services in the network. ZMS is capable of interfacing with and managing other vendors equipment already deployed in network service providers’ networks. Our Broadband Aggregation and Service products aggregate, concentrate and optimize communications traffic from copper and fiber networks. These products are deployed in central offices, remote offices, points of presence, curbsides, data and co-location centers and large enterprises. Our Customer Premise Equipment, or CPE, products offer a cost-effective solution for combining analog voice and data services to the subscriber’s premises over a single platform. These products deliver voice, data and video interface connectivity for broadcast and subscription television, internet routers and traditional telephony equipment.

Our SLMS products include:

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Digital Loop Carrier Products

Our Digital Loop Carrier, or DLC products, aggregate large numbers of individual subscriber telephone calls within a neighborhood, office building, or industrial park and sends these calls over a single line back to the network service provider’s central office where switching equipment is located. Our DLC product category includes a number of first and second generation products. These products support a variety of voice and data services, and are ideally suited for small-line and low-density applications. Our DLC products include:

Multiplexer Products

In a telecommunications network, multiplexers, or MUX, allow multiple signals to be combined and transmitted as one signal over a single line. Our MUX product family provides full-featured multiplexing in a range of modular designs that are designed to ensure flexibility and ease of deployment by network service providers. Our MUX products include the following:

Technology

We believe that our future success is dependent upon continued investment in the development and acquisition of advanced technologies in a number of areas. SLMS is based on a number of core technologies that provide sustainable advantage, including the following:

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Acquired Technologies. We recognize the need to acquire complementary technologies to augment engineering resources when necessary to respond rapidly to service providers’ needs. As of December 31, 2003, we had completed nine acquisitions pursuant to which we acquired products, technology and additional technical expertise. See Note 2 to our consolidated financial statements for detailed information regarding acquisitions.

Customers

Our products are deployed by over 300 network service providers on six continents worldwide. Our six largest customers during the year ended December 31, 2003 were Motorola, Qwest, XEL, Verizon, Bell Canada, and North State Telecom. For the year ended December 31, 2003, Motorola accounted for 17% of our revenue and Qwest accounted for 11% of our revenue. For the year ended December 31, 2002, Motorola accounted for 12% of our revenue. For the year ended December 31, 2001, Motorola accounted for 30% of our revenue and Qwest accounted for 11% of our revenue. See Note 14 to our consolidated financial statements for additional information regarding revenue by geographic area and product family.

Backlog

Our backlog consists of purchase orders for products and services that we expect to ship or perform within the next year. At December 31, 2003, our backlog was $6.8 million, as compared to $5.0 million at December 31, 2002. We consider backlog to be an indicator, but not the sole predictor, of future sales because our customers may cancel or defer orders without penalty.

Research and Product Development

We have made, and will continue to make, substantial investments in research and product development. As of December 31, 2003, we had 99 employees engaged in research and product development activities.

We conduct the majority of our research and product development activities in Oakland, California. In Oakland, we have built an extensive communications laboratory with hundreds of access infrastructure products from multiple vendors that serves as an interoperability and test facility. This facility allows us to emulate a telecommunications network with serving capacity equivalent to that supporting a city of 350,000 residents. We also have focused engineering staff and activities at additional development centers located in Alpharetta, Georgia, Westlake Village, California and Ottawa, Canada.

Our current plans for research and product development include:

Our research and product development expenditures were $22.5 million, $29.8 million and $63.9 million in 2003, 2002 and 2001, respectively. All of our expenditures for research and product development, as well as stock-based compensation expense relating to research and product development of $0.7 million, $4.2 million and $10.7 million, for 2003, 2002 and 2001, respectively, are expensed as incurred. In addition, we also charged to expense purchased in-process research and development relating to acquisitions of $0, $0.1 million and $12.0 million in 2003, 2002 and 2001, respectively.

Sales and Marketing

We currently focus our sales efforts in three areas:

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Our marketing team works closely with our sales and research and product development organizations and our customers by providing communications that keep the market current on our products and features. Marketing also identifies and sizes new target markets for our products, creates awareness of our company and its products, generates contacts and leads within these targeted markets and performs outbound education and public relations.

Manufacturing

We outsource a significant portion of the manufacturing of our products. We utilize contract manufacturers to provide manufacturing services, including material procurement and handling, printed circuit board assembly and mechanical board assembly. We design, specify, and monitor all of the tests that are required to meet our internal and external quality standards. We work closely with our contract manufacturers to manage costs and delivery times. Our contract manufacturing agreements generally have indefinite terms and are cancelable by either party with advance notice. We believe that outsourced manufacturing enables us to deliver products more quickly and allows us to focus on our core competencies, including research and product development, sales and customer service.

Through the third quarter of 2003, we utilized Solectron for the majority of our manufacturing requirements for all product lines. In 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 an agreement which is currently scheduled to expire 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.

We complement our contract manufacturing relationships with in-house capabilities for final assembly and testing of our products. Our internal manufacturing expertise is focused on product design for testability, design for manufacturability and the transfer of products from development to manufacturing. We also configure, package, and ship products from our facilities after a series of inspections, reliability tests and quality control measures. Our manufacturing engineers design and build all of our testing stations, establish quality standards and protocols and develop test procedures to assure the reliability and quality of our products. We are ISO-9001 certified which is based upon our model for quality assurance in design, development, production, installation and service processes meeting rigorous quality standards.

Our manufacturing engineers work closely with our design engineers to ensure manufacturability and feasibility of our products and to ensure that manufacturing and testing processes evolve as our technologies evolve. Additionally, our manufacturing engineers interface with our contract manufacturers to ensure that outsourced manufacturing processes and products will integrate easily and cost-effectively with our in-house manufacturing systems.

In the future, we may expand our existing contract manufacturing relationships or establish new contract manufacturing relationships. Furthermore, we may expand our current manufacturing facilities or secure new manufacturing facilities to meet our anticipated manufacturing requirements.

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We depend on sole source and limited source suppliers for several key components. We do not currently have any long term contracts or arrangements that assure that we can continue to obtain such components from such sources on a timely basis or acceptable terms, or at all.

Customer Care and Support

We work closely with our customers in developing programs to effectively sell to, support and expand their subscriber base. We offer standard one-year warranties for our products, and the opportunity to upgrade to enhanced services, critical network support and extended warranty protection. We provide customers with pre-sales and post-sales support, education and professional services that enable them to deploy and manage their networks more efficiently. We also provide to our customers application notes, business planning information, and installation guides, as well as web-based and phone-based trouble-shooting assistance.

Our customer service personnel also work closely with our design and manufacturing engineers to ensure that customer feedback is integrated into our research and product development and production strategies.

We intend to continue to grow this organization to offer our customers 24-hour service, seven days a week. As our customer service team grows, we plan to enhance our ability to tailor customer support services to suit the unique needs of particular customers.

Competition

Competition in the communications equipment market is intense. Many companies offer products or services that address particular aspects of the features and functions that our products provide. Our primary competitors include large equipment companies, such as Alcatel and Lucent Technologies, which offer a much broader range of products addressing the entire telecommunications equipment industry, and Advanced Fiber Communications, which principally focuses on the traditional access market. We may also face competition from other large communication companies that enter our market in the future. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, sales and marketing resources than us and may be able to undertake more extensive marketing efforts, adopt more aggressive pricing policies and provide more customer financing options than we are able to provide.

In our markets, competitive factors include:

While we believe that we compete successfully with respect to each of these factors, we expect to face intense competition in our markets. There can be no assurance that we will be able to compete successfully

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against our current or future competitors, or that competitive pressures will not materially and adversely affect our business, financial condition and results of operations.

Compliance with Regulatory and Industry Standards

Our products must comply with a significant number of voice and data regulations and standards which vary between the U.S. and international markets, and which vary between specific international markets. Standards for new services continue to evolve, and we may need to modify our products or develop new versions to meet these standards. Standards setting and compliance verification in the U.S. are determined by the Federal Communications Commission, or FCC, Underwriters Laboratories, Quality Management Institute, Telcordia Technologies, Inc., and other telecommunications companies. In international markets, our products must comply with standards issued by ETSI and implemented and enforced by the telecommunications regulatory authorities of each nation.

We are ISO-9001 certified which demonstrates for our customers and partners that our manufacturing and service processes meet rigorous quality standards.

Environmental Matters

Our operations and manufacturing processes are subject to federal, state, local, and foreign environmental protection laws and regulations. These laws and regulations relate to the use, handling, storage, discharge and disposal of certain hazardous materials and wastes, the pre-treatment and discharge of process waste waters and the control of process air pollutants. We believe that we are in compliance in all material respects with applicable environmental regulations.

Intellectual Property

We believe that our success and ability to compete is dependent on our ability to develop and protect our technology and to operate without infringing on the proprietary rights of others. To protect our proprietary technology, we rely primarily on patent, trademark, service mark, trade secret and copyright laws and contractual restrictions.

We currently have 26 U.S. patents issued, which expire from March 2011 to March 2019. We have also applied for 11 other U.S. patents and have 4 pending foreign patent applications. It is possible that no patents will be issued from our currently pending patent applications and that any potential future patents may be found invalid or unenforceable, or may be successfully challenged. It is also possible that any patent issued to us may not provide any competitive advantages or that we may not develop future proprietary products or technologies that are patentable. Additionally, we have not performed any comprehensive analysis of patents of others that may limit our ability to do business.

Despite our efforts to protect our proprietary rights, we may be unable to prevent others from infringing upon or misappropriating our intellectual property. Any steps taken to protect our intellectual property may be inadequate, time consuming and expensive. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as the laws of the United States.

Substantial litigation regarding intellectual property rights exists in the telecommunications industry. To date, we have not been notified that our technologies infringe on the proprietary rights of anyone. We have received in the past, and may receive in the future, communications from third parties inquiring about our interest in licensing certain of the third party’s intellectual property or more generally identifying intellectual property that may be the basis of a future infringement claim. We cannot assure you that others will not claim that we have infringed proprietary rights relating to past, current or future technologies. We expect that we could become subject to intellectual property infringement claims as the number of our competitors grows and our services

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overlap with competitive offerings. These claims, even if without merit, could be expensive, time-consuming to defend, divert management’s attention from the operation of our business and cause product shipment delays. If we become liable for infringing intellectual property rights, we could be required to pay substantial damage awards and to develop non-infringing technology, obtain a license or cease selling the products that contain the infringing intellectual property. We may be unable to develop non-infringing technology or obtain a license on commercially reasonable terms, if at all.

Trademarks

We have registered U.S. trademarks for: “ARCADACS”, “BAN”, “FLEXBAND”, “MALC”, “RAPTOR”, “SECHTOR”, “SLMS”, “VISTA”, “VPACKET”, “ZEDGE”, “ZINC”, “ZHONE”, the Zhone logo, and “ZPLEX”, and we intend to file additional trademark applications to support its branding and marketing efforts.

Employees

As of December 31, 2003, we had 231 employees, of which 99 were engaged in research and product development, 67 in sales, marketing and customer support, 36 in manufacturing, and 29 in finance and administration. None of our employees are covered by collective bargaining agreements, and we have never experienced a work stoppage, strike or labor dispute. We believe that our relations with our employees are good.

Executive Officers

Set forth below is information concerning our current executive officers and their ages as of February 26, 2004.

Morteza Ejabat is a co-founder of Zhone and has served as its Chairman of the Board of Directors and Chief Executive Officer since its inception. Prior to co-founding Zhone, from June 1995 to June 1999, Mr. Ejabat was President and Chief Executive Officer of Ascend Communications, Inc., a provider of telecommunications equipment which was acquired by Lucent Technologies, Inc. in June 1999. Previously, Mr. Ejabat held various senior management positions with Ascend from September 1990 to June 1995, most recently as Executive Vice President and Vice President, Operations. Mr. Ejabat holds a B.S. in Industrial Engineering and an M.S. in Systems Engineering from California State University at Northridge and an M.B.A. from Pepperdine University.

Jeanette Symons is a co-founder of Zhone and has served as its Chief Technology Officer and Vice President, Engineering since its inception. Prior to co-founding Zhone, Ms. Symons was Chief Technical Officer and Executive Vice President of Ascend Communications, Inc., which Ms. Symons co-founded, from January 1989 to June 1999. Before co-founding Ascend, Ms. Symons was a software engineer at Hayes Microcomputer, a modem manufacturer, where she developed and managed its ISDN program. Ms. Symons holds a B.S. in Systems Engineering from the University of California at Los Angeles.

Kirk Misaka has served as Zhone’s Vice President, Finance and Corporate Treasurer since November 2000 and as Chief Financial Officer since July 2003. Prior to joining Zhone, Mr. Misaka was with KPMG LLP from 1980 to 2000, becoming a partner in 1989. He is a Certified Public Accountant and member of the American Institute of Certified Public Accountants. Mr. Misaka received his B.S. and an M.S. in Accounting from the University of Utah and an M.S. in Tax from Golden Gate University.

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In March 2001, we entered into an agreement pursuant to which we purchased the land and buildings in Oakland, California which we had previously leased under a synthetic lease agreement. As part of the financing for the purchase, we granted a deed of trust on the property to Fremont Bank and were required to transfer the land and buildings to a new entity, Zhone Technologies Campus, LLC, from which we lease the land and buildings. We are the sole member and manager of Zhone Technologies Campus, LLC. Our lease for this facility will expire in March 2011. The Oakland facilities, which consist of three buildings with an aggregate of approximately 180,000 square feet, are used for our executive offices, research and product development activities and manufacturing and warehousing. We also have development rights to expand our facilities by adding one additional building of approximately 120,000 square feet to our Oakland campus. Under the terms of the original purchase agreement, because we did not commence construction of the fourth building by January 21, 2004, the Redevelopment Agency of the City of Oakland has a 120-day option to repurchase approximately 3.625 acres of the unimproved land for the purchase price of approximately $1.5 million. To date, the Redevelopment Agency of the City of Oakland has not exercised, or announced any intention to exercise, the repurchase option.

We also lease facilities for research and development purposes at locations including Alpharetta, Georgia, Westlake Village, California and Ottawa, Canada. We also maintain smaller offices to provide sales and customer support at various domestic and international locations. In addition, we have leases for various facilities which are currently vacant, which relate primarily to companies that we have acquired. We believe that our current facilities will be adequate and suitable for our operations for at least the next twelve months.

On October 16, 2003, the Company agreed with HeliOss Communications, Inc. to dismiss HeliOss’ claims filed against us on March 27, 2003 in the Superior Court of the State of California, County of Alameda, in an action entitled HeliOss Communications, Inc. v. Zhone Technologies, Inc., case no. RG 03088921 and our cross-complaint against HeliOss, in consideration of a $1.6 million payment from Zhone to HeliOss. The payment of $1.6 million was made on November 25, 2003 to settle the matter.

The Company is also 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 our 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 Asarte. On December 24, 2003, Asarte and Tellium filed a potentially dispositive Motion to Suppress. Corning’s opposition to the Motion to Suppress is due February 4,

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2004 and any reply is due February 11, 2004. On January 28, 2004, Asarte filed a Motion for Summary Judgment. Corning’s opposition is due February 11, 2004, and any reply is due February 18, 2004. A two week hearing on the merits of the arbitration is currently scheduled for the weeks of March 15-19 and March 22-26, 2004. It is too early in the dispute process to determine what impact, if any, this dispute will have upon our business, financial condition, or results of operations. We intend 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.

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 and 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 a motion to dismiss the complaint. The motions to dismiss have been fully briefed, and the parties are awaiting the Court’s decision on the motions. It is too early in the legal process to determine what impact, if any, these suits will have upon our business, financial condition, or results of operations. We intend to vigorously defend the claims made in these actions and the consolidated amended complaint.

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 our business, financial condition, or results of operations. We intend 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 our current or former officers or employees is a target of the investigation. We are cooperating fully with these investigations. We are not able, at this time, to say when the SEC and/or U.S. Attorney investigations will be completed and resolved, or what the ultimate outcome with respect to Tellium will be. These investigations could result in substantial costs

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and a diversion of management’s attention and may have a material and adverse effect on our 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.

At a special meeting of stockholders on November 13, 2003, stockholders of Tellium approved the merger of Zhone and Tellium by a vote of 54,892,048 shares for, 3,711,207 shares against, with 107,518 shares abstaining. The total shares voted represented 50.2% of the outstanding shares eligible to vote. Effective immediately upon the closing of the merger, the combined company’s name was changed from Tellium, Inc. to Zhone Technologies, Inc.

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PART II

Price Range of Common Stock

Our common stock has been traded on the NASDAQ National Market under the symbol “ZHNE” since November 14, 2003, following the consummation of the merger with Tellium, Inc. Prior to that date, Tellium’s common stock was traded on the NASDAQ under the symbol “TELM”. The following table sets forth, for the periods indicated, the high and low closing sale prices as reported on NASDAQ for Zhone and Tellium common stock, as adjusted for all stock splits. Immediately prior to the consummation of the merger with Zhone, Tellium effected a one-for-four reverse split of its outstanding shares of common stock.

As of January 31, 2004, there were approximately 1,179 stockholders of record.

Dividend Policy

We have never paid or declared any cash dividends on our common stock or other securities and do not anticipate paying cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of the Board of Directors, subject to any applicable restrictions under our debt and credit agreements, and will be dependent upon our financial condition, results of operations, capital requirements, general business condition and such other factors as the Board of Directors may deem relevant.

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The following selected financial data has been derived from our consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial data included elsewhere in this report. The historical results are not necessarily indicative of results to be expected for any future period.

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The following discussion and analysis should be read in conjunction with our 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, unanticipated regulatory changes, 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 from those expressed in any forward-looking statements. Readers are referred to risks and uncertainties identified below, under “Risk Factors” and elsewhere in this report. 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 $595.8 million at December 31, 2003. The global telecommunications market has deteriorated significantly over the last two to three 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 during 2003 due to continued uncertainties regarding the state of the global economy, network overcapacity, customer bankruptcies, network build-out delays and limited capital availability. As a result, our revenue declined by 26% from 2002 to 2003. 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

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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:

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 the our Equity Restructuring (as described in Note 6 to our consolidated financial statements), 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.

Stockholders’ equity (deficit) 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.

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. 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 December 31, 2003, we had completed nine 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.

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We are likely to acquire additional businesses, products and technologies in the future. In February 2004, we announced a definitive agreement to acquire the assets of Gluon Networks, Inc. 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 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 its 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 our 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 intend to 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. 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 reasonably assured, and the amount of our 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

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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 December 31, 2003, we have $100.3 million of goodwill, $12.9 million of other acquisition-related intangible assets and $22.6 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

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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.

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 consolidated statement of operations as a percentage of revenue for the periods indicated.

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2003 COMPARED WITH 2002

Revenue

Information about our revenue for products and services for 2003 and 2002 is summarized below (in millions):

Information about our revenue for North America and International markets for 2003 and 2002 is summarized below (in millions):

Information about our revenue by product line for 2003 and 2002 is summarized below (in millions):

Total revenue decreased 26% or $29.6 million to $83.1 million for 2003 compared to $112.7 million for 2002. The decrease in total revenue was due to the continued capital constraints and economic slowdown affecting the telecommunications industry and the technology industry in general. On a quarterly basis, our revenue declined significantly in the first quarter of 2003 as compared to the fourth quarter of 2002, but then increased sequentially over the remainder of the year.

In 2003, product revenue declined by 29% or $30.0 million while service revenue increased by 6% or $0.4 million compared to 2002. The decrease in product revenue was due to the overall economic environment impacting service provider capital spending. The modest increase in service revenue was due to revenue from maintenance and other services associated with product shipments that occurred in previous periods. International revenue declined 61% or $11.9 million to $7.6 million in 2003 and represented 9% of total revenue compared with 17% in 2002. The decline in international revenue was due to the global economic environment and declining sales to non-U.S. based competitive local exchange carriers, or CLECs.

By product family, revenue for our SLMS product family declined by $10.0 million or 25% in 2003 as compared to 2002. Revenue for our DLC product family declined by $20.7 million or 52% in 2003. The percentage decline in the DLC product line revenue exceeded the overall percentage decline in revenue due in part to our decision to phase out marketing and sales efforts with respect to the Access Concentrator, or Access Node, products. Revenue for our MUX product line increased by $1.1 million or 3% in 2003. Due to the current economic environment affecting service providers, our customers and potential customers have limited capital

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expenditures to sustain their current revenue generating activities while significantly reducing capital expenditures for newer technologies. As a result, network service providers have continued to invest in our MUX product line which includes legacy equipment and applications while spending more conservatively on newer technologies in the SLMS product line.

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.

In 2003, Motorola and Qwest accounted for approximately 17% and 11% of total revenue, respectively. In 2002, Motorola accounted for approximately 12% of total revenue. No other customer accounted for 10% or more of total revenue in either period. We anticipate that our results of operations in any given period will continue to depend to a large 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

Total cost of revenue decreased $18.6 million to $51.1 million for 2003 compared to $69.7 million for 2002, driven primarily by the overall decrease in revenue. Total cost of revenue was 61% of revenue for 2003, compared to 62% of revenue for 2002. Cost of revenue included excess inventory charges of $6.0 million in 2003 and $2.4 million in 2002, representing 7% and 2% of revenue, respectively. The higher excess inventory charges recorded in 2003 were primarily due to the impact of our reduced sales forecasts.

Excluding the effect of excess inventory charges, total cost of revenue as a percentage of revenue would have been 54% in 2003 compared to 60% in 2002. This was primarily attributable to a shift in product mix towards a higher percentage of revenue from our MUX product line and an offsetting decrease in the percentage of revenue from our DLC product line, which has higher material costs as a percentage of revenue than the MUX product line.

We expect that, in the future, our cost of revenue will vary as a percentage of net revenue depending on the mix and average selling prices of products sold. In addition, competitive and economic pressures could cause us to reduce our prices, adjust the carrying values of our inventory, or record inventory charges relating to discontinued products and excess or obsolete inventory.

Research and Product Development Expenses

Research and product development expenses decreased 25% or $7.3 million to $22.5 million for 2003 compared to $29.8 million for 2002. The decrease was primarily due to lower depreciation expense and facilities related costs, and a decrease in personnel-related expenses resulting from our restructuring activities in 2002, which resulted in a consolidation of product offerings and more focused development programs. Depreciation expense and facilities related costs decreased by approximately $4.1 million due to the effect of an impairment charge for certain facilities and equipment in 2002 and a consolidation of research and product development office locations. Personnel related expenses decreased by approximately $2.0 million due primarily to headcount reductions resulting from the consolidation of product offerings. We intend to continue to invest in research and product development to attain our strategic product development objectives, while seeking to manage the associated costs through expense controls.

Sales and Marketing Expenses

Sales and marketing expenses decreased 19% or $3.8 million to $15.9 million for 2003 compared to $19.7 million for 2002. The decrease was primarily due to a credit to sales and marketing expense of $2.4 million

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recorded in 2003, as a result of the termination of a customer financing agreement with a financial institution. The amount represented the recovery of a reserve for projected credit losses which had originally been recorded as sales and marketing expense in 2001.

General and Administrative Expenses

General and administrative expenses decreased 51% or $5.5 million to $5.3 million for 2003 compared to $10.8 million for 2002. The decrease was primarily due to lower bad debt expense of approximately $7.1 million which occurred because there were no additional specifically reserved customer accounts in 2003. This decrease was offset modestly by higher legal and accounting expenses of approximately $1.5 million, which was primarily attributable to increased costs associated with being an SEC registrant.

Restructuring Charges

We did not record any restructuring charges in 2003, as compared to $4.5 million of charges recorded during 2002 relating to severance and related charges, facilities and lease cancellations and equipment write-offs.

Litigation Settlement

In 2003, we recorded a charge of $1.6 million relating to the settlement of a litigation matter involving HeliOss Communications, Inc. No litigation settlement charges were recorded in 2002.

Stock-Based Compensation Expenses

Stock-based compensation expense decreased $9.6 million to $1.2 million for 2003 compared to $10.8 million for 2002. The decrease was primarily attributable to lower amortization of deferred compensation due to the use of an accelerated amortization method. For the years ended December 31, 2003 and 2002, $(85,000) and $0.4 million of stock-based compensation expense was classified as cost of revenue, respectively, and $1.2 million and $10.4 million was classified as operating expenses, respectively. 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.

For each period, we recorded stock-based compensation expense representing the amortization of deferred compensation, offset by a benefit due to the reversal of previously recorded stock compensation expense on forfeited shares. For the year ended December 31, 2002, we also recorded compensation expense of $2.5 million due to the cancellation of notes receivable due from officers relating to the repurchase by us of common stock subject to repurchase rights and issuance of promissory notes to the founders relating to the purchase of our common stock. For the year ended December 31, 2002, we also recorded compensation expense of $1.8 million due to the exchange of certain shares of its common stock subject to repurchase rights for Series B preferred stock. Components of stock-based compensation expense were comprised as follows (in millions):

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Amortization and Impairment of Intangibles

Amortization and impairment of intangibles decreased $8.1 million to $7.9 million for 2003 compared to $16.0 million for 2002. The decrease was primarily attributable to the intangibles from acquisitions made in previous years becoming fully amortized, offset by the incremental amortization expense of $1.3 million relating to the acquisition of eLuminant in February 2003. In addition, we recorded an impairment charge of $0.7 million during 2002 relating to the discontinuation of the development of certain technology obtained from the acquisition of Optaphone Networks, Inc.

Impairment of Long-Lived Assets

We did not record any impairment charges in 2003, as compared to $50.8 million of charges recorded during 2002 relating primarily to a writedown in the carrying value of our headquarters facility and related assets. The impairment charge in 2002 was recorded following an impairment review that resulted from factors including a significant reduction in forecasted revenues and excess equipment and building capacity caused by restructuring activities earlier during that year.

Other Income (Expense), Net

Other income (expense), net was $(2.6) million for 2003 compared to $(9.4) million for 2002. The components for each period were comprised as follows (in millions):

Interest expense for 2003 decreased by $5.6 million compared to 2002 due primarily to a reduction in average borrowings outstanding during the year. Other income (expense) increased by $1.2 million due to various non-operating cash receipts, none of which were individually material.

Income Tax (Benefit) Provision

During the year ended December 31, 2003, we recorded a net tax benefit of $7.8 million, which consisted of a current tax benefit of $8.0 million, offset by foreign and state taxes of $0.2 million. No deferred tax benefit was recorded due to our operating losses and net operating loss carryforwards. Due to the significant uncertainty regarding the realization of our net deferred tax assets, a full valuation allowance was recorded.

We recognized a current tax benefit of $8.0 million in 2003 relating to the final resolution of tax refund claims for net operating loss carrybacks of post-acquisition losses incurred by Premisys. We had originally received the tax refunds related to Premisys in previous years, but did not recognize any income tax benefit at that time due to the substantial uncertainty regarding whether the benefit could be sustained upon examination by tax authorities.

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2002 COMPARED WITH 2001

Revenue

Information about our revenue for products and services for 2002 and 2001 is summarized below (in millions):

Information about our revenue for North America and International markets for 2002 and 2001 is summarized below (in millions):

Information about our revenue by product line for 2002 and 2001 is summarized below (in millions):

Revenue increased 2% or $2.0 million to $112.7 million for the year ended 2002 compared to $110.7 million for 2001. Product revenue declined by 3% or $3.2 million while service revenue increased by 236% or $5.2 million compared to 2001. The decrease in product revenue was due to the decline in the overall economic environment and deteriorating conditions in the telecommunications industry. The increase in service revenue was due to revenue from maintenance and other services associated with product shipments that occurred in previous periods. International revenues declined 48% or $18.1 million to $19.5 million in 2002 and represented 17% of total revenues compared with 34% in 2001. The decline in international revenues was attributable to the elimination of a contract in 2002 with Motorola to purchase and deploy products in Germany, the decrease of product revenues from a contract with Time Telecommunications to purchase and deploy products in Malaysia, and the overall decrease of revenues from non-U.S. based competitive local exchange carriers, or CLECs, due to the deteriorating global economic environment. International revenues were higher in 2001 as a percentage of total revenues as sales to non-U.S. based CLECs continued strong even after sales to U.S. based CLECs had substantially declined. In 2002, sales to non-U.S. based CLECs experienced similar declines as had been experienced in the U.S. during 2001.

Revenue for our SLMS product family was flat in 2002. Revenue for our DLC product family increased significantly in 2002 due to higher Access Node products sales. We acquired the Access Node product line from Nortel Networks in August 2001 and had a full year of sales activities in 2002. Revenue for our MUX product line decreased significantly in 2002 due to lower Multi-Access System, or IMACS, products sales. IMACS product sales accounted for all of the revenue for our MUX product line in 2001 and 2002. We acquired the IMACS product line as a result of our purchase of Premisys Communications, Inc. in 1999.

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Our strategy has been to focus on next generation products while utilizing the MUX product line to provide operating cash flow. The MUX product line was 29%, 58% and 88% of total revenues in 2002, 2001 and 2000, respectively.

Although revenues from the MUX product line have decreased 54% from the years ended December 31, 2000 to December 31, 2002, we continue to generate sustained revenue from this product line. While we do not plan on focusing marketing and sales efforts on this product line, we continue to earn revenues from sales into existing supporting legacy applications and occasionally find new opportunities for sales of this product to customers.

For the year ended 2002, Motorola accounted for approximately 12% of total revenues. In 2001, Motorola and Qwest accounted for approximately 30% and 11% of total revenues, respectively. No other customer accounted for 10% or more of total revenues 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 revenues 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

Total cost of revenue decreased $36.3 million to $69.7 million for 2002 compared to $106.0 million for 2001. Total cost of revenue was 62% of revenue for 2002, compared to 96% of revenue for 2001. Cost of revenue was higher in 2001 primarily as a result of excess inventory charges recorded in 2001. In the second quarter of 2001, we recorded charges of $11.6 million for excess and obsolete inventory and $16.4 million for inventory purchase agreements. We also experienced delays in some of our larger customers’ build-out plans. This, along with a rapid decline in our customers’ capital spending, accounted for all of the excess and obsolete inventory write-down. We reduced our forecasted shipments and were unable to cancel purchase commitments or return excess inventories to our vendors. Cost of revenue for 2001 also included an inventory write-down of $9.7 million associated with lower pricing from quantity discounts. We also reduced staffing levels for our manufacturing group by approximately 28% due to our restructuring activities. Excluding the effect of excess inventory charges and inventory write-downs, total cost of revenue as a percentage of revenue would be 62% for 2002 and 2001.

Research and Product Development Expenses

Research and product development expenses decreased 53% or $34.1 million to $29.8 million for 2002 compared to $63.9 million for 2001. The decrease was primarily due to a decrease in material and personnel related expenses resulting from our restructuring activities, which resulted in a consolidation of product offerings and more focused development programs. Personnel related expenses decreased by approximately $16.6 million, or 53%. Staffing levels of research and product development personnel were lower by approximately 56% in 2002 as compared to 2001 primarily due to our restructuring efforts. Material related expenses decreased by approximately $7.0 million, or 70%. Consulting and outside services expenses decreased by approximately $1.8 million, or 75%.

Sales and Marketing Expenses

Sales and marketing expenses decreased 45% or $15.8 million to $19.7 million for 2002 compared to $35.5 million for 2001. This decrease was due primarily to a decrease in salaries and commissions related to headcount reductions, and decreased activities and costs related to advertising, trade shows and public relations. Personnel related expenses decreased by approximately $6.8 million, or 40%. Staffing levels for sales and marketing personnel were lower by approximately 32% in 2002 as compared to 2001 primarily due to our restructuring efforts. Advertising, trade shows and public relations expenses decreased by approximately $2.4 million, or 96%. In 2001, we recorded a $2.5 million charge to reflect our estimate of the cost of creating a customer financing program with a financial institution.

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General and Administrative Expenses

General and administrative expenses decreased 18% or $2.3 million to $10.8 million for 2002 compared to $13.1 million for 2001. The decrease was primarily due to reduced costs for personnel and related expenses following our restructuring activities. Personnel related expenses decreased by approximately $3.6 million, or 53%. Staffing levels for general and administrative personnel were lower by approximately 32% in 2002 as compared to 2001 primarily due to our restructuring efforts. These savings were offset by increases in provisions for doubtful accounts of $1.2 million due to the financial difficulty of one of our customers.

Restructuring Charges

We responded to continuing market declines in 2002, by implementing additional restructuring actions. We reduced our workforce by 153 employees throughout all functional areas, or approximately 35% of our worldwide headcount at the beginning of the year. As a result of these actions, we recorded restructuring charges of $4.5 million during 2002 relating to severance and related charges, facilities and lease cancellations and equipment write-offs.

The following table displays the activity of the restructuring reserve for 2002, the reserve at December 31, 2002, and the components of the net charges for 2002 (in millions):

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Stock-Based Compensation Expenses

Stock based compensation expenses decreased $8.0 million to $10.8 million for 2002 compared to $18.8 million for 2001. For the years ended December 31, 2002 and 2001, $0.4 million and $1.7 million of stock based compensation expense was classified as cost of revenue, respectively, and $10.4 million and $17.1 million was classified as operating expenses, respectively. Stock 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. For the year ended December 31, 2002, we amortized $21.5 million of deferred stock compensation expense, offset by a benefit of $14.4 million due to the reversal of previously recorded stock compensation expense on forfeited shares. This was a result of the reduction in workforce that occurred in 2002. For the year ended December 31, 2001, we amortized $37.3 million of deferred stock compensation expense, offset by a benefit of $16.5 million due to the reversal of previously recorded stock compensation expense on forfeited shares. For the year ended December 31, 2002, we also recorded compensation expense of $2.5 million due to cancellation of notes receivable due from officers relating to the repurchase by us of common stock subject to repurchase rights and issuance of promissory notes to the founders relating to the purchase of our common stock. For the year ended December 31, 2002, we also recorded compensation expense of $1.8 million due to the exchange of certain shares of our common stock subject to repurchase rights for Series B preferred stock. We amortize the deferred stock compensation over the vesting periods of the applicable options, or repurchase periods for the exercised options, generally over four years. Components of stock-based compensation expense were comprised as follows (in millions):

Amortization and Impairment of Intangibles

As of January 1, 2001, we 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. Amortization and impairment of intangibles decreased $72.8 million to $16.0 million for 2002 compared to $88.8 million for 2001. In 2001, we discontinued the development and use of certain assets, products, and technologies obtained from the acquisitions of CAG Technologies, Inc., Roundview Inc., and Xybridge Technologies, Inc. and recorded a related impairment charge of approximately $41.7 million. In 2002, we discontinued the development of certain technology obtained from the acquisition of Optaphone Networks, Inc. and recorded a related impairment charge of approximately $0.7 million. Amortization of goodwill and workforce was $31.3 million in 2001. Amortization of other acquisition-related intangible assets was $15.8 million in 2001 as compared to $15.3 million in 2002. We generally amortize intangibles over a period of three to five years.

Impairment of Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review long-lived assets, such as property, plant and equipment, and purchased intangibles subject to amortization, 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. We estimate the fair value of our long-lived assets based on a combination of the market, income and

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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.

During the fourth quarter ended December 31, 2002, we identified impairment indicators, which included a significant reduction in forecasted revenues and excess equipment and building capacity caused by our restructuring during the year. The commercial real estate market in the San Francisco Bay Area also has been negatively impacted by the downturn in the economy. Accordingly, we performed, with the assistance of independent valuation experts, an impairment review of our other intangible assets and long-lived assets. We recorded an impairment charge of $50.8 million.

The impairment charge to other intangible assets and long-lived assets from the impairment review resulted in a write-off of the net book value as follows (in millions):

The write-down resulted in the elimination of historical accumulated depreciation and amortization for long-lived assets that were impaired. The remaining balances in property and equipment and acquisition-related technology and intangibles will be depreciated and amortized, respectively, over their remaining estimated lives.

Other income (expense), net

Other income (expense), net increased $3.2 million from $(12.6) million for 2001. The detail is as follows (in millions):

Interest expense for 2002 was $1.0 million lower due mainly to a reduction in borrowings in 2002.

Interest income for 2002 was $2.5 million lower than 2001 due to lower average cash balances throughout the year.

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 which our common stock became publicly traded, we expect to finance our operations through a combination of our existing cash,

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cash equivalents and investments, available credit facilities, and sales of equity and debt instruments, based on our operating requirements and market conditions.

At December 31, 2003, cash, cash equivalents and short-term investments, all of which are available to fund current operations, were $98.3 million. This amount includes cash and cash equivalents of $32.5 million, as compared with $10.6 million at December 31, 2002. The increase in cash and cash equivalents of $21.9 million was attributable to cash provided by investing activities of $80.2 million, offset by cash used in operating activities of $45.1 million and cash used in financing activities of $13.2 million.

Net cash provided by investing activities consisted primarily of cash acquired through the acquisition of Tellium of $140.6 million and a reduction in restricted cash of $5.7 million, offset by net purchases of short-term investments of $65.7 million. Net cash used in operating activities consisted of the net loss of $17.2 million, adjusted for non-cash charges totaling $10.5 million and changes in operating assets and liabilities totaling $38.4 million. The most significant components of the changes in operating assets and liabilities were a decrease in accrued expenses of $48.6 million and a decrease in accounts receivable of $7.6 million. Net cash used in financing activities consisted primarily of net repayments of debt of $14.6 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. During the fourth quarter of 2003, we terminated an agreement to provide customer financing with a financial institution which had originally required us to establish a $2.5 million reserve for projected credit losses.

Currently, our primary source of liquidity comes from our cash and cash equivalents and short-term investments, which totaled $98.3 million at December 31, 2003, and our line of credit agreement, under which $4.8 million was outstanding at December 31, 2003, and an additional $6.1 million was committed as security for obligations under our Secured Real Estate Loan Facility and other letters of credit. 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. 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 December 31, 2003, two customers represented 31% and 11%, 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.

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Contractual Commitments and Off-Balance Sheet Arrangements

At December 31, 2003, our future contractual commitments by fiscal year were as follows (in thousands):

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 December 31, 2003, the interest rate on the majority of 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 December 31, 2003.

We also had commitments under outstanding letters of credit totaling $0.6 million at December 31, 2003. We have recorded restricted cash on our balance sheet equal to the amount outstanding under these letters of credit.

Related Party Transactions

For the year ended December 31, 2003, related party transactions were comprised as described below. See Note 10 to our consolidated financial statements for details regarding related party transactions that occurred in previous periods.

On July 29, 2003, we borrowed $2.0 million from Mory Ejabat, our Chairman and Chief Executive Officer, and Jeanette Symons, our Chief Technology Officer and Vice President, Engineering. On August 7, 2003, we borrowed an additional $2.0 million from Ms. Symons. Each of these loans had an interest rate of 12% per year and matured upon the closing of our merger with Tellium, Inc. The principal balance and accrued interest for each loan were repaid in November 2003. Mr. Ejabat and Ms. Symons received interest income relating to the loans of $35,836 and $106,521, respectively.

In the ordinary course of business, our executive officers and non-employee directors are reimbursed for travel related expenses when incurred for business purposes. We reimburse our Chairman and Chief Executive Officer, Mory Ejabat, for the direct operating expenses incurred in the use of his private aircraft when used for business purposes. The amount reimbursed for these expenses was $473,000 for the year ended December 31, 2003.

Recent Accounting Pronouncements

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus regarding Issue 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables.” The consensus addresses not only when and how an arrangement involving multiple deliverables should be divided into separate elements of accounting but also how the arrangement’s consideration should be allocated among separate units. The applicable provisions of EITF 00-21 were applied to the Company’s revenue transactions beginning in the quarter ended September 30, 2003. The adoption of EITF 00-21 did not have a material impact on the Company’s consolidated financial statements.

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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 would become effective on January 1, 2004. Accordingly, the provisions of FIN 46R will become effective for the Company in the first quarter of 2004. The adoption of FIN 46R is not expected to have a material impact on the Company’s consolidated financial statements.

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 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, and we had an accumulated deficit of $595.8 million at December 31, 2003.

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 significant manufacturing, research and 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 will be 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.

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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 to 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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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 year ended December 31, 2003, two customers accounted for approximately 17% and 11% of our revenue, respectively. During the year ended December 31, 2002, one customer accounted for approximately 12% of our revenue. 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 December 31, 2003, we have acquired nine companies or product lines, and we are likely to acquire additional businesses, products or technologies in the future. In November 2003, we completed our merger with Tellium, Inc., and in February 2004, we announced the acquisition of the assets of Gluon Networks, Inc. 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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Any acquisitions or investments that we make in the future will involve numerous risks, including:

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.