10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2008

OR

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

For the transition period from          to         

Commission File Number: 000-32743

ZHONE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

Delaware	22-3509099
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

7001 Oakport Street

Oakland, California 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:

Common Stock, $0.001 Par Value	The Nasdaq Stock Market LLC
(Title of class)	(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer ¨	Accelerated filer x	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

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

As of January 31, 2009, there were 150,684,109 shares outstanding of the registrant’s common stock, $0.001 par value. As of June 30, 2008 (the last business day of the registrant’s most recently completed second fiscal quarter), the aggregate market value of common stock held by non-affiliates of the registrant was approximately $81,469,800.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the 2009 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K where indicated.

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business	3
Item 1A.	Risk Factors	13
Item 1B.	Unresolved Staff Comments	26
Item 2.	Properties	26
Item 3.	Legal Proceedings	26
Item 4.	Submission of Matters to a Vote of Security Holders	27
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	29
Item 6.	Selected Financial Data	30
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 8.	Financial Statements and Supplementary Data	49
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	82
Item 9A.	Controls and Procedures	82
Item 9B.	Other Information	83
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	84
Item 11.	Executive Compensation	84
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	84
Item 13.	Certain Relationships and Related Transactions, and Director Independence	84
Item 14.	Principal Accountant Fees and Services	84
PART IV
Item 15.	Exhibits, Financial Statement Schedules	85
Signatures		86
Exhibits		87

Forward-looking Statements

This Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding future events and our future results that are subject to the safe harbors created under the Securities Act of 1933 and the Securities Exchange Act of 1934. These statements are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. We use words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “goal,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” variations of such words and similar expressions to identify forward-looking statements. In addition, statements that refer to projections of earnings, revenue, costs or other financial items; anticipated growth and trends in our business or key markets; future growth and revenues from our Single Line Multi-Service (SLMS) products; future economic conditions and performance; anticipated performance of products or services; plans, objectives and strategies for future operations; and other characterizations of future events or circumstances, are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified under the heading “Risk Factors” in Item 1A, elsewhere in this report and our other filings with the SEC. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.

PART I

ITEM 1. BUSINESS

Company Overview

We design, develop and manufacture communications network equipment for telephone companies and cable operators worldwide. We believe that these network service providers can increase their revenues and lower their operating costs by using our products to deliver video and interactive entertainment services in addition to their existing voice and data service offerings, all on a platform that permits a seamless migration from legacy technologies to a converged packet-based architecture. Our Single Line Multi-Service (SLMS) architecture provides cost-efficiency and feature flexibility with support for voice over internet protocol (VoIP) and IP video (IPTV). Within this versatile SLMS architecture, our products allow service providers to deliver all of these converged packet services over their existing copper lines while providing support for fiber build-out. With our products, network service providers can seamlessly migrate from traditional circuit-based networks to packet-based networks and from copper-based access lines to fiber-based access lines without abandoning the investments they have made in their existing infrastructures.

Corporate Information

We were incorporated in Delaware under the name Zhone Technologies, Inc. in June 1999, and in November 2003, we consummated our merger with Tellium, Inc. Although Tellium acted as the legal acquirer, due to various factors, including the relative voting rights, board control and senior management composition of the combined company, Zhone was treated as the “acquirer” for accounting purposes. Following the merger, the combined company was renamed Zhone Technologies, Inc. and retained substantially all of Zhone’s previous management and operating structure. The mailing address of our worldwide headquarters is 7001Oakport Street, Oakland, California 94621, and our telephone number at that location is (510) 777-7000. Our website address is www.zhone.com. The information on our website does not constitute part of this report. Through a link on the Investor Relations section of our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. All such filings are available free of charge.

3

Industry Background

Over the past several years, the communications network industry has experienced rapid expansion as the internet and the proliferation of bandwidth intensive applications and services have led to an increased demand for high bandwidth communications networks. The broad adoption of new technologies such as MP3 players, digital cameras and high definition televisions allow music, pictures, user-generated content (as found on the many video-sharing sites) and high definition video to be a growing part of consumers’ regular exchange of information. All of these new technologies share a common dependency on high bandwidth communication networks and sophisticated traffic management tools. However, network service providers have struggled to meet the increased demand for high speed broadband access due to the constraints of the existing communications network infrastructure. This infrastructure consists of two interconnected networks:

• the “core” network, which interconnects service providers with each other; and

• the “access” network, which connects end-users to a service provider’s closest facility.

To address the increased demand for higher transmission speeds via greater bandwidth, service providers have expended significant capital over the past decade to upgrade the core network by replacing much of their copper infrastructure with high-speed optical infrastructure. While the use of fiber optic equipment in the core network has relieved the bandwidth capacity constraints in the core network between service providers, the access network continues to be a “bottleneck” that severely limits the transmission speed between service providers and end-users. As a result, communications in the core network can travel at up to 10 gigabits per second, while in stark contrast, many communications over the access network throughout the world still occur at a mere 56 kilobits per second, a speed that is 175,000 times slower. At 56 kilobits per second, it may take several minutes to access even a modestly media laden website and several hours to download large files. Fiber access lines have the potential to remedy this disparity, but re-wiring every home or business with fiber optic cable is both cost prohibitive and extremely time consuming. Consequently, solving the access network bottleneck has typically required more efficient use of the existing copper wire infrastructure and support for the gradual migration from copper to fiber.

In an attempt to deliver high bandwidth services over existing copper wire in the access network, service providers began deploying digital subscriber line (DSL) technology over a decade ago. However, this early DSL technology has practical limitations. Copper is a distance sensitive medium in that the amount of bandwidth available over a copper wire is inversely proportional to the length of the copper wire. In other words, the greater the distance between the service provider’s equipment and the customer’s premises, the lower the bandwidth. Unfortunately, most DSL services available today are provided by first generation DSL access multiplexer (DSLAM) equipment. These large unwieldy devices require conditioned power and a climate controlled environment typically found only in a telephone company’s central office, which is often at great distance from the customer. While adequate for basic data services, these first generation DSLAMs were not designed to meet the needs of today’s high bandwidth applications. The modest bandwidth provided by existing DSLAM equipment is often incapable of delivering even a single channel of standard definition video, much less multiple channels of standard definition video or high definition video.

More recently, regulatory changes have introduced new competitors in the telecommunication services industry. Cable operators, with extensive networks designed originally to provide only video programming, have collaborated to adopt new packet technologies that leverage their hybrid fiber/coaxial cable infrastructure. Using more recent technologies, cable operators have begun to cost-effectively deliver new service bundles. The new service offerings provide not only enhanced features and capabilities, but also allow the cable operators to deliver these services over a common network. The resulting cost-efficiencies realized by cable operators are difficult for incumbent telephone companies to match. Even with the telephone companies’ legacy voice switches fully paid for, maintaining separate networks for their circuit-based voice and packet-based video and data networks is operationally non-competitive. Perhaps even more important than economic efficiencies, by integrating these services over a common packet infrastructure, cable operators will realize levels of integration between applications and new features that will be difficult to achieve from a multi-platform solution. Despite these benefits, coaxial cable has its own share of limitations. Unlike DSL, coaxial cable shares its bandwidth among all customers

4

connected to it. Consequently, as new customers are added to coaxial cable networks, performance decreases. As a shared medium, large numbers of subscribers who simultaneously access the same segment of the coaxial cable network can potentially compromise performance and security. This represents a source of strategic advantage for telecom operators who employ technology designed to maximize their service capabilities on the point-to-point (i.e. not shared) architecture of their copper infrastructure. This increased competition has placed significant pressure on all network service providers. With significant service revenues at risk, these service providers have started to make investments to upgrade their networks and broaden their service offerings. In response to these competitive pressures, existing service providers have commenced a search for ways to modernize their legacy networks, to enable delivery of additional high bandwidth, high margin services, and to lower the cost of delivering these services.

The Zhone Solution

We believe that we are the first company dedicated solely to developing the full spectrum of next-generation access network solutions to cost-effectively deliver high bandwidth services while simultaneously preserving the investment in today’s networks. Our next-generation solutions are based upon our Single Line Multi-Service, or SLMS, architecture. From its inception, this SLMS architecture was specifically designed for the delivery of multiple classes of subscriber services (such as voice, data and video distribution), rather than being based on a particular protocol or media. In other words, our SLMS products are built to support the migration from legacy circuit to packet technologies and from copper to fiber technologies. This flexibility and versatility allows our products to adapt to future technologies while allowing service providers to focus on the delivery of additional high bandwidth services. Because this SLMS architecture is designed to interoperate with existing legacy equipment, service providers can leverage their existing networks to deliver a combination of voice, data and video services today, while they migrate, either simultaneously or at a future date, from legacy equipment to next-generation equipment with minimal interruption. We believe that our SLMS solution provides an evolutionary path for service providers using their existing infrastructures, as well as giving newer service providers the capability to deploy cost-effective, multi-service networks that can support voice, data and video.

Triple Play Services with Converged Voice, Data and Video – SLMS simplifies the access network by consolidating new and existing services onto a single line. This convergence of services and networks simplifies provisioning and operations, ensures quality of service and reliability, and reduces the time required to provide services. SLMS integrates access, transport, customer premises equipment, and management functions in a standards-based system that provides scalability, interoperability and functionality for voice, data and video services.

Packet Migration – SLMS is a flexible multi-service architecture that provides current services while simultaneously supporting migration to a pure packet network. This flexibility allows service providers to cost-effectively provide carrier class performance, and functionality for current and future services without interrupting existing services or abandoning existing subscribers. SLMS also protects the value of the investments made by residential and commercial subscribers in equipment, inside wiring and applications, thereby minimizing transition impact and subscriber attrition.

Fiber to the Home, Premise, Node, or Curb (FTTx) — We provide support for the full range of fiber-based access network architectures that are seeing increased use by today’s carriers. In many markets worldwide, both business and residential demand for bandwidth is growing to the point where the deployment of fiber in the access network is increasingly desirable. Where copper loops are plentiful and where civil restrictions make fiber deployment all the way to the customer premises prohibitively expensive, if not impossible, many operators are choosing to deploy fiber from central offices to neighborhoods and then using VDSL2 over copper to deliver broadband connectivity over the last hundred meters or so. In other circumstances operators choose to deploy passive optical networks (PON) all the way to the customer premises, where a single fiber’s bandwidth is shared through splitters with up to 64 subscribers. Some circumstances demand so-called “home run” fiber networks

5

(with dedicated fiber resources linking every customer directly to the central office) to maximize bandwidth or service segmentation. By supporting all these architectures within a common SLMS-based platform, we provide carriers maximum flexibility to build the network that best suits their needs.

Ethernet Service Delivery – We offer a complete array of equipment that allows carriers to deliver ethernet services over copper or fiber. For business subscribers, our ethernet over copper product family allows carriers to quickly deliver ethernet services over existing copper SHDSL or T1/E1 circuits. Multiple circuits can be bonded to provide over 70 Megabits per second, enough to deliver ample ethernet bandwidth to satisfy business subscribers’ growing service requirements. This copper-based solution provides a compelling alternative to burying fiber and dedicating valuable fiber strands to long-haul ethernet services to small and medium enterprises.

The Zhone Strategy

Our strategy has been to combine internal development with acquisitions of established access equipment vendors to achieve the critical mass required of telecommunications equipment providers. We expect that our future growth will focus primarily on organic growth in emerging technology markets. Going forward, the key elements of our strategy include:

• Expand Our Infrastructure to Meet Service Provider Needs. Network service providers require extensive support and integration with manufacturers to deliver reliable, innovative and cost-effective services. By combining advanced, computer-aided design, test and manufacturing systems with experienced, customer-focused management and technical staff, we believe that we have established the critical mass required to fully support global service provider requirements. We continue to expand our infrastructure through ongoing development and strategic relationships, continuously improving quality, reducing costs and accelerating delivery of advanced solutions.

• Continue the Advancement and Introduction of Our SLMS Products. Our SLMS architecture is the cornerstone of our product development strategy. The design criteria for SLMS products include carrier-class reliability, multi-protocol and multi-service support, and ease of provisioning. We intend to continue to introduce SLMS products that offer the configurations and feature sets that our customers require. In addition, we have introduced products that adhere to the standards, protocols and interfaces dictated by international standards bodies and service providers. To facilitate the rapid development of our SLMS architecture and products, we have established engineering teams responsible for each critical aspect of the architecture and products. We intend to continue to leverage our expertise in voice, data and video technologies to enhance our SLMS architecture, supporting new services, protocols and technologies as they emerge. To further this objective, we intend to continue investing in research and development efforts to extend the SLMS architecture and introduce new SLMS products.

• Deliver Full Customer Solutions. In addition to delivering hardware and software product solutions, we provide customers with pre-sales and post-sales support, education and professional services to enable our customers to more efficiently deploy and manage their networks. We provide customers with application notes, business planning information, web-based and phone-based troubleshooting assistance and installation guides. Our support programs provide a comprehensive portfolio of support tools and resources that enable our customers to effectively sell to, support and expand their subscriber base using our products and solutions.

6

Product Portfolio

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 being shipped to customers. Our products span two distinct categories:

SLMS Products

Our SLMS products address three areas of customer requirements. 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. The Zhone Management System, or ZMS, product provides optional software tools to help manage aggregation and customer premises network hardware. These products deliver voice, data and video interface connectivity for broadcast and subscription television, internet routers and traditional telephony equipment.

Our SLMS products include:

Category	Product	Function
Broadband Aggregation and Service	MALC	Multi-Access Line Concentrator
	Raptor	Scalable DSLAM
	MALC-OLT	FTTx Optical Line Terminal
	4000 /8000 /12000	DSLAMs
Customer Premise Equipment (CPE)	EtherXtend	Ethernet Over Copper
	16xx, 17xx, 6xxx zNID	Wireline/Wireless DSL Modems Optical Network Terminals
Network and Subscriber Management	ZMS	Zhone Management System

Legacy, Service and Other Products

Our legacy products support a variety of voice and data services, and are broadly deployed by service providers worldwide. Our legacy products during 2008 and 2007 included:

Product	Function
IMACS	Multi-Access Multiplexer
Access Node	Access Concentrator
GigaMux	Optical Transport

In December 2007, we sold our legacy Access Node product line and in January 2008, we sold our legacy GigaMux product line.

Global Service & Support

In addition to our product offerings, we provide a broad range of service offerings through our Global Service & Support organization. We supplement our standard and extended product warranties with programs that offer technical support, product repair, education services and enhanced support services. These services enable our customers to protect their network investments, manage their networks more efficiently and minimize downtime for mission-critical systems. Technical support services are designed to help ensure that our products operate efficiently, remain highly available, and benefit from recent software releases. Through our education services program, we offer in-depth training courses covering network design, installation, configuration, operation, trouble-shooting and maintenance. Our enhanced services offering is a comprehensive program that

7

provides network engineering, configuration, integration, project management and other consultative support to maximize the results of our customers during the design, deployment and operational phases. As part of our commitment to ensure around-the-clock support, we maintain a technical assistance center and a staff of qualified network support engineers to provide customers with 24-hour service, seven days a week.

Technology

We believe that our future success is built upon our investment in the development of advanced technologies. SLMS is based on a number of technologies that provide sustainable advantages, including the following:

• Services-Centric Architecture. SLMS has been designed from inception for the delivery of multiple classes of subscriber services (such as voice, data or video distribution), rather than being based on a particular protocol or media. Our SLMS products are built to interoperate in networks supporting packet, cell and circuit technologies. This independence between services and the underlying transportation is designed to position our products to be able to adapt to future transportation technologies within established architectures and to allow our customers to focus on service delivery.

• Common Code Base. Our SLMS products share a common base of software code, which is designed to accelerate development, improve software quality, enable rapid deployment, and minimize training and operations costs, in conjunction with network management software.

• Network Management and Operations. Our ZMS product provides management capabilities that enable rapid, cost-effective, and secure control of the network; standards-based interfaces for seamless integration with supporting systems; hierarchical service and subscriber profiles to allow rapid service definition and provisioning, and to enable wholesaling of services; automated and intelligent CPE provisioning to provide the best end-user experience and accelerate service turn-up; load-balancing for scalability; and full security features to ensure reliability and controlled access to systems and data.

• Test Methodologies. Our SLMS architecture provides for interoperability with a variety of products that reside in networks in which we will deploy our products. To ensure interoperability, we have built a testing facility to conduct extensive multi-vendor trials and to ensure full performance under valid network conditions. Testing has included participation with partners’ certification and accreditation programs for a wide range of interoperable products, including softswitches, SAN equipment and management software. The successful completion of these processes is required by our largest customers to ensure interoperability with their existing software and systems.

• Acquired Technologies. Since our inception, we have completed twelve acquisitions pursuant to which we acquired products, technology and additional technical expertise.

Customers

We sell our products and services to network service providers that offer voice, data and video services to businesses, governments, utilities and residential consumers. Our global customer base includes regional, national and international telecommunications carriers. To date, our products are deployed by over 700 network service providers on six continents worldwide. No customer accounted for 10% or more of total revenue in 2008 or 2007.

Research and Development

The industry in which we compete is subject to rapid technological developments, evolving industry standards, changes in customer requirements, and continuing developments in communications service offerings. Our continuing ability to adapt to these changes, and to develop new and enhanced products, is a significant factor in maintaining or improving our competitive position and our prospects for growth. Therefore, we continue to make significant investments in product development.

8

We conduct the majority of our research and product development activities at our Oakland, California campus. In Oakland, we have built an extensive communications laboratory with hundreds of access infrastructure products from multiple vendors that serve as an interoperability and test facility. This facility allows us to emulate a communications 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, Largo, Florida, Westlake Village, California, and Portsmouth, New Hampshire.

Our product development activities focus on products to support both existing and emerging technologies in the segments of the communications industry that we consider viable revenue opportunities. We are actively engaged in continuing to refine our SLMS architecture, introducing new products under our SLMS architecture, and creating additional interfaces and protocols for both domestic and international markets.

We continue our commitment to invest in leading edge technology research and development. Our research and product development expenditures were $27.1 million, $32.7 million, and $36.1 million, in 2008, 2007 and 2006, respectively. All of our expenditures for research and product development costs, as well as stock-based compensation expense relating to research and product development, have been expensed as incurred. These amounts include stock-based compensation of $0.5 million, $0.7 million, and $1.6 million reported under Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R) for 2008, 2007, and 2006, respectively. We plan to continue to support the development of new products and features, while seeking to carefully manage associated costs through expense controls.

Intellectual Property

We seek to establish and maintain our proprietary rights in our technology and products through the use of patents, copyrights, trademarks and trade secret laws. We also seek to maintain our trade secrets and confidential information by nondisclosure policies and through the use of appropriate confidentiality agreements. We have obtained a number of patents and trademarks in the United States and in other countries. There can be no assurance, however, that these rights can be successfully enforced against competitive products in every jurisdiction. Although we believe the protection afforded by our patents, copyrights, trademarks and trade secrets has value, the rapidly changing technology in the networking industry and uncertainties in the legal process make our future success dependent primarily on the innovative skills, technological expertise, and management abilities of our employees rather than on the protection afforded by patent, copyright, trademark, and trade secret laws. In addition, we sold certain of our non-strategic patents for $1.1 million, $5.0 million, and $9.0 million in 2008, 2007, and 2006, respectively.

Many of our products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe, based upon past experience and standard industry practice, that such licenses generally could be obtained on commercially reasonable terms. Nonetheless, there can be no assurance that the necessary licenses would be available on acceptable terms, if at all. Our inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results and financial condition.

The communications industry is characterized by rapidly changing technology, a large number of patents, and frequent claims and related litigation regarding patent and other intellectual property rights. We cannot assure you that our patents and other proprietary rights will not be challenged, invalidated or circumvented, that others will not assert intellectual property rights to technologies that are relevant to us, or that our rights will give us a competitive advantage. In addition, the laws of some foreign countries may not protect our proprietary rights to the same extent as the laws of the United States.

9

Sales and Marketing

We have a sales presence in various domestic and foreign locations, and we sell our products and services both directly and indirectly through channel partners with support from our sales force. Channel partners include distributors, resellers, system integrators and service providers. These partners sell directly to end customers and often provide system installation, technical support, professional services and support services in addition to the network equipment sale. Our sales efforts are generally organized according to geographical regions:

• U.S. Sales. Our U.S. Sales organization establishes and maintains direct relationships with domestic customers, which include communication service providers, cable operators, independent operating companies, or IOCs, as well as competitive carriers, developers and utilities. In addition, this organization is responsible for managing our distribution and original equipment manufacturer, or OEM, partnerships.

• International Sales. Our International Sales organization targets foreign based service providers and is staffed with individuals with specific experience dealing with service providers in their designated international territories.

Our marketing team works closely with our sales, 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 products, generates contacts and leads within these targeted markets and performs outbound education and public relations.

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, 2008, our backlog was $4.2 million, as compared to $14.0 million at December 31, 2007. 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.

Competition

We compete in the communications equipment market, providing products and services for the delivery of voice, data and video services. This market is characterized by rapid change, converging technologies and a migration to solutions that offer superior advantages. These market factors represent both an opportunity and a competitive threat to us. We compete with numerous vendors, including Alcatel-Lucent, Calix, Huawei, and Occam Networks, among others. In addition, a number of companies have introduced products that address the same network needs that our products address, both domestically and abroad. The overall number of our competitors may increase, and the identity and composition of competitors may change. As we continue to expand our sales globally, we may see new competition in different geographic regions. Barriers to entry are relatively low, and new ventures to create products that do or could compete with our products are regularly formed. Many of our competitors have greater financial, technical, sales and marketing resources than we do.

The principal competitive factors in the markets in which we presently compete and may compete in the future include:

• product performance;

• interoperability with existing products;

• scalability and upgradeability;

• conformance to standards;

• breadth of services;

10

• reliability;

• ease of installation and use;

• geographic footprints for products;

• ability to provide customer financing;

• price;

• technical support and customer service; and

• brand recognition.

While we believe that we compete successfully with respect to each of these factors, we expect to face intense competition in our market. In addition, the inherent nature of communications networking requires interoperability. As such, we must cooperate and at the same time compete with many companies.

Manufacturing

We manufacture our products using a strategic combination of procurement from qualified suppliers, in-house manufacturing at our facility in Florida, and the use of original design manufactures (ODM) located in the Far East. Since our acquisition of Paradyne Networks, Inc., or Paradyne, in September 2005, we have been manufacturing a significant majority of our more complex products at our manufacturing facility in Florida.

Our parts and components are procured from a variety of qualified suppliers in the U.S., Far East, Mexico, and other countries around the world per our Approved Supplier List and detailed engineering specifications. We also acquire completed products from certain suppliers and configure and ship from our facility. Some of these purchases are significant. We purchase both standard off-the-shelf parts and components, which are generally available from more than one supplier, and single-source parts and components. We have generally been able to obtain adequate supplies to meet customer demand in a timely manner from our current vendors, or, when necessary, from alternate vendors. We believe that alternate vendors can be identified if current vendors are unable to fulfill our needs, or design changes can be made to employ alternate parts.

We design, specify, and monitor all of the tests that are required to meet our internal and external quality standards. Our manufacturing and test engineers work closely with our design engineers to ensure manufacturability and testability of our products, and to ensure that manufacturing and testing processes evolve as our technologies evolve. Our manufacturing engineers specify, build, or procure our test stations, establish quality standards and protocols, and develop comprehensive test procedures and processes to assure the reliability and quality of our products. These processes and tests are reviewed by our design engineers to ensure they meet the intent of the design. Products that are procured complete or partially complete are inspected, tested, and audited for quality control.

Our manufacturing quality system is ISO-9001 and is certified to ISO-9001 by our external registrar. ISO-9001 ensures our processes are documented, followed, and continuously improved. Internal audits are conducted on a regular schedule by our quality assurance personnel, and external audits are conducted by our external registrar every six months. Our quality system is based upon our model for quality assurance in design, development, production, installation, and service to ensure our products meet rigorous quality standards.

We believe that we have sufficient production capacity to meet current and future demand for our product offerings through a combination of existing and added capacity, additional employees, or the outsourcing of products or components.

11

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 communications companies. In international markets, our products must comply with standards issued by the European Telecommunications Standards Institute, or ETSI, and implemented and enforced by the telecommunications regulatory authorities of each nation.

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 our operations and manufacturing processes currently comply in all material respects with applicable environmental protection laws and regulations. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of our products. In addition, such regulations could require us to incur other significant expenses to comply with environmental regulations, including expenses associated with the redesign of any non-compliant product. From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. For example, in 2003 the European Union enacted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE), for implementation in European Union member states. We are aware of similar legislation that is currently in force or is being considered in the United States, as well as other countries. Our failure to comply with any of such regulatory requirements or contractual obligations could result in our being liable for costs, fines, penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the jurisdictions where these regulations apply.

Employees

As of December 31, 2008, we employed 359 individuals worldwide. We consider the relationships with our employees to be positive. Competition for technical personnel in our industry is intense. We believe that our future success depends in part on our continued ability to hire, assimilate and retain qualified personnel. To date, we believe that we have been successful in recruiting qualified employees, but there is no assurance that we will continue to be successful in the future.

Executive Officers

Set forth below is information concerning our executive officers and their ages as of December 31, 2008.

Name	Age	Position
Morteza Ejabat	58	Chief Executive Officer, President and Chairman of the Board of Directors
Kirk Misaka	50	Chief Financial Officer, Corporate Treasurer and Secretary

Morteza Ejabat is a co-founder of Zhone and has served as Chairman of the Board of Directors, President and Chief Executive Officer since June 1999. Prior to co-founding Zhone, from June 1995 to June 1999,

12

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.

Kirk Misaka has served as Zhone’s Corporate Treasurer since November 2000 and as Chief Financial Officer and Secretary since July 2003. Prior to joining Zhone, Mr. Misaka was a Certified Public Accountant with KPMG LLP from 1980 to 2000, becoming a partner in 1989. Mr. Misaka earned a B.S. and an M.S. in Accounting from the University of Utah, and an M.S. in Tax from Golden Gate University.

ITEM 1A. RISK FACTORS

Set forth below and elsewhere in this report and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report.

Our future operating results are difficult to predict and our stock price may continue to be volatile.

As a result of a variety of factors discussed in this report, our revenues for a particular quarter are difficult to predict. 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:

• commercial acceptance of our SLMS products;

• fluctuations in demand for network access products;

• the timing and size of orders from customers;

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

• new product introductions, enhancements or announcements by our competitors;

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

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

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

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

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

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

• changes in accounting rules, such as recording expenses for employee stock option grants;

• integrating and operating any acquired businesses;

• our ability to achieve targeted cost reductions;

• how well we execute on our strategy and operating plans; and

13

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

Any of the foregoing factors, or any other factors discussed elsewhere herein, could have a material adverse effect on our business, results of operations, and financial condition that could adversely affect our stock price. In addition, public stock markets have experienced, and may in the future experience, extreme price and trading volume volatility, particularly in the technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to or disproportionately impacted by the operating performance of these companies. These broad market fluctuations may adversely affect the market price of our common stock. In addition, if our average market capitalization falls below the carrying value of our assets for an extended period of time such as in 2008, this may indicate that the fair value of our net assets is below their carrying value, and may result in recording impairment charges.

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 continue to incur losses in the foreseeable future. Our net losses for 2008 and 2007 were $92.5 million and $12.1 million, respectively, and we had an accumulated deficit of $1,005.6 million at December 31, 2008. We have significant fixed expenses and expect that we will continue to incur substantial manufacturing, research and product development, sales and marketing, customer support, administrative and other expenses in connection with the ongoing development of our 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 acquisitions and the integration of new technologies and other acquisitions that may occur in the future. 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 significant debt obligations, which could adversely affect our business, operating results and financial condition.

As of December 31, 2008, we had approximately $34.1 million of total debt, of which $15.4 million was current and $18.7 million was long-term. Our debt obligations could materially and adversely affect us in a number of ways, including:

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

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

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

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

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

We cannot assure you that we will be able to generate sufficient cash flow in amounts sufficient to enable us to service our debt or to meet our working capital and capital expenditure requirements. If we are unable to

14

generate sufficient cash flow from operations or to borrow sufficient funds to service our debt, due to borrowing base restrictions or otherwise, we may be required to sell assets, reduce capital expenditures or obtain additional financing. We cannot assure you that we will be able to engage in any of these actions on reasonable terms, if at all.

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

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

• the market for our products develops more slowly than anticipated;

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

• our capital expenditure forecasts change or prove inaccurate; or

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

As a result, we may need to raise substantial additional capital. Additional capital, if required, may not be available on acceptable terms, or at all. For example, U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused the spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in debt markets, making financing terms for borrowers less attractive and resulting in the general unavailability of many forms of debt financing. Continued uncertainty in credit markets may negatively impact our ability to access debt financing or to refinance existing indebtedness in the future on favorable terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict our ability to operate our business. Likewise, equity financing could result in additional dilution of our stockholders. The recent events in the U.S. credit markets have also had an adverse effect on other U.S. financial markets and have adversely affected the trading prices of equity securities of many U.S. companies, including Zhone, which may make it more difficult or costly for us to raise capital through the issuance of common stock, preferred stock or other equity securities. If we are unable to obtain additional capital or are required to obtain additional capital on terms that are not favorable to us, we may be required to reduce the scope of our planned product development and sales and marketing efforts beyond the reductions that we have previously taken, which could have a material adverse effect on our business, financial condition and results of operations.

Our lack of liquid funds and other sources of financing may limit our ability to maintain our existing operations, grow our business and compete effectively.

Our continued losses reduced our cash, cash equivalents and short-term investments in 2007 and 2008. As of December 31, 2008, we had approximately $36.2 million in cash, cash equivalents and short-term investments and $15.0 million outstanding under our bank lending facility. In order to meet our liquidity needs and finance our capital expenditures and working capital needs for our business, we may be required to sell assets, or to borrow on potentially unfavorable terms. We may be unable to sell assets, or access additional indebtedness to meet these needs. As a result, we may become unable to pay our ordinary expenses, including our debt service, on a timely basis. Our current lack of liquidity could harm us by:

• increasing our vulnerability to adverse economic conditions in our industry or the economy in general;

• requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations;

15

• limiting our ability to plan for, or react to, changes in our business and industry; and

• influencing investor and customer perceptions about our financial stability and limiting our ability to obtain financing or acquire customers.

The recent downturn in the equity and debt markets generally makes it more difficult for us to obtain financing through the issuance of equity or debt securities in the capital markets. We cannot be certain that additional financing, if needed, will be available on acceptable terms or at all. If we cannot raise any necessary additional financing on acceptable terms, we may not be able to fund our business expansion, take advantage of future opportunities, meet our existing debt obligations or respond to competitive pressures or unanticipated capital requirements, any of which could have a material adverse effect on our business, financial condition and results of operations. Further, if we issue additional equity or debt securities, stockholders may experience additional dilution or the new equity securities may have rights, preference or privileges senior to those of existing holders of our common stock.

We face a number of risks related to unfavorable economic and market conditions and severe tightening in the global credit markets.

Recent global market and economic conditions have been unprecedented and challenging, with tighter credit conditions and recession in most major economies continuing into 2009. Continued concerns about the systemic impact of potential long-term and widespread recession, energy costs, geopolitical issues, the availability and cost of credit, and the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for western and emerging economies. In the second half of 2008, federal government interventions in the U.S. financial system led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels. These global unfavorable economic and market conditions and the financial crisis could impact our business in a number of ways, including:

Potential deferment of purchases and orders by customers: Uncertainty about current and future global economic conditions may cause consumers, businesses and governments to defer purchases in response to significant decreases in their revenues, tighter credit, decreased cash availability and declining consumer confidence. Accordingly, future demand for our products could differ materially from our current expectations.

Customers’ inability to obtain financing to make purchases from Zhone and/or maintain their business: Some of our customers require substantial financing in order to finance their business operations, including capital expenditures on new equipment and equipment upgrades, and make purchases from Zhone. The inability of these customers to access the capital needed to finance purchases of our products and meet their payment obligations to us could adversely impact our financial condition and results of operations. If the financial crisis results in insolvencies for our customers, it could have a material adverse impact on our business, financial condition and results of operations.

Negative impact from increased financial pressures on third-party dealers, distributors and retailers: We make sales in certain regions through third-party dealers, distributors and retailers. These third parties may be impacted by the significant decrease in available credit that has resulted from the current financial crisis. If credit pressures or other financial difficulties result in insolvency for these third parties and we are unable to successfully transition end customers to purchase our products from other third parties, or from us directly, it could adversely impact our financial condition and results of operations.

Negative impact from increased financial pressures on key suppliers: Our ability to meet customers’ demands depends, in part, on our ability to obtain timely and adequate delivery of quality materials, parts and components

16

from our suppliers. Certain of our components are available only from a single source or limited sources. If certain key suppliers were to become capacity constrained or insolvent as a result of the financial crisis, it could result in a reduction or interruption in supplies or a significant increase in the price of supplies and adversely impact our financial condition and results of operations. In addition, credit constraints of key suppliers could result in accelerated payment of accounts payable by Zhone, impacting our cash flow.

If the economic, market and geopolitical conditions in the United States and the rest of the world do not improve, or if they continue to deteriorate, we may experience material adverse impacts on our business, operating results and financial condition.

Our common stock may be delisted from The Nasdaq Global Market, which could negatively impact the price of our common stock and our ability to access the capital markets.

Our common stock is listed on The Nasdaq Global Market. On June 11, 2008, we received a letter from The Nasdaq Stock Market, or Nasdaq, indicating that, for the last 30 consecutive business days preceding the date of the letter, the bid price of our common stock had closed below the $1.00 minimum per share bid price required for continued inclusion on The Nasdaq Global Market under Marketplace Rule 4450(a)(5). In accordance with Marketplace Rule 4450(e)(2), we were given 180 calendar days from the date of the Nasdaq letter, or until December 8, 2008, to regain compliance with the minimum bid price rule. Our stock price has not closed above $1.00 since the date of the receipt of the letter from Nasdaq. On October 22, 2008, we received a letter from Nasdaq indicating that there was a temporary suspension of the minimum bid price rule through January 16, 2009. As a result, we were given until March 16, 2009 to regain compliance with the minimum bid price rule. On December 23, 2008, we received a letter from Nasdaq further extending the temporary suspension of the minimum bid price rule until April 20, 2009. Nasdaq has advised us that they will notify us of our new compliance deadline prior to the lifting of this suspension. We anticipate that we will have until June 2009 to regain compliance with the minimum bid price rule.

To regain compliance, the closing bid price of our common stock must be at or above $1.00 per share for a minimum of 10 consecutive business days. Nasdaq may, in its discretion, require us to maintain a bid price of at least $1.00 per share for a period in excess of 10 consecutive business days, but generally no more than 20 consecutive business days, before determining that we have demonstrated an ability to maintain long-term compliance. If we do not regain compliance by the applicable compliance deadline, Nasdaq will provide written notification to us that our common stock will be delisted. At that time, we may appeal Nasdaq’s delisting determination to a Nasdaq Listing Qualifications Panel. Alternatively, we could apply to transfer our common stock to The Nasdaq Capital Market if we satisfy all of the requirements, other than the minimum bid price requirement, for initial listing on The Nasdaq Capital Market set forth in Marketplace Rule 4310(c). If we were to elect to apply for such transfer and if such application were approved, we would have an additional 180 days to regain compliance with the minimum bid price rule while listed on The Nasdaq Capital Market. In October 2008, Zhone’s stockholders approved an amendment to our restated certificate of incorporation to effect a reverse stock split at an exchange ratio ranging from one-for-five to one-for-ten, with the exchange ratio determined by Zhone. We are currently actively monitoring the bid price for our common stock, and will consider available options to resolve the deficiency and regain compliance with the Nasdaq minimum bid price requirement.

Delisting from The Nasdaq Global Market could have an adverse effect on our business and on the trading of our common stock. If a delisting of our common stock were to occur, our common stock would trade on the OTC Bulletin Board or on the “pink sheets” maintained by the National Quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may be adversely impacted as a result. Delisting from The Nasdaq Global Market could also have other negative results, including the potential loss of confidence by suppliers and employees, the loss of institutional investor interest and fewer business development opportunities.

17

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 must convince our service provider customers that they will achieve substantial benefits by deploying 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.

We depend upon the development of new products and enhancements to existing products, and if we fail to predict and respond to emerging technological trends and customers’ changing needs, our operating results and market share may suffer.

The markets for our products are characterized by rapidly changing technology, evolving industry standards, changes in end-user requirements, frequent new product introductions and changes in communications offerings from network service provider customers. Our future success depends on our ability to anticipate or adapt to such changes and to offer, on a timely and cost-effective basis, products that meet changing customer demands and industry standards. We may not have sufficient resources to successfully and accurately anticipate customers’ changing needs and technological trends, manage long development cycles or develop, introduce and market new products and enhancements. The process of developing new technology is complex and uncertain, and if we fail to develop new products or enhancements to existing products on a timely and cost-effective basis, or if our new products or enhancements fail to achieve market acceptance, our business, financial condition and results of operations would be materially adversely affected.

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

We produce highly complex products that incorporate leading-edge technology, including both hardware and software. Software typically contains defects or programming flaws that can unexpectedly interfere with expected operations. In addition, our products are complex and are designed to be deployed in large quantities across complex networks. Because of the nature of these products, they can only be fully tested when completely deployed in large networks with high amounts of traffic, and there is no assurance that our pre-shipment testing programs will be adequate to detect all defects. As a result, our customers may discover errors or defects in our hardware or software, or our products may not operate as expected, after they have been fully deployed by our customers. If we are unable to cure a product defect, we could experience damage to our reputation, reduced customer satisfaction, loss of existing customers and failure to attract new customers, failure to achieve market acceptance, reduced sales opportunities, loss of revenue and market share, increased service and warranty costs, diversion of development resources, legal actions by our customers, and increased insurance costs. Defects, integration issues or other performance problems in our products could also result in financial or other damages to our customers. Our customers could seek damages for related losses from us, which could seriously harm our business, financial condition and results of operations. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly. The occurrence of any of these problems would seriously harm our business, financial condition and results of operations.

A shortage of adequate component supply or manufacturing capacity could increase our costs or cause a delay in our ability to fulfill orders, and our failure to estimate customer demand properly may result in excess or obsolete component inventories that could adversely affect our gross margins.

18

Occasionally, we may experience a supply shortage, or a delay in receiving, certain component parts as a result of strong demand for the component parts and/or capacity constraints or other problems experienced by suppliers. If shortages or delays persist, the price of these components may increase, or the components may not be available at all, and we may also encounter shortages if we do not accurately anticipate our needs. Conversely, we may not be able to secure enough components at reasonable prices or of acceptable quality to build new products in a timely manner in the quantities or configurations needed. Accordingly, our revenue and gross margins could suffer until other sources can be developed. Our operating results would also be adversely affected if, anticipating greater demand than actually develops, we commit to the purchase of more components than we need. Furthermore, as a result of binding price or purchase commitments with suppliers, we may be obligated to purchase components at prices that are higher than those available in the current market. In the event that we become committed to purchase components at prices in excess of the current market price when the components are actually used, our gross margins could decrease.

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

We rely on contract manufacturers to perform a portion of the manufacturing operations for our products. These contract manufacturers build product for other companies, including our competitors. In addition, we do not have contracts in place with some of these providers and may not be able to effectively manage those relationships. We cannot be certain that our contract manufacturers will be able to fill our orders in a timely manner. We face a number of risks associated with this dependence on contract manufacturers including reduced control over delivery schedules, the potential lack of adequate capacity during periods of excess demand, poor manufacturing yields and high costs, quality assurance, increases in prices, and the potential misappropriation of our intellectual property. We have experienced in the past, and may experience in the future, problems with our contract manufacturers, such as inferior quality, insufficient quantities and late delivery of products.

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

We currently purchase several key components from a limited number of suppliers. If any of our limited source of suppliers become insolvent, cease business or experience capacity constraints, work stoppages or any other reduction or disruption in output, they may be unable to meet our delivery schedules. Our suppliers may enter into exclusive arrangements with our competitors, be acquired by our competitors, stop selling their products or components to us at commercially reasonable prices, refuse to sell their products or components to us at any price or be unable to obtain or have difficulty obtaining components for their products from their suppliers. If we do not receive critical components from our limited source of suppliers in a timely manner, we will be unable to meet our customers’ product delivery requirements. Any failure to meet a customer’s delivery requirements could materially adversely affect our business, operating results and financial condition and could materially damage customer relationships.

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. While no customer accounted for more than 10% of our revenue in 2008 or 2007, we expect that 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.

19

Industry consolidation may lead to increased competition and may harm our operating results.

There has been a trend toward industry consolidation in the communications equipment market for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could have a material adverse effect on our business, financial condition and results of operations. Furthermore, rapid consolidation could result in a decrease in the number of customers we serve. Loss of a major customer could have a material adverse effect on our business, financial condition and results of operations.

We are exposed to the credit risk of some of our customers and to credit exposures in weakened markets, which could result in material losses.

The current financial crisis, industry and economic conditions have weakened the financial position of some of our customers and their ability to access capital to finance their business operations, including capital expenditures. To sell to some of these customers, we may be required to assume incremental risks of uncollectible accounts or to extend credit or credit support. While we monitor these situations carefully and attempt to take appropriate measures to protect ourselves, including factoring credit arrangements to financial institutions, it is possible that we may have to defer revenue until cash is collected or write down or write off uncollectible accounts. Such write-downs or write-offs, if large, could have a material adverse effect on our operating results and financial condition.

The market we serve is highly competitive and we may not be able to compete successfully.

Competition in the communications equipment market is intense. This market is characterized by rapid change, converging technologies and a migration to networking solutions that offer superior advantages. We are aware of many companies in related markets that address particular aspects of the features and functions that our products provide. Currently, our primary competitors include Alcatel-Lucent, Calix, Huawei, and Occam Networks, among others. We also may face competition from other large communications equipment companies or other companies that may enter our market in the future. In addition, a number of companies have introduced products that address the same network needs that our products address, both domestically and abroad. Many of our competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, sales and marketing resources than we do and may be able to undertake more extensive marketing efforts, adopt more aggressive pricing policies and provide more customer financing than we can. In particular, we are encountering price-focused competitors from Asia, especially China, which places pressure on us to reduce our prices. If our competitors offer deep discounts on certain products, we may need to lower prices or offer other favorable terms in order to compete successfully. Moreover, our competitors may foresee the course of market developments more accurately than we do and could develop new technologies that render our products less valuable or obsolete.

In our markets, principal competitive factors include:

• product performance;

• interoperability with existing products;

• scalability and upgradeability;

• conformance to standards;

• breadth of services;

• reliability;

20

• ease of installation and use;

• geographic footprints for products;

• ability to provide customer financing;

• price;

• technical support and customer service; and

• brand recognition.

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

Our success largely depends on our ability to retain and recruit key personnel, and any failure to do so would harm our ability to meet key objectives.

Our future success depends upon the continued services of our executive officers and our ability to identify, attract and retain highly skilled technical, managerial, sales and marketing personnel who have critical industry experience and relationships that we rely on to build our business, including Morteza Ejabat, our co-founder, Chairman, President and Chief Executive Officer, and Kirk Misaka, our Chief Financial Officer. The loss of the services of any of our key employees, including Messrs. Ejabat and Misaka, could delay the development and production of our products and negatively impact our ability to maintain customer relationships, which would harm our business, financial condition and results of operations.

Any strategic acquisitions or investments we make could disrupt our operations and harm our operating results.

As of December 31, 2008, we had acquired twelve companies or product lines since we were founded in 1999. Further, we may acquire additional businesses, products or technologies in the future. On an ongoing basis, we may evaluate acquisitions of, or investments in, complementary companies, products or technologies to supplement our internal growth. Also, in the future, we may encounter difficulties identifying and acquiring suitable acquisition candidates on reasonable terms.

If we do complete future acquisitions, we could:

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

• consume a substantial portion of our cash resources;

• incur substantial debt;

• assume liabilities;

• increase our ongoing operating expenses and level of fixed costs;

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

• incur amortization expenses related to certain intangible assets;

• incur large and immediate write-offs; and

• become subject to litigation.

21

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

• difficulties in integrating the operations, technologies, products and personnel of the acquired companies;

• unanticipated costs;

• diversion of management’s time and attention away from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions;

• difficulties in entering markets in which we have no or limited prior experience;

• insufficient revenues to offset increased expenses associated with acquisitions and where competitors in such markets have stronger market positions; and

• potential loss of key employees, customers, distributors, vendors and other business partners of the companies we acquire following and continuing after announcement of acquisition plans.

Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control, and we cannot be certain that our previous or future acquisitions will be successful and will not materially adversely affect our business, operating results or financial condition. 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.

Sales to communications service providers are especially volatile, and weakness in sales orders from this industry may harm our operating results and financial condition.

Sales activity in the service provider industry depends upon the stage of completion of expanding network infrastructures, the availability of funding, and the extent to which service providers are affected by regulatory, economic and business conditions in the country of operations. Although some service providers may be increasing capital expenditures over the depressed levels that have prevailed over the last few years, weakness in orders from this industry could have a material adverse effect on our business, operating results and financial condition. Slowdowns in the general economy, overcapacity, changes in the service provider market, regulatory developments and constraints on capital availability have had a material adverse effect on many of our service provider customers, with many of these customers going out of business or substantially reducing their expansion plans. These conditions have materially harmed our business and operating results, and we expect that some or all of these conditions may continue for the foreseeable future. Finally, service provider customers typically have longer implementation cycles; require a broader range of service including design services; demand that vendors take on a larger share of risks; often require acceptance provisions, which can lead to a delay in revenue recognition; and expect financing from vendors. All these factors can add further risk to business conducted with service providers.

Decreased effectiveness of share-based compensation could adversely affect our ability to attract and retain employees.

We have historically used stock options as a key component of our employee compensation program in order to align the interests of our employees with the interests of our stockholders, encourage employee retention and provide competitive compensation and benefit packages. In the first quarter of 2006, we adopted SFAS 123R, which required the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. As a result, starting with fiscal 2006, our operating results contain a charge for share-based compensation expense related to employee stock options and employee stock purchases. This charge is in addition to share-based compensation expense we have recognized in prior periods related to stock options under APB Opinion No. 25. As a result of the adoption of SFAS 123R, beginning with fiscal 2006, our earnings were lower than they would have been had we not been required to

22

adopt SFAS 123R. This will continue to be the case for future periods. We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock. If the trading price of our common stock declines, this would reduce the value of our share-based compensation to our present employees and could affect our ability to retain them. In addition, in recent periods, some of our employee stock options have had exercise prices in excess of our stock price, which reduces their value to employees and could affect our ability to retain present, or attract prospective employees. To address these issues, in the fourth quarter of 2008, we conducted an exchange offer, or the Exchange Offer, in which eligible employees, officers and directors of Zhone could exchange outstanding options to purchase shares of Zhone common stock previously granted under our equity incentive compensation plans with an exercise price per share equal to or greater than $0.35 on a one-for-one basis for the grant of new options to purchase shares of Zhone common stock. Options to acquire approximately 14.5 million shares of Zhone common stock were tendered in the Exchange Offer for new options with an exercise price of $0.10 per share. Difficulties relating to obtaining stockholder approval of equity compensation plans could also make it harder or more expensive for us to grant share-based payments to employees in the future.

Due to the international nature of our business, political or economic changes or other factors in a specific country or region could harm our future revenue, costs and expenses and financial condition.

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

• trade protection measures and other regulatory requirements which may affect our ability to import or export our products into or from various countries;

• political considerations that affect service provider and government spending patterns;

• differing technology standards or customer requirements;

• developing and customizing our products for foreign countries;

• fluctuations in currency exchange rates;

• longer accounts receivable collection cycles and financial instability of customers;

• difficulties and excessive costs for staffing and managing foreign operations;

• potentially adverse tax consequences; and

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

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

Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.

We are subject to a variety of federal, state, local and foreign environmental regulations. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of our products. In addition, such regulations could require us to incur other significant expenses to comply with environmental regulations, including expenses associated with the redesign of any non-compliant product. From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. For example, in 2003 the European Union enacted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment

23

Directive (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE), for implementation in European Union member states. We are aware of similar legislation that is currently in force or is being considered in the United States, as well as other countries, such as Japan and China. Our failure to comply with any of such regulatory requirements or contractual obligations could result in our being liable for costs, fines, penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the jurisdictions where these regulations apply.

Adverse resolution of litigation may harm our operating results or financial condition.

We are a party to various lawsuits and claims in the normal course of our business. Litigation can be expensive, lengthy, and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results and financial condition. For additional information regarding litigation in which we are involved, see Item 3, “Legal Proceedings,” contained in Part I of this report.

Our intellectual property rights may prove difficult to protect and enforce.

We generally rely on a combination of copyrights, patents, trademarks and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to and distribution of our proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our technology is difficult, and we do not know whether the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as extensively as in the United States. We cannot assure you that our pending, or any future, patent applications will be granted, that any existing or future patents will not be challenged, invalidated, or circumvented, or that any existing or future patents will be enforceable. While we are not dependent on any individual patents, if we are unable to protect our proprietary rights, we may find ourselves at a competitive disadvantage to others who need not incur the substantial expense, time and effort required to create the innovative products.

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

Third parties have in the past and may in the future assert claims or initiate litigation related to patent, copyright, trademark and other intellectual property rights to technologies and related standards that are relevant to us. The asserted claims or initiated litigation can include claims against us or our manufacturers, suppliers or customers alleging infringement of their proprietary rights with respect to our existing or future products, or components of those products. We have received correspondence from companies claiming that many of our products are using technology covered by or related to the intellectual property rights of these companies and inviting us to discuss licensing arrangements for the use of the technology. Regardless of the merit of these claims, intellectual property litigation can be time consuming and costly, and result in the diversion of technical and management personnel. Any such litigation could force us to stop selling, incorporating or using our products that include the challenged intellectual property, or redesign those products that use the technology. In addition, if a party accuses us of infringing upon its proprietary rights, we may have to enter into royalty or licensing agreements, which may not be available on terms acceptable to us, if at all. If we are unsuccessful in any such litigation, we could be subject to significant liability for damages and loss of our proprietary rights. Any of these results could have a material adverse effect on our business, financial condition and results of operations.

We rely on the availability of third party licenses.

Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various elements of the technology

24

used to develop these products. We cannot assure you that our existing and future third-party licenses will be available to us on commercially reasonable terms, if at all. Our inability to maintain or obtain any third-party license required to sell or develop our products and product enhancements could require us to obtain substitute technology of lower quality or performance standards, or at greater cost.

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

The target customers for our products have substantial and complex networks that they traditionally expand in large increments on a periodic basis. Accordingly, our marketing efforts are focused primarily on prospective customers that may purchase our products as part of a large-scale network deployment. Our target customers typically require a lengthy evaluation, testing and product qualification process. Throughout this process, we are often required to spend considerable time and incur significant expense educating and providing information to prospective customers about the uses and features of our products. Even after a company makes the final decision to purchase our products, it may deploy our products over extended periods of time. The timing of deployment of our products varies widely, and depends on a number of factors, including our customers’ skill sets, geographic density of potential subscribers, the degree of configuration and integration required to deploy our products, and our customers’ ability to finance their purchase of our products as well as their operations. As a result of any of these factors, our revenue and operating results may vary significantly from quarter to quarter.

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

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

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

At December 31, 2008, our executive officers, directors and entities affiliated with them beneficially owned, in the aggregate, approximately 32% of our outstanding common stock. These stockholders, if acting together, will be able to influence substantially all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. Circumstances may arise in which the interests of these stockholders could conflict with the interests of our other stockholders. These stockholders could delay or prevent a change in control of our company even if such a transaction would be beneficial to our other stockholders. In addition, provisions of our certificate of incorporation, bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to certain stockholders.

Our business and operations are especially subject to the risks of earthquakes and other natural catastrophic events.

Our corporate headquarters, including a significant portion of our research and development operations, are located in Northern California, a region known for seismic activity. Additionally, some of our facilities,

25

including our manufacturing facilities, are located near geographic areas that have experienced hurricanes in the past. A significant natural disaster, such as an earthquake, hurricane, fire, flood or other catastrophic event, could severely affect our ability to conduct normal business operations, and as a result, our future operating results could be materially and adversely affected.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our worldwide headquarters are located at our Oakland, California campus. In March 2001, 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 the lender and were required to transfer the land and buildings to a new wholly-owned consolidated subsidiary, Zhone Technologies Campus, LLC, from which we currently 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 campus consists of three buildings with an aggregate of approximately 180,000 square feet, and is used for our executive offices, research and product development activities, and administrative and marketing activities.

In addition to our Oakland campus, we also lease facilities for manufacturing, research and development purposes at locations including Largo, Florida, Alpharetta, Georgia, Portsmouth, New Hampshire and Westlake Village, California. We also maintain smaller offices to provide sales and customer support at various domestic and international locations. We believe that our existing facilities are suitable and adequate for our present purposes.

ITEM 3. LEGAL PROCEEDINGS

Paradyne Matters

As a result of our acquisition of Paradyne, we became involved in various legal proceedings, claims and litigation, including those identified below, relating to the operations of Paradyne prior to our acquisition of Paradyne.

A purported stockholder class action complaint was filed in December 2001 in the United States District Court in the Southern District of New York against Paradyne, Paradyne’s then-current directors and executive officers, and each of the underwriters (the “Underwriter Defendants”) who participated in Paradyne’s initial public offering and follow-on offering (collectively, the “Paradyne Offerings”). The complaint alleges that, in connection with the Paradyne Offerings, the Underwriter Defendants charged excessive commissions, inflated transaction fees not disclosed in the applicable registration statements and allocated shares of the Paradyne Offerings to favored customers in exchange for purported promises by such customers to purchase additional shares in the aftermarket, thereby allegedly inflating the market price for the Paradyne Offerings. The complaint seeks damages in an unspecified amount for the purported class for the losses suffered during the class period. This action has been consolidated with hundreds of other securities class actions commenced against more than 300 companies (collectively, the “Issuer Defendants”) and approximately 40 investment banks in which the plaintiffs make substantially similar allegations as those made against Paradyne with respect to the initial public offerings and/or follow-on offerings at issue in those other cases. All of these actions have been consolidated before Judge Shira Scheindlin under the caption In re: Initial Public Offering Securities Litigation (the “IPO Actions”).

In 2003, the Issuer Defendants participated in a global settlement among the plaintiffs and the insurance companies that provided directors’ and officers’ insurance coverage to the Issuer Defendants (the “Issuer

26

Settlement”). The Issuer Settlement agreements provided for the Issuer Defendants (including Paradyne) to be fully released and dismissed from the IPO Actions. Under the terms of the Issuer Settlement agreements, Paradyne would not have been required to make any cash payment to the plaintiffs. Although the District Court preliminarily approved the Issuer Settlement, the preliminary approval remained subject to a future final settlement order, after notice of settlement had been provided to class members and they had been afforded the opportunity to oppose or opt out of the settlement. However, before the District Court could conduct its final settlement hearing, on December 5, 2006, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) reversed an October 13, 2004 order of the District Court in which Judge Scheindlin had granted class certification for six “test cases” in the IPO Actions. On April 4, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of the December 5, 2006 ruling. The District Court has since made clear that the Issuer Settlement cannot be approved — in its current form — as a class action settlement in light of the Second Circuit’s December 5, 2006 ruling and has declined to schedule a final approval hearing with respect to the Issuer Settlement for that reason. Counsel for the plaintiffs, for the Issuer Defendants and for the insurance companies that provided directors’ and officers’ insurance to the Issuer Defendants are currently engaged in discussions to restructure and salvage the Issuer Settlement. There can be no assurance that a restructured Issuer Settlement will be reached by the parties or that any such future settlement will meet the conditions for final approval by the District Court.

Other Matters

We are 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, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On October 16, 2008, Zhone held a special meeting of stockholders to vote on the following five proposals:

Proposal 1: To approve an amendment to Zhone’s restated certificate of incorporation to effect a reverse stock split, pursuant to which the existing shares of Zhone common stock would be combined into new shares of Zhone common stock at an exchange ratio ranging from one-for-five to one-for-ten, with the exchange ratio to be determined by Zhone, and the total number of shares of common stock that Zhone is authorized to issue would be correspondingly reduced.

For	Against	Abstentions	Not Voted
124,717,786	9,748,667	1,010,979	0

Proposal 2: To approve an amendment to the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan to (a) permit the repricing of stock options and (b) increase the number of shares of common stock reserved for issuance by 1,700,000.

For	Against	Abstentions	Not Voted
44,378,784	25,936,690	458,435	64,703,523

Proposal 3: To approve an amendment to the Zhone Technologies, Inc. 1999 Stock Option Plan to permit the repricing of stock options.

For	Against	Abstentions	Not Voted
44,604,940	25,717,966	451,003	64,703,523

27

Proposal 4: To approve an amendment to the Paradyne Networks, Inc. 2000 Broad-Based Stock Plan to permit the repricing of stock options.

For	Against	Abstentions	Not Voted
44,557,758	25,754,910	461,241	64,703,523

Proposal 5: To approve an amendment to the Paradyne Networks, Inc. Amended and Restated 1996 Equity Incentive Plan to permit the repricing of stock options.

For	Against	Abstentions	Not Voted
44,604,428	25,754,910	461,241	64,703,523

28

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

Our common stock is listed on the Nasdaq Global Market under the symbol “ZHNE”. The following table sets forth, for the periods indicated, the high and low per share sales prices of our common stock as reported on Nasdaq.

2008:
	High		Low
Fourth Quarter ended December 31, 2008	$	0.28	$	0.05
Third Quarter ended September 30, 2008		0.76		0.16
Second Quarter ended June 30, 2008		1.07		0.70
First Quarter ended March 31, 2008		1.22		0.86
2007:
	High		Low
Fourth Quarter ended December 31, 2007	$	1.64	$	1.16
Third Quarter ended September 30, 2007		1.45		1.06
Second Quarter ended June 30, 2007		1.58		1.17
First Quarter ended March 31, 2007		1.37		1.12

As of December 31, 2008, there were 1,534 registered stockholders of record. A substantially greater number of holders of Zhone common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.

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.

Recent Sales of Unregistered Securities

There were no unregistered sales of equity securities during 2008.

29

ITEM 6. SELECTED FINANCIAL DATA

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.” During the years ended December 31, 2008, 2007, 2006, 2005 and 2004, we recorded charges of $70.4 million, zero, $113.7 million, $102.1 million, and $0.2 million, respectively, related to the impairment of acquisition related intangibles and goodwill as discussed in Note 3 to the consolidated financial statements.

	As of December 31,
	2008			2007			2006			2005			2004
	(in thousands, except per share data)
Statement of Operations Data:
Net revenue	$	146,160		$	175,448		$	194,344		$	151,828		$	97,168
Cost of revenue (1)		101,096			116,370			131,749			88,958			55,305
Gross profit		45,064			59,078			62,595			62,870			41,863
Operating expenses:
Research and product development (1)		27,063			32,720			36,099			27,062			23,791
Sales and marketing (1)		28,269			33,192			38,225			29,756			22,417
General and administrative (1)		15,609			10,170			14,036			14,534			10,772
Purchased in-process research and development		—			—			—			1,190			8,631
Gain on sale of fixed assets		(455	)		(659	)		—			—			—
Gain on sale of intangible assets		(4,397	)		(5,000	)		—			—			—
Amortization of intangible assets		—			—			2,764			12,452			9,893
Impairment of intangible assets and goodwill		70,401			—			113,666			102,106			239
Total operating expenses		136,490			70,423			204,790			187,100			75,743
Operating loss		(91,426	)		(11,345	)		(142,195	)		(124,230	)		(33,880	)
Interest expense		(1,625	)		(2,213	)		(2,774	)		(3,357	)		(3,991	)
Interest income		708			1,813			2,328			1,433			1,312
Other income (expense), net		78			37			239			(522	)		1,118
Loss before income taxes		(92,265	)		(11,708	)		(142,402	)		(126,676	)		(35,441	)
Income tax provision		270			394			264			215			205
Net loss	$	(92,535	)	$	(12,102	)	$	(142,666	)	$	(126,891	)	$	(35,646	)
Basic and diluted net loss per share	$	(0.62	)	$	(0.08	)	$	(0.96	)	$	(1.13	)	$	(0.42	)
Shares used in per-share calculation		150,342			149,623			148,727			112,004			85,745
(1) Amounts include stock-based compensation cost as follows:
Cost of revenue	$	158		$	296		$	892		$	153		$	210
Research and product development		479			717			1,632			223			581
Sales and marketing		511			603			1,380			226			459
General and administrative		1,203			1,250			1,601			2,670			356
	As of December 31,
	2008			2007			2006			2005			2004
	(in thousands)
Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	36,243		$	50,165		$	64,310		$	71,140		$	65,216
Working capital		62,007			77,496			83,872			102,521			71,789
Total assets		123,449			223,406			240,182			380,105			325,227
Long-term debt, including current portion		19,078			19,405			27,049			29,767			41,313
Stockholders’ equity	$	59,297		$	149,547		$	157,604		$	291,789		$	229,784

30

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We believe that we are the first company dedicated solely to developing the full spectrum of next-generation access network solutions to cost-effectively deliver high bandwidth services while simultaneously preserving the investment in today’s networks. Our next-generation solutions are based upon our Single Line Multi Service, or SLMS, architecture. From its inception, this SLMS architecture was specifically designed for the delivery of multiple classes of subscriber services (such as voice, data and video distribution), rather than being based on a particular protocol or media. In other words, our SLMS products are built to support the migration from legacy circuit to packet technologies and from copper to fiber technologies. This flexibility and versatility allows our products to adapt to future technologies while allowing service providers to focus on the delivery of additional high bandwidth services. Because this SLMS architecture is designed to interoperate with existing legacy equipment, service providers can leverage their existing networks to deliver a combination of voice, data and video services today, while they migrate, either simultaneously or at a future date, from legacy equipment to next-generation equipment with minimal interruption. We believe that our SLMS solution provides an evolutionary path for service providers from their existing infrastructures, as well as gives newer service providers the capability to deploy cost-effective, multi-service networks that can support voice, data and video.

Our product offerings fall within two categories: (1) the SLMS product family and (2) legacy, services, and other. Commencing with the first quarter of 2007, we have reported our optical transport business with our legacy, services and other product category. We have reclassified prior period balances in order to conform to the current period’s presentation. We sold our legacy iMarc product line in December 2006, our legacy Access Node product line in December 2007 and our legacy GigaMux product line in January 2008.

Our global customer base includes regional, national and international telecommunications carriers. To date, our products are deployed by over 700 network service providers on six continents worldwide. We believe that we have assembled the employee base, technological breadth and market presence to provide a simple yet comprehensive set of next-generation solutions to the bandwidth bottleneck in the access network and the other problems encountered by network service providers when delivering communications services to subscribers.

Since inception, we have incurred significant operating losses and had an accumulated deficit of $1,005.6 million as of December 31, 2008.

Going forward, our key financial objectives include the following:

• Increasing revenue while continuing to carefully control costs;

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

• Minimizing consumption of our cash and short-term investments.

Recent global market and economic conditions have been unprecedented and challenging, with tighter credit conditions and recession in most major economies continuing into 2009. Continued concerns about the systemic impact of potential long-term and widespread recession, energy costs, geopolitical issues, the availability and cost of credit, and the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for western and emerging economies. In the second half of 2008, federal government interventions in the U.S. financial system led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have contributed to volatility of unprecedented levels. These global unfavorable economic and market conditions and the financial crisis may result in an adverse effect on our financial condition and results of operations.

31

Sale of Legacy Inventory and Other Assets

In January 2008, we sold our GigaMux legacy product line to a third party. The sale of the GigaMux legacy product line was not treated as a discontinued operation since it did not represent a component of the company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. We allocated the proceeds received to receivables, inventory, fixed assets and intangible assets based on the relative fair value of the assets sold. We recognized a gain of $1.3 million on the sale of the inventory related to this product line in the first quarter of 2008 that was recorded in cost of revenue. We also recognized a gain of $0.5 million and $3.2 million on the sale of fixed assets and intangible assets, respectively, in the first quarter of 2008 that was recorded as a component of operating expenses. We are entitled to additional contingent consideration for the sale of the GigaMux legacy product line upon the buyer’s usage of inventory and/or attainment of certain performance targets through December 2010. Additional contingent consideration, if any, will be recorded upon receipt of cash as an additional gain in cost of revenue. During 2008, we received contingent consideration of $1.1 million related to the buyer’s usage of inventory related to the GigaMux legacy product line.

In December 2007, we sold inventory and certain assets related to our Access Node legacy product line to a third party. The sale of the Access Node product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon sale of the Access Node inventory, we recognized a gain of $1.7 million in 2007 that was recorded in cost of revenue. In 2008, we recognized an additional gain of $0.2 million that was recorded in cost of revenue. We will continue to record additional gain in the future contingent upon attainment of certain earnout provisions. In addition to the sale of the inventory, we also sold fixed assets related to the Access Node product line, which resulted in a gain of $0.7 million in 2007 that was recorded as a component of operating expenses.

During December 2006, we entered into an agreement to sell inventory and certain assets related to our iMarc legacy product line to a third party. The sale of the iMarc legacy product line was not treated as a discontinued operation since it did not represent a component of the company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon the performance of certain obligations and delivery of the assets in the first quarter of 2007, we recognized a gain of $1.8 million that was recorded in cost of revenue. Upon the sale of the remaining iMarc inventory during the second quarter of 2007, we recognized an additional gain of $1.1 million that was recorded in cost of revenue.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The policies discussed below are considered by management to be critical because changes in such estimates can materially affect the amount of our reported net income or loss. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions.

Revenue Recognition

We recognize revenue when the earnings process is complete. We recognize product revenue upon shipment of product under contractual terms which transfer title to customers upon shipment, under normal credit terms, 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

32

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 post-warranty support. For multiple element revenue arrangements, we establish the fair value of these products and services based primarily on sales prices when the products and services are sold separately. If fair value cannot be established for undelivered elements, all of the revenue under the arrangement is deferred until those elements have been delivered. 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. Return privileges generally allow distributors to return inventory based on a percent of purchases made within a specific period of time. We recognize revenue on sales to distributors that have contractual return rights when the products have been sold by the distributors, unless there is sufficient customer specific sales and sales returns history to support revenue recognition upon shipment. In those instances when revenue is recognized upon shipment to distributors, we use historical rates of return from the distributors to provide for estimated product returns in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 48, Revenue Recognition When Right of Return Exists. 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. The allowance for doubtful accounts is recorded as a charge to general and administrative expenses. We base our allowance on periodic assessments of our customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement reviews and historical collection trends. Additional allowances may be required in the future if the liquidity or financial condition of our customers deteriorates, resulting in impairment in their ability to make payments.

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

Our long-lived assets have consisted primarily of goodwill, other acquisition-related intangible assets and property and equipment. We review goodwill for impairment in November of each year, or more frequently if events or circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142). Such events or circumstances include, but are not limited to, a significant decrease in the benefits realized from an acquired business, difficulty and delays in integrating an acquired business, a significant change in the operations of an acquired business, or significant negative economic trends, such as stock price movements. The provisions of SFAS 142 require that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. We have determined that we operate in a single segment with one operating unit. We estimate the fair value of our reporting unit 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. If the fair value of the reporting unit exceeds the carrying value, goodwill is not impaired and we are not required to perform further testing. If the carrying value exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit. An impairment loss is recognized to the extent that the carrying amount exceeds the implied fair value of the reporting unit.

33

During 2008, 2006 and 2005, we determined that indicators of impairment existed, resulting in an impairment charge to goodwill of $70.4 million, $110.5 million and $55.2 million, respectively. As of December 31, 2008, we had no remaining goodwill.

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review long-lived assets, including intangible assets subject to amortization and property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable based on expected undiscounted cash flows attributable to that asset. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future net undiscounted cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset.

During 2006 and 2005, we determined that indicators of impairment related to our intangible assets existed and an impairment analysis was performed, resulting in an impairment loss to amortizable intangible assets of $3.2 million and $46.9 million, respectively. As a result of the impairment charges, our amortizable intangible assets at December 31, 2008 and December 31, 2007 were zero. At December 31, 2008, our other long-lived assets consisted of $20.0 million of net property and equipment.

Stock-Based Compensation

We estimate the fair value of stock-based payment awards on the date of grant using the Black Scholes pricing model, which is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee option exercise behaviors, risk free interest rate and expected dividends. The expected stock price volatility is based on the weighted average of the historical volatility of our common stock over the most recent period commensurate with the estimated expected life of our stock options. We base our expected life assumption on our historical experience and on the terms and conditions of the stock awards we grant to employees. Risk free interest rates reflect the yield on zero-coupon U.S. Treasury securities. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero.

If factors change, and we employ different assumptions for estimating stock-based compensation expense in future periods, or if we decide to use a different valuation model, the future periods may differ significantly from what we have recorded in the current period and could materially affect our operating income, net loss and net loss per share. We are also required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.

Fair value stock-based compensation expense under SFAS 123R (revised 2004), Share-Based Payment (SFAS 123R), for the year ended December 31, 2008 includes compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro-forma provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In conjunction with the provisions of SFAS 123R, we changed our method of attributing the value of stock-based compensation to expense from the accelerated method to the straight line method. Compensation expense for all employee share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the accelerated method while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 is recognized using the straight line method.

34

In addition, stock-based compensation expense was recorded for options issued to non-employees. These options are generally immediately exercisable and expire seven to ten years from the date of grant. We value non-employee options using the Black Scholes model. Non-employee options subject to vesting are valued as they become vested.

In November 2008, we completed our Exchange Offer to exchange certain stock options issued to eligible employees, officers and directors of Zhone under Zhone’s equity incentive compensation plans. Stock options previously granted that had an exercise price per share of equal to or greater than $0.35 per share were eligible to be exchanged on a one-for-one basis for new stock options with an exercise price equal to the last reported sale price of Zhone common stock on The Nasdaq Global Market on the date of grant. Options for an aggregate of 14.5 million shares of common stock were exchanged. The new stock options issued pursuant to the Exchange Offer have an exercise price of $0.10, will vest over a four-year period with no credit for past vesting and have a seven-year term. The Exchange Offer will result in incremental stock-based compensation of approximately $0.7 million to be recognized over the four-year vesting period. The remaining unrecognized compensation expense of the original grant will be amortized over the original requisite service period. The primary purpose of the Exchange Offer was to motivate, retain and reward talented employees and directors.

Inventories

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

Operating Lease Liabilities

As a result of our acquisition of Paradyne in September 2005, we assumed certain lease liabilities for facilities in Largo, Florida. In accordance with Emerging Issues Task Force Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (EITF 95-3), we accrued a liability for the excess portion of these facilities. The computation of the estimated liability includes a number of assumptions and subjective variables. These variables include the level and timing of future sublease income, amount of contractual variable costs, future market rental rates, discount rate, and other estimated expenses. If circumstances change, and we employ different assumptions in future periods, the lease liability may differ significantly from what we have recorded in the current period and could materially affect our net loss and net loss per share. During the second quarter of 2008, we increased the excess lease liability balance by $3.3 million with a corresponding charge to general and administrative expenses.

35

RESULTS OF OPERATIONS

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

	Year Ended December 31,
	2008		2007		2006
Net revenue	100	%	100	%	100	%
Cost of revenue	69	%	66	%	68	%
Gross profit	31	%	34	%	32	%
Operating expenses:
Research and product development	19	%	19	%	19	%
Sales and marketing	19	%	19	%	20	%
General and administrative	11	%	6	%	7	%
Gain on sale of fixed assets	0	%	0	%	0	%
Gain on sale of intangible assets	(3	)%	(3	)%	0	%
Amortization of intangible assets	0	%	0	%	1	%
Impairment of intangible assets and goodwill	48	%	0	%	58	%
Total operating expenses	94	%	41	%	105	%
Operating loss	(63	)%	(7	)%	(73	)%
Interest expense	(1	)%	(1	)%	(1	)%
Interest income	1	%	1	%	1	%
Other income	0	%	0	%	0	%
Loss before income taxes	(63	)%	(7	)%	(73	)%
Income tax provision	0	%	0	%	0	%
Net loss	(63	)%	(7	)%	(73	)%

2008 COMPARED WITH 2007

Revenue

Information about our revenue for products and services for 2008 and 2007 is summarized below (in millions):

	2008		2007		Decrease			% change
Products	$	141.9	$	164.6	$	(22.7	)	(14	)%
Services		4.3		10.8		(6.5	)	(60	)%
	$	146.2	$	175.4	$	(29.2	)	(17	)%

36

Information about our revenue for North America and International markets for 2008 and 2007 is summarized below (in millions):

	2008		2007		Increase (Decrease)			% change
Revenue by geography:
United States	$	60.8	$	79.4	$	(18.6	)	(23	)%
Canada		5.4		10.5		(5.1	)	(49	)%
Total North America		66.2		89.9		(23.7	)	(26	)%
Latin America		32.2		37.8		(5.6	)	(15	)%
Europe, Middle East, Africa		43.9		42.2		1.7		4	%
Asia Pacific		3.9		5.5		(1.6	)	(29	)%
Total International		80.0		85.5		(5.5	)	(6	)%
Total	$	146.2	$	175.4	$	(29.2	)	(17	)%

Total revenue decreased 17% or $29.2 million to $146.2 million for 2008 compared to $175.4 million for 2007 of which $24.5 million of the decrease was due to the sales of our Access Node and GigaMux legacy product lines in December 2007 and January 2008, respectively.

Product revenue accounted for the majority of the total decrease in revenue. In 2008, product revenue decreased 14% or $22.7 million and service revenue decreased 60% or $6.5 million compared to 2007. Service revenue represents revenue from maintenance and other services associated with product shipments.

International revenue decreased 6% or $5.5 million to $80.0 million in 2008 and represented 55% of total revenue compared with 49% in 2007. The increase in the concentration of international revenue represents the relative demand for our next-generation products in both existing and new network deployments among emerging international carriers compared to carriers in developed countries. Revenues in North America were adversely impacted by sale of legacy product lines, the global economic recession and credit contraction which caused many of our customers to defer or reduce their network expansion in 2008.

While no customer accounted for 10% or more of net revenue in 2008 or 2007, we anticipate that our results of operations in any given period may 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 and Gross Profit

Total cost of revenue, including stock-based compensation, decreased $15.3 million, or 13% to $101.1 million for 2008, compared to $116.4 million for 2007. Total cost of revenue was 69% of revenue for 2008, compared to 66% of revenue for 2007. Gross profit percentage decreased from 34% in 2007 to 31% in 2008 due to an overall decline in net revenue and product mix. Personnel-related costs for 2008 decreased over 2007 by $2.4 million due to headcount reductions as a result of the consolidation of our manufacturing operations into one facility.

In December 2006, we entered into an agreement to sell inventory and certain assets related to our iMarc legacy product line to a third party. The sale of the iMarc product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon performance of certain obligations and delivery of assets in the first quarter of 2007, we recognized a gain of $1.8 million that was recorded in cost of revenue. Upon sale of the remaining iMarc inventory during the second quarter of 2007, we recognized an additional gain of $1.1 million that was recorded in cost of revenue.

37

In December 2007, we sold inventory and certain assets related to our Access Node legacy product line to a third party. The sale of the Access Node product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon sale of the Access Node inventory, we recognized a gain of $1.7 million that was recorded in cost of revenue in 2007. In 2008, we recognized an additional gain of $0.2 million that was recorded in cost of revenue. We will continue to record additional gain in the future contingent upon attainment of certain earnout provisions.

In January 2008, we sold inventory and certain assets related to our GigaMux legacy product line to a third party. The sale of the GigaMux legacy product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon sale of the GigaMux legacy product line, we recognized a gain of $1.3 million during the first quarter of 2008 that was recorded in cost of revenue. Additional gains of $1.1 million were recognized in 2008 related to certain earnout provisions which were recorded in cost of revenue.

We expect that in the future, our cost of revenue will also vary as a percentage of net revenue depending on the mix and average selling prices of products sold in the future. 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 17% or $5.6 million to $27.1 million for 2008 compared to $32.7 million for 2007. The decrease was primarily due to restructuring efforts to streamline processes which reduced personnel-related costs by $4.1 million and prototype costs by $0.5 million. 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 15% or $4.9 million to $28.3 million for 2008 compared to $33.2 million for 2007. The decrease was primarily attributable to reduced personnel-related costs of $2.5 million from lower headcount as we realigned our resources to focus on emerging markets and also due to lower commission expenses of $1.1 million related to decreased sales, and reduced travel expenses of $0.7 million.

General and Administrative Expenses

General and administrative expenses increased 53% or $5.4 million to $15.6 million for 2008 compared to $10.2 million for 2007. During the second quarter of 2008, we significantly reduced our assumptions regarding estimated future sublease income primarily as a result of the deteriorating real estate market. Accordingly, during the second quarter of 2008, we increased the excess lease liability for our Largo, Florida facility by $3.3 million with a corresponding charge to general and administrative expenses. In addition, the general and administrative expenses increased over prior year due to a higher allocation of facility-related expenses of $1.9 million due to consolidation of certain facilities.

Gain on sale of fixed assets

Gain on sale of fixed assets decreased $0.2 million to $0.5 million for 2008 compared to $0.7 million for 2007. The gain in 2008 was attributable to the sale of fixed assets associated with our sale of the GigaMux legacy product line in January 2008, while the gain in 2007 was primarily attributable to the sale of fixed assets associated with our sale of the Access Node legacy product line in December 2007.

38

Gain on sale of intangible assets

Gain on sale of intangible assets decreased $0.6 million to $4.4 million for 2008 compared to $5.0 million for 2007. The gain in 2008 was attributable to the sale of intangible assets related to our GigaMux legacy product line sold in January 2008 and the sale of non-strategic legacy patents. The gain in 2007 was attributable to the sale of non-strategic legacy patents.

Impairment of Intangible Assets and Goodwill

We review goodwill and other long-lived assets, including intangible assets, for impairment annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. In June 2008, we reviewed goodwill for impairment due to the significant decrease in our market capitalization in the three months ended June 30, 2008 as well as subsequent to period end. We determined that indicators of impairment existed, resulting in a goodwill impairment loss of $70.4 million during the second quarter of 2008. No impairment of goodwill or intangible assets was recorded in 2007.

Interest Expense

Interest expense for 2008 decreased by $0.6 million to $1.6 million compared to $2.2 million in 2007 due to a decrease in the outstanding debt balances and a reduction in interest rates during 2008.

Interest Income

Interest income for 2008 decreased by $1.1 million to $0.7 million compared to $1.8 million in 2007 due to lower average balances of cash and short-term investments and a reduction in interest rates during 2008.

Income Tax Provision

During the years ended December 31, 2008 and 2007, we recorded an income tax provision of $0.3 million and $0.4 million, respectively, related to foreign and state taxes. No material provision or benefit for income taxes was recorded in 2008 and 2007, due to our recurring operating losses and the significant uncertainty regarding the realization of our net deferred tax assets, against which we have continued to record a full valuation allowance.

2007 COMPARED WITH 2006

Revenue

Information about our revenue for products and services for 2007 and 2006 is summarized below (in millions):

	2007		2006		Decrease			% change
Products	$	164.6	$	181.9	$	(17.3	)	(10	)%
Services		10.8		12.4		(1.6	)	(13	)%
	$	175.4	$	194.3	$	(18.9	)	(10	)%

39

Information about our revenue for North America and International markets for 2007 and 2006 is summarized below (in millions):

	2007		2006		Increase (Decrease)			% change
Revenue by geography:
United States	$	79.4	$	105.1	$	(25.7	)	(24	)%
Canada		10.5		10.6		(0.1	)	(1	)%
Total North America		89.9		115.7		(25.8	)	(22	)%
Latin America		37.8		25.2		12.6		50	%
Europe, Middle East, Africa		42.2		45.4		(3.2	)	(7	)%
Asia Pacific		5.5		8.0		(2.5	)	(31	)%
Total International		85.5		78.6		6.9		9	%
Total	$	175.4	$	194.3	$	(18.9	)	(10	)%

Total revenue decreased 10% or $18.9 million to $175.4 million for 2007 compared to $194.3 million for 2006. The decrease in total revenue was due to decreased demand for our legacy, service and other products compared to the prior year, particularly in the domestic region. Additionally, a reduction in customers’ capital expenditure spending contributed to the overall decrease in revenue.

Product revenue accounted for the majority of the total decrease in revenue. In 2007, product revenue decreased 10% or $17.3 million and service revenue decreased 13% or $1.6 million compared to 2006. Service revenue represents revenue from maintenance and other services associated with product shipments.

International revenue increased 9% or $6.9 million to $85.5 million in 2007 and represented 49% of total revenue compared with 40% in 2006. The increase in international revenue represents the increasing opportunity for our next-generation products in both existing and new network deployments among emerging international carriers in Latin America.

Cost of Revenue and Gross Profit

Total cost of revenue, including stock-based compensation, decreased $15.3 million, or 12% to $116.4 million for 2007, compared to $131.7 million for 2006. Total cost of revenue was 66% of revenue for 2007, compared to 68% of revenue for 2006. The decrease in cost of revenue for 2007 compared to 2006 was primarily due to a significantly decreased obsolescence provision for legacy products. As compared to 2006, the 2007 provision for obsolescence decreased by $7.1 million. In addition, gains of $4.6 million related to the sale of the Access Node and iMarc product lines during 2007 further reduced cost of revenue as compared to the prior year. Finally, personnel related costs for 2007 decreased over 2006 by $3.3 million due to the operating leverage on fixed manufacturing costs as a result of the consolidation of our manufacturing operations into one facility.

In December 2006, we entered into an agreement to sell inventory and certain assets related to our iMarc legacy product line to a third party. The sale of the iMarc product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon performance of certain obligations and delivery of assets in the first quarter of 2007, we recognized a gain of $1.8 million that was recorded in cost of revenue. Upon sale of the remaining iMarc inventory during the second quarter of 2007, we recognized an additional gain to cost of revenue of $1.1 million related to the sale of the legacy iMarc product line.

40

In December 2007, we sold inventory and certain assets related to our Access Node legacy product line to a third party. The sale of the Access Node product line was not treated as a discontinued operation since it did not represent a component of our company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. Upon sale of the Access Node inventory, we recognized a gain of $1.7 million that was recorded in cost of revenue.

Research and Product Development Expenses

Research and product development expenses decreased 9% or $3.4 million to $32.7 million for 2007 compared to $36.1 million for 2006. The decrease was primarily due to approximately $1.4 million in non-recurring specific new product development efforts expended during 2006. Additionally, for the year ended December 31, 2007, approximately $0.7 million of stock-based compensation expense was included in research and product development expenses, compared to $1.6 million during the year ended December 31, 2006. The decrease was primarily due to the decline in stock price as well as reduced volatility rate assumptions, increased forfeitures, and the decline in interest rates.

Sales and Marketing Expenses

Sales and marketing expenses decreased 13% or $5.0 million to $33.2 million for 2007 compared to $38.2 million in 2006. The decrease was primarily attributable to reduced personnel related costs of $1.2 million from lower headcount as we realigned our resources to focus on emerging markets, and reduced demonstration and trade show expenses of $1.8 million. Additionally, for the year ended December 31, 2007, approximately $0.6 million of stock-based compensation expense was included in sales and marketing expenses, compared to $1.4 million during the year ended December 31, 2006. The decrease was primarily due to the decline in stock price as well as reduced volatility rate assumptions, increased forfeitures, and the decline in interest rates.

General and Administrative Expenses

General and administrative expenses decreased 27% or $3.8 million to $10.2 million for 2007 compared to $14.0 million for 2006. The decrease was primarily due to the reversal of certain contingent liabilities of $1.1 million in the third quarter of 2007, reduced accounting and legal fees of $1.4 million over the prior year, the reversal of certain liabilities of $0.4 million in the first quarter of 2007, and a $1.5 million favorable legal settlement in the second quarter of 2007, offset by a $0.5 million accrual for acquired lease liabilities during the third quarter of 2007. Additionally, for the year ended December 31, 2007, approximately $1.3 million of stock-based compensation expense was included in general and administrative expenses, compared to $1.6 million during the year ended December 31, 2006. The decrease was primarily due to the decline in stock price as well as reduced volatility rate assumptions, increased forfeitures, and the decline in interest rates.

Gain on sale of fixed assets

Gain on sale of fixed assets increased from zero in 2006 to $0.7 million in 2007. The gain in 2007 was primarily attributable to the sale of fixed assets associated with our sale of the Access Node legacy product line in December 2007.

Gain on sale of intangible assets

Gain on sale of intangible assets increased from zero in 2006 to $5.0 million in 2007. The gain in 2007 was attributable to the sale of non-strategic legacy patents originally acquired from Paradyne.

41

Amortization of Intangible Assets

There was no amortization of intangible assets for 2007 compared to $2.8 million for 2006 because the intangible assets were fully amortized as of December 31, 2006.

Impairment of Intangible Assets and Goodwill

We review goodwill and other long-lived assets, including intangible assets, for impairment annually or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. During the third quarter of 2006, we determined that indicators of impairment existed as we experienced an adverse change in our business as evidenced by a decline in our projected revenue due to technology transition issues with our largest international customers, and a resulting decline in our market capitalization. We performed an impairment analysis which resulted in a non-cash goodwill impairment charge of $110.5 million as the fair value of our reporting unit was less than book value. See Note 3 to the consolidated financial statements for further detail. We also recorded a non-cash impairment charge for other intangible assets of $3.2 million, which represented the amount by which the carrying value of the intangible assets exceeded the fair value. No impairment of goodwill or intangible assets was recorded in 2007.

Interest Expense

Interest expense for 2007 decreased by $0.6 million to $2.2 million compared to 2006 due primarily to a decrease in the outstanding debt balances.

Interest Income

Interest income for 2007 decreased by $0.5 million to $1.8 million compared to 2006 due to lower average balances of cash and short-term investments.

Other Income, Net

Other income for 2007 decreased by $0.2 million to $0.04 million compared to $0.2 million for 2006. The decrease was primarily due to foreign exchange losses of $0.1 million on foreign currencies in the current year compared to exchange gains of $0.2 million in the prior year. We transact business in various foreign countries and are exposed to currency exchange rate risk associated with foreign currency denominated assets and liabilities, primarily intercompany receivables and payables.

Income Tax Provision

During the years ended December 31, 2007 and 2006, we recorded an income tax provision of $0.4 million and $0.3 million, respectively, related to foreign and state taxes. No material provision or benefit for income taxes was recorded, due to our recurring operating losses and the significant uncertainty regarding the realization of our net deferred tax assets, against which we have continued to record a full valuation allowance.

LIQUIDITY AND CAPITAL RESOURCES

Our operations are financed through a combination of our existing cash, 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, 2008, cash, cash equivalents and short-term investments were $36.2 million compared to $50.2 million at December 31, 2007. Total debt was $34.1 million at December 31, 2008 as compared to $34.4 million at December 31, 2007. The decrease in cash and cash equivalents of $4.5 million was attributable to net cash used in operating activities and changes in exchange rates of $17.2 million and $0.4 million, respectively, offset by net cash provided by investing activities of $13.1 million.

42

Operating Activities

For fiscal year 2008, net cash used in operating activities consisted of a net loss of $92.5 million, adjusted for non-cash charges totaling $77.9 million and a decrease in operating assets totaling $2.2 million, offset by a gain on sales of assets and intangible assets of $0.5 million and $4.4 million, respectively. The most significant components of the changes in net operating assets were decreases in accounts receivable and inventories of $6.5 million and $4.0 million, respectively, offset by a decrease in accounts payable of $8.6 million. The decrease in accounts receivable was primarily a result of lower revenue due to the global credit contraction. The decrease in inventories was primarily the result of the sale of the GigaMux legacy product line in January 2008 in which we allocated proceeds of $8.5 million to the sale of such inventories.

For fiscal year 2007, net cash used in operating activities consisted of the net loss of $12.1 million, adjusted for non-cash charges totaling $8.4 million, and offset by a gain on sale of assets of $5.7 million and increases in net operating assets totaling $5.4 million. The most significant components of the increases in net operating assets in 2007 were an increase in accounts receivable of $4.7 million and a decrease in accrued and other liabilities of $4.0 million, offset by an increase in accounts payable of $2.4 million.

Investing Activities

For fiscal year 2008, net cash provided by investing activities consisted primarily of proceeds from the sale and maturity of short-term investments of $20.4 million and proceeds from the sale of assets and intangible assets of $4.9 million, offset by purchases of short-term investments of $10.9 million and equipment purchases of $1.4 million. The proceeds from the sale of assets and intangible assets of $4.9 million were related to the sale of the GigaMux legacy product line in January 2008, and sale of non-strategic legacy patents in November 2008.

For fiscal year 2007, net cash provided by investing activities consisted primarily of cash acquired through the net sale of short-term investments of $5.4 million and proceeds from the sale of assets of $7.3 million, offset by capital equipment purchases of $1.4 million.

Financing Activities

For fiscal year 2008, net cash used in financing activities consisted primarily of repayment of debt of $0.3 million, offset by proceeds from the issuance of common stock of $0.3 million.

For fiscal year 2007, net cash used in financing activities consisted primarily of repayment of debt of $7.6 million, partially offset by proceeds from the issuance of common stock of $0.7 million and borrowings under credit facilities of $0.5 million.

Cash Management

Our primary source of liquidity comes from our cash and cash equivalents and short-term investments, which totaled $36.2 million at December 31, 2008, and our $25.0 million revolving line of credit and letter of credit facility, and an accounts receivable purchase facility with Silicon Valley Bank (the SVB Facilities). Our cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our operating accounts. To date, we have experienced no loss of access to our cash or cash equivalents; however, there can be no assurance that access to our cash and cash equivalents will not be impacted by adverse conditions in the financial markets.

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. Our short-term investments are available for use in current operations or other activities. To date, we have experienced no significant realized losses or

43

other-than-temporary impairment losses with respect to our short-term investments; however, there can be no assurance that our short-term investments will not be affected by future volatility and uncertainty in the financial markets. At current revenue levels, we anticipate that some portion of our existing cash and cash equivalents and short-term investments will continue to be consumed by operations.

Under the SVB Facilities, we have the option of borrowing funds at agreed upon rates of interest, so long as the aggregate amount of outstanding borrowings does not exceed $25.0 million. In addition, we may sell specific accounts receivables to Silicon Valley Bank, on a non-recourse basis, at agreed upon discounts to the face amount of those accounts receivables, so long as the aggregate amount of the outstanding accounts receivables does not exceed $10.0 million.

Under the SVB Facilities, $15.0 million was outstanding at December 31, 2008, and an additional $3.4 million was committed as security for various letters of credit. The amounts borrowed under the revolving credit facility bear interest, payable monthly, at a floating rate that, at our option, is either (1) Silicon Valley Bank’s prime rate, or (2) the sum of LIBOR plus 2.9%: provided that in either case, the minimum interest rate is 4.0%. The interest rate was 4.0% at December 31, 2008.

Our obligations under the SVB Facilities are secured by substantially all of our personal property assets and those of our subsidiaries, including our intellectual property. The SVB Facilities contain certain financial covenants, and customary affirmative covenants and negative covenants. If we do not comply with the various covenants and other requirements under the SVB Facilities, Silicon Valley Bank is entitled to, among other things, require the immediate repayment of all outstanding amounts and sell our assets to satisfy the obligations under the SVB Facilities. As of December 31, 2008, we were in compliance with these covenants.

For fiscal year 2008, we sold $10.2 million of customer trade receivables to Silicon Valley Bank on a non-recourse basis in exchange for cash. The sale of the receivables did not represent a securitization, and there was no continuing involvement or interests in the receivables by us after the sale.

In January 2009, we repaid the $15.0 million outstanding under the SVB Facilities. In March 2009, the SVB Facilities were replaced when we entered into a new $20.0 million secured revolving credit arrangement with Silicon Valley Bank as discussed in Note 15 to the consolidated financial statements.

Future Requirements and Funding Sources

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. As a result of the Paradyne acquisition in 2005, we assumed a lease commitment for facilities in Largo, Florida. The term of the lease expires in June 2012 and had an estimated remaining obligation of approximately $15.2 million as of December 31, 2008. We intend to continue to occupy only a portion of these facilities. We have recorded a liability of $5.6 million as of December 31, 2008, which we believe is adequate to cover costs incurred to exit the excess portion of these facilities, net of estimated sublease income.

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 the terms for product payments to customers. Depending upon market conditions, we may seek to factor these arrangements to financial institutions and investors to reduce the amount of our financial commitments associated with such arrangements. For example, during the year ended December 31, 2008, we sold $10.2 million of customer trade receivables to Silicon Valley Bank on a non-recourse basis in exchange for cash. The sale of the receivables did not represent a securitization, and there was no continuing involvement or interests in the receivables by us after the sale. 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.

44

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 large balances due from a relatively small number of customer account balances. As of December 31, 2008, two customers accounted for 13% and 10% of accounts receivable, and receivables from customers in territories outside of the United States of America represented 69% of accounts receivable. 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 expect that operating losses and negative cash flows from operations will continue. In order to meet our liquidity needs and finance our capital expenditures and working capital needs for our business, we may need to raise additional capital through the issuance of debt or equity financing or the sale of assets. Continued uncertainty in credit markets may negatively impact our ability to access debt financing or to refinance existing indebtedness in the future on favorable terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict our ability to operate our business. Likewise, any equity financing could result in additional dilution of our stockholders. If we are unable to obtain additional capital or are required to obtain additional capital on terms that are not favorable to us, we may be required to reduce the scope of our planned product development and sales and marketing efforts beyond the reductions we have previously taken. Based on our current plans and business conditions, we believe that our existing cash, cash equivalents and short-term investments and available credit facilities will be sufficient to satisfy our anticipated cash requirements for the foreseeable future.

Contractual Commitments and Off-Balance Sheet Arrangements

At December 31, 2008, our estimated future contractual commitments by fiscal year were as follows (in thousands):

	Total		2009		2010		2011		2012		2013
Operating leases	$	16,036	$	4,773	$	4,506	$	4,478	$	2,279	$	—
Line of credit		15,000		15,000		—		—		—		—
Debt		19,078		380		408		18,290		—		—
Inventory purchase commitments		43		43		—		—		—		—
Total	$	50,157	$	20,196	$	4,914	$	22,768	$	2,279	$	—

Operating Leases

The operating lease amounts shown above represent primarily off-balance sheet arrangements. 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. For operating leases that include contractual commitments for operating expenses and maintenance, estimates of such amounts are included based on current rates. Payments made under operating leases will be treated as rent expense for the facilities currently being utilized. Of the total $16.0 million operating lease amount, $5.6 million has been recorded as a liability on our balance sheet as of December 31, 2008.

Line of Credit and Debt

The debt and line of credit obligations have been recorded as liabilities on our balance sheet. The debt obligation 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, 2008, the interest rate on our outstanding debt obligations ranged from 4% to 6.9%.

As of December 31, 2008, we had $15.0 million outstanding under our line of credit and an additional $3.4 million committed as security for various letters of credit, as discussed in Note 6 to the consolidated financial statements.

45

Inventory Purchase Commitments

Inventory purchase commitments represent the amount of excess inventory purchase commitments that have been recorded as a liability on our balance sheet at December 31, 2008.

Recent Accounting Pronouncements

SFAS 157 – Fair Value Measurements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157 (SFAS 157), Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities. In February 2008, the FASB issued FASB FSP 157-2 which delays the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We adopted the provisions of SFAS 157 with respect to our financial assets and liabilities beginning in the first quarter of fiscal year 2008. The adoption of SFAS 157 did not have a material effect on our consolidated financial condition or results of operations or cash flows. We are still in the process of evaluating this standard with respect to its effect on non-financial assets and liabilities and therefore have not yet determined the impact it will have on our consolidated financial statements upon full adoption in our 2009 fiscal year. Non-financial assets and liabilities for which we have not applied the provisions of SFAS 157 include those measured at fair value in impairment testing.

SFAS 159 – Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. We were required to adopt SFAS 159 beginning in the first quarter of fiscal year 2008. We did not elect the fair value option, therefore the adoption of SFAS 159 did not have any impact on our consolidated financial statements.

SFAS 141R – Business Combinations

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), which replaces SFAS No. 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree and the goodwill acquired. This statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations which close in fiscal years beginning after December 15, 2008. We will be required to adopt SFAS 141R in our 2009 fiscal year.

FSP APB 14-1 – Accounting for Convertible Debt Instruments

In May 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement), (FSP APB 14-1), which requires issuers of convertible debt that may be settled wholly or partly in cash when converted to account for the debt and equity components separately. This statement is effective for fiscal years beginning after December 15, 2008 and must be applied retrospectively to all periods. We are currently evaluating the impact, if any, that the adoption of FSP ABP 14-1 will have on our consolidated financial statements.

46

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Cash, Cash Equivalents and Investments

We consider all cash and highly liquid investments purchased with an original maturity of less than three months to be cash equivalents.

Cash, cash equivalents and short-term investments consisted of the following as of December 31, 2008 and 2007 (in thousands):

	December 31, 2008		December 31, 2007
Cash and cash equivalents	$	33,251	$	37,804
Short-term investment		2,992		12,361
	$	36,243	$	50,165

Concentration of Credit Risk

Financial instruments which potentially subject us to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable. Cash and cash equivalents and short-term investments consist principally of demand deposit and money market accounts, commercial paper and corporate debentures and bonds with credit ratings of AA or better. Cash and cash equivalents and short-term investments are principally held with various domestic financial institutions with high credit standing. As of December 31, 2008 and 2007, receivables from customers in international territories represented 69% and 63%, respectively, of accounts receivable.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and long-term debt. We do not use derivative financial instruments in our investment portfolio. We do not hold financial instruments for trading or speculative purposes. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt instruments of high credit quality and relatively short average maturities. Our cash and cash equivalents and short-term investments are not subject to material interest rate risk due to their short maturities. Under our investment policy, short-term investments have a maximum maturity of one year from the date of acquisition, and the average maturity of the portfolio cannot exceed six months. Due to the relatively short maturity of the portfolio, a 10% increase in market interest rates at December 31, 2008 would decrease the fair value of the portfolio by less than $0.1 million.

As of December 31, 2008, our outstanding debt balance was $19.1 million. Interest on our long-term debt accrues on the unpaid principal balance at a variable interest rate (which adjusts every six months) equal to the sum of the LIBOR rate plus 3.0% per annum; provided that in no event will the variable interest rate (a) exceed 14.2488% per annum, (b) be less than 6.5% per annum, or (c) be adjusted by more than 1.0% at any adjustment date. Assuming the outstanding balance on our variable rate long-term debt remains constant over a year, a 2% increase in the interest rate would decrease pre-tax income and cash flow by approximately $0.4 million.

Foreign Currency Risk

We transact business in various foreign countries. Substantially all of our assets are located in the United States. We have sales operations throughout Europe, Asia, the Middle East and Latin America. We are exposed to foreign currency exchange rate risk associated with foreign currency denominated assets and liabilities, primarily intercompany receivables and payables. Accordingly, our operating results are exposed to changes in

exchange rates between the U.S. dollar and those currencies. During 2008 and 2007, we did not hedge any of our foreign currency exposure. During both 2008 and 2007, we recorded $0.1 million of foreign exchange loss in other income (expense) on our statements of operations.

47

We have performed sensitivity analyses as of December 31, 2008 and 2007, using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The sensitivity analyses indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would result in a foreign exchange loss of $0.1 million for both 2008 and 2007. This sensitivity analysis assumes a parallel adverse shift in foreign currency exchange rates, which do not always move in the same direction. Actual results may differ materially.

48

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	Page
Reports of Independent Registered Public Accounting Firm	50
Consolidated Balance Sheets	52
Consolidated Statements of Operations	53
Consolidated Statements of Stockholders’ Equity	54
Consolidated Statements of Cash Flows	56
Notes to Consolidated Financial Statements	57

49

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Zhone Technologies, Inc.:

We have audited the accompanying consolidated balance sheets of Zhone Technologies, Inc. and subsidiaries (“the Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Zhone Technologies, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Zhone Technologies, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Mountain View, California

March 16, 2009

50

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Zhone Technologies, Inc.:

We have audited Zhone Technologies, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Zhone Technologies, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Zhone Technologies, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Zhone Technologies, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated March 16, 2009 expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Mountain View, California

March 16, 2009

51

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2008 and 2007

(In thousands, except par value)

	2008			2007
Assets
Current assets:
Cash and cash equivalents	$	33,251		$	37,804
Short-term investments		2,992			12,361
Accounts receivable, net of allowances for sales returns and doubtful accounts of $5,155 in 2008 and $5,941 in 2007		23,665			33,258
Inventories		40,706			44,698
Prepaid expenses and other current assets		2,654			3,804
Total current assets		103,268			131,925
Property and equipment, net		20,003			20,818
Goodwill		—			70,401
Restricted cash		123			186
Other assets		55			76
Total assets	$	123,449		$	223,406
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	12,719		$	21,276
Line of credit		15,000			15,000
Current portion of long-term debt		380			265
Accrued and other liabilities		13,162			17,888
Total current liabilities		41,261			54,429
Long-term debt, less current portion		18,698			19,140
Other long-term liabilities		4,193			290
Total liabilities		64,152			73,859
Stockholders’ equity:
Common stock, $0.001 par value. Authorized 900,000 shares; issued and outstanding 150,683 and 150,024 shares as of December 31, 2008 and 2007, respectively		151			150
Additional paid-in capital		1,064,493			1,061,849
Other comprehensive income		250			610
Accumulated deficit		(1,005,597	)		(913,062	)
Total stockholders’ equity		59,297			149,547
Total liabilities and stockholders’ equity	$	123,449		$	223,406

See accompanying notes to consolidated financial statements.

52

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

Years ended December 31, 2008, 2007 and 2006

(In thousands, except per share data)

	2008			2007			2006
Net revenue	$	146,160		$	175,448		$	194,344
Cost of revenue (1)		101,096			116,370			131,749
Gross profit		45,064			59,078			62,595
Operating expenses:
Research and product development (1)		27,063			32,720			36,099
Sales and marketing (1)		28,269			33,192			38,225
General and administrative (1)		15,609			10,170			14,036
Gain on sale of fixed assets		(455	)		(659	)		—
Gain on sale of intangible assets		(4,397	)		(5,000	)		—
Amortization of intangible assets		—			—			2,764
Impairment of intangible assets and goodwill		70,401			—			113,666
Total operating expenses		136,490			70,423			204,790
Operating loss		(91,426	)		(11,345	)		(142,195	)
Interest expense		(1,625	)		(2,213	)		(2,774	)
Interest income		708			1,813			2,328
Other income		78			37			239
Loss before income taxes		(92,265	)		(11,708	)		(142,402	)
Income tax provision		270			394			264
Net loss	$	(92,535	)	$	(12,102	)	$	(142,666	)
Basic and diluted net loss per share	$	(0.62	)	$	(0.08	)	$	(0.96	)
Weighted average shares outstanding used to compute basic and diluted net loss per share		150,342			149,623			148,727
(1) Amounts include stock-based compensation cost as follows:
Cost of revenue		158			296			892
Research and product development		479			717			1,632
Sales and marketing		511			603			1,380
General and administrative		1,203			1,250			1,601

See accompanying notes to consolidated financial statements.

53

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

Years ended December 31, 2008, 2007 and 2006 (In thousands)

	Common stock			Additional paid-in capital			Notes receivable from stockholders			Deferred stock-based compensation			Other comprehensive income (loss)			Accumulated deficit			Total stockholders’ equity
	Shares	Amount
Balances as of December 31, 2005	147,759	$	148	$	1,051,320		$	(550	)	$	(818	)	$	(17	)	$	(758,294	)	$	291,789
Exercise of stock options for cash	913		1		1,393			—			—			—			—			1,394
Issuance of common stock in connection with employee stock purchase plan	581		—		867			—			—			—			—			867
Issuance of common stock for services	24		—		50			—			—			—			—			50
Reversal of unamortized deferred stock-based compensation	—		—		(818	)		—			818			—			—			—
Stock-based compensation under SFAS 123R	—		—		5,505			—			—			—			—			5,505
Proceeds from repayment of officer loans	—		—		—			550			—			—			—			550
Comprehensive loss:
Net loss	—		—		—			—			—			—			(142,666	)		(142,666	)
Foreign currency translation adjustment	—		—		—			—			—			84			—			84
Unrealized gain on available for sale securities	—		—		—			—			—			31			—			31
Total comprehensive loss																				(142,551	)
Balances as of December 31, 2006	149,277		149		1,058,317			—			—			98			(900,960	)		157,604
Exercise of stock options for cash	68		—		14			—			—			—			—			14
Issuance of common stock in connection with employee stock purchase plan	641		1		652			—			—			—			—			653
Issuance of common stock for services	38		—		49			—			—			—			—			49
Stock-based compensation under SFAS 123R	—		—		2,817			—			—			—			—			2,817
Comprehensive loss:
Net loss	—		—		—			—			—			—			(12,102	)		(12,102	)
Foreign currency translation adjustment	—		—		—			—			—			505			—			505
Unrealized gain on available for sale securities	—		—		—			—			—			7			—			7
Total comprehensive loss																				(11,590	)

54

	Common stock			Additional paid-in capital		Notes receivable from stockholders		Deferred stock-based compensation		Other comprehensive income (loss)			Accumulated deficit			Total stockholders’ equity
	Shares	Amount
Balances as of December 31, 2007	150,024		150		1,061,849		—		—		610			(913,062	)		149,547
Exercise of stock options for cash	28		—		6		—		—		—			—			6
Issuance of common stock in connection with employee stock purchase plan	557		1		287		—		—		—			—			288
Issuance of common stock for services	74		—		81		—		—		—			—			81
Stock-based compensation under SFAS 123R	—		—		2,270		—		—		—			—			2,270
Comprehensive loss:
Net loss	—		—		—		—		—		—			(92,535	)		(92,535	)
Foreign currency translation adjustment	—		—		—		—		—		(355	)		—			(355	)
Unrealized loss on available for sale securities	—		—		—		—		—		(5	)		—			(5	)
Total comprehensive loss																	(92,895	)
Balances as of December 31, 2008	150,683	$	151	$	1,064,493	$	—	$	—	$	250		$	(1,005,597	)	$	59,297

See accompanying notes to consolidated financial statements.

55

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2008, 2007 and 2006

(In thousands)

	2008			2007			2006
Cash flows from operating activities:
Net loss	$	(92,535	)	$	(12,102	)	$	(142,666	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,204			2,660			5,383
Stock-based compensation		2,351			2,866			5,505
Impairment of goodwill and intangible assets		70,401			—			113,666
Gain on sale of intangible assets		(4,397	)		(5,000	)		—
Gain on sale of fixed assets		(455	)		(659	)		(301	)
(Accretion) or impairment of investments		(169	)		(462	)		(527	)
Provision for sales returns and doubtful accounts		3,143			3,305			6,638
Changes in operating assets and liabilities:
Accounts receivable		6,450			(4,735	)		(3,074	)
Inventories		3,992			338			3,334
Prepaid expenses and other current assets		1,150			585			239
Other assets		21			3			30
Accounts payable		(8,557	)		2,383			771
Accrued and other liabilities		(823	)		(3,958	)		(5,236	)
Net cash used in operating activities		(17,224	)		(14,776	)		(16,238	)
Cash flows from investing activities:
Tax refund related to acquisition of Sorrento		—			336			—
Proceeds from sale of intangible assets		4,397			5,000			9,000
Proceeds from sale of assets		502			2,250			1,716
Purchases of property and equipment		(1,436	)		(1,365	)		(2,004	)
Purchases of short-term investments		(10,879	)		(26,992	)		(37,905	)
Proceeds from maturity of short-term investments		20,412			32,437			40,100
Changes in restricted cash		63			(87	)		(89	)
Net cash provided by investing activities		13,059			11,579			10,818
Cash flows from financing activities:
Proceeds from issuance of common stock and warrants		294			667			2,311
Proceeds from repayment of officer loans		—			—			550
Borrowings under credit facilities		—			500			—
Repayment of debt		(327	)		(7,644	)		(2,718	)
Net cash provided by (used in) financing activities		(33	)		(6,477	)		143
Effect of exchange rate changes on cash		(355	)		505			84
Net decrease in cash and cash equivalents		(4,553	)		(9,169	)		(5,193	)
Cash and cash equivalents at beginning of year		37,804			46,973			52,166
Cash and cash equivalents at end of year	$	33,251		$	37,804		$	46,973
Supplemental disclosures of cash flow information:
Cash paid during period for:
Taxes	$	371		$	349		$	740
Interest		1,639			2,226			2,635
Noncash investing and financing activities:
Purchase price allocation adjustment		—			—			1,206
Reclassification of restricted cash		—			537			—

See accompanying notes to consolidated financial statements.

56

ZHONE TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Organization and Summary of Significant Accounting Policies

(a) Description of Business

Zhone Technologies, Inc. (sometimes referred to, collectively with its subsidiaries, as “Zhone” or the “Company”) designs, develops and manufactures communications network equipment for telephone companies and cable operators worldwide. The Company’s products allow network service providers to deliver video and interactive entertainment services in addition to their existing voice and data service offerings. The Company was incorporated under the laws of the state of Delaware in June 1999. The Company began operations in September 1999 and is headquartered in Oakland, California.

(b) Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

(c) Risks and Uncertainties

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company’s continued losses reduced cash, cash equivalents and short-term investments in 2007 and 2008. As of December 31, 2008, the Company had approximately $36.2 million in cash, cash equivalents and short-term investments and $15.0 million outstanding under its bank lending facility. Continued uncertainty in the credit markets may negatively impact the Company’s ability to access debt financing or to refinance existing indebtedness in the future on favorable terms, or at all. In order to meet liquidity needs and finance capital expenditures and working capital, the Company may be required to sell assets, or to borrow on potentially unfavorable terms. The Company may be unable to sell assets or access additional indebtedness to meet these needs. As a result, the Company may become unable to pay its ordinary expenses, including its debt service, on a timely basis. The Company’s current lack of liquidity could harm it by:

• increasing its vulnerability to adverse economic conditions in its industry or the economy in general;

• requiring substantial amounts of cash to be used for debt servicing, rather than other purposes, including operations;

• limiting its ability to plan for, or react to, changes in its business and industry; and

• influencing investor and customer perceptions about its financial stability and limiting its ability to obtain financing or acquire customers.

The global unfavorable economic and market conditions and the financial crisis could impact the Company’s business in a number of ways, including:

• Potential deferment of purchases and orders by customers;

• Customers’ inability to obtain financing to make purchases from the Company and/or maintain their business;

• Negative impact from increased financial pressures on third-party dealers, distributors and retailers; and

• Negative impact from increased financial pressures on key suppliers.

57

If the economic, market and geopolitical conditions in the United States and the rest of the world do not improve, or if they continue to deteriorate, the Company may experience material adverse impacts on its business, operating results and financial condition.

During 2008, the Company implemented several activities intended to reduce costs, improve operating efficiencies and change its operations to more closely align them with its key strategic focus, including the sale of legacy product lines and headcount reductions.

The Company expects that operating losses and negative cash flows from operations will continue. In order to meet the Company’s liquidity needs and finance its capital expenditures and working capital needs for the business, the Company may need to raise additional capital through the issuance of debt or equity financing or the sale of assets. Continued uncertainty in credit markets may negatively impact the Company’s ability to access debt financing or to refinance existing indebtedness in the future on favorable terms, or at all. If additional capital is raised through the issuance of debt securities or other debt financing, the terms of such debt may include covenants, restrictions and financial ratios that may restrict the Company’s ability to operate its business. Likewise, any equity financing could result in additional dilution of the Company’s stockholders. If the Company is unable to obtain additional capital or is required to obtain additional capital on terms that are not favorable, it may be required to reduce the scope of its planned product development and sales and marketing efforts beyond the reductions it has previously taken. Based on the Company’s current plans and business conditions, it believes that its existing cash, cash equivalents and short-term investments and available credit facilities will be sufficient to satisfy its anticipated cash requirements for the foreseeable future.

(d) Use of Estimates

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

(e) Revenue Recognition

The Company recognizes revenue when the earnings process is complete. The Company recognizes product revenue upon shipment of product under contractual terms which transfer title to customers upon shipment, under normal credit terms, net of estimated sales returns and allowances at the time of shipment. Revenue is deferred if there are significant post-delivery obligations, if collection is not considered reasonably assured at the time of sale, or if the fees are not fixed or determinable. When significant post-delivery obligations exist, revenue is deferred until such obligations are fulfilled. The Company’s arrangements generally do not have any significant post-delivery obligations. The Company offers products and services such as support, education and training, hardware upgrades and post-warranty support. For multiple element revenue arrangements, the Company establishes the fair value of these products and services based primarily on sales prices when the products and services are sold separately. If fair value cannot be established for undelivered elements, all of the revenue under the arrangement is deferred until those elements have been delivered. When collectibility is not reasonably assured, revenue is recognized when cash is collected. Revenue from education services and support services is recognized over the contract term or as the service is performed. The Company makes certain sales to product distributors. These customers are given certain privileges to return a portion of inventory. Return privileges generally allow distributors to return inventory based on a percent of purchases made within a specific period of time. The Company recognizes revenue on sales to distributors that have contractual return rights when the products have been sold by the distributors, unless there is sufficient customer specific sales and sales returns history to support revenue recognition upon shipment. In those instances when revenue is recognized upon shipment to distributors, the Company uses historical rates of return from the distributors to provide

58

for estimated products return in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 48, Revenue Recognition When Right of Return Exists. The Company accrues for warranty costs, sales returns, and other allowances at the time of shipment based on historical experience and expected future costs. In accordance with the provisions of Emerging Issues Task Force Issue No. 06-3 (EITF 06-3), How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation), the Company nets sales taxes against revenue.

(f) Allowances for Sales Returns and Doubtful Accounts

The Company records an allowance for sales returns for estimated future product returns related to current period product revenue. The allowance is recorded as a reduction of revenues in the Company’s consolidated financial statements. The Company bases its allowance 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, the Company’s revenue could be adversely affected.

The Company records an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make payments. The allowance is recorded as a general and administrative expense in the Company’s consolidated financial statements. The Company bases its allowance on periodic assessments of its customers’ liquidity and financial condition through analysis of information obtained from credit rating agencies, financial statement review and historical collection trends. Additional allowances may be required if the liquidity or financial condition of its customers were to deteriorate.

Activity under the Company’s allowance for sales returns and doubtful accounts was comprised as follows (in thousands):

	Year ended December 31,
	2008			2007			2006
Balance at beginning of year	$	5,941		$	6,939		$	5,643
Charged to revenue		2,356			2,728			5,574
Charged to expenses		787			577			1,064
Utilization		(3,929	)		(4,303	)		(5,342	)
Balance at end of year	$	5,155		$	5,941		$	6,939

The allowance for doubtful accounts was $3.9 million and $4.3 million as of December 31, 2008 and 2007, respectively.

(g) Inventories

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

h) Operating Lease Liabilities

As a result of the acquisition of Paradyne in September 2005, the Company assumed certain lease liabilities for facilities in Largo, Florida. In accordance with Emerging Issues Task Force Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (EITF 95-3), the Company

59

accrued a liability for the excess portion of these facilities. The computation of the estimated liability includes a number of assumptions and subjective variables. These variables include the level and timing of future sublease income, amount of contractual variable costs, future market rental rates, discount rate, and other estimated expenses. If circumstances change, and the Company employs different assumptions in future periods, the future lease liability may differ significantly from what the Company has recorded in the current period and could materially affect its net loss and net loss per share.

(i) Foreign Currency Translation

For operations outside the United States, the Company translates assets and liabilities of foreign subsidiaries, whose functional currency is the local currency, at end of period exchange rates. Revenues and expenses are translated at monthly average rates of exchange prevailing during the year. The adjustment resulting from translating the financial statements of such foreign subsidiaries, is included in accumulated other comprehensive income (loss), which is reflected as a separate component of stockholders’ equity. Realized gains and losses on foreign currency transactions are included in other income (expense) in the accompanying consolidated statement of operations. During 2008 and 2007, the Company recorded a $0.1 million realized foreign exchange loss for each period in other income (expense) on its statements of operations.

(j) Cash and Cash Equivalents, and Short-Term Investments

The Company considers all cash and highly liquid investments purchased with an original maturity of less than three months to be cash equivalents.

Short-term investments include securities with original maturities greater than three months and less than one year and are available for use in current operations or other activities. Short-term investments consist principally of commercial paper, corporate debentures and bonds. Short-term investments have been classified as available for sale. Under this classification, the investments are reported at fair value, with unrealized gains and losses excluded from results of operations and reported, net of tax, as a component of other comprehensive loss in stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary are included in results of operations. Gains and losses from the sale of securities are based on the specific-identification method.

Cash, cash equivalents, and short-term investments consisted of the following as of December 31, 2008 (in thousands):

	Cost		Unrealized Gain		Unrealized Loss			Fair Value
Cash and Cash Equivalents:
Cash	$	26,607	$	—	$	—		$	26,607
Money Market Funds		6,644		—		—			6,644
	$	33,251	$	—	$	—		$	33,251
Short-term investments:
Commercial Paper	$	896	$	2	$	—		$	898
Corporate Securities		2,091		5		(2	)		2,094
	$	2,987	$	7	$	(2	)	$	2,992

60

Cash, cash equivalents, and short-term investments consisted of the following as of December 31, 2007 (in thousands):

	Cost		Unrealized Gain		Unrealized Loss			Fair Value
Cash and Cash Equivalents:
Cash	$	13,674	$	—	$	—		$	13,674
Money Market Funds		20,491		—		—			20,491
Commercial Paper		3,638		1		—			3,639
	$	37,803	$	1	$	—		$	37,804
Short-term investments:
Commercial Paper	$	6,082	$	4	$	—		$	6,086
US Agency Securities		900		—		—			900
Corporate Securities		5,370		6		(1	)		5,375
	$	12,352	$	10	$	(1	)	$	12,361

(k) Fair Value of Financial Instruments

The carrying amounts of the Company’s consolidated financial instruments which include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values as of December 31, 2008 and 2007 due to the relatively short maturities of these instruments. The carrying value of the Company’s debt obligations at December 31, 2008 and 2007 approximate their fair value.

(l) Concentration of Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. Cash and cash equivalents consist principally of demand deposits and money market accounts, commercial paper and debt securities of domestic municipalities with credit ratings of AA or better. Cash and cash equivalents are principally held with various domestic financial institutions with high credit standing. The Company’s customers include competitive and incumbent local exchange carriers, competitive access providers, internet service providers, wireless carriers, and resellers serving these markets. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Allowances are maintained for potential doubtful accounts. The Company’s accounts receivable represents a concentration of credit risk because a significant portion of the accounts receivable balance at any point in time typically consists of large balances due from a relatively small number of customer account balances. As of December 31, 2008, two customers accounted for 13% and 10% of accounts receivable. In addition, as of December 31, 2008 and 2007, receivables from customers in international territories represented 69% and 63%, respectively, of accounts receivable.

The Company may provide or commit to extend credit or credit support to certain customers. During the years ended December 31, 2008 and 2007, the Company sold $10.2 million and $2.0 million, respectively, of customer trade receivables to financial institutions on a non-recourse basis in exchange for cash. The sale of the receivables did not represent a securitization, and there was no continuing involvement or interests in the receivables by the Company after the sale. As of December 31, 2008, the Company did not have any significant customer financing commitments or guarantees.

The Company’s products are concentrated in the communications equipment market, which is highly competitive and subject to rapid change. Significant technological changes in the industry could adversely affect operating results. The Company’s inventories include components that may be specialized in nature, and subject to rapid technological obsolescence. The Company actively manages inventory levels, and the

61

Company considers technological obsolescence and potential changes in product demand based on macroeconomic conditions when estimating required allowances to reduce recorded inventory amounts to market value. Such estimates could change in the future.

The Company’s growth and ability to meet customer demands are also dependent on its ability to obtain timely deliveries of components from suppliers and contract manufacturers. The Company depends on contract manufacturers and sole or limited source suppliers for several key components. If the Company were unable to obtain these components on a timely basis, the Company would be unable to meet its customers’ product delivery requirements which could adversely impact operating results. While the Company is not solely dependent on one contract manufacturer, it expects to continue to rely on contract manufacturers to fulfill a portion of its product manufacturing requirements.

(m) Property and Equipment

Property and equipment are stated at cost and depreciated using the straight-line method over their estimated useful lives. Useful life for buildings is 30 years. Useful lives for laboratory and manufacturing equipment range from 10 to 30 years. Useful lives of all other property and equipment range from 3 to 5 years. Leasehold improvements are generally amortized over the shorter of their useful lives or the remaining lease term.

(n) Goodwill

Costs in excess of the fair value of tangible and identifiable intangible assets acquired and liabilities assumed in a purchase business combination are recorded as goodwill. SFAS No. 142, Goodwill and Other Intangible Assets, requires that companies test for goodwill impairment at least annually using a two-step approach. The Company evaluates goodwill on an annual basis in November, at a minimum, and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The Company has determined that it operates in a single segment with one operating unit. The Company performs the annual goodwill impairment test using the market approach. If the carrying amount of the reporting unit exceeds its fair value, indication of goodwill impairment exists and a second step is performed to measure the amount of impairment loss, if any. During the years ended December 31, 2008 and 2006, the Company recorded non-cash goodwill impairment charges of $70.4 million, and $110.5 million, respectively, as discussed in Note 3.

(o) Purchased Intangibles and Other Long-Lived Assets

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company reviews long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable based on expected undiscounted cash flows attributable to that asset. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future net undiscounted cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Any assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet.

During the year ended December 31, 2006, the Company recorded non-cash impairment charges of $3.2 million related to the impairment of purchased technology, customer relationships and other amortizable intangibles as discussed in Note 3.

62

(p) Research and Product Development Expenditures

Costs related to research, design, and development of products are charged to research and product development expense as incurred.

(q) Accounting for Stock-Based Compensation

SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), requires companies to estimate the fair value of share-based payment awards on the date of grant using an option pricing model. The Company adopted the Black Scholes model to estimate the fair value of options. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations.

Awards of stock options granted to consultants under the Company’s share-based compensation plans are accounted for at fair value determined by using the Black Scholes option pricing model in accordance with Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or In Conjunction with Selling, Goods or Services (EITF 96-18). These options are generally immediately exercisable and expire seven to ten years from the date of grant. The Company values non-employee options using the Black Scholes model. Non-employee options subject to vesting are valued as they become vested.

Fair value stock-based compensation expense under SFAS 123R for the year ended December 31, 2008 includes compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro-forma provisions of SFAS 123, and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In conjunction with the provisions of SFAS 123R, the Company changed its method of attributing the value of stock-based compensation to expense from the accelerated method to the straight line method. Compensation expense for all employee share-based payment awards granted on or prior to December 31, 2005 will continue to be recognized using the accelerated method while compensation expense for all share-based payment awards granted subsequent to December 31, 2005 is recognized using the straight line method.

(r) Income Taxes

The Company uses the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and the income tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The Company has recorded a full valuation allowance against its net deferred tax assets at December 31, 2008 and 2007 due to the significant uncertainty regarding whether the deferred tax assets will be realized.

(s) Net Loss per Common Share

Basic net loss per share is computed by dividing the net loss applicable to holders of common stock for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net loss per share gives effect to common stock equivalents; however, potential common equivalent shares are excluded if their effect is antidilutive. Potential common equivalent shares are composed of common stock subject to repurchase rights and incremental shares of common equivalent shares issuable upon the exercise of stock options and warrants, and the conversion of convertible debt.

63

(t) Other Comprehensive Income (Loss)

Other comprehensive income (loss) is recorded directly to stockholders’ equity and includes unrealized gains and losses which have been excluded from the consolidated statements of operations. These unrealized gains and losses consist of foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities.

(u) Recent Accounting Pronouncements

SFAS 157 – Fair Value Measurements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157 (SFAS 157), Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities. In February 2008, the FASB issued FASB FSP 157-2 which delays the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company adopted the provisions of SFAS 157 with respect to its financial assets and liabilities beginning in the first quarter of fiscal year 2008. The adoption of SFAS 157 did not have a material effect on the Company’s consolidated financial condition or results of operations or cash flows. The Company is still in the process of evaluating this standard with respect to its effect on non-financial assets and liabilities and therefore has not yet determined the impact it will have on its consolidated financial statements upon full adoption in fiscal year 2009. Non-financial assets and liabilities for which the Company has not applied the provisions of SFAS 157 include those measured at fair value in impairment testing.

SFAS 159 – Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. The Company was required to adopt SFAS 159 beginning in the first quarter of fiscal year 2008. The Company did not elect the fair value option, therefore the adoption of SFAS 159 did not have any impact on its consolidated financial statements.

SFAS 141R – Business Combinations

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R), which replaces SFAS No. 141. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree and the goodwill acquired. This statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for business combinations which close in fiscal years beginning after December 15, 2008. The Company will be required to adopt SFAS 141R in its 2009 fiscal year.

FSP APB 14-1 – Accounting for Convertible Debt Instruments

In May 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement), (FSP APB 14-1), which requires issuers of convertible debt that may be settled wholly or partly in cash when converted to account for the debt and equity components separately. This statement is effective for fiscal years beginning after December 15, 2008 and must be applied retrospectively to all periods. The Company is currently evaluating the impact, if any, that the adoption of FSP ABP 14-1 will have on its consolidated financial statements.

64

(v) Reclassifications

Certain reclassifications have been made to prior period balances in order to conform to the current period’s presentation. These include the reclassification of stock-based compensation expense to the associated operating expense line items in the consolidated statement of operations; and, commencing with the first quarter of 2007, the reclassification of prior period balances relating to the Company’s historical optical transport business as part of its balances relating to its legacy, services and other product category.

(2) Operating Lease Liabilities

As a result of the acquisition of Paradyne Networks, Inc. (“Paradyne”) in September 2005, the Company assumed a lease commitment for facilities in Largo, Florida. In accordance with Emerging Issues Task Force Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination (EITF 95-3), the Company accrued a liability for the excess portion of these facilities. The term of the lease expires in June 2012 and had an estimated remaining obligation of approximately $15.2 million as of December 31, 2008, of which $5.6 million was accrued for excess facilities, net of estimated sublease income. The computation of the estimated liability includes a number of assumptions and subjective variables. These variables include the level and timing of future sublease income, amount of contractual variable costs, future market rental rates, discount rate, and other estimated expenses. If circumstances change, and the Company employs different assumptions in future periods, the lease liability may differ significantly from what the Company has recorded in the current period and could materially affect its net loss and net loss per share. During the second quarter of 2008, the Company significantly reduced its assumptions regarding estimated future sublease income primarily as a result of the deteriorating real estate market. Accordingly, during the second quarter of 2008, the Company increased its excess lease liability balance by $3.3 million with a corresponding charge to general and administrative expenses. A summary of current period activity related to excess lease liabilities accrued is as follows (in thousands):

	Exit Costs
Balance at December 31, 2007	$	3,695
Cash payments, net		(1,403	)
Change in estimate		3,305
Balance at December 31, 2008	$	5,597

A summary of the assumed lease liabilities related to excess facilities at their net present value is as follows (in thousands):

	Exit Costs
Future lease payments	$	8,250
Less: contractual sublease income		(2,079	)
Less: estimated sublease income		(599	)
Other sublease expenses		25
Balance at December 31, 2008	$	5,597

The current portion of the excess lease liability as of December 31, 2008 of $1.7 million is classified in “Accrued and other liabilities” and the long-term portion of $3.9 million is classified in “Other long-term liabilities” in the accompanying consolidated balance sheet.

(3) Long-lived Assets, Goodwill and Other Acquisition-Related Intangible Assets

The Company tests goodwill for impairment using a two step approach on an annual basis in November, or when certain indicators of impairment exist in accordance with SFAS No. 142, Goodwill and Other Intangible

65

Assets. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit using the market approach. The Company has determined that it operates in a single segment with one reporting unit. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to measure the amount of impairment loss, if any. In 2008 and 2006, the Company determined that the reporting unit’s carrying value exceeded its fair value and the second step was performed, resulting in a goodwill impairment loss of $70.4 million and $110.5 million, respectively.

Changes in the carrying amount of goodwill were as follows (in thousands):

	Year ended December 31,
	2008			2007
Beginning balance	$	70,401		$	70,737
Impairment of goodwill		(70,401	)		—
Other adjustments		—			(336	)
Ending balance	$	—		$	70,401

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, the Company reviews long-lived assets, including intangible assets other than goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.

The Company estimates the fair value of its long-lived assets based on a combination of the market, income and replacement cost approaches. In the application of the impairment testing, the Company is 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 third quarter of 2006, the Company determined that indicators of impairment existed and an impairment analysis was performed, resulting in an impairment loss to amortizable intangibles of $3.2 million. The Company’s amortizable intangibles at December 31, 2008 and 2007 were zero.

Sale of Intangible Assets

During 2008 and 2007, the Company sold some of its non-strategic patents for $1.1 million and $5.0 million, respectively. The resulting $1.1 million and $5.0 million gain were recorded within operating expenses as gain on sale of intangible assets. During the second quarter of 2006, the Company sold some of its non-strategic patents for $9.0 million, resulting in a gain of $0.3 million, which was recorded within general and administrative operating expenses.

Sale of Legacy Inventory and Other Assets

In January 2008, the Company sold its GigaMux legacy product line to a third party. The sale of the GigaMux legacy product line was not treated as a discontinued operation since it did not represent a component of the Company that had operations and cash flows that were clearly distinguishable, operationally and for financial reporting purposes, from the rest of the entity. The Company allocated the proceeds received to receivables, inventory, fixed assets and intangible assets based on the relative fair value of the assets sold. The Company recognized a gain of $1.3 million on the sale of the inventory related to this product line in the first quarter of 2008 that was recorded in cost of revenue. The Company also recognized a gain of $0.5 million and $3.2 million on the sale of fixed assets and intangible assets, respectively, in the first quarter of 2008 that was recorded as a component of operating expenses. The Company is entitled to additional contingent consideration

for the sale of the GigaMux legacy product line upon the buyer’s usage of inventory and/or attainment of certain

66

performance targets through December 2010. Additional contingent consideration, if any, will be recorded upon receipt of cash as an additional gain in cost of revenue. In the second, third and fourth quarters of 2008, the Company received contingent consideration of $0.6 million, $0.4 million and $0.1 million, respectively, related to the buyer’s usage of inventory related to the GigaMux legacy product line.

In December 2007, the Company sold its Access Node legacy product line to a third party. In addition to sale of inventory, the Company also sold fixed assets related to the Access Node legacy product line. Upon sale of the fixed assets, the Company recorded a gain of $0.7 million, which was recorded as a component of operating expenses.

Sale of Land

During the second quarter of 2007, the Company completed the sale of approximately 3.625 acres of undeveloped land at a price of $1.5 million to the Redevelopment Agency of the City of Oakland pursuant to a repurchase option exercised by it. No gain or loss was recorded on the sale.

(4) Fair Value Measurement

The Company adopted SFAS 157 during the first fiscal quarter of 2008, which requires enhanced disclosures about assets and liabilities measured at fair value. The Company’s adoption of SFAS 157 was limited to financial assets and liabilities, which primarily relate to its fixed income securities.

The Company utilizes the market approach to measure fair value of its financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

SFAS 157 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. The fair value hierarchy consists of the following three levels:

Level 1	-	Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2	-	Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
Level 3	-	Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

67

The following table represents the Company’s financial assets and liabilities at fair value on a recurring basis as of December 31, 2008 and the basis for that measurement:

	Fair Value Measurements at Reporting Date Using (In Thousands)
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Money market funds and overnight deposits (1)	$	21,639	$	21,639	$	—	$	—
Fixed income available-for-sale securities (2)		2,992		—		2,992		—
Total	$	24,631	$	21,639	$	2,992	$	—

(1) Included in cash and cash equivalents on the Company’s consolidated balance sheet.

(2) Included in short-term investments on the Company’s consolidated balance sheet.

(5) Balance Sheet Detail

Balance sheet detail as of December 31, 2008 and 2007 is as follows (in thousands):

	2008			2007
Inventories:
Raw materials	$	26,720		$	33,479
Work in process		5,160			5,194
Finished goods		8,826			6,025
	$	40,706		$	44,698
Property and equipment:
Land	$	4,821		$	4,821
Buildings		14,007			14,007
Machinery and equipment		8,682			7,729
Computers and acquired software		3,536			3,401
Furniture and fixtures		513			389
Leasehold improvements		381			378
		31,940			30,725
Less accumulated depreciation and amortization		(11,937	)		(9,907	)
	$	20,003		$	20,818

Depreciation and amortization expense associated with property and equipment amounted to $2.2 million, $2.7 million and $2.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.

	2008		2007
Accrued and other liabilities (in thousands):
Accrued warranty	$	1,979	$	2,487
Accrued compensation		2,765		3,051
Accrued exit costs		1,718		3,695
Deferred revenue		683		656
Other		6,017		7,999
	$	13,162	$	17,888

68

The Company accrues for warranty costs based on historical trends for the expected material and labor costs to provide warranty services. Warranty periods are generally one year from the date of shipment. The following table summarizes the activity related to the product warranty liability during the years ended December 31, 2008 and 2007 (in thousands):

Balance at December 31, 2006	$	3,128
Charged to operations		2,410
Claims/settlements		(3,051	)
Balance at December 31, 2007	$	2,487
Charged to operations		1,625
Claims/settlements		(2,133	)
Balance at December 31, 2008	$	1,979

(6) Debt

Secured Real Estate Loan

Long-term debt as of December 31, 2008 and 2007 consisted of a secured real estate loan as follows (in thousands):

	2008			2007
Secured real estate loan due April 2011	$	19,078		$	19,405
Less current portion of long-term debt		(380	)		(265	)
	$	18,698		$	19,140

Aggregate debt maturities as of December 31, 2008 are $0.4 million in each of fiscal 2009 and 2010 and $18.3 million in fiscal 2011.

In December 2005, the Company entered into an amendment to an existing loan with a financial institution relating to the financing of its Oakland, California campus (the “Amended Loan”). Under the Amended Loan, (a) the outstanding principal balance was paid down from approximately $31.1 million to approximately $20.0 million, (b) the maturity date was extended five years to April 1, 2011, (c) the floor rate was reduced from 8.0% per annum to 6.5% per annum, (d) the variable rate margin was reduced from 3.5% per annum to 3.0% per annum, (e) the amortization period for purposes of calculating monthly principal payments was amended to a period of 25 years commencing on January 1, 2006, and (f) the financial institution cancelled the Company’s $6.0 million letter of credit. Interest accrues on the unpaid principal balance at a variable interest rate (which adjusts every six months) equal to the sum of the LIBOR rate plus 3.0% per annum; provided that in no event will the variable interest rate (a) exceed 14.2488% per annum, (b) be less than 6.5% per annum, or (c) be adjusted by more than 1.0% at any adjustment date. The Company is obligated to make monthly payments of principal and interest in an amount which fully amortizes the then unpaid principal balance of the loan and interest accruing thereon at the interest rate in effect in equal monthly installments over the remaining term of the amortization period. The interest rate on this debt was 6.9% as of December 31, 2008. The Company’s obligations under the Amended Loan remain secured by a security interest in the Company’s campus. As of December 31, 2008 and 2007, the debt was collateralized by land and buildings with a net book value of $16.1 million and $16.5 million, respectively.

Convertible Debentures

In July 2004, the Company assumed convertible debentures of $11.7 million in connection with the acquisition of Sorrento, with an interest rate of 7.5%. During 2006, the Company made a voluntary repayment of

69

$1.5 million relating to the convertible debenture debt. On August 2, 2007, the convertible debentures matured and the Company repaid the outstanding principal amount of $7.4 million plus accrued interest. The debentures were convertible into common stock at the option of the holder at a conversion price of $6.02 per share. No holders elected to convert their debentures into common stock.

Credit Facility

The Company has a revolving line of credit and letter of credit facility and an accounts receivable purchase facility with Silicon Valley Bank (the “SVB Facilities”). Under the facilities, the Company has the option of borrowing funds at agreed upon rates of interest, so long as the aggregate amount of outstanding borrowings does not exceed $25.0 million. In addition, the Company may sell specific accounts receivables to Silicon Valley Bank, on a non recourse basis, at agreed upon discounts to the face amount of those accounts receivables, so long as the aggregate amount of outstanding accounts receivables does not exceed $10.0 million.

Under the SVB Facilities, $15.0 million was outstanding at December 31, 2008 and 2007, and an additional $3.4 million was committed as security for various letters of credit as of December 31, 2008. The amounts borrowed under the revolving credit facility bear interest, payable monthly, at a floating rate that, at the Company’s option, is either (1) Silicon Valley Bank’s prime rate, or (2) the sum of the LIBOR rate plus 2.9%; provided that in either case, the minimum interest rate is 4.0%. The interest rate was 4.0% at December 31, 2008.

The Company’s obligations under the SVB Facilities are secured by substantially all of the Company’s personal property assets and those of its subsidiaries, including their intellectual property. The SVB Facilities contain certain financial covenants, and customary affirmative covenants and negative covenants. If the Company does not comply with the various covenants and other requirements under the SVB Facilities, Silicon Valley Bank is entitled to, among other things, require the immediate repayment of all outstanding amounts and sell the Company’s assets to satisfy the obligations under the SVB Facilities. As of December 31, 2008, the Company was in compliance with these covenants.

In January 2009, the Company repaid the $15.0 million outstanding under the SVB Facilities. In March 2009, the Company replaced the SVB Facilities when it entered into a new $20.0 million secured revolving credit arrangement with Silicon Valley Bank as discussed in Note 15 to the consolidated financial statements.

(7) Stockholders’ Equity

(a) Overview

As of December 31, 2008 and 2007, the Company’s equity capitalization consisted of 900 million authorized shares of common stock, of which 150.7 million and 150.0 million, respectively, were outstanding.

(b) Warrants

At December 31, 2008, the Company had a total of 1.39 million warrants to purchase common stock outstanding at a weighted average exercise price of $4.67 per share. Of these, 1.35 million fully vested warrants were assumed through the Company’s acquisition of Sorrento Networks Corporation (“Sorrento”) in July 2004 at a weighted average exercise price of $3.88 per share. These warrants were valued using the Black-Scholes option pricing model and the resulting fair value of $7.1 million was included in the purchase price for the acquisition. Warrants to purchase 0.8 million shares of common stock expired unexercised in 2008 with an aggregate exercise price of $2.7 million. The remaining warrants will expire in the years 2009 through 2014. No warrants were exercised in 2008, 2007 or 2006.

70

(c) Stock-Based Compensation

As of December 31, 2008, the Company had two types of share-based compensation plans related to stock options and employee stock purchases. The compensation cost that has been charged as an expense in the statement of operations for those plans was $2.4 million, $2.9 million and $5.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.

The following table summarizes stock-based compensation expense for the years ended December 31, 2008, 2007 and 2006 (in thousands):

	Year ended December 31,
	2008		2007		2006
Stock-based compensation under SFAS 123R	$	2,140	$	2,603	$	5,180
Compensation expense relating to non-employees		81		49		10
Compensation expense relating to Employee Stock Purchase Plan		130		214		315
Stock-based compensation expense	$	2,351	$	2,866	$	5,505

Stock Options

The share-based compensation plans are designed to attract, motivate, retain and reward talented employees, directors and consultants and align stockholder and employee interests. The Company has two active plans, the Amended and Restated Special 2001 Stock Incentive Plan and the Amended and Restated 2001 Stock Incentive Plan. Stock options are primarily issued from the Amended and Restated 2001 Stock Incentive Plan. This plan provides for the grant of incentive stock options, non-statutory stock options, restricted stock awards and other stock-based awards to officers, employees, directors and consultants of the Company. Options may be granted at an exercise price less than, equal to or greater than the fair market value on the date of grant, except that any options granted to a 10% stockholder must have an exercise price equal to at least 110% of the fair market value of the Company’s common stock on the date of grant. The Board of Directors determines the term of each option, the option exercise price and the vesting terms. Stock options are generally granted at an exercise price equal to the fair market value on the date of grant, expiring seven to ten years from the date of grant and vesting over a period of four years. On January 1 of each year, if the number of shares available for grant under the Amended and Restated 2001 Stock Incentive Plan is less than 5% of the total number of shares of common stock outstanding as of that date, the shares available for grant under the plan are automatically increased by the amount necessary to make the total number of shares available for grant equal to 5% of the total number of shares of common stock outstanding, or by a lesser amount as determined by the Board of Directors. As of December 31, 2008, 2.1 million shares were available for grant under these plans.

Through the acquisition of Paradyne in September 2005 and Sorrento in July 2004, the Company assumed several stock option plans, including the Amended and Restated 1996 Equity Incentive Plan, the 1999 Non-Employee Directors’ Stock Option Plan, the 2000 Broad-Based Stock Plan, the Amended and Restated Osicom Technologies, Inc. 1997 Incentive and Non-Qualified Stock Option Plan, Sorrento Networks Corporation 2000 Stock Incentive Plan and the 2003 Equity Incentive Plan. In February 2006, the Company amended and froze these plans as well as the Zhone Technologies, Inc. 1999 Stock Option Plan and the 2002 Stock Incentive Plan to provide that no further awards be made under these plans. As a result of this amendment, approximately 12.4 million shares were no longer available for grant. During the year ended December 31, 2008 and 2007, there were cancelled shares relating to plans which were frozen and therefore unavailable for grant of 3.5 million and 1.7 million, respectively.

The Company has estimated the fair value of stock-based payment awards on the date of grant using the Black Scholes pricing model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the Company’s expected stock price

71

volatility over the term of the awards, actual and projected employee option exercise behaviors, risk free interest rate and expected dividends. The estimated expected term of options granted was determined based on historical option exercise trends. Estimated volatility was based on historical volatility and the risk free interest rate was based on U.S. Treasury yield in effect at the time of grant for the expected life of the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore used an expected dividend yield of zero in the option valuation model. The Company is also required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. Historical data was used to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that are expected to vest.

The assumptions used to value option grants for the years ended December 31, 2008, 2007 and 2006 are as follows:

	Year ended December 31,
	2008		2007		2006
Expected term	4.7 years		4.7 years		4.9 years
Expected volatility	75	%	60	%	73	%
Risk free interest rate	1.86	%	4.13	%	4.7	%

The weighted average grant date fair value of options granted during the years ended December 31, 2008, 2007 and 2006 was $0.09, $0.68 and $1.10 per share, respectively. The intrinsic value of options exercised for the years ended December 31, 2008, 2007 and 2006 was $0.02 million, $0.08 million and $0.8 million, respectively. For the years ended December 31, 2008, 2007 and 2006, the Company received $0.01 million, $0.01 million and $1.4 million in proceeds from stock option exercises, respectively.

The following table sets forth the summary of option activity under the stock option program for the year ended December 31, 2008 (in thousands, except per share data):

	Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding as of December 31, 2007	24,939		$	4.21	4.92	$	406
Granted (1)	18,181		$	0.16
Canceled/Forfeited (1)	(16,592	)	$	2.81
Exercised	(28	)	$	0.21
Outstanding as of December 31, 2008	26,500		$	2.29	5.00	$	—
Vested and expected to vest at December 31, 2008	24,117		$	2.64	4.69	$	—
Vested and exercisable at December 31, 2008	9,443		$	6.19	1.82	$	—

(1) Includes options of 14.5 million shares exchanged in the Exchange Offer.

The aggregate intrinsic value represents the total pretax intrinsic value, based on the Company’s closing stock price as of December 31, 2008 of $0.08, which would have been received by the option holders had the option holders exercised their options as of that date.

As of December 31, 2008, there was $4.3 million of unrecognized compensation costs, adjusted for estimated forfeitures related to unvested stock-based payments granted which are expected to be recognized over a weighted average period of 2 years.

72

In October 2008, the Company’s stockholders approved an amendment to the Company’s restated certificate of incorporation that would effect a reverse stock split, pursuant to which the existing shares of Zhone’s common stock would be combined into new shares of common stock at an exchange ratio ranging from one-for-five to one-for-ten, with the exchange ratio to be determined by Zhone. In addition, the Company’s stockholders approved amendments to certain of its equity incentive compensation plans to permit the repricing of stock options and to increase the number of shares reserved for issuance under the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan.

In November 2008, the Company completed an offer (the “Exchange Offer”) to exchange certain stock options issued to eligible employees, officers and directors of Zhone under Zhone’s equity incentive compensation plans. Stock options previously granted that had an exercise price per share of equal to or greater than $0.35 per share were eligible to be exchanged on a one-for-one basis for new stock options with an exercise price equal to the last reported sale price of Zhone common stock on The Nasdaq Global Market on the date of grant. Options for an aggregate of 14.5 million shares of common stock were exchanged. The new stock options issued pursuant to the Exchange Offer have an exercise price of $0.10, will vest over a four-year period with no credit for past vesting and have a seven-year term. The Exchange Offer will result in incremental stock-based compensation of approximately $0.7 million to be recognized over the four-year vesting period. The remaining unrecognized compensation expense of the original grant will be amortized over the original requisite service period.

Employee Stock Purchase Plan

The Company’s 2002 Employee Stock Purchase Plan (“ESPP”) allows eligible employee participants to purchase shares of the Company’s common stock at a price equal to 85% of the lower of the fair market value of the common stock at the beginning or the end of each offering period. Participation is limited to 10% of an employee’s eligible compensation, not to exceed amounts allowed by the Internal Revenue Code. During the second quarter of 2006, the number of available shares under the ESPP was increased by 2.0 million. At September 1, 2005, the Company changed from a six month offering period to a three month offering period under the ESPP. The following table summarizes shares purchased, weighted average purchase price, cash received and the aggregate intrinsic value for ESPP purchases during the years ended December 31, 2008, 2007 and 2006 (in thousands, except per share data):

	Year ended December 31,
	2008		2007		2006
Shares purchased		557		641		581
Weighted average purchase price	$	0.52	$	1.02	$	1.49
Cash received	$	288	$	653	$	867
Aggregate intrinsic value	$	50	$	182	$	351

The assumptions used to value stock purchases under the Company’s ESPP for the years ended December 31, 2008, 2007 and 2006 are as follows:

	Year ended December 31,
	2008		2007		2006
Expected term	3 months		3 months		3 months
Volatility	68	%	60	%	57	%
Risk free interest rate	2.0	%	4.7	%	4.7	%
Weighted average fair value per share	$0.24		$0.35		$0.54

73

(8) Net Loss Per Share

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

	Year ended December 31,
	2008			2007			2006
Numerator:
Net loss	$	(92,535	)	$	(12,102	)	$	(142,666	)
Denominator:
Weighted average common stock outstanding		150,342			149,623			148,727
Basic and diluted net loss per share	$	(0.62	)	$	(0.08	)	$	(0.96	)

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

	2008	Weighted Average Exercise price
Warrants	1,389	$	4.67
Outstanding stock options and unvested restricted shares	26,548	$	2.29
	27,937
	2007	Weighted Average Exercise price
Warrants	2,185	$	4.20
Outstanding stock options and unvested restricted shares	24,977	$	4.21
	27,162
	2006	Weighted Average Exercise price
Warrants	2,716	$	4.68
Convertible debentures	1,231	$	6.02
Outstanding stock options	25,141	$	4.56
	29,088

As of December 31, 2008 and 2007, there were zero shares of issued common stock subject to repurchase.

74

(9) Income Taxes

The following is a summary of the components of income tax expense applicable to net loss before income taxes (in thousands):

	Year ended December 31,
	2008		2007		2006
Current:
Federal	$	—	$	—	$	—
State		104		150		117
Foreign		166		244		147
		270		394		264
Deferred:
Federal		—		—		—
State		—		—		—
Foreign		—		—		—
	$	270	$	394	$	264

A reconciliation of the expected tax expense (benefit) to the actual tax expense is as follows (in thousands):

	Year ended December 31,
	2008			2007			2006
Expected tax benefit at statutory rate (35%)	$	(32,292	)	$	(4,098	)	$	(49,841	)
State taxes, net of Federal effect		68			98			76
Goodwill amortization and impairment		24,640			—			38,665
Foreign rate differential		(759	)		(1,474	)		5,833
Valuation allowance		7,764			4,886			3,834
Stock-based compensation		810			948			1,615
Other		39			34			82
	$	270		$	394		$	264

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2008 and 2007 are as follows (in thousands):

	2008			2007
Deferred assets:
Net operating loss, capital loss, and tax credit carryforwards	$	493,534		$	478,835
Fixed assets and intangible assets		50,687			59,542
Inventory and other reserves		12,056			14,321
Other		126			120
Gross deferred tax assets		556,403			552,818
Less valuation allowance		(556,403	)		(552,818	)
Total deferred tax assets	$	—		$	—

For the years ended December 31, 2008 and 2007, the net changes in the valuation allowance were an increase of $3.6 million and a decrease of $0.1 million, respectively. The Company recorded a full valuation allowance against the net deferred tax assets at December 31, 2008 and 2007 since it is more likely than not that

75

the net deferred tax assets will not be realized due to the lack of previously paid taxes and anticipated taxable income. Approximately $359.0 million of the valuation allowance for deferred tax assets relates to various acquisitions.

As of December 31, 2008, the Company had net operating loss carryforwards for federal and California income tax purposes of approximately $1,275.3 million and $389.2 million, respectively, which are available to offset future taxable income, if any, in years through 2028. Approximately $3.1 million and $2.0 million net operating loss carryforwards for federal and California income tax purposes, respectively, are attributable to employee stock option deductions, the benefit from which will be allocated to paid-in-capital rather than current income when subsequently recognized. Federal and state laws impose substantial restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an ownership change for tax purposes, as defined in Section 382 of the Internal Revenue Code. As a result of such ownership changes, the Company’s ability to realize the potential future benefit of tax losses and tax credits that existed at the time of the ownership change will be significantly reduced. The Company’s deferred tax asset and related valuation allowance would be reduced as a result. The Company has not yet performed a Section 382 study to determine the amount of reduction, if any.

As of December 31, 2008, the Company also had research credit carryforwards for federal and state income tax purposes of approximately $20.8 million and $7.7 million, respectively, which are available to reduce future income taxes, if any, in years through 2028 and over an indefinite period, respectively. Additionally, the Company had alternative minimum tax credit carryforwards for federal income tax purposes of approximately $0.1 million which are available to reduce future income taxes, if any, over an indefinite period. The Company also had enterprise zone credit carryforwards for state income tax purposes of approximately $0.2 million which are available to reduce future state income taxes, if any, over an indefinite period.

The Company may have unrecognized tax benefits included in its deferred tax assets which are subject to a full valuation allowance as of December 31, 2008 and 2007. However, the Company has not yet performed a study to determine the amount of such unrecognized tax benefits.

Interest and penalties, to the extent accrued on unrecognized tax benefits in the future, will be included in tax expense.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. The open tax years for the major jurisdictions are as follows:

•       Federal	2005 – 2008
•       California and Canada	2004 – 2008
•       Brazil	2001 – 2008
•       Germany and United Kingdom	2005 – 2008

However, due to the fact the Company had net operating losses and credits carried forward in most jurisdictions, certain items attributable to technically closed years are still subject to adjustment by the relevant taxing authority through an adjustment to tax attributes carried forward to open years.

In addition, to the extent the Company is deemed to have a sufficient connection to a particular taxing jurisdiction to enable that jurisdiction to tax the Company but the Company has not filed an income tax return in that jurisdiction for the year(s) at issue, the jurisdiction would typically be able to assert a tax liability for such years without limitation on the number of years it may examine.

The Company is not currently under examination for income taxes in any material jurisdiction.

76

(10) Related-Party Transactions

In the ordinary course of business, the Company’s executive officers and non-employee directors are reimbursed for travel related expenses when incurred for business purposes. The Company reimburses its Chairman, President and Chief Executive Officer, Morteza 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 $0.5 million, $0.6 million and $0.7 million during the years ended December 31, 2008, 2007 and 2006, respectively.

(11) Commitments and Contingencies

Operating Leases

The Company has entered into operating leases for certain office space and equipment, some of which contain renewal options.

Estimated future lease payments under all non-cancelable operating leases with terms in excess of one year, including taxes and services fees, are as follows (in thousands):

	Operating leases
Year ending December 31:
2009		4,773
2010		4,506
2011		4,478
2012		2,279
2013		—
Total minimum lease payments	$	16,036

The total minimum lease payments shown above include projected payments and obligations for leases, some of which relate to excess facilities obtained through acquisitions. At December 31, 2008, the Company had estimated commitments of $15.2 million related to facilities assumed as a result of the Paradyne acquisition, of which $5.6 million was accrued for excess facilities in accrued liabilities as of December 31, 2008. For operating leases that include contractual commitments for operating expenses and maintenance, estimates of such amounts are included based on current rates. Rent expense under operating leases, excluding rent relating to excess facilities previously accrued, totaled $4.0 million, $4.9 million and $4.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. Sublease rental income totaled $1.3 million, $1.5 million and $1.0 million for the years ended December 31, 2008, 2007 and 2006, respectively.

Other Commitments

The Company has agreements with various contract manufacturers which include inventory repurchase commitments for excess material based on the Company’s sales forecasts. The Company has recorded a liability for estimated charges of $0.04 million and $0.01 million related to these arrangements as of December 31, 2008 and 2007, respectively.

The Company is currently under audit examination by several state taxing authorities for non income based taxes. The Company has reserved an estimated amount which the Company believes is sufficient to cover potential claims. However, there are certain examinations including those related to acquired entities, for which an amount cannot be reasonably estimated. In these instances, the examinations are still in the information gathering stage and no formal assessment has been made.

77

Performance Bonds

In the normal course of operations, the Company arranges for the issuance of various types of surety bonds, such as bid and performance bonds, which are agreements under which the surety company guarantees that the Company will perform in accordance with contractual or legal obligations. If the Company fails to perform under its obligations, the maximum potential payment under these surety bonds would have been $0.8 million as of December 31, 2008.

Royalties

The Company has certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.

(12) Litigation

Paradyne Matters

As a result of the acquisition of Paradyne, the Company became involved in various legal proceedings, claims and litigation, including those identified below, relating to the operations of Paradyne prior to the acquisition of Paradyne.

A purported stockholder class action complaint was filed in December 2001 in the United States District Court in the Southern District of New York against Paradyne, Paradyne’s then-current directors and executive officers, and each of the underwriters (the “Underwriter Defendants”) who participated in Paradyne’s initial public offering and follow-on offering (collectively, the “Paradyne Offerings”). The complaint alleges that, in connection with the Paradyne Offerings, the Underwriter Defendants charged excessive commissions, inflated transaction fees not disclosed in the applicable registration statements and allocated shares of the Paradyne Offerings to favored customers in exchange for purported promises by such customers to purchase additional shares in the aftermarket, thereby allegedly inflating the market price for the Paradyne Offerings. The complaint seeks damages in an unspecified amount for the purported class for the losses suffered during the class period. This action has been consolidated with hundreds of other securities class actions commenced against more than 300 companies (collectively, the “Issuer Defendants”) and approximately 40 investment banks in which the plaintiffs make substantially similar allegations as those made against Paradyne with respect to the initial public offerings and/or follow-on offerings at issue in those other cases. All of these actions have been consolidated before Judge Shira Scheindlin under the caption In re: Initial Public Offering Securities Litigation (the “IPO Actions”).

In 2003, the Issuer Defendants participated in a global settlement among the plaintiffs and the insurance companies that provided directors’ and officers’ insurance coverage to the Issuer Defendants (the “Issuer Settlement”). The Issuer Settlement agreements provided for the Issuer Defendants (including Paradyne) to be fully released and dismissed from the IPO Actions. Under the terms of the Issuer Settlement agreements, Paradyne would not have been required to make any cash payment to the plaintiffs. Although the District Court preliminarily approved the Issuer Settlement, the preliminary approval remained subject to a future final settlement order, after notice of settlement had been provided to class members and they had been afforded the opportunity to oppose or opt out of the settlement. However, before the District Court could conduct its final settlement hearing, on December 5, 2006, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) reversed an October 13, 2004 order of the District Court in which Judge Scheindlin had granted class certification for six “test cases” in the IPO Actions. On April 4, 2007, the Second Circuit denied the plaintiffs’ petition for rehearing of the December 5, 2006 ruling. The District Court has since made clear that the Issuer Settlement cannot be approved — in its current form — as a class action settlement in light of the Second Circuit’s December 5, 2006 ruling and has declined to schedule a final approval hearing with respect to the Issuer Settlement for that reason. Counsel for the plaintiffs, for the Issuer Defendants and for the insurance companies

78

that provided directors’ and officers’ insurance to the Issuer Defendants are currently engaged in discussions to restructure and salvage the Issuer Settlement. There can be no assurance that a restructured Issuer Settlement will be reached by the parties or that any such future settlement will meet the conditions for final approval by the District Court.

Other Matters

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, the Company does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position or results of operations. However, litigation is subject to inherent uncertainties, and unfavorable rulings could occur. If an unfavorable ruling were to occur, there exists the possibility of a material adverse impact on the results of operations of the period in which the ruling occurs, or future periods.

(13) Employee Benefit Plan

The Company maintains a 401(k) plan for its employees whereby eligible employees may contribute up to a specified percentage of their earnings, on a pretax basis, subject to the maximum amount permitted by the Internal Revenue Code. Under the 401(k) plan, the Company may make discretionary contributions. The Company made no discretionary contributions to the plan during the three years ended December 31, 2008.

Through the acquisition of Paradyne in September 2005, the Company assumed the Paradyne Corporation Retirement Savings Plan 401K Plan. In December 2005, the plan was amended thereby freezing all future contributions and eliminating any Company contributions. In March 2006, the plan’s assets were merged into the Zhone Technologies, Inc. 401(k) Plan.

(14) Enterprise Wide Information

The Company designs, develops and markets communications products for network service providers. The Company derives substantially all of its revenues from the sales of the Zhone product family. The Company’s chief operating decision maker is the Company’s Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis accompanied by disaggregated information about revenues by geographic region for purposes of making operating decisions and assessing financial performance. The Company has determined that it has operated within one discrete reportable business segment since inception. The following summarizes required disclosures about geographic concentrations and revenue by products and services (in thousands).

	Year ended December 31,
	2008		2007		2006
Revenue by Geography:
United States	$	60,830	$	79,453	$	105,098
Canada		5,391		10,497		10,611
Total North America		66,221		89,950		115,709
Latin America		32,197		37,808		25,154
Europe, Middle East, Africa		43,820		42,208		45,441
Asia Pacific		3,922		5,482		8,040
Total International		79,939		85,498		78,635
	$	146,160	$	175,448	$	194,344

79

	Year ended December 31,
	2008		2007		2006
Revenue by products and services:
Products	$	141,916	$	164,570	$	181,988
Services		4,244		10,878		12,356
	$	146,160	$	175,448	$	194,344

(15) Subsequent Event

On March 16, 2009, the Company entered into a secured revolving credit arrangement (“SVB Facility”) with Silicon Valley Bank (“SVB”) to provide liquidity and working capital through March 15, 2010. The SVB Facility replaced the existing SVB Facilities.

Under the SVB Facility, the Company has the option of borrowing funds at agreed upon interest rates as long as the aggregate amount outstanding does not exceed $20.0 million. The amount that the Company is able to borrow under the SVB Facility will vary based on the eligible accounts receivable, as defined in the agreement. Also, under the SVB Facility, the Company is able to utilize up to $7.0 million of the facility as security for letters of credit.

The amounts borrowed under the revolving credit facility will bear interest, payable monthly, at a floating rate that is SVB’s prime rate plus 2.5%. The minimum interest rate is 4.0%. The Company’s obligations under the SVB Facility are secured by substantially all of its personal property assets and those of its subsidiaries, including their intellectual property. The SVB Facility contains certain new financial covenants, and customary affirmative and negative covenants. If Zhone does not comply with the various covenants and other requirements under the SVB Facility, SVB is entitled, among other things, to require the immediate repayment of all outstanding amounts and to sell Zhone’s assets to satisfy the obligations under the SVB Facility.

80

(16) Quarterly Information (unaudited)

	Year ended December 31, 2008
	Q1			Q2			Q3			Q4
	(in thousands, except per share data)
Net revenue	$	43,033		$	40,069		$	32,020		$	31,038
Gross profit		13,806			11,616			9,644			9,998
Gain on sale of intangible assets		(3,204	)		(93	)		—			(1,100	)
Impairment of intangible assets and goodwill		—			70,401			—			—
Operating loss (a)		(888	)		(80,091	)		(6,153	)		(4,294	)
Net loss		(941	)		(80,334	)		(6,529	)		(4,731	)
Basic and diluted net loss per share	$	(0.01	)	$	(0.53	)	$	(0.04	)	$	(0.03	)
Weighted-average shares outstanding used to compute basic and diluted net loss per share		150,072			150,260			150,443			150,595
	Year ended December 31, 2007
	Q1			Q2			Q3			Q4
	(in thousands, except per share data)
Net revenue	$	43,146		$	44,085		$	41,604		$	46,613
Gross profit		15,539			14,976			12,471			16,092
Gain on sale of intangible assets		—			—			(5,000	)		—
Operating loss (b)		(4,569	)		(4,403	)		(1,389	)		(984	)
Net loss		(4,786	)		(4,554	)		(1,530	)		(1,232	)
Basic and diluted net loss per share	$	(0.03	)	$	(0.03	)	$	(0.01	)	$	(0.01	)
Weighted-average shares outstanding used to compute basic and diluted net loss per share		149,338			149,533			149,715			149,907

(a) Operating loss included a $1.1 million gain on sale of patents during the fourth quarter ended December 31, 2008, a $3.2 million and $0.1 million gain on sale of intangible assets related to the GigaMux legacy product line during the first and second quarters ended March 31, 2008 and June 30, 2008, respectively, and $70.4 million of goodwill impairment during the second quarter ended June 30, 2008.

(b) Operating loss included a $5.0 million gain on sale of patents during the third quarter ended September 30, 2007.

81

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. The controls evaluation was done under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted in this Part II, Item 9A, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information relating to Zhone and its consolidated subsidiaries is made known to management, including our Chief Executive Officer and Chief Financial Officer, particularly during the period when our periodic reports are being prepared.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, the end of our fiscal year. In making this assessment, management used the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in the report entitled “Internal Control-Integrated Framework.” Based on our assessment of internal control over financial reporting, management has concluded that, as of December 31, 2008, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. Our independent registered public accounting firm, KPMG LLP, has issued an attestation report on our internal control over financial reporting. Such report appears at page 51.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or

82

by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

ITEM 9B. OTHER INFORMATION

On March 16, 2009, we entered into a secured revolving credit arrangement (“SVB Facility”) with Silicon Valley Bank (“SVB”) to provide liquidity and working capital. The SVB Facility replaced the existing SVB Facilities.

Under the SVB Facility, we have the option of borrowing funds at agreed upon interest rates as long as the aggregate amount outstanding does not exceed $20.0 million. The amount that we are able to borrow under the SVB Facility will vary based on the eligible accounts receivable, as defined in the agreement. Also, under the SVB Facility, we are able to utilize up to $7.0 million of the facility as security for letters of credit.

The amounts borrowed under the revolving credit facility will bear interest, payable monthly, at a floating rate that is SVB’s prime rate plus 2.5%. The minimum interest rate is 4.0%. Our obligations under the SVB Facility are secured by substantially all of our personal property assets and those of our subsidiaries, including our intellectual property. The SVB Facility contains certain new financial covenants, and customary affirmative and negative covenants. If we do not comply with the various covenants and other requirements under the SVB Facility, SVB is entitled, among other things, to require the immediate repayment of all outstanding amounts and to sell our assets to satisfy the obligations under the SVB Facility.

The foregoing description of the SVB Facility does not purport to be complete and is qualified in its entirety by reference to the Second Amended and Restated Loan and Security Agreement and the Loan and Security Agreement (EXIM Facility) with SVB, which are filed as Exhibits 10.19 and 10.20 to this report and incorporated herein by reference.

83

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item relating to our directors and nominees, and compliance with Section 16(a) of the Securities Exchange Act of 1934 is included under the captions “Corporate Governance Principles and Board Matters,” “Ownership of Securities” and “Proposal 1: Election of Directors” in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders and is incorporated herein by reference.

The information required by this item relating to our executive officers is included under the caption “Executive Officers” in Part I of this Form 10-K and is incorporated by reference into this section.

We have adopted a Code of Conduct and Ethics applicable to all of our employees, directors and officers (including our principal executive officer, principal financial officer, principal accounting officer and controller). The Code of Conduct and Ethics is designed to deter wrongdoing and to promote honest and ethical conduct and compliance with applicable laws and regulations. The full text of our Code of Conduct and Ethics is published on our website at www.zhone.com. We intend to disclose future amendments to certain provisions of our Code of Conduct and Ethics, or waivers of such provisions granted to executive officers and directors, on our website within four business days following the date of such amendment or waiver.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is included under the captions “Executive Compensation” and “Compensation Committee Report” in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item relating to security ownership of certain beneficial owners and management, and securities authorized for issuance under equity compensation plans is included under the captions “Ownership of Securities” and “Executive Compensation” in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is included under the captions “Certain Relationships and Related Transactions” and “Corporate Governance Principles and Board Matters” in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is included under the caption “Proposal 2: Ratification of Appointment of Independent Registered Public Accounting Firm” in our definitive Proxy Statement for the 2009 Annual Meeting of Stockholders and is incorporated herein by reference.

84

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

1. Financial Statements

The Index to Consolidated Financial Statements on page 49 is incorporated herein by reference as the list of financial statements required as part of this report.

2. Exhibits

The Exhibit Index on page 87 is incorporated herein by reference as the list of exhibits required as part of this report.

85

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	ZHONE TECHNOLOGIES, INC.
Date: March 16, 2009	By:	/S/    MORTEZA EJABAT
		Morteza Ejabat
		Chief Executive Officer

Know all persons by these presents, that each person whose signature appears below constitutes and appoints Morteza Ejabat and Kirk Misaka, jointly and severally, his attorneys-in-fact, each with the full power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/S/    MORTEZA EJABAT	Chairman of the Board of Directors,	March 16, 2009
Morteza Ejabat	President, and Chief Executive Officer     (Principal Executive Officer)
/S/    KIRK MISAKA	Chief Financial Officer,	March 16, 2009
Kirk Misaka	Treasurer and Secretary     (Principal Financial and Accounting     Officer)
/S/    MICHAEL CONNORS	Director	March 16, 2009
Michael Connors
/S/    ROBERT DAHL	Director	March 16, 2009
Robert Dahl
/S/    JAMES H. GREENE, JR.	Director	March 16, 2009
James H. Greene, Jr.
/S/    C. RICHARD KRAMLICH	Director	March 16, 2009
C. Richard Kramlich
/S/    STEVEN LEVY	Director	March 16, 2009
Steven Levy
/S/    JAMES TIMMINS	Director	March 16, 2009
James Timmins

86

EXHIBIT INDEX

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File Number	Exhibit	Filing Date
3.1	Restated Certificate of Incorporation dated February 16, 2005	10-K	000-32743	3.1	March 16, 2005
3.2	Amended and Restated Bylaws	10-K	000-32743	3.2	March 16, 2005
4.1	Form of Second Restated Rights Agreement dated November 13, 2003	10-Q	000-32743	4.1	May 14, 2004
10.1	Zhone Technologies, Inc. 1999 Stock Option Plan	10	000-50263	10.2	April 30, 2003
10.2	Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan	8-K	000-32743	10.1	May 17, 2007
10.3	Form of Stock Option Agreement for the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan	8-K	000-32743	10.1	September 1, 2006
10.4	Zhone Technologies, Inc. Amended and Restated Special 2001 Stock Incentive Plan	10-Q	000-32743	10.28	August 15, 2002
10.5	Form of Restricted Stock Award Agreement for the Zhone Technologies, Inc. Amended and Restated 2001 Stock Incentive Plan	8-K	000-32743	10.2	May 17, 2007
10.6	Zhone Technologies, Inc. 2002 Employee Stock Purchase Plan	8-K	000-32743	10.1	May 17, 2006
10.7	Incentive Awards Program Summary	8-K	000-32743	10.2	March 15, 2006
10.8	Form of Indemnity Agreement between Zhone Technologies, Inc. and its directors and officers	10-Q	000-32743	10.20	May 14, 2004
10.9	Letter Agreement dated November 13, 2003 between Zhone Technologies, Inc. and KKR–ZT, L.L.C.	Schedule 13D	005-61973	4	November 24, 2003
10.10	Letter Agreement dated May 24, 2006 between Zhone Technologies, Inc. and KKR–ZT, L.L.C.	10-K	000-32743	10.10	March 8, 2007
10.11	Letter Agreement dated November 13, 2003 between Zhone Technologies, Inc. and New Enterprise Associates VIII, Limited Partnership	Schedule 13D	005-61973	5	November 24, 2003
10.12	Letter Agreement dated November 13, 2003 between Zhone Technologies, Inc. and TPG Zhone, L.L.C.	Schedule 13D	005-61973	2	November 25, 2003

87

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File Number	Exhibit	Filing Date
10.13	Loan and Security Agreement dated March 30, 2001 between Zhone Technologies, Inc. and Fremont Investment and Loan	10	000-50263	10.21	April 30, 2003
10.14	Pledge and Assignment of Cash Collateral Account dated March 30, 2001 between Zhone Technologies, Inc. and Fremont Investment and Loan	10	000-50263	10.22	April 30, 2003
10.15	Secured Promissory Note dated March 30, 2001 between Zhone Technologies, Inc. and Fremont Investment and Loan	10	000-50263	10.23	April 30, 2003
10.16	Second Amendment to Deed of Trust and Other Loan Documents dated December 27, 2005 between Zhone Technologies, Inc., Zhone Technologies Campus, LLC, and Fremont Investment & Loan	8-K	000-32743	10.1	December 27, 2005
10.17	Purchase and Sale Agreement with Repurchase Options dated January 20, 2000 between Zhone Technologies, Inc. and the Redevelopment Agency of the City of Oakland	10	000-50263	10.28	April 30, 2003
10.18	Amended and Restated Employment Agreement dated November 8, 2007 by and between Zhone Technologies, Inc. and Morteza Ejabat	10-K	000-32743	10.27	March 6, 2008
10.19	Second Amended and Restated Loan and Security Agreement with an effective date of March 16, 2009 among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc. and Silicon Valley Bank					X

88

Exhibit Number	Exhibit Description	Incorporated by Reference				Filed Herewith
		Form	File Number	Exhibit	Filing Date
10.20	Loan and Security Agreement (EXIM Facility) with an effective date of March 16, 2009 among Zhone Technologies, Inc., ZTI Merger Subsidiary III, Inc. and Silicon Valley Bank					X
21.1	List of Subsidiaries	10-K	000-32743	21.1	March 6, 2008
23.1	Consent of Independent Registered Public Accounting Firm					X
24.1	Power of Attorney (see signature page)					X
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)					X
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)					X
32.1	Section 1350 Certification of Chief Executive Officer and Chief Financial Officer					X

89

EX-10.19

EXHIBIT 10.19

SECOND AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT

THIS SECOND AMENDED AND RESTATED LOAN AND SECURITY AGREEMENT (this “Agreement”), dated as of March 16, 2009 (the “Effective Date”), between, on the one hand, SILICON VALLEY BANK, a California corporation (“Bank”), and, on the other hand, ZTI Merger Subsidiary III, Inc., a Delaware corporation formerly known as Zhone Technologies, Inc. (“ZMS-III”, and also a “Borrower”), and Zhone Technologies, Inc., a Delaware corporation formerly known as Tellium, Inc. (“Zhone”, and also a “Borrower”) (individually and collectively, and jointly and severally, “Borrower”), provides the terms on which Bank shall lend to Borrower and Borrower shall repay Bank. This Agreement amends and restates in its entirety that certain Amended and Restated Loan and Security Agreement, dated as of February 24, 2004, between Bank and Borrower (as amended, restated, supplemented, or otherwise modified from time to time, the “2004 Loan Agreement”).

Reference also is made to that certain Non-Recourse Receivables Purchase Agreement, dated as of March 15, 2005, between Bank and Borrower (as amended, restated, supplemented, or otherwise modified from time to time, the “2005 Receivables Purchase Agreement”). Bank and Borrower hereby acknowledge that the 2005 Receivables Purchase Agreement terminated in accordance with its terms on March 4, 2009 and is of no further force or effect.

Except for the 2004 Loan Agreement (which is being amended and restated in its entirety by this Agreement), all other existing documents, instruments and agreements between Borrower and Bank shall continue in full force and effect, including without limitation, all documents entered into by the Borrower and Bank in connection with Letters of Credit, FX Forward Contracts, or Cash Management Services, all security agreements (which shall continue to secure all present and future indebtedness, liabilities, guarantees and other Obligations), all negative pledge agreements (including but not limited to those relating to patents, trademarks, copyrights and other intellectual property), all lockbox agreements and blocked account agreements, all control agreements relating to deposit accounts, securities accounts or other accounts, all warrants to purchase stock or other securities or interests, all investor rights and other agreements relating to stock or securities, and all UCC-1 financing statements and other documents filed with governmental offices which perfect liens or security interests in favor of Bank. References in any such surviving Loan Documents to “Loan Agreement” shall be deemed to refer to this Agreement instead of the 2004 Loan Agreement.

The parties agree as follows:

A EXIM LOAN AGREEMENT; CROSS-COLLATERALIZATION; CROSS-DEFAULT

Concurrently herewith, Bank and the Borrower are entering into that certain other Loan and Security Agreement (Exim Facility), dated as of the Effective Date (as amended, restated, supplemented, or otherwise modified from time to time, the “Exim Loan Agreement”). Both this Agreement and the Exim Loan Agreement shall continue in full force and effect, and all rights and remedies under this Agreement and the Exim Loan Agreement are cumulative. The term “Obligations” as used in this Agreement and in the Exim Loan Agreement shall include without limitation the obligation to pay when due all Credit Extensions made pursuant to this Agreement (the “Non-Exim Loans”) and all interest thereon and the obligation to pay when due all Credit Extensions made pursuant to the Exim Loan Agreement (the “Exim Loans”) and all interest thereon. Without limiting the generality of the foregoing, all “Collateral” as defined in this Agreement and as defined in the Exim Loan Agreement shall secure all Exim Loans and all Non-Exim Loans, and all other Obligations. Any Event of Default under this Agreement shall also constitute an Event of Default under the Exim Loan Agreement, and any Event of Default under the Exim Loan Agreement shall also constitute an Event of Default under this Agreement. In the event Bank assigns its rights under the Exim Loan Agreement and/or under any note evidencing Exim Loans and/or its rights under this Agreement and/or under any note evidencing Non-Exim Loans, to any third party, including without limitation the Export-Import Bank of the United States (“Exim Bank”), whether before or after the occurrence of any Event of Default, Bank shall have the right (but not any obligation), in its sole discretion, to allocate and apportion Collateral to this Agreement, the Exim Loan Agreement, and/or any note(s) assigned and to specify the priorities of the respective security interests in such Collateral between itself and the assignee, all without consent of the Borrower.

1

1 ACCOUNTING AND OTHER TERMS

Accounting terms not defined in this Agreement shall be construed following GAAP. Calculations and determinations must be made following GAAP. Capitalized terms not otherwise defined in this Agreement shall have the meanings set forth in Section 13. All other terms contained in this Agreement, unless otherwise indicated, shall have the meaning provided by the Code to the extent such terms are defined therein.

2 LOAN AND TERMS OF PAYMENT

2.1 Promise to Pay. Borrower hereby unconditionally promises to pay Bank the outstanding principal amount of all Credit Extensions, and all accrued and unpaid interest thereon, as and when due in accordance with this Agreement.

2.1.1 Revolving Advances.

(a) Availability. Subject to the terms and conditions of this Agreement and subject to deduction of Reserves, Bank shall make Advances not exceeding the Availability Amount; provided, however, that the sum of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) under this Agreement, plus all outstanding Exim Loans under the Exim Loan Agreement, shall not exceed at any time the Maximum Combined Amount.

Amounts borrowed pursuant to this Section may be repaid and, prior to the Revolving Line Maturity Date, reborrowed, subject to the applicable terms and conditions precedent herein. Advances and other Credit Extensions will be made to each Borrower based on the Eligible Accounts of such Borrower, subject to the Maximum Revolver Amount for all Advances and other Credit Extensions hereunder to all Borrowers combined, and subject to the Maximum Combined Amount for all Non-Exim Loans and Exim Loans to all Borrowers combined.

(b) Allocation of Credit Extensions and Reserves as Between this Agreement and the Exim Loan Agreement. Subject at all times to Section 5.10 of this Agreement and Section 5.10 of the Exim Loan Agreement (with respect to permitted purposes of Non-Exim Loans and Exim Loans), Bank and Borrower hereby acknowledge and agree that, if and to the extent that there is both sufficient borrowing availability in accordance with the terms and conditions of this Agreement and sufficient borrowing availability in accordance with the terms and conditions of the Exim Loan Agreement, Bank shall have the right (but not the obligation) to require that Advances and other Credit Extensions will be made, and deemed outstanding, first under the Exim Loan Agreement to the extent of borrowing availability under the Exim Loan Agreement, before being made, and deemed outstanding, under this Agreement. Without limiting the generality of the foregoing, Bank shall have the right (but not the obligation) to allocate any Reserves (other than reserves in respect of specific Credit Extensions under this Agreement, specific “Credit Extensions” under the Exim Loan Agreement, or specific Accounts) first against borrowing availability under the Exim Loan Agreement before being allocated against borrowing availability under this Agreement.

(c) Termination of Revolving Line; Repayment. Bank’s obligation under this Agreement to provide Advances and other Credit Extensions in respect of the Revolving Line shall terminate on the Revolving Line Maturity Date. The principal amount of all Advances, the unpaid interest thereon, and all other Obligations relating to the Revolving Line shall be immediately due and payable on the Revolving Line Maturity Date.

2.1.2 Letters of Credit Sublimit.

(a) As part of the Revolving Line, Bank shall issue or have issued Letters of Credit for Borrower’s account, as requested by Borrower. The aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit), plus any Letter of Credit Reserves, under this Agreement may not exceed $7,000,000, subject to the Combined LC Sublimit set forth in Section 2.1.5(a). Such aggregate amounts utilized hereunder shall at all times reduce the amount otherwise available for Advances under the Revolving Line and the Combined Revolving Line. If, on the Revolving Line Maturity Date, there are any outstanding Letters of Credit, then on such date Borrower shall provide to Bank cash collateral in an amount equal to 105% of the face amount of all such Letters of Credit plus all interest, fees, and costs due or to become due in connection therewith

2

(as estimated by Bank in its good faith business judgment), to secure all of the Obligations relating to said Letters of Credit. All Letters of Credit shall be in form and substance acceptable to Bank in its sole discretion and shall be subject to the terms and conditions of Bank’s standard Application and Letter of Credit Agreement (the “Letter of Credit Application”). Borrower agrees to execute any further documentation in connection with the Letters of Credit as Bank may reasonably request. Borrower further agrees to be bound by the regulations and interpretations of the issuer of any Letters of Credit guarantied by Bank and opened for Borrower’s account or by Bank’s interpretations of any Letter of Credit issued by Bank for Borrower’s account, and Borrower understands and agrees that Bank shall not be liable for any error, negligence, or mistake, whether of omission or commission, in following Borrower’s instructions or those contained in the Letters of Credit or any modifications, amendments, or supplements thereto.

(b) The obligation of Borrower to immediately reimburse Bank for drawings made under Letters of Credit shall be absolute, unconditional, and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement, such Letters of Credit, and the Letter of Credit Application. Without limiting the generality of the foregoing, any payment by Bank under or in connection with a Letter of Credit shall constitute an Advance hereunder on the date such payment is made.

(c) Borrower may request that Bank issue a Letter of Credit payable in a Foreign Currency. If a demand for payment is made under any such Letter of Credit, Bank shall treat such demand as an Advance to Borrower of the equivalent of the amount thereof (plus fees and charges in connection therewith such as wire, cable, SWIFT or similar charges) in Dollars at the then-prevailing rate of exchange in San Francisco, California, for sales of the Foreign Currency for transfer to the country issuing such Foreign Currency.

(d) To guard against fluctuations in currency exchange rates, upon the issuance pursuant to this Agreement of any Letter of Credit payable in a Foreign Currency, Bank shall create a reserve (the “Letter of Credit Reserve”) under the Revolving Line in an amount equal to ten percent (10%) of the face amount of such Letter of Credit. The amount of the Letter of Credit Reserve may be adjusted by Bank from time to time to account for fluctuations in the exchange rate. The availability of funds under the Revolving Line shall be reduced by the amount of such Letter of Credit Reserve for as long as such Letter of Credit remains outstanding and shall be subject to the Combined LC Sublimit set forth in Section 2.1.5.

2.1.3 Foreign Exchange Sublimit. As part of the Revolving Line, Borrower may enter into foreign exchange contracts with Bank under which Borrower commits to purchase from or sell to Bank a specific amount of Foreign Currency (each, a “FX Forward Contract”) on a specified date (the “Settlement Date”). FX Forward Contracts shall have a Settlement Date of at least one (1) FX Business Day after the contract date and shall be subject to a reserve of ten percent (10%) of each outstanding FX Forward Contract in a maximum aggregate amount equal to $5,000,000 for all such FX Forward Contracts pursuant to this Agreement (the “FX Reserve”) and further subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, the aggregate amount of FX Forward Contracts at any one time may not exceed ten (10) times the amount of the FX Reserve. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, the amount otherwise available for Credit Extensions under the Revolving Line hereunder shall be reduced by an amount equal to ten percent (10%) of each outstanding FX Forward Contract (the “FX Reduction Amount”). Any amounts needed to fully reimburse Bank in respect of FX Forward Contracts entered into pursuant to this Section 2.1.3 will be treated as Advances under the Revolving Line and will accrue interest at the interest rate applicable to Advances.

2.1.4 Cash Management Services Sublimit. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, Borrower may use up to $5,000,000 (the “Cash Management Services Sublimit”) of the Revolving Line for Bank’s cash management services which may include merchant services, direct deposit of payroll, business credit card, and check cashing services identified in Bank’s various cash management services agreements (collectively, the “Cash Management Services”). Any amounts Bank pays on behalf of Borrower, or any amounts that are not paid by Borrower, for any Cash Management Services provided pursuant to this Section 2.1.4 will be treated as Advances under the Revolving Line and will accrue interest at the interest rate applicable to Advances.

3

2.1.5 Combined LC Sublimit; Combined FX/CMS Sublimit.

(a) Anything herein to the contrary notwithstanding, the sum of (i) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, plus (ii) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Exim Loan Agreement, shall not exceed $7,000,000 (the “Combined LC Sublimit”).

(b) Anything herein to the contrary notwithstanding, the sum of (i) the FX Reserve under this Agreement, plus (ii) the “FX Reserve” under the Exim Loan Agreement, plus (iii) the aggregate amount of Obligations in respect of Cash Management Services under this Agreement, plus (iv) the aggregate amount of Obligations in respect of “Cash Management Services” under the Exim Loan Agreement, shall not exceed $5,000,000 (the “Combined FX/CMS Sublimit”).

2.2 Overadvances. If at any time or for any reason any one or more of the following occurs (in any such case, an “Overadvance”):

(a) the total of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) exceeds the lesser of (1) the Maximum Revolver Amount or (2) the Borrowing Base; or

(b) the sum of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) under this Agreement, plus all outstanding Exim Loans (and other monetary “Obligations”) under the Exim Loan Agreement (including (iv) amounts used under the Exim Loan Agreement for “Cash Management Services”, (v) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Exim Loan Agreement, and (vi) the “FX Reduction Amount” under the Exim Loan Agreement), exceeds the Maximum Combined Amount; or

(c) the sum of (i) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, plus (ii) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Exim Loan Agreement, exceeds the Combined LC Sublimit; or

(d) the sum of (i) the FX Reduction Amount under this Agreement, plus (ii) the “FX Reduction Amount” under the Exim Loan Agreement, plus (iii) the aggregate amount of Obligations in respect of Cash Management Services under this Agreement, plus (iv) the aggregate amount of Obligations in respect of “Cash Management Services” under the Exim Loan Agreement, exceeds the Combined FX/CMS Sublimit;

then, Borrower shall promptly pay to Bank in cash such Overadvance within one Business Day following notice thereof from Bank to Borrower. Without limiting Borrower’s obligation to repay Bank any amount of the Overadvance, Borrower agrees to pay Bank interest on the outstanding amount of any Overadvance, on demand, at the Default Rate.

2.3 Payment of Interest on the Credit Extensions.

(a) Interest Rate. Subject to Section 2.3(b), the principal amount outstanding under the Revolving Line shall accrue interest at a per annum rate equal to the sum of the Loan Margin plus the Prime Rate, provided that the interest rate in effect on any day shall not be less than 6.50% per annum, which interest shall be payable monthly.

As used herein, the term “Loan Margin” means, as of any date of determination, 2.50 percentage points.

4

(b) Default Rate. Immediately upon the occurrence and during the continuance of an Event of Default, Obligations shall bear interest at a rate per annum which is four percentage points above the rate which is otherwise applicable to the Obligations (the “Default Rate”). Payment or acceptance of the increased interest rate provided in this Section 2.3(b) is not a permitted alternative to timely payment and shall not constitute a waiver of any Event of Default or otherwise prejudice or limit any rights or remedies of Bank.

(c) Adjustment to Interest Rate. Changes to the interest rate of any Credit Extension based on changes to the Prime Rate shall be effective on the effective date of any change to the Prime Rate and to the extent of any such change.

(d) 360-Day Year. Interest shall be computed on the basis of a 360-day year for the actual number of days elapsed.

(e) Debit of Accounts. Bank may debit any of Borrower’s deposit accounts, including the Designated Deposit Account, for (i) principal and interest payments, when due, or (ii) any other amounts Borrower owes Bank, when due. These debits shall not constitute a set-off.

(f) [reserved]

(g) Payment; Interest Computation; Float Charge. Interest is payable monthly on the last calendar day of each month. In computing interest on the Obligations, all Payments received after 12:00 p.m. Pacific time on any day shall be deemed received on the next Business Day. When the payment of an Obligation is due on a day that is not a Business Day, such payment shall be due the next Business Day and additional fees or interest, as applicable, shall continue to accrue until such Obligation is paid. In addition, Bank shall be entitled to charge Borrower a “float” charge in an amount equal to two (2) Business Days interest, at the interest rate applicable to the Advances, on all Payments received by Bank and applied to outstanding Advances. Said float charge is not included in interest for purposes of computing Minimum Monthly Interest (if any) under this Agreement. The float charge for each month shall be payable on the last day of such month. Bank shall not, however, be required to credit Borrower’s account for the amount of any item of payment which is unsatisfactory to Bank in its good faith business judgment, and Bank may charge Borrower’s Designated Deposit Account for the amount of any item of payment which is returned to Bank unpaid.

2.4 Fees. Borrower shall pay to Bank:

(a) Combined Commitment Fee. A non-refundable commitment fee (fully earned on the Effective Date) of $100,000, payable on the Effective Date, in respect of both this Agreement and the Exim Loan Agreement.

(b) Letter of Credit Fee. Bank’s customary fees and expenses for the issuance or renewal of Letters of Credit, upon the issuance, each anniversary of the issuance, and the renewal, of any such Letter of Credit by Bank.

(c) [intentionally omitted]

(d) Unused Combined Revolving Line Facility Fee. A fee (the “Unused Combined Revolving Line Facility Fee”), payable monthly, in arrears, in an amount equal to one-half of one percent (0.50%) per annum of the average unused portion of the Combined Revolving Line, as determined by Bank. The unused portion of the Combined Revolving Line, for the purposes of this calculation, shall: (i) not include amounts reserved under Section 2.1.2 of this Agreement in respect of outstanding Letters of Credit issued pursuant to this Agreement and under Section 2.1.2 of the Exim Loan Agreement in respect of outstanding “Letters of Credit” issued pursuant to the Exim Loan Agreement; but shall include (y) amounts reserved under Section 2.1.3 of this Agreement in respect of FX Forward Contracts entered into pursuant to this Agreement and under Section 2.1.3 of the Exim Loan Agreement in respect of “FX Forward Contracts” entered into pursuant to the Exim Loan Agreement, and (z) amounts reserved under Section 2.1.4 of this Agreement in respect of Cash Management Services used pursuant to this Agreement and under Section 2.1.4 of the Exim Loan Agreement in respect of “Cash Management Services” used pursuant to the Exim Loan Agreement. Borrower shall not be entitled to any credit, rebate or repayment of any Unused Combined Revolving Line Facility Fee previously earned by Bank pursuant to this Section notwithstanding any termination of the Agreement, or suspension or termination of Bank’s obligation to make loans and advances hereunder or under the Exim Loan Agreement.

5

(e) Combined Collateral Monitoring Fee. With respect to any “Qualified CMF Month” (as defined below), a monthly collateral monitoring fee of $1,000.00, payable in arrears on the last day of each such Qualified CMF Month (prorated for any partial such Qualified CMF Month at the beginning and upon termination of this Agreement). As used herein, the term “Qualified CMF Month” means any month during which there are outstanding any Advances under Section 2.1.1 of this Agreement, or any “Advances” under Section 2.1.1 of the Exim Loan Agreement, or any combination of Advances under Section 2.1.1 of this Agreement and “Advances” under Section 2.1.1 of the Exim Loan Agreement, for more than 3 consecutive Business Days.

(f) Bank Expenses. All Bank Expenses (including reasonable attorneys’ fees and expenses for documentation and negotiation of this Agreement and the other Loan Documents) incurred through and after the Effective Date, when due.

3 CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Credit Extension. Bank’s obligation to make the initial Credit Extension is subject to the condition precedent that Borrower shall consent to or have delivered, in form and substance satisfactory to Bank, such documents, and completion of such other matters, as Bank may reasonably deem necessary or appropriate, including, without limitation:

(a) Borrower and Guarantor shall have delivered duly executed original signatures to the Loan Documents to which it is a party, including this Agreement, the Exim Loan Agreement, the IP Security Agreement, the Guaranty, the Guarantor Security Agreement, the Intercompany Subordination Agreement, and one or more Control Agreements relative to all Collateral Accounts maintained with any affiliate of Bank;

(b) certified copies, dated as of a recent date, of financing statement searches with respect to each of Borrower and Guarantor, as Bank shall request, accompanied by written evidence (including any UCC termination statements) that the Liens indicated in any such financing statements either constitute Permitted Liens or have been or will be terminated or released;

(c) Borrower and Guarantor shall have delivered duly executed original signatures to one or more Control Agreements relative to all Collateral Accounts maintained with any institution (other than Bank or any affiliate of Bank), except to the extent expressly not required under Section 6.8(b);

(d) Borrower and Guarantor shall have delivered: (i) its Operating Documents; and (ii) good standing certificates with respect to each Borrower and each Guarantor issued by the applicable Secretary of State (and, if separate, the state tax authority) of the jurisdiction of organization of each such Borrower or Guarantor and the applicable Secretary of State (and, if separate, the state tax authority) of the jurisdictions (other than the applicable jurisdiction of organization of such Borrower or such Guarantor) in which such Borrower’s or such Guarantor’s failure to be duly qualified or licensed would constitute a Material Adverse Change , in each case, as of a date no earlier than thirty (30) days prior to the Effective Date; provided, however, that with respect to Xybridge Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date;

(e) Borrower shall have delivered duly executed original signatures to the completed Borrowing Resolutions for Borrower, and Guarantor shall have delivered executed original complete certified resolutions and incumbency certificate of Guarantor;

(f) With respect to each Borrower and each Guarantor, Bank shall have received certified copies, dated as of a recent date, of financing statement searches, as Bank shall request, reflecting Bank’s financing statements filed of record with respect to Bank’s Liens, and accompanied by written evidence (including any UCC termination statements) that the Liens (other than the Bank’s Liens) indicated in any financing statements either constitute Permitted Liens or have been or, in connection with the initial Credit Extension, will be terminated or released;

6

(g) Each Borrower shall have delivered a separate Perfection Certificate executed by such Borrower;

(h) [reserved]

(i) [reserved]

(j) Borrower shall have delivered evidence reasonably satisfactory to Bank that the insurance policies required by Section 6.7 hereof are in full force and effect, together with appropriate evidence showing loss payable and/or additional insured clauses or endorsements in favor of Bank;

(k) Borrower shall have paid the fees and Bank Expenses then due as specified in Section 2.4 hereof.

3.2 Conditions Precedent to all Credit Extensions. Bank’s obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following:

(a) except as otherwise provided in Section 3.4, timely receipt of an executed Transaction Report;

(b) the representations and warranties in Section 5 shall be true in all material respects on the date of the Transaction Report and on the Funding Date of each Credit Extension; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date, and no Event of Default shall have occurred and be continuing or result from the Credit Extension. Each Credit Extension is Borrower’s representation and warranty on that date that the representations and warranties in Section 5 remain true in all material respects; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date; and

(c) in Bank’s good faith business judgment, there has not been a Material Adverse Change.

3.3 Covenant to Deliver.

Borrower agrees to deliver to Bank each item required to be delivered to Bank under this Agreement as a condition to any Credit Extension. Borrower expressly agrees that a Credit Extension made prior to the receipt by Bank of any such item shall not constitute a waiver by Bank of Borrower’s obligation to deliver such item, and any Credit Extension in the absence of a required item shall be made in Bank’s sole discretion.

3.4 Procedures for Borrowing. Subject to the prior satisfaction of all other applicable conditions to the making of an Advance set forth in this Agreement, in order for any Borrower to obtain an Advance (other than Advances under Sections 2.1.2, 2.1.3, or 2.1.4), Zhone, as agent for all Borrowers, shall notify Bank (which notice shall be irrevocable) by electronic mail, facsimile, or telephone by 12:00 p.m. Pacific time on the Funding Date of the request for such Advance, which notice shall specify on behalf of which Borrower Zhone is requesting such Advance. Borrower must promptly deliver to Bank by electronic mail or facsimile a completed Transaction Report executed by a Responsible Officer or his or her designee. Bank shall credit Advances to the Designated Deposit Account. Bank may make Advances under this Agreement based on instructions from a Responsible Officer or his or her designee or without instructions if the Advances are necessary to meet Obligations which have become due. Bank may rely on any telephone notice given by a person whom Bank in its good faith business judgment believes is a Responsible Officer or designee.

7

4 CREATION OF SECURITY

4.1 Grant of Security Interest. Each Borrower hereby grants Bank, to secure the payment and performance in full of all of the Obligations, continuing security interests in, and pledges to Bank, all right, title, and interest of such Borrower in and to the Collateral, wherever located, whether now owned or hereafter acquired or arising, and all proceeds and products thereof. Borrower represents, warrants, and covenants that the security interests granted herein are and shall at all times continue to be first priority perfected security interests in the Collateral (subject in lien priority only to those Permitted Liens that are expressly entitled to such priority over the security interests of Bank by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens). If Borrower shall acquire one or more commercial tort claims involving amounts in excess of $250,000 (individually or in the aggregate with respect to all such acquired commercial tort claims), Borrower shall promptly notify Bank in a writing signed by Borrower of the general details thereof (unless and except to the extent such information would waive the attorney-client privilege). Such notification to Bank shall constitute an additional grant, hereunder, of a continuing security interest in the commercial tort claims and all proceeds thereof to Bank, and Borrower shall execute and deliver all such documents and take all such actions as Bank may reasonably request in connection therewith.

If both this Agreement and the Exim Loan Agreement are terminated, Bank’s Lien in the Collateral shall continue until the Obligations (other than inchoate indemnity obligations) are repaid in full in cash. Upon payment in full in cash of the Obligations (other than inchoate indemnity obligations) and at such time as Bank’s obligation to make Credit Extensions under this Agreement and the Exim Loan Agreement has terminated, Bank shall, at Borrower’s sole cost and expense, promptly release its Liens in the Collateral and all rights therein shall revert to Borrower.

4.2 Authorization to File Financing Statements. Borrower hereby authorizes Bank to file financing statements, without notice to Borrower, with all appropriate jurisdictions to perfect or protect Bank’s interest or rights hereunder, including a notice that any disposition of the Collateral prohibited under the Loan Documents, by either Borrower or any other Person, shall be deemed to violate the rights of Bank under the Code. Such financing statements may indicate the Collateral as “all assets of the Debtor” or words of similar effect, or as being of an equal or lesser scope, or with greater detail, all in Bank’s discretion.

5 REPRESENTATIONS AND WARRANTIES

Borrower represents, warrants, and agrees, as follows:

5.1 Due Organization, etc.; Authorization; Power and Authority; Material Domestic Subsidiaries.

(a) Borrower and each of its Subsidiaries are duly existing and in good standing in their respective jurisdictions of formation and are qualified and licensed to do business and are in good standing in any jurisdiction in which the conduct of their business or their ownership of property requires that they be qualified except where the failure to do so could not reasonably be expected to result in a Material Adverse Change; provided, however, that with respect to Xybridge Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date. In connection with this Agreement, Borrower has delivered to Bank, a separate completed certificate (for each of the Borrowers), dated on or about the Effective Date, signed by the applicable Borrower (individually and collectively, the “Perfection Certificate”). Borrower represents and warrants to Bank that: (i) Borrower’s exact legal name is that indicated on the Perfection Certificate and on the signature page hereof; (ii) Borrower is an organization of the type and is organized in the jurisdiction set forth in the Perfection Certificate; (iii) the Perfection Certificate accurately sets forth Borrower’s organizational identification number or accurately states that Borrower has none; (iv) the Perfection Certificate accurately sets forth Borrower’s place of business, or, if more than one, its chief executive office as well as Borrower’s mailing address (if different than its chief executive office); (v) Borrower (and each of its predecessors) has not, in the past five (5) years, changed its jurisdiction of formation, organizational structure or type, or any organizational number assigned by its jurisdiction, in each case, except as expressly identified in the Perfection Certificate; and (vi) all other information set forth on the Perfection Certificate pertaining to Borrower and each of its Subsidiaries is accurate and complete in all material respects (it being understood and agreed that Borrower may from time to time update certain information in the Perfection Certificate after the Effective Date to the extent permitted by one or more specific provisions in this Agreement). If Borrower is not now a Registered Organization but later becomes one, Borrower shall promptly notify Bank of such occurrence and provide Bank with Borrower’s organizational identification number.

8

(b) The execution, delivery and performance by Borrower of the Loan Documents to which it is a party have been duly authorized, and do not (i) conflict with any of Borrower’s organizational documents, (ii) contravene, conflict with, constitute a default under or violate any material Requirement of Law, (iii) contravene, conflict or violate, in any material respect, any applicable order, writ, judgment, injunction, decree, determination or award of any Governmental Authority by which Borrower or any its Subsidiaries or any of their property or assets (other than immaterial property and immaterial assets) may be bound or affected, (iv) require any action by, filing, registration, or qualification with, or Governmental Approval from, any Governmental Authority (except such Governmental Approvals which have already been obtained and are in full force and effect), or (v) constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which it is a party or by which it is bound in which the default could reasonably be expected to result in a Material Adverse Change.

(c) Concurrently herewith, Borrower has caused the following companies (the “Existing Guarantors”) to each execute and deliver to Bank the Guaranty and the Guarantor Security Agreement:

(1) Paradyne Corporation;

(2) Paradyne Networks, Inc.;

(3) Premisys Communications, Inc.;

(4) Xybridge Technologies, Inc.; and

(5) Zhone Technologies International, Inc.

Borrower represents and warrants that the Existing Guarantors are all of its domestic subsidiaries constituting Material Domestic Subsidiaries (as defined below) as of the Effective Date, except for Zhone Technologies Campus, LLC (“Campus”), which Borrower represents and warrants is a special purpose limited liability company whose sole asset is real property utilized by Borrower and which is not permitted to guaranty the obligations of the Borrower under its agreement with its lender. In the event that, in the future, any other Domestic Subsidiaries of Borrower become Material Domestic Subsidiaries, Borrower shall promptly cause any such additional Domestic Subsidiaries to execute and deliver to Bank a Guaranty and a Security Agreement, together with related documentation and certified resolutions or other evidence of authority with respect to the execution and delivery of such Loan Documents. Throughout the term of this Agreement Borrower shall cause the Guaranties and Security Agreements referred to in this Section to continue in full force and effect. It is acknowledged that the former California corporation domestic subsidiary of Borrower known as VPacket Communications, Inc. was merged with and into ZMS-III on or about 12/18/2006.

As used herein, the term “Material Domestic Subsidiary” means any domestic subsidiary of Borrower, other than a domestic subsidiary of Borrower that has less than $200,000 in tangible assets and less than $1,000,000 in fair market value of total assets.

5.2 Collateral.

(a) Borrower has good title to the Collateral, free of Liens except Permitted Liens. Borrower has no deposit account other than the deposit accounts with Bank and deposit accounts described in the Perfection Certificate delivered to Bank in connection herewith or as disclosed to Bank pursuant to Section 6.8(b), other than deposit accounts not required to be disclosed pursuant to Section 6.8(b). The Accounts are bona fide, existing obligations of the Account Debtors.

(b) The Collateral is not in the possession of any third party bailee (such as a warehouse), except for Permitted Locations. None of the components of the Collateral with an aggregate value in excess of $500,000 shall be maintained at locations other than Permitted Locations or as permitted pursuant to Section 7.2. In the event that Borrower, after the date hereof, intends to store or otherwise deliver any portion of the Collateral with an aggregate value in excess of $500,000 to any one or more bailees, then Borrower shall, promptly upon Bank’s

9

request therefor, use commercially reasonable efforts to deliver to Bank a bailee agreement (in form and substance satisfactory to Bank in its good faith business judgment) duly executed by such bailee. In the event that Bank requests such a bailee agreement and Borrower uses such efforts but does not succeed in delivering such a bailee agreement, Bank may (in its good faith business judgment) maintain a Reserve with respect to the Collateral located with such bailee.

(c) With respect to any leased premises of Borrower at which Collateral with an aggregate value of more than $500,000 is located, Borrower shall, promptly upon Bank’s request therefor, use commercially reasonable efforts to deliver to Bank a landlord agreement (in form and substance satisfactory to Bank in its good faith business judgment) duly executed by the lessor of such leased premises. Without limiting the generality of the foregoing, Borrower shall use such efforts to obtain from the applicable landlord, no later than 60 days following the Effective Date, landlord agreements (in form and substance satisfactory to Bank) duly executed by such landlords in favor of Bank in respect of the following leased locations of Borrower: (1) 7001 Oakport Street, Oakland, CA 94621; (2) 8545 126th Avenue N. (G Building), Largo, FL 33773; and (3) 8625 126th Avenue N., Suite 100 (H Building), Largo, FL 33773. In the event that Bank requests such a landlord agreement and Borrower uses such efforts but does not succeed in delivering such a landlord agreement, Bank may (in its good faith business judgment) maintain a Reserve with respect to such leased premises.

(d) All Inventory is in all material respects of good and marketable quality, free from material defects, except for Inventory for which adequate reserves are maintained in accordance with GAAP.

(e) Borrower is the sole owner of its intellectual property, except for (i) non-exclusive licenses granted by Borrower as licensor to third-parties, and (ii) such intellectual property as is licensed by Borrower as a licensee. Each patent owned by Borrower that is material to Borrower’s business is valid and enforceable, and, to Borrower’s knowledge, no part of the intellectual property that is material to Borrower’s business has been judged invalid or unenforceable, in whole or in part, and to Borrower’s knowledge, no claim has been made that any part of the intellectual property that is material to Borrower’s business violates, in any material respect, the rights of any third party, except to the extent such claim could not reasonably be expected to result in a Material Adverse Change.

(f) Except as noted on the Perfection Certificate (or as disclosed to Bank in written updates of the Perfection Certificate with respect to the following), Borrower is not a party to, nor is bound by, any material license or other agreement with respect to which Borrower is the licensee (other than over-the-counter or shrink-wrap software licenses generally available to the public) relating to any material product lines of Borrower or Guarantor (i) that prohibits or otherwise restricts Borrower from granting a security interest in Borrower’s interest in such license or agreement or any other property (to the extent such prohibition is enforceable), or (ii) for which a default under or termination of could interfere in any material respect with Bank’s right to sell any Collateral. Borrower shall provide written notice to Bank within thirty (30) days of entering or becoming bound by any such license or agreement which is reasonably likely to have a material impact on Borrower’s business or financial condition (other than over-the-counter software that is commercially available to the public). Upon Bank’s request, Borrower shall use commercially reasonable efforts to promptly obtain the consent of, or waiver by, any person whose consent or waiver is necessary for (x) all such licenses or agreements to be deemed “Collateral” and for Bank to have a security interest in the same that is otherwise restricted or prohibited by law or by the terms of any such license or agreement, whether now existing or entered into in the future, and (y) Bank to have the ability in the event of a liquidation of any Collateral to dispose of such Collateral in accordance with Bank’s rights and remedies under this Agreement and the other Loan Documents. If Borrower is unsuccessful in obtaining any such consent or waiver requested by Bank, then Borrower shall notify Bank in writing of same.

5.3 Accounts Receivable.

(a) For each Account with respect to which Advances are requested, on the date each Advance is requested and made, such Account shall be an Eligible Account.

(b) All statements made and all unpaid balances appearing in all invoices, instruments and other documents evidencing such Eligible Accounts are and shall be true and correct in all material respects as of the date such statement is made or such unpaid balance is disclosed to Bank, and all such invoices, instruments and other documents, and all of Borrower’s Books, are genuine and in all material respects what they purport to be. Whether or not an Event of Default has occurred and is continuing, Bank may notify any Account Debtor owing Borrower money of Bank’s security interest in such funds and verify the amount of such Eligible Account. All sales

10

and other transactions underlying or giving rise to each Account shall comply in all material respects with all applicable laws and governmental rules and regulations. Borrower has no knowledge of any actual or imminent Insolvency Proceeding of any Account Debtor whose accounts are shown as Eligible Accounts in any Transaction Report. To the best of Borrower’s knowledge, all signatures and endorsements on all documents, instruments, and agreements relating to all Eligible Accounts are and will be genuine, and, to the best of Borrower’s knowledge, all such documents, instruments and agreements are and will be legally enforceable in accordance with their terms.

5.4 Litigation. Except as disclosed to the Bank in writing, there are no actions or proceedings pending or, to the knowledge of the Responsible Officers, threatened in writing by or against Borrower or any of its Subsidiaries involving more than $250,000 or more in the aggregate.

5.5 No Material Deviation in Financial Statements. All consolidated financial statements for Borrower and any of its Subsidiaries delivered to Bank fairly present in all material respects Borrower’s consolidated financial condition and Borrower’s consolidated results of operations as of the date of such financial statements, except that that interim financial statements may be subject to normal year-end audit adjustments (which will not be material in the aggregate) and need not contain footnote disclosures required by GAAP. There has not been any material deterioration in Borrower’s consolidated financial condition since the date of the most recent financial statements submitted to Bank.

5.6 Solvency. The fair salable value of Borrower’s assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; Borrower is not left with unreasonably small capital after the transactions in this Agreement; and Borrower is able to pay its debts (including trade debts) as they mature.

5.7 Regulatory Compliance. Borrower is not an “investment company” or a company “controlled” by an “investment company” under the Investment Company Act of 1940, as amended. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations X, T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Neither Borrower nor any of its Subsidiaries is a “holding company” or an “affiliate” of a “holding company” or a “subsidiary company” of a “holding company” as each term is defined and used in the Public Utility Holding Company Act of 2005. Borrower has not violated any laws, ordinances or rules, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower’s or any of its Subsidiaries’ properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower’s knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each of its Subsidiaries have obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all Government Authorities that are necessary to continue their respective businesses as currently conducted.

5.8 Subsidiaries; Investments. Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments.

5.9 Tax Returns and Payments; Pension Contributions. Borrower has timely filed (i) all required federal tax returns and reports, and (ii) all required state, local, and foreign, material tax returns and reports. Subject to Borrower’s right to contest taxes in accordance with the immediately following sentence, Borrower has timely paid all federal taxes, assessments, deposits and contributions owed by Borrower, and all state, local, and foreign, material taxes, assessments, deposits and contributions owed by Borrower. Borrower may defer payment of any contested taxes, provided that Borrower (a) in good faith contests its obligation to pay the taxes by appropriate proceedings promptly and diligently instituted and conducted, (b) notifies Bank in writing of the commencement of, and any material development in, such proceedings, and (c) posts bonds or takes any other steps required to prevent the governmental authority levying such contested taxes from obtaining a Lien upon any of the Collateral that is other than a “Permitted Lien”. Borrower is unaware of any claims or adjustments proposed for any of Borrower’s prior tax years which could result in additional taxes becoming due and payable by Borrower and which have not been timely discharged or contested in accordance with the immediately preceding sentence. Borrower has paid all amounts necessary to fund all present pension, profit sharing and deferred compensation plans in accordance with their terms, and Borrower has not withdrawn from participation in, and has not permitted partial or complete termination of, or permitted the occurrence of any other event with respect to, any such plan which could reasonably be expected to result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency.

11

5.10 Use of Proceeds. Borrower shall use the proceeds of the Credit Extensions solely as working capital, and to fund its general business requirements and not for personal, family, household or agricultural purposes; provided, however, that any “Credit Accommodations” (as such term is defined in the Exim Borrower Agreement) made by Bank to Borrower for any of the purposes set forth in Section 2.01(a)(i)-(iv) of the Exim Borrower Agreement shall be deemed made under (and shall be subject to the terms and conditions of) this Agreement as a Non-Exim Loan instead of under the Exim Loan Agreement as an Exim Loan.

5.11 Full Disclosure. No written representation, warranty or other statement of Borrower in any certificate or written statement given to Bank, as of the date such representation, warranty, or other statement was made, taken together with all such written certificates and written statements given to Bank, contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements not misleading (it being recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected or forecasted results).

6 AFFIRMATIVE COVENANTS

Borrower shall do all of the following:

6.1 Government Compliance. (a) Maintain its and all its Subsidiaries’ legal existence and good standing in their respective jurisdictions of formation and maintain qualification in each jurisdiction in which the failure to so qualify would reasonably be expected to cause a Material Adverse Change; provided, however, that with respect to Xybridge Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date. Borrower shall comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which it is subject, noncompliance with which could reasonably be expected to cause a Material Adverse Change.

(b) Obtain all of the Governmental Approvals necessary for the performance by Borrower of its obligations under the Loan Documents to which it is a party and the grant of a security interest to Bank in all of its property. Borrower shall promptly provide copies of any such obtained Governmental Approvals to Bank.

6.2 Financial Statements, Reports, Certificates.

(a) Borrower shall provide Bank with the following written reports, and such other written reports with respect to Borrower (including budgets, sales projections, operating plans and other financial documentation, and lists of stockholders of record), as Bank shall from time to time specify in its good faith business judgment:

(i) a Transaction Report, (i) at the time of each Advance, and (ii) so long as any Advance is outstanding, in addition not less frequently than weekly;

(ii) within fifteen (15) days after the end of each month:

(A) (1) monthly accounts receivable agings, aged by invoice date; and (2) concurrently with such monthly accounts receivable agings in respect of any month that is also the last month of a fiscal quarter, copies of actual invoices in respect of Eligible Accounts representing not less than 10% of the aggregate accounts receivable agings balance as of the end of such last month of a fiscal quarter;

(B) monthly accounts payable agings, aged by invoice date, and outstanding or held check registers, if any;

(C) monthly reconciliations of accounts receivable agings (aged by invoice date), Transaction Reports, and general ledger;

(D) [intentionally omitted]

12

(E) monthly Deferred Revenue reports;

(iii) as soon as available, and in any event within thirty (30) days after the end of each month, monthly unaudited financial statements;

(iv) within thirty (30) days after the end of each month a monthly Compliance Certificate signed by a Responsible Officer, certifying that as of the end of such month, Borrower was in full compliance with all of the terms and conditions of this Agreement, and setting forth calculations showing compliance with the financial covenants set forth in this Agreement and such other information as Bank shall reasonably request, including, without limitation, a statement that at the end of such month there were no held checks;

(v) within thirty (30) days after the end of each fiscal quarter, a written status update with respect to Borrower’s ongoing discussions with the New Jersey tax authority regarding the New Jersey sales & use tax obligation of Zhone (for the period covering 10/01/2001 – 09/30/2003) described in the Perfection Certificate; provided, however, that in addition, Borrower shall also deliver such a status update (irrespective of whether such quarterly report is then due) of, and promptly upon, the occurrence of a material adverse development (if any) in such discussions with the New Jersey tax authority regarding such tax obligation;

(vi) as soon as available, and in any event within thirty (30) days prior to the end of each fiscal year of Borrower, (A) annual financial projections and operating budgets (including income statements, balance sheets and cash flow statements, by month) for the upcoming fiscal year (on a monthly basis) of Borrower, as approved by Borrower’s board of directors; and

(vii) as soon as available, and in any event within 120 days following the end of Borrower’s fiscal year, annual financial statements certified by, and with an unqualified opinion of, independent certified public accountants reasonably acceptable to Bank.

(b) At all times that Borrower is subject to the reporting requirements under the Securities Exchange Act of 1934, as amended, within five (5) days after filing, all reports on Form 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission or a link thereto on Borrower’s or another website on the Internet.

(c) Prompt written notice of (i) any material change in the composition of the intellectual property, (ii) the registration (or filed application for registration) of any copyright (including any subsequent ownership right of Borrower in or to any copyright), any patent (including any subsequent ownership right of Borrower in or to any patent) constituting Material Intellectual Property, or any trademark (including any subsequent ownership right of Borrower in or to any trademark) constituting Material Intellectual Property, in each case, that is not previously disclosed in writing to Bank, or (iii) Borrower’s knowledge of an event that materially adversely affects the value of the intellectual property.

6.3 Accounts Receivable.

(a) Schedules and Documents Relating to Accounts. Borrower shall deliver to Bank transaction reports and schedules of collections, as provided in Section 6.2, on Bank’s standard forms; provided, however, that Borrower’s failure to execute and deliver the same shall not affect or limit Bank’s Lien and other rights in all of Borrower’s Accounts, nor shall Bank’s failure to advance or lend against a specific Account affect or limit Bank’s Lien and other rights therein. If requested by Bank, Borrower shall furnish Bank with copies (or, at Bank’s request, originals) of all contracts, orders, invoices, and other similar documents, and all shipping instructions, delivery receipts, bills of lading, and other evidence of delivery, for any goods the sale or disposition of which gave rise to such Accounts. Without limiting the generality of the foregoing, Borrower shall deliver to Bank the copies of the invoices required under Section 6.2(a)(ii)(A)(2) above. In addition, Borrower shall deliver to Bank, on its request, the originals of all instruments, chattel paper, security agreements, guarantees and other documents and property evidencing or securing any Accounts, in the same form as received, with all necessary endorsements, and copies of all credit memos.

13

(b) Disputes. Borrower shall promptly notify Bank of all disputes or claims relating to Accounts, in excess of $250,000 individually or in the aggregate at any one time, on the Transaction Reports. Borrower may forgive (completely or partially), compromise, or settle any Account for less than payment in full, or agree to do any of the foregoing so long as (i) Borrower does so in good faith, in a commercially reasonable manner, in the ordinary course of business, in arm’s-length transactions, and reports the same to Bank in the regular reports provided to Bank; (ii) no Event of Default has occurred and is continuing; and (iii) after taking into account all such discounts, settlements and forgiveness, no Overadvance exists.

(c) Collection of Accounts. Borrower shall have the right to collect all Accounts, unless and until a Default or an Event of Default has occurred and is continuing. Whether or not an Event of Default has occurred and is continuing, Borrower shall hold all payments on, and proceeds of, Accounts in trust for Bank, and Borrower shall immediately deliver all such payments and proceeds to Bank in their original form, duly endorsed, which payments and proceeds shall be applied to the Obligations pursuant to the terms of Section 9.4 hereof. Bank may, in its good faith business judgment, require that all proceeds of Accounts be deposited by Borrower into a lockbox account, or such other “blocked account” as Bank may specify, pursuant to a blocked account agreement in such form as Bank may specify in its good faith business judgment.

(d) Returns. Provided no Event of Default has occurred and is continuing, if any Account Debtor returns any Inventory to Borrower, Borrower shall promptly (i) determine the reason for such return, (ii) issue a credit memorandum to the Account Debtor in the appropriate amount, and (iii) in the event that the amount of such credit memorandum, individually or in the aggregate, exceeds $250,000, provide a copy of each such credit memorandum to Bank. In the event any attempted return occurs after the occurrence and during the continuance of any Event of Default, Borrower shall hold the returned Inventory in trust for Bank, and immediately notify Bank of the return of the Inventory.

(e) Verification. Bank may, from time to time, verify directly with the respective Account Debtors the validity, amount and other matters relating to the Accounts, either in the name of Borrower or Bank or such other name as Bank may choose.

(f) No Liability. Bank shall not be responsible or liable for any shortage or discrepancy in, damage to, or loss or destruction of, any goods, the sale or other disposition of which gives rise to an Account, or for any error, act, omission, or delay of any kind occurring in the settlement, failure to settle, collection or failure to collect any Account, or for settling any Account in good faith for less than the full amount thereof, nor shall Bank be deemed to be responsible for any of Borrower’s obligations under any contract or agreement giving rise to an Account. Nothing herein shall, however, relieve Bank from liability for its own gross negligence or willful misconduct.

6.4 Remittance of Proceeds. Except as otherwise provided in Section 6.3(c), deliver, in kind, all proceeds arising from the disposition of any Collateral to Bank in the original form in which received by Borrower not later than the following Business Day after receipt by Borrower, which, shall be dealt with as provided in Section 6.3(c); provided that, if no Default or Event of Default has occurred and is continuing, Borrower shall not be obligated to remit to Bank the proceeds of the sale of worn out, surplus, or obsolete Equipment disposed of by Borrower in good faith in an arm’s length transaction for an aggregate purchase price of $250,000 or less (for all such transactions in any fiscal year). Borrower agrees that it will not commingle proceeds of Collateral with any of Borrower’s other funds or property, but will hold such proceeds separate and apart from such other funds and property and in an express trust for Bank. Nothing in this Section limits the restrictions on disposition of Collateral set forth elsewhere in this Agreement.

6.5 Taxes; Pensions. Timely file, and require each of its Subsidiaries to timely file, all required federal tax returns and reports (and all required state, local, and foreign, material tax returns and reports), and timely pay, and require each of its Subsidiaries to timely file, all federal taxes, assessments, deposits and contributions (and all state, local, and foreign, material taxes, assessments, deposits and contributions) owed by Borrower and each of its Subsidiaries, except for deferred payment of any taxes contested pursuant to the terms of Section 5.9 hereof, and shall deliver to Bank, on demand, appropriate certificates attesting to such payments, and pay all amounts necessary to fund all present pension, profit sharing and deferred compensation plans in accordance with their terms.

14

6.6 Access to Collateral; Books and Records. At reasonable times, on at least one (1) Business Day’s notice (provided no notice is required if an Event of Default has occurred and is continuing), Bank, or its agents, shall have the right to inspect the Collateral and the right to audit and copy Borrower’s Books; provided, however, that, so long as no Event of Default has occurred and is continuing, any audits shall be conducted no more often than once every 6 months (it being understood that audits taking place at one or more locations of Borrower during substantially the same overall examination period shall constitute but a single audit for purposes of the foregoing proviso). The foregoing inspections and audits shall be at Borrower’s expense, and the charge therefor shall be $750 per person per day (or such higher amount as shall represent Bank’s then-current standard charge for the same), plus reasonable out-of-pocket expenses. In the event Borrower and Bank schedule an audit more than ten (10) days in advance, and Borrower cancels or seeks to reschedules the audit with less than ten (10) days written notice to Bank, then (without limiting any of Bank’s rights or remedies), Borrower shall pay Bank a fee of $1,000 plus any out-of-pocket expenses incurred by Bank to compensate Bank for the anticipated costs and expenses of the cancellation or rescheduling.

6.7 Insurance. Keep its business and the Collateral insured for risks and in amounts standard for companies in Borrower’s industry and location and as Bank may reasonably request. Insurance policies shall be in a form, with companies, and in amounts that are satisfactory to Bank. All property policies shall have a lender’s loss payable endorsement showing Bank as lender loss payee and waive subrogation against Bank, and all liability policies shall show, or have endorsements showing, Bank as an additional insured. All policies (or the lender loss payable and additional insured endorsements) shall provide that the insurer must give Bank at least twenty (20) days notice before canceling, amending, or declining to renew its policy. At Bank’s request, Borrower shall deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy shall (subject only to the applicable senior claims of those holders of Permitted Liens that are expressly entitled to lien priority over the security interests of Bank in the applicable insured Collateral by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens), at Bank’s option, be payable to Bank on account of the Obligations. Notwithstanding the foregoing, (a) so long as no Event of Default has occurred and is continuing, Borrower shall have the option of applying the proceeds of any casualty policy up to $250,000, in the aggregate, toward the replacement or repair of destroyed or damaged property; provided that any such replaced or repaired property shall be deemed Collateral in which Bank has been granted a first priority security interest (subject in lien priority only to those Permitted Liens described in clause (c) of the definition of “Permitted Liens”, if any, that are applicable to such replaced or repaired property), and (b) after the occurrence and during the continuance of an Event of Default, all proceeds payable under such casualty policy shall, at the option of Bank, be payable to Bank on account of the Obligations. If Borrower fails to obtain insurance as required under this Section 6.7 or to pay any amount or furnish any required proof of payment to third persons and Bank, Bank may make all or part of such payment or obtain such insurance policies required in this Section 6.7, and take any action under the policies Bank deems prudent.

6.8 Operating Accounts.

(a) Maintain all of its and its Subsidiaries’ primary depository and operating accounts and securities accounts with Bank and Bank’s Affiliates, which accounts shall represent at least 85% of the dollar value of Borrower’s and such Subsidiaries accounts at all financial institutions.

(b) Provide Bank five (5) days prior written notice before Borrower or any of its Subsidiaries establishes or has any Collateral Account at or with any bank or financial institution other than Bank or Bank’s Affiliates, if such Collateral Account is not expressly identified on the Perfection Certificate and if Borrower holds a balance of more than $20,000 in such Collateral Account (except that the total of amounts in all Collateral Accounts with a balance of $20,000 or less and as to which written notice of the same is not given to Bank shall not exceed $250,000 in the aggregate). In addition, for each Collateral Account that Borrower or any Guarantor at any time maintains, Borrower shall, upon Bank’s request, cause the applicable bank or financial institution (other than Bank) at or with which any such Collateral Account is maintained to execute and deliver a Control Agreement or other appropriate instrument with respect to such Collateral Account to perfect Bank’s Lien in such Collateral Account in accordance with the terms hereunder. The provisions of the previous sentence shall not apply to (i) deposit accounts exclusively used for payroll, payroll taxes and other employee wage and benefit payments to or for the benefit of Borrower’s or Guarantor’s employees and identified to Bank by Borrower or Guarantor as such, and (ii) deposit accounts located outside the United States used to facilitate payment of local operating expenses provided that the amount on deposit in any such account described in this clause (ii) shall not exceed, at any time, the amount necessary to fund operating expenses for such jurisdiction for the then current fiscal quarter. Without limiting the generality of the foregoing, Borrower and Bank hereby agree that: (1) no later than 60 days following the Effective Date, Borrower and Guarantor shall cause Wachovia Bank to execute and deliver such a Control Agreement in favor of Bank with respect to the Collateral Accounts of Borrower and Guarantor maintained with Wachovia Bank; and

15

(2) no Control Agreement by Wells Fargo in favor of Bank shall be required under this Section 6.8(b) so long as the total amount of funds of all Borrowers and all Guarantors on deposit in any and all Collateral Accounts of Borrower and Guarantor maintained with Wells Fargo does not exceed $250,000 in the aggregate.

6.9 Financial Covenants. Borrower shall maintain at all times, to be tested as of the last day of each month, unless otherwise noted, on a consolidated basis with respect to Borrower and its Subsidiaries:

(a) Minimum Liquidity Ratio. As of the end of each month, commencing March 31, 2009, and continuing as of the end of each month thereafter, Borrower shall maintain a Liquidity Ratio of at least 2.00 to 1.00.

As used herein, the term “Liquidity Ratio” means, as of any date of determination, the ratio of:

(A) the total of Borrower’s unrestricted cash, as shown on Borrower’s consolidated balance sheet, plus the sum of the net amount of Eligible Accounts under this Agreement and the net amount of “Eligible Accounts” under the Exim Loan Agreement;

to

(B) the aggregate amount of all outstanding Obligations (including the following (without duplication): all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) and all other monetary Obligations under this Agreement, plus all outstanding Exim Loans (and other monetary “Obligations”) under the Exim Loan Agreement (including (iv) amounts used under the Exim Loan Agreement for “Cash Management Services”, (v) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Exim Loan Agreement, and (vi) the “FX Reduction Amount” under the Exim Loan Agreement)).

(b) Required EBITDA for any 2 Consecutive Fiscal Quarters. For each EBITDA Test Period (as defined below), Borrower shall achieve EBITDA of not less than the required amount set forth below [note: amounts shown below within pointed brackets ( < $ > ) are negative amounts]:

EBITDA Test Period ending on:	Minimum EBITDA Amount
March 31, 2009	<$9,000,000.00>
June 30, 2009	<$6,400,000.00>
September 30, 2009	<$1,400,000.00>
December 31, 2009	$1,400,000.00
March 31, 2010	$2,000,000.00

As used herein, the term “EBITDA Test Period” means the 2 consecutive fiscal quarter period then or most recently ended.

16

6.10 Protection and Registration of Intellectual Property Rights. Borrower shall: (a) protect, defend and maintain the validity and enforceability of any and all of its intellectual property that (individually or in the aggregate) is material to Borrower’s business (individually and collectively, “Material Intellectual Property”); (b) promptly advise Bank in writing of known material infringements of its Material Intellectual Property; and (c) not allow any Material Intellectual Property to be abandoned, forfeited or dedicated to the public without Bank’s written consent. Borrower hereby represents and warrants that, as of the Effective Date, Borrower does not own any maskworks, computer software, or other copyrights of Borrower that are registered (or the subject of an application for registration) with the United States Copyright Office (collectively, the “Registered Copyrights”). Borrower will NOT register with the United States Copyright Office (or apply for such registration of) any of Borrower’s maskworks, computer software, or other copyrights, unless Borrower: (x) provides Bank with at least fifteen (15) days prior written notice of its intent to register such copyrights or mask works together with a copy of the application it intends to file with the United States Copyright Office (excluding exhibits thereto); (y) executes and delivers a security agreement or such other documents as Bank may reasonably request to maintain the perfection and priority of Bank’s security interest in the copyrights or mask works intended to be registered with the United States Copyright Office; and (z) records such security agreement with the United States Copyright Office contemporaneously with or promptly (but in no event more than 10 days) after filing the copyright or mask work application(s) with the United States Copyright Office. Borrower shall promptly provide to Bank a copy of the application(s) actually filed with the United States Copyright Office together with evidence of the recording of the security agreement necessary for Bank to maintain the perfection and priority of its security interest in the copyrights or mask works intended to be registered with the United States Copyright Office. Borrower hereby represents and warrants that, as of the Effective Date, the IP Security Agreement identifies all patents (constituting Material Intellectual Property) and trademarks (constituting Material Intellectual Property) of Borrower that are registered (or the subject of an application for registration) with the United States Patent and Trademark Office. From and after the Effective Date, Borrower shall provide written notice to Bank of any application filed by Borrower in the United States Patent and Trademark Office for a patent (constituting Material Intellectual Property) or to register a trademark (constituting Material Intellectual Property) or service mark (constituting Material Intellectual Property) within 30 days after any such filing, and, upon the request of Bank, Borrower shall promptly execute and deliver a security agreement or such other documents as Bank may reasonably request with respect to such additional patents (constituting Material Intellectual Property) and/or trademarks (constituting Material Intellectual Property) of Borrower that are registered (or the subject of an application for registration) with the United States Patent and Trademark Office. The foregoing notwithstanding, Bank shall not acquire any interest in any intent to use a federal trademark application for a trademark, servicemark, or other mark filed on Borrower’s behalf prior to the filing under applicable law of a verified statement of use (or equivalent) for such mark that is the subject of such application.

6.11 Litigation Cooperation. From the date hereof and continuing through the termination of this Agreement, make available to Bank, without expense to Bank, Borrower and its officers, employees and agents and Borrower’s books and records, to the extent that Bank may deem them reasonably necessary to prosecute or defend any third-party suit or proceeding instituted by or against Bank with respect to any Collateral or relating to Borrower.

6.12 Intercompany Debt. All present and future indebtedness of Borrower and any Guarantor owed or owing to any one or more of Borrower, any Guarantor, or any other Affiliate of Borrower or any other Affiliate of any Guarantor shall, at all times, be subordinated to the Obligations pursuant to a subordination agreement on Bank’s standard form (the “Intercompany Subordination Agreement”).

6.13 [intentionally omitted]

6.14 Further Assurances. Borrower shall execute any further instruments and take further action as Bank reasonably requests to perfect or continue Bank’s Lien in the Collateral or to effect the purposes of this Agreement.

7 NEGATIVE COVENANTS

Borrower shall not do any of the following without Bank’s prior written consent:

7.1 Dispositions. Convey, sell, lease, transfer or otherwise dispose of (collectively, “Transfer”), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, except for (A) the sale of Inventory in the ordinary course of Borrower’s business, (B) the sale or other disposition of obsolete or unneeded Equipment in the ordinary course of business; (C) non-exclusive licenses and similar non-exclusive arrangements

17

for the use of the property of Borrower; (D) Transfers consisting of the granting of Permitted Liens or the making of Permitted Investments or the liquidation of Permitted Investments; (E) Transfers consisting of the payment of operating expenses in the ordinary course of business; and (F) Transfers of Inventory and Equipment to Borrower’s contract manufacturers in the ordinary course of Borrower’s business.

7.2 Changes in Business, Management, Ownership, or Business Locations.

(a) Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower and such Subsidiary, as applicable, or reasonably related thereto;

(b) liquidate or dissolve; or

(c) cause, permit or suffer any Change in Control; or

(d) without at least ten (10) days prior written notice to Bank, add any new offices or business locations, including warehouses (unless such new offices or business locations contain assets and property of Borrower with an aggregate value of less than $100,000 or are Permitted Locations); or

(e) without at least thirty (30) days prior written notice to Bank: (1) change its jurisdiction of organization; (2) change its organizational structure or type; (3) change its legal name set forth in its articles/certificate of incorporation/formation; or (4) change its organizational number (if any) assigned by its jurisdiction of organization.

7.3 Mergers or Acquisitions.

(a) Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person without Bank’s prior written consent (which shall be a matter of its good faith business judgment); or

(b) acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person;

in each case (of (a) or (b) above), provided however that (i) prior or concurrent written notice by Borrower to Bank (rather than such written consent of Bank) is required with respect to any such transaction as to which Borrower (or, as to any such transaction to which Borrower is not a party, such Subsidiary) is the surviving or successor person and no Default or Event of Default has occurred and is continuing or would result therefrom, and (ii) a Subsidiary of Borrower may merge or consolidate into another Subsidiary of Borrower.

In connection with any such acquisition, Borrower may create a subsidiary that has nominal assets (and would not constitute a Material Domestic Subsidiary prior to giving effect to the acquisition) solely for the purpose of and in preparation for such acquisition prior to obtaining Bank’s consent.

7.4 Indebtedness. Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary of Borrower to do so, other than Permitted Indebtedness.

7.5 Encumbrance. Create, incur, allow, or suffer any Lien on any of the Collateral, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, permit any Collateral not to be subject to the first priority security interests of Bank therein (subject in lien priority only to those Permitted Liens that are expressly entitled to such priority over the security interests of Bank by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens), or enter into any agreement, document, instrument or other arrangement (except with or in favor of Bank) with any Person which directly or indirectly prohibits or has the effect of prohibiting Borrower or any Subsidiary from assigning, mortgaging, pledging, granting a security interest in or upon, or encumbering any of Borrower’s or any Subsidiary’s owned (as opposed to licensed) Material Intellectual Property, except as is otherwise permitted in Section 7.1 hereof and the definition of “Permitted Lien” herein.

7.6 Maintenance of Collateral Accounts. Maintain any Collateral Account except pursuant to the terms of Section 6.8.(b) hereof.

18

7.7 Investments; Distributions; Special Investment re Campus Real Estate Loan. (a) Directly or indirectly make any Investment other than Permitted Investments, or permit any of its Subsidiaries to do so; or (b) pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock, provided that (i) Zhone may convert any of its convertible securities into other securities pursuant to the terms of such convertible securities or otherwise in exchange thereof, (ii) Borrower may pay dividends solely in equity securities; (iii) Zhone may repurchase the stock of former employees, directors, or consultants pursuant to stock repurchase agreements so long as no Default or Event of Default has occurred at the time of such repurchase and would not exist after giving effect to such repurchase, provided such repurchase does not exceed in the aggregate of $250,000 per fiscal year; and (iv) payments of dividends or distributions made by (x) any Borrower to any other Borrower, or (y) any Subsidiary of Borrower to Borrower, or (z) any Subsidiary of Borrower to any other Subsidiary of Borrower, are expressly permitted. With respect to the real estate loan of Campus secured by the real property used by Borrower, Borrower may make Investments in Campus solely for the purpose of funding, when due, regularly scheduled principal and interest payments in respect of such real estate loan, provided that (i) no Event of Default has occurred and is continuing or would result therefrom, and (ii) after giving pro forma effect to such Investment, Borrower would be in compliance with the financial covenant(s) in Section 6.9.

7.8 Transactions with Affiliates. Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower, except for transactions that are upon fair and reasonable terms and no less favorable to Borrower than would be obtained in an arm’s length transaction with a non-Affiliated Person, other than bona fide sales of Borrower’s equity securities.

7.9 Subordinated Debt. Without Bank’s prior written consent, (a) make or permit any payment on any Subordinated Debt, except under the terms of the subordination, intercreditor, or other similar agreement to which such Subordinated Debt is subject, or (b) amend any provision in any document relating to the Subordinated Debt which would increase the amount thereof or the amount of any permitted payments thereunder or adversely affect the subordination thereof to Obligations owed to Bank.

7.10 Compliance. Become an “investment company” or a company controlled by an “investment company”, under the Investment Company Act of 1940, as amended, or undertake as one of its important activities extending credit to purchase or carry margin stock (as defined in Regulation U of the Board of Governors of the Federal Reserve System), or use the proceeds of any Credit Extension for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation could reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so; withdraw or permit any Subsidiary to withdraw from participation in, permit partial or complete termination of, or permit the occurrence of any other event with respect to, any present pension, profit sharing and deferred compensation plan which could reasonably be expected to result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency.

8 EVENTS OF DEFAULT

Any one of the following shall constitute an event of default (an “Event of Default”) under this Agreement:

8.1 Payment Default. Borrower fails to (a) make any payment of principal or interest on any Credit Extension on its due date, or (b) pay any other Obligations within three (3) Business Days after such Obligations are due and payable (which three (3) day grace period shall not apply to payments due on the Revolving Line Maturity Date). During the cure period, the failure to cure the payment default is not an Event of Default (but no Credit Extension will be made during the cure period);

8.2 Covenant Default.

(a) Borrower fails or neglects to perform any obligation in Sections 6.2, 6.3, 6.4, 6.6, 6.8, or 6.9, or violates any covenant in Section 7; or

(b) Borrower fails or neglects to perform, keep, or observe, in any material respect, any other term, provision, condition, covenant or agreement contained in this Agreement or any Loan Documents, and as to any default (other than those specified in this Section 8) under such other term, provision, condition, covenant or

19

agreement that can be cured, has failed to cure the default within ten (10) days after the occurrence thereof; provided, however, that if the default cannot by its nature be cured within the ten (10) day period or cannot after diligent attempts by Borrower be cured within such ten (10) day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to cure the default shall not be deemed an Event of Default (but no Credit Extensions shall be made during such cure period). Grace periods provided under this section shall not apply, among other things, to financial covenants or any other covenants set forth in subsection (a) above;

8.3 Material Adverse Change. A Material Adverse Change occurs;

8.4 Attachment; Levy; Restraint on Business. (a) (i) The service of process seeking to attach, by trustee or similar process, any funds of Borrower or of any Material Domestic Subsidiary on deposit with Bank or any Bank Affiliate, or (ii) a notice of lien, levy, or assessment is filed against any of Borrower’s assets by any government agency, and the same under subclauses (i) and (ii) hereof are not, within ten (10) days after the occurrence thereof, discharged or stayed (whether through the posting of a bond or otherwise); provided, however, no Credit Extensions shall be made during any ten (10) day cure period; and (b) (i) any material portion of Borrower’s assets is attached, seized, levied on, or comes into possession of a trustee or receiver, or (ii) any court order enjoins, restrains, or prevents Borrower from conducting any part of its business;

8.5 Insolvency. (a) Borrower is unable to pay its debts (including trade debts) as they become due or otherwise becomes insolvent; (b) Borrower commences an Insolvency Proceeding in respect of Borrower as debtor or debtor-in-possession; or (c) an Insolvency Proceeding is commenced against Borrower as debtor or debtor-in-possession and not dismissed or stayed within forty-five (45) days (but no Credit Extensions shall be made while of any of the conditions described in clause (a) exist and/or until any Insolvency Proceeding is dismissed);

8.6 Other Agreements. There is a default in any agreement to which Borrower or any Material Guarantor is a party with a third party or parties resulting in a right by such third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of $250,000 or that could result in a Material Adverse Change with respect to Borrower or any Material Guarantor; provided, however, that the Event of Default under this Section 8.6 caused by the occurrence of a default under such other agreement shall be cured or waived for purposes of this Agreement upon Bank receiving written notice from the party asserting such default of such cure or waiver of the default under such other agreement, if at the time of such cure or waiver under such other agreement (a) Bank has not declared an Event of Default under this Agreement and/or exercised any rights with respect thereto; (b) any such cure or waiver does not result in an Event of Default under any other provision of this Agreement or any Loan Document; and (c) in connection with any such cure or waiver under such other agreement, the terms of any agreement with such third party are not modified or amended in any manner which could in the good faith judgment of Bank be materially less advantageous to Borrower or any Material Guarantor;

8.7 Judgments. One or more judgments, orders, or decrees for the payment of money in an amount, individually or in the aggregate, of $250,000 or more (not covered by independent third-party insurance as to which liability has been accepted by such insurance carrier) shall be rendered against Borrower and shall remain unsatisfied, unvacated, or unstayed for a period of ten (10) days after the entry thereof (provided that no Credit Extensions will be made prior to the satisfaction, vacation, or stay of such judgment, order, or decree);

8.8 Misrepresentations. Borrower or any Person acting for Borrower makes any representation, warranty, or other statement now or later in this Agreement, any Loan Document or in any writing delivered to Bank or to induce Bank to enter this Agreement or any Loan Document, and such representation, warranty, or other statement is incorrect in any material respect when made;

8.9 Subordinated Debt. A default or breach occurs under any agreement between Borrower and any creditor of Borrower that signed a subordination, intercreditor, or other similar agreement with Bank, or any creditor that has signed such an agreement with Bank breaches any terms of such agreement; or

8.10 Guaranty. (a) Any guaranty of any Obligations terminates or ceases for any reason to be in full force and effect; (b) any Material Guarantor does not perform any obligation or covenant under any guaranty of the Obligations; (c) any circumstance described in Sections 8.3, 8.4, 8.5, 8.7, or 8.8. occurs with respect to any Material Guarantor, or (d) the death, liquidation, winding up, or termination of existence of any Guarantor.

20

9 BANK’S RIGHTS AND REMEDIES

9.1 Rights and Remedies. If an Event of Default has occurred and is continuing, Bank may, without notice or demand, do any one or more or all of the following:

(a) declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank);

(b) stop advancing money or extending credit for Borrower’s benefit under this Agreement or under any other agreement between Borrower and Bank;

(c) demand that Borrower (i) deposit cash with Bank in an amount equal to the aggregate amount of any Letters of Credit remaining undrawn, as collateral security for the repayment of any future drawings under such Letters of Credit, and Borrower shall forthwith deposit and pay such amounts, and (ii) pay in advance all Letter of Credit fees scheduled to be paid or payable over the remaining term of any Letters of Credit;

(d) terminate any FX Forward Contracts;

(e) demand payment of, and collect any Accounts and General Intangibles comprising Collateral, settle or adjust disputes and claims directly with Account Debtors for amounts, on terms, and in any order that Bank considers advisable, notify any Account Debtor or other Person owing Borrower money of Bank’s security interest in such funds, verify the amount of the same and collect the same;

(f) make any payments and do any acts it considers necessary or reasonable to protect the Collateral and/or its security interest in the Collateral. Borrower shall assemble the Collateral if Bank requests and make it available as Bank designates. Bank may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Bank a license to enter and occupy any of its premises, without charge, to exercise any of Bank’s rights or remedies;

(g) apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower;

(h) ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral. Bank is hereby granted a non-exclusive, royalty-free license or other right to use, without charge, Borrower’s premises, vehicles, hoists, lifts, cranes, and other Equipment and all other property, including Borrower’s labels, patents, copyrights, mask works, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any similar property as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank’s exercise of its rights under this Section, Borrower’s rights under all licenses and all franchise agreements inure to Bank’s benefit;

(i) place a “hold” on any account maintained with Bank and/or deliver a notice of exclusive control, any entitlement order, or other directions or instructions pursuant to any Control Agreement or similar agreements providing control of any Collateral;

(j) demand and receive possession of Borrower’s Books; and

(k) exercise all rights and remedies available to Bank under the Loan Documents or at law or equity, including all remedies provided under the Code (including disposal of the Collateral pursuant to the terms thereof).

9.2 Power of Attorney. Borrower hereby irrevocably appoints Bank as its lawful attorney-in-fact, exercisable upon the occurrence and during the continuance of an Event of Default, to: (a) endorse Borrower’s name on any checks or other forms of payment or security; (b) sign Borrower’s name on any invoice or bill of lading for any Account or drafts against Account Debtors; (c) settle and adjust disputes and claims about the Accounts

21

directly with Account Debtors, for amounts and on terms Bank determines reasonable; (d) make, settle, and adjust all claims under Borrower’s insurance policies; (e) pay, contest or settle any Lien, charge, encumbrance, security interest, and adverse claim in or to the Collateral, or any judgment based thereon, or otherwise take any action to terminate or discharge the same; and (f) transfer the Collateral into the name of Bank or a third party as the Code permits. Borrower hereby appoints Bank as its lawful attorney-in-fact to sign Borrower’s name on any documents necessary to perfect or continue the perfection of Bank’s security interest in the Collateral regardless of whether an Event of Default has occurred until all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been satisfied in full and Bank is under no further obligation to make Credit Extensions hereunder. Bank’s foregoing appointment as Borrower’s attorney in fact, and all of Bank’s rights and powers, coupled with an interest, are irrevocable until all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been fully repaid and performed and Bank’s obligation to provide Credit Extensions terminates.

9.3 Protective Payments. If Borrower fails to obtain the insurance called for by Section 6.7 or fails to pay any premium thereon or fails to pay any other amount which Borrower is obligated to pay under this Agreement or any other Loan Document, Bank may obtain such insurance or make such payment, and all amounts so paid by Bank are Bank Expenses and immediately due and payable, bearing interest at the then highest applicable rate, and secured by the Collateral. Bank will make reasonable efforts to provide Borrower with notice of Bank obtaining such insurance at the time it is obtained or within a reasonable time thereafter. No payments by Bank are deemed an agreement to make similar payments in the future or Bank’s waiver of any Event of Default.

9.4 Application of Payments and Proceeds. Borrower shall have no right to specify the order or the accounts to which Bank shall allocate or apply any payments required to be made by Borrower to Bank or otherwise received by Bank under this Agreement when any such allocation or application is not specified elsewhere in this Agreement. If an Event of Default has occurred and is continuing, Bank may apply any funds in its possession, whether from Borrower account balances, payments, proceeds realized as the result of any collection of Accounts or other disposition of the Collateral, or otherwise, to the Obligations in such order as Bank shall determine in its sole discretion. Any surplus shall be paid to Borrower by credit to the Designated Deposit Account or to other Persons legally entitled thereto; Borrower shall remain liable to Bank for any deficiency. If Bank, in its good faith business judgment, directly or indirectly enters into a deferred payment or other credit transaction with any purchaser at any sale of Collateral, Bank shall have the option, exercisable at any time, of either reducing the Obligations by the principal amount of the purchase price or deferring the reduction of the Obligations until the actual receipt by Bank of cash therefor.

9.5 Bank’s Liability for Collateral. So long as Bank complies with Bank’s obligations (as a secured party), if any, under the Code, and reasonable banking practices, regarding the safekeeping of the Collateral in the possession or under the control of Bank, Bank shall not be liable or responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other Person. Borrower bears all risk of loss, damage or destruction of the Collateral.

9.6 No Waiver; Remedies Cumulative. Bank’s failure, at any time or times, to require strict performance by Borrower of any provision of this Agreement or any other Loan Document shall not waive, affect, or diminish any right of Bank thereafter to demand strict performance and compliance herewith or therewith. No waiver hereunder shall be effective unless signed by Bank and then is only effective for the specific instance and purpose for which it is given. Bank’s rights and remedies under this Agreement and the other Loan Documents are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank’s exercise of one right or remedy is not an election, and Bank’s waiver of any Event of Default is not a continuing waiver. Bank’s delay in exercising any remedy is not a waiver, election, or acquiescence.

9.7 Demand Waiver. Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Bank on which Borrower is liable.

22

10 NOTICES

All notices, consents, requests, approvals, demands, or other communication by any party to this Agreement or any other Loan Document must be in writing and shall be deemed to have been validly served, given, or delivered: (a) upon the earlier of actual receipt and three (3) Business Days after deposit in the U.S. mail, first class, registered or certified mail return receipt requested, with proper postage prepaid; (b) upon transmission, when sent by electronic mail or facsimile transmission; (c) one (1) Business Day after deposit with a reputable overnight courier with all charges prepaid; or (d) when delivered, if hand-delivered by messenger, all of which shall be addressed to the party to be notified and sent to the address, facsimile number, or email address indicated below. Bank or Borrower may change its mailing or electronic mail address or facsimile number by giving the other party written notice thereof in accordance with the terms of this Section 10. All notices to Borrower shall be sent, as provided herein, in care of Zhone with respect to any and all Borrowers.

If to Borrower:	c/o ZHONE TECHNOLOGIES, INC. 7001 Oakport Street Oakland, CA 94621
	Attn: Chief Financial Officer Fax: 510.777.7593 Email: kmisaka@zhone.com
If to Bank:	SILICON VALLEY BANK
	185 Berry Street, Suite 3000
	San Francisco, CA 94107 Attn: CFD Relationship Manager Fax: 415.856.0810
	Email: rfreeman@svb.com

11 CHOICE OF LAW, VENUE, JURY TRIAL WAIVER AND JUDICIAL REFERENCE.

California law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Santa Clara County, California; provided, however, that nothing in this Agreement shall be deemed to operate to preclude Bank from bringing suit or taking other legal action in any other jurisdiction to realize on the Collateral or any other security for the Obligations, or to enforce a judgment or other court order in favor of Bank. Borrower expressly submits and consents in advance to such jurisdiction in any action or suit commenced in any such court, and Borrower hereby waives any objection that it may have based upon lack of personal jurisdiction, improper venue, or forum non conveniens and hereby consents to the granting of such legal or equitable relief as is deemed appropriate by such court. Borrower hereby waives personal service of the summons, complaints, and other process issued in such action or suit and agrees that service of such summons, complaints, and other process may be made by registered or certified mail addressed to Borrower at the address set forth in Section 10 of this Agreement and that service so made shall be deemed completed upon the earlier to occur of Borrower’s actual receipt thereof or three (3) days after deposit in the U.S. mails, proper postage prepaid.

TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.

WITHOUT INTENDING IN ANY WAY TO LIMIT THE PARTIES’ AGREEMENT TO WAIVE THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY, if the above waiver of the right to a trial by jury is not enforceable, the parties hereto agree that any and all disputes or controversies of any nature between them arising at any time shall be decided by a reference to a private judge, mutually selected by the parties (or, if they cannot agree, by the Presiding Judge of the Santa Clara County, California Superior Court) appointed in accordance with California Code of Civil Procedure Section 638 (or pursuant to comparable provisions of federal law if the dispute falls within the exclusive jurisdiction of the federal courts), sitting without a jury, in Santa Clara County, California; and the parties hereby submit to the jurisdiction of such court. The reference proceedings shall be conducted pursuant to and in accordance with the provisions of California Code of Civil Procedure §§ 638 through 645.1, inclusive. The private judge shall have the power, among

23

others, to grant provisional relief, including without limitation, entering temporary restraining orders, issuing preliminary and permanent injunctions and appointing receivers. All such proceedings shall be closed to the public and confidential and all records relating thereto shall be permanently sealed. If during the course of any dispute, a party desires to seek provisional relief, but a judge has not been appointed at that point pursuant to the judicial reference procedures, then such party may apply to the Santa Clara County, California Superior Court for such relief. The proceeding before the private judge shall be conducted in the same manner as it would be before a court under the rules of evidence applicable to judicial proceedings. The parties shall be entitled to discovery which shall be conducted in the same manner as it would be before a court under the rules of discovery applicable to judicial proceedings. The private judge shall oversee discovery and may enforce all discovery rules and order applicable to judicial proceedings in the same manner as a trial court judge. The parties agree that the selected or appointed private judge shall have the power to decide all issues in the action or proceeding, whether of fact or of law, and shall report a statement of decision thereon pursuant to the California Code of Civil Procedure § 644(a). Nothing in this paragraph shall limit the right of any party at any time to exercise self-help remedies, foreclose against collateral, or obtain provisional remedies. The private judge shall also determine all issues relating to the applicability, interpretation, and enforceability of this paragraph.

12 GENERAL PROVISIONS

12.1 Maturity Date; Early Termination of this Agreement.

(a) On the Revolving Line Maturity Date or on any earlier effective date of termination, Borrower shall pay and perform in full all Obligations, whether evidenced by installment notes or otherwise, and whether or not all or any part of such Obligations are otherwise then due and payable.

(b) This Agreement (together with, but not separately from, the Exim Loan Agreement) may be terminated prior to the Revolving Line Maturity Date by Borrower, effective three (3) Business Days after written notice of termination is given to Bank, or by Bank upon the occurrence and during the continuation of an Event of Default. Notwithstanding any termination of this Agreement, Bank’s liens and security interests in the Collateral shall continue until Borrower pays in full in cash, and otherwise performs in full, its Obligations (other than inchoate indemnity obligations).

12.2 Successors and Assigns. This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights or obligations under it without Bank’s prior written consent (which may be granted or withheld in Bank’s discretion). Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank’s obligations, rights, and benefits under this Agreement and the other Loan Documents.

12.3 Indemnification. Borrower agrees to indemnify, defend and hold Bank and its directors, officers, employees, agents, attorneys, or any other Person affiliated with or representing Bank (each, an “Indemnified Person”) harmless against: (a) all obligations, demands, claims, and liabilities (collectively, “Claims”) asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses incurred, or paid by such Indemnified Person from, following, or arising from transactions between Bank and Borrower (including reasonable attorneys’ fees and expenses), except for Claims and/or losses directly caused by such Indemnified Person’s gross negligence or willful misconduct. This Section 12.2 shall survive any termination of this Agreement or any other Loan Document.

12.4 Time of Essence. Time is of the essence for the performance of all Obligations in this Agreement.

12.5 Severability of Provisions. Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

12.6 Correction of Loan Documents. Bank may correct patent errors and fill in any blanks in this Agreement and the other Loan Documents consistent with the agreement of the parties.

24

12.7 Amendments in Writing; Integration. All amendments to this Agreement must be in writing and signed by both Bank and Borrower. This Agreement and the Loan Documents represent the entire agreement about this subject matter and supersede prior negotiations or agreements. All prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement and the Loan Documents merge into this Agreement and the Loan Documents.

12.8 Counterparts. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.9 Survival. All covenants, representations and warranties made in this Agreement continue in full force until this Agreement has terminated pursuant to its terms and all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been satisfied. The obligation of Borrower in Section 12.2 to indemnify Bank shall survive until the statute of limitations with respect to all claims and causes of action with respect to which indemnity is given to Bank shall have run.

12.10 Confidentiality. In handling any confidential information, Bank shall exercise the same degree of care that it exercises for its own proprietary information, but disclosure of information may be made: (a) to Bank’s Subsidiaries or Affiliates; (b) to prospective transferees or purchasers of any interest in the Credit Extensions (provided, however, Bank shall use commercially reasonable efforts to obtain such prospective transferee’s or purchaser’s agreement to the terms of this provision); (c) as required by law, regulation, subpoena, or other order; (d) to Bank’s regulators or as otherwise required in connection with Bank’s examination or audit; (e) as Bank considers appropriate in exercising remedies under the Loan Documents; and (f) to third-party service providers of Bank so long as such service providers have executed a confidentiality agreement with Bank with terms no less restrictive than those contained herein. Confidential information does not include information that either: (i) is in the public domain or in Bank’s possession when disclosed to Bank, or becomes part of the public domain after disclosure to Bank; or (ii) is disclosed to Bank by a third party, if Bank does not know that the third party is prohibited from disclosing the information.

Subject to the foregoing, Bank may use confidential information for any bona fide Bank purpose, including, without limitation, for the development of client databases, reporting purposes, and market analysis, so long as Bank does not disclose Borrower’s identity or the identity of any person associated with Borrower unless otherwise expressly permitted by this Agreement. The provisions of this Section 12.10 shall survive the termination of this Agreement.

12.11 Attorneys’ Fees, Costs and Expenses. In any action or proceeding between Borrower and Bank arising out of or relating to the Loan Documents, the prevailing party shall be entitled to recover its reasonable attorneys’ fees and other costs and expenses incurred, in addition to any other relief to which it may be entitled.

13 DEFINITIONS

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

“Account” is any “account” as defined in the Code with such additions to such term as may hereafter be made, and includes, without limitation, all accounts receivable and other sums owing to Borrower.

“Account Debtor” is any “account debtor” as defined in the Code with such additions to such term as may hereafter be made.

“Advance” or “Advances” means an advance (or advances) under Section 2.1.1(a) hereof.

“Affiliate” of any Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person’s senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person’s managers and members.

“Agreement” is defined in the preamble hereof.

25

“Availability Amount” is the result of (a) the lesser of (i) the Maximum Revolver Amount or (ii) the amount available under the Borrowing Base, minus (b) the sum of the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) and an amount equal to the Letter of Credit Reserve, minus (c) the FX Reserve, minus (d) any amounts used for Cash Management Services, and minus (e) the outstanding principal balance of any Advances and (without duplication) any Reserves.

“Bank” is defined in the preamble hereof.

“Bank Expenses” are all audit fees and expenses, and all other costs and expenses (including reasonable attorneys’ fees and expenses) for preparing, amending, negotiating, administering, defending and enforcing the Loan Documents (including, without limitation, those incurred in connection with appeals or Insolvency Proceedings) or otherwise incurred with respect to Borrower.

“Borrower” is defined in the preamble hereof.

“Borrower’s Books” are all Borrower’s books and records including ledgers, federal and state tax returns, records regarding Borrower’s assets or liabilities, the Collateral, business operations or financial condition, and all computer programs or storage or any equipment containing such information.

“Borrowing Base” is, as of any date of determination, 80% (the “Eligible Accounts Advance Rate” and also an “Advance Rate”) of the net amount of Borrower’s Eligible Accounts (as determined by Bank from Borrower’s most recent Transaction Report). The foregoing notwithstanding, Bank may decrease any one or more Advance Rates in its good faith business judgment based on events, conditions, contingencies, or risks which, as determined by Bank, may adversely affect Collateral.

“Borrowing Resolutions” are, with respect to any Person, those resolutions adopted by such Person’s Board of Directors and delivered by such Person to Bank approving the Loan Documents to which such Person is a party and the transactions contemplated thereby, together with a certificate executed by its secretary on behalf of such Person certifying that (a) such Person has the authority to execute, deliver, and perform its obligations under each of the Loan Documents to which it is a party, (b) sets forth the resolutions then in full force and effect authorizing and ratifying the execution, delivery, and performance by such Person of the Loan Documents to which it is a party, (c) the names of the Persons authorized to execute the Loan Documents on behalf of such Person, together with a sample of the true signatures of such Persons, and (d) that Bank may conclusively rely on such certificate unless and until such Person shall have delivered to Bank a further certificate canceling or amending such prior certificate.

“Business Day” is any day that is not a Saturday, Sunday or a day on which Bank is closed.

“Campus” is defined in Section 5.1(c).

“Cash Equivalents” means (a) marketable direct obligations issued or unconditionally guaranteed by the United States or any agency or any State thereof having maturities of not more than one (1) year from the date of acquisition; (b) commercial paper maturing no more than one (1) year after its creation and having the highest rating from either Standard & Poor’s Ratings Group or Moody’s Investors Service, Inc., (c) Bank’s certificates of deposit issued maturing no more than one (1) year after issue; and (d) money market funds at least ninety-five percent (95%) of the assets of which constitute Cash Equivalents of the kinds described in clauses (a) through (c) of this definition.

“Cash Management Services” is defined in Section 2.1.4.

“Change in Control” means any event, transaction, or occurrence as a result of which (a) any “person” (as such term is defined in Sections 3(a)(9) and 13(d)(3) of the Securities Exchange Act of 1934, as an amended (the “Exchange Act”)), other than a trustee or other fiduciary holding securities under an employee benefit plan of Zhone, is or becomes a beneficial owner (within the meaning Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of securities of Zhone, representing thirty-five percent (35%) or more of the combined voting power of Zhone’s then outstanding securities; or (b) Zhone shall cease to own and control 100% of the issued and outstanding capital stock of each other Borrower.

26

“Code” is the Uniform Commercial Code, as the same may, from time to time, be enacted and in effect in the State of California; provided, that, to the extent that the Code is used to define any term herein or in any Loan Document and such term is defined differently in different Articles or Divisions of the Code, the definition of such term contained in Article or Division 9 shall govern; provided further, that in the event that, by reason of mandatory provisions of law, any or all of the attachment, perfection, or priority of, or remedies with respect to, Bank’s Lien on any Collateral is governed by the Uniform Commercial Code in effect in a jurisdiction other than the State of California, the term “Code” shall mean the Uniform Commercial Code as enacted and in effect in such other jurisdiction solely for purposes on the provisions thereof relating to such attachment, perfection, priority, or remedies and for purposes of definitions relating to such provisions.

“Collateral” is any and all properties, rights and assets of Borrower described on Exhibit A.

“Collateral Account” is any Deposit Account, Securities Account, or Commodity Account.

“Combined FX/CMS Sublimit” has the meaning set forth in Section 2.1.5.

“Combined LC Sublimit” has the meaning set forth in Section 2.1.5.

“Combined Revolving Line” is one or more Advances and Exim Loans in an aggregate amount of up to the Maximum Combined Amount outstanding at any time.

“Commodity Account” is any “commodity account” as defined in the Code with such additions to such term as may hereafter be made.

“Compliance Certificate” is that certain certificate in the form attached hereto as Exhibit B.

“Contingent Obligation” is, for any Person, any direct or indirect liability, contingent or not, of that Person for (a) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (b) any obligations for undrawn letters of credit for the account of that Person; and (c) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but “Contingent Obligation” does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under any guarantee or other support arrangement.

“Control Agreement” is any control agreement entered into among the depository institution at which Borrower maintains a Deposit Account or the securities intermediary or commodity intermediary at which Borrower maintains a Securities Account or a Commodity Account, Borrower, and Bank pursuant to which Bank obtains control (within the meaning of the Code) over such Deposit Account, Securities Account, or Commodity Account.

“Credit Extension” is any Advance, Letter of Credit, FX Forward Contract, amount utilized for Cash Management Services, or any other extension of credit by Bank for Borrower’s benefit.

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

“Default Rate” is defined in Section 2.3(b).

“Deferred Revenue” is all amounts received or invoiced in advance of performance under contracts and not yet recognized as revenue.

“Deposit Account” is any “deposit account” as defined in the Code with such additions to such term as may hereafter be made.

27

“Designated Deposit Account” is Borrower’s deposit account, account number                     , maintained with Bank.

“Dollars,” “dollars” and “$” each mean lawful money of the United States.

“Domestic Subsidiary” means a Subsidiary organized under the laws of the United States or any state or territory thereof or the District of Columbia.

“EBITDA” shall mean, for any period, (a) Net Income, plus (b) Interest Expense, plus (c) to the extent deducted in the calculation of Net Income, (i) depreciation expense, (ii) amortization expense, and (iii) the sum of non-cash stock compensation and foreign exchange gains and losses, plus (d) income tax expense, plus (e) other adjustments, if any, expressly agreed to by Bank (which shall be a matter of Bank’s good faith business judgment) in writing from time to time.

“Effective Date” has the meaning ascribed to such term in the preamble of this Agreement.

“Eligible Accounts” are Accounts which arise in the ordinary course of Borrower’s business that are subject to Bank’s first-priority perfected security interests therein and meet all Borrower’s representations and warranties in Section 5.3. Bank reserves the right at any time and from time to time after the Effective Date, with notice to Borrower, to adjust any of the criteria set forth below and to establish new criteria in its good faith business judgment. Unless Bank agrees otherwise in writing, Eligible Accounts shall exclude:

(a) Accounts that the Account Debtor has not paid within ninety (90) days of invoice date regardless of invoice payment period terms;

(b) Accounts owing from an Account Debtor, fifty percent (50%) or more of whose Accounts have not been paid within ninety (90) days of invoice date;

(c) Accounts owing from an Account Debtor which does not have its principal place of business in the United States;

(d) Accounts billed and payable outside of the United States unless the Bank has a first priority, perfected security interest or other enforceable Lien in such Accounts;

(e) Accounts owing from an Account Debtor to the extent that Borrower is indebted or obligated in any manner to the Account Debtor (as creditor, lessor, supplier or otherwise - sometimes called “contra” accounts, accounts payable, customer deposits or credit accounts), with the exception of customary credits, adjustments and/or discounts given to an Account Debtor by Borrower in the ordinary course of its business;

(f) Accounts for which the Account Debtor is Borrower’s Affiliate, officer, employee, or agent;

(g) Accounts with credit balances over ninety (90) days from invoice date;

(h) Accounts owing from an Account Debtor, including Affiliates, whose total obligations to Borrower exceed twenty-five percent (25%) of all Accounts, for the amounts that exceed that percentage, unless Bank approves in writing;

(i) Accounts owing from an Account Debtor which is a United States government entity or any department, agency, or instrumentality thereof unless Borrower has assigned its payment rights to Bank and the assignment has been acknowledged under the Federal Assignment of Claims Act of 1940, as amended;

(j) Accounts for demonstration or promotional equipment, or in which goods are consigned, or sold on a “sale guaranteed”, “sale or return”, “sale on approval”, or other terms if Account Debtor’s payment may be conditional;

(k) Accounts owing from an Account Debtor that has not been invoiced or where goods or services have not yet been rendered to the Account Debtor (sometimes called memo billings or pre-billings);

28

(l) Accounts subject to contractual arrangements between Borrower and an Account Debtor where payments shall be scheduled or due according to completion or fulfillment requirements where the Account Debtor has a right of offset for damages suffered as a result of Borrower’s failure to perform in accordance with the contract (sometimes called contracts accounts receivable, progress billings, milestone billings, or fulfillment contracts);

(m) Accounts owing from an Account Debtor the amount of which may be subject to withholding based on the Account Debtor’s satisfaction of Borrower’s complete performance (but only to the extent of the amount withheld; sometimes called retainage billings);

(n) Accounts subject to trust provisions, subrogation rights of a bonding company, or a statutory trust;

(o) Accounts owing from an Account Debtor that has been invoiced for goods that have not been shipped to the Account Debtor unless Bank, Borrower, and the Account Debtor have entered into an agreement acceptable to Bank in its sole discretion wherein the Account Debtor acknowledges that (i) it has title to and has ownership of the goods wherever located, (ii) a bona fide sale of the goods has occurred, and (iii) it owes payment for such goods in accordance with invoices from Borrower (sometimes called “bill and hold” accounts);

(p) Accounts owing from an Account Debtor with respect to which Borrower has received Deferred Revenue (but only to the extent of such Deferred Revenue);

(q) Accounts for which the Account Debtor has not been invoiced;

(r) Accounts that represent non-trade receivables or that are derived by means other than in the ordinary course of Borrower’s business;

(s) Accounts for which Borrower has permitted Account Debtor’s payment to extend beyond 90 days;

(t) Accounts subject to chargebacks or others payment deductions taken by an Account Debtor (but only to the extent the chargeback is determined invalid and subsequently collected by Borrower);

(u) Accounts in which the Account Debtor disputes liability or makes any claim (but only up to the disputed or claimed amount), or if the Account Debtor is subject to an Insolvency Proceeding, or becomes insolvent, or goes out of business;

(v) Accounts for which Bank in its good faith business judgment determines collection to be doubtful; and

(w) other Accounts Bank deems ineligible in the exercise of its good faith business judgment.

“Equipment” is all “equipment” as defined in the Code with such additions to such term as may hereafter be made, and includes without limitation all machinery, fixtures, goods, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing.

“ERISA” is the Employee Retirement Income Security Act of 1974, and its regulations.

“Event of Default” is defined in Section 8.

“Exim Bank” is defined in Section A.

“Exim Borrower Agreement” has the meaning ascribed to such term in the Exim Loan Agreement.

“Exim Loan” is defined in Section A.

“Exim Loan Agreement” is defined in Section A.

“Existing Guarantors” is defined in Section 5.1(c).

“Foreign Currency” means lawful money of a country other than the United States.

29

“Foreign Subsidiary” means any Subsidiary which is not a Domestic Subsidiary.

“Funding Date” is any date on which a Credit Extension is made to or on account of Borrower which shall be a Business Day.

“FX Business Day” is any day when (a) Bank’s Foreign Exchange Department is conducting its normal business and (b) the Foreign Currency being purchased or sold by Borrower is available to Bank from the entity from which Bank shall buy or sell such Foreign Currency.

“FX Forward Contract” is defined in Section 2.1.3.

“FX Reduction Amount” is defined in Section 2.1.3.

“FX Reserve” is defined in Section 2.1.3.

“GAAP” is generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other Person as may be approved by a significant segment of the accounting profession, which are applicable to the circumstances as of the date of determination.

“General Intangibles” is all “general intangibles” as defined in the Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation, all copyright rights, copyright applications, copyright registrations and like protections in each work of authorship and derivative work, whether published or unpublished, any patents, trademarks, service marks and, to the extent permitted under applicable law, any applications therefor, whether registered or not, any trade secret rights, including any rights to unpatented inventions, payment intangibles, royalties, contract rights, goodwill, franchise agreements, purchase orders, customer lists, route lists, telephone numbers, domain names, claims, income and other tax refunds, security and other deposits, options to purchase or sell real or personal property, rights in all litigation presently or hereafter pending (whether in contract, tort or otherwise), insurance policies (including without limitation key man, property damage, and business interruption insurance), payments of insurance and rights to payment of any kind.

“Governmental Approval” is any consent, authorization, approval, order, license, franchise, permit, certificate, accreditation, registration, filing or notice, of, issued by, from or to, or other act by or in respect of, any Governmental Authority.

“Governmental Authority” is any nation or government, any state or other political subdivision thereof, any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative functions of or pertaining to government, any securities exchange and any self-regulatory organization.

“Guarantor” is any present or future guarantor of any of the Obligations, including without limitation the Existing Guarantors identified in Section 5.1(c).

“Guarantor Security Agreement” is, with respect to each Guarantor, a security agreement (in form and substance satisfactory to Bank in its good faith business judgment) by such Guarantor in favor of Bank.

“Guaranty” is, with respect to each Guarantor, a continuing guaranty (in form and substance satisfactory to Bank in its good faith business judgment) by such Guarantor in favor of Bank, relative to Borrower.

“Indebtedness” is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations, and (d) Contingent Obligations.

“Indemnified Person” is defined in Section 12.3.

30

“Insolvency Proceeding” is any proceeding by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

“Intercompany Subordination Agreement” is defined in Section 6.12.

“Interest Expense” means for any fiscal period, interest expense (whether cash or non-cash) determined in accordance with GAAP for the relevant period ending on such date, including, in any event, interest expense with respect to any Credit Extension and other Indebtedness of Borrower and its Subsidiaries, including, without limitation or duplication, all commissions, discounts, or related amortization and other fees and charges with respect to letters of credit and bankers’ acceptance financing and the net costs associated with interest rate swap, cap, and similar arrangements, and the interest portion of any deferred payment obligation (including leases of all types).

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

“Investment” is any beneficial ownership interest in any Person (including stock, partnership interest or other securities), and any loan, advance or capital contribution to any Person.

“IP Security Agreement” is that certain Intellectual Property Security Agreement executed and delivered by Borrower and Guarantor to Bank dated as of the Effective Date (as the same may be amended, restated, supplemented or otherwise modified from time to time).

“Letter of Credit” means a standby letter of credit issued by Bank or another institution based upon an application, guarantee, indemnity or similar agreement on the part of Bank as set forth in Section 2.1.2.

“Letter of Credit Application” is defined in Section 2.1.2(a).

“Letter of Credit Reserve” has the meaning set forth in Section 2.1.2(d).

“Lien” is a claim, mortgage, deed of trust, levy, charge, pledge, security interest or other encumbrance of any kind, whether voluntarily incurred or arising by operation of law or otherwise against any property.

“Loan Documents” are, collectively, this Agreement, the Exim Loan Agreement, the Perfection Certificate, the IP Security Agreement, the Guaranty, the Guarantor Security Agreement, any note, or notes or guaranties executed by Borrower or any Guarantor, and any other present or future agreement between Borrower or any Guarantor and/or for the benefit of Bank in connection with this Agreement (or the Exim Loan Agreement), all as amended, restated, or otherwise modified.

“Loan Margin” is defined in Section 2.3(a)(i).

“Material Adverse Change” is: (a) a material impairment in the perfection or priority of Bank’s Lien in the Collateral or in the value of such Collateral; or (b) a material adverse change in the business, operations, or condition (financial or otherwise) of Borrower or any Guarantor taken as a whole; or (c) a material impairment of the prospect of repayment of any portion of the Obligations; or (d) Bank determines, based upon information available to it and in its reasonable judgment, that there is a reasonable likelihood that Borrower shall fail to comply with one or more of the financial covenants in Section 6 during the next succeeding financial reporting period.

“Material Guarantor” is a Guarantor, that as of any date of determination has greater than $200,000 in tangible assets and greater than $500,000 in fair market value of total assets.

“Maximum Combined Amount” is $20,000,000.

“Maximum Revolver Amount” is $10,000,000.

31

“Net Income” means, as calculated on a consolidated basis for Borrower and its Subsidiaries for any period as at any date of determination, the net profit (or loss), after provision for taxes, of Borrower and its Subsidiaries for such period taken as a single accounting period.

“Non-Exim Loan” is defined in Section A.

“Obligations” are Borrower’s obligation to pay when due any debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, whether under this Agreement, the other Loan Documents, or otherwise, including, without limitation, all obligations relating to letters of credit (including reimbursement obligations for drawn and undrawn letters of credit), cash management services, and foreign exchange contracts, if any, and including interest, and other amounts, accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank, and the performance of Borrower’s duties under the Loan Documents. It is expressly acknowledged and agreed that each and all of the Borrowers are, and at all times shall be, jointly and severally liable for all Obligations, regardless of which Borrower or Borrowers requested, received, used, or directly enjoyed the benefit of, the Obligations.

“Operating Documents” are, for any Person, such Person’s formation documents, as certified with the Secretary of State of such Person’s state of formation on a date that is no earlier than 30 days prior to the Effective Date, and, (a) if such Person is a corporation, its bylaws in current form, (b) if such Person is a limited liability company, its limited liability company agreement (or similar agreement), and (c) if such Person is a partnership, its partnership agreement (or similar agreement), each of the foregoing with all current amendments or modifications thereto.

“Overadvance” is defined in Section 2.2.

“Payment” means all checks, wire transfers and other items of payment received by Bank (including proceeds of Accounts and payment of the Obligations in full) for credit to Borrower’s outstanding Advances or, if the balance of the Advances have been reduced to zero, for credit to the Designated Deposit Account.

“Perfection Certificate” is defined in Section 5.1.

“Permitted Indebtedness” is:

(a) Borrower’s Indebtedness to Bank under this Agreement and the other Loan Documents;

(b) Indebtedness existing on the Effective Date and shown on the Perfection Certificate;

(c) Subordinated Debt;

(d) unsecured Indebtedness to trade creditors incurred in the ordinary course of business;

(e) Indebtedness incurred as a result of endorsing negotiable instruments received in the ordinary course of business;

(f) Indebtedness, in an aggregate principal amount not to exceed $100,000, secured by Permitted Liens described in clause (c) of the definition of “Permitted Liens”;

(g) unsecured Indebtedness under any performance, surety, statutory, or appeal bonds or similar obligations incurred in the ordinary course of business;

(h) other Indebtedness not otherwise permitted by Section 7.4 not exceeding $250,000 in the aggregate outstanding at any time; and

(i) extensions, refinancings, modifications, amendments and restatements of any items of Permitted Indebtedness (a) through (h) above, provided that the principal amount thereof is not increased or the terms thereof are not modified to impose more burdensome terms upon Borrower or its Subsidiary, as the case may be.

32

“Permitted Investments” are:

(a) Investments shown on the Perfection Certificate and existing on the Effective Date;

(b)(i) Cash Equivalents; and (ii) any Investments permitted by Borrower’s investment policy, as amended from time to time, provided that such investment policy (and any such amendment) has been approved by Bank in Bank’s good faith business judgment;

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

(d) Investments consisting of deposit and securities accounts, in which Bank has a perfected security interest;

(e) Investments accepted in connection with Transfers permitted by Section 7.1;

(f) Investments consisting of (i) travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business, and (ii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower or its Subsidiaries pursuant to employee stock purchase plans or agreements approved by Borrower’s Board of Directors;

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

(h) Investments consisting of notes receivable of, or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates, in the ordinary course of business; provided that this paragraph shall not apply to Investments of Borrower in any Subsidiary;

(i) Investments by Borrower in Subsidiaries from time to time in amounts sufficient to fund operating expenses of such Subsidiaries in the ordinary course of business;

(j) Investments consisting of joint ventures entered into by Borrower or any Subsidiary in the ordinary course of Borrower’s or such Subsidiary’s (as the case may be) business consisting of the non-exclusive licensing of technology from Borrower or such Subsidiary, the development of technology or the providing of technical support, provided that any cash investments by Borrower and all such Subsidiaries do not exceed $250,000 in the aggregate in any fiscal year;

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

(l) the special real estate loan payment Investments by Borrower to Campus described in the last sentence of Section 7.7; and

(m) other Investments not otherwise permitted by Section 7.7 not exceeding $100,000 in the aggregate outstanding at any time.

“Permitted Liens” are:

(a)(i) Liens existing on the Effective Date and shown on the Perfection Certificate; and (ii) Liens arising under this Agreement and the other Loan Documents;

(b) inchoate Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, provided that no notice of any such Lien has been filed or recorded under the Internal Revenue Code of 1986, as amended, and the Treasury Regulations adopted thereunder;

33

(c) purchase money Liens (including the interests of lessors under capitalized leases): (i) on Equipment (and related software) acquired or held by Borrower incurred for financing the acquisition of the Equipment (and related software) securing no more than $100,000 in the aggregate amount outstanding; or (ii) existing on Equipment (and related software) when acquired; in each case, only if such Lien is confined to such Equipment (and related software) and related improvements, related accessions, related replacements, and the proceeds thereof;

(d) inchoate Liens of carriers, warehousemen, suppliers, or other Persons that are possessory in nature arising in the ordinary course of business so long as such Liens attach only to Inventory, and which are (i) not delinquent or (ii) remain payable without penalty or (iii) are being contested in good faith and by appropriate proceedings which proceedings have the effect of preventing the forfeiture or sale of the property subject thereto;

(e) inchoate Liens to secure payment of workers’ compensation, employment insurance, old-age pensions, social security and other like obligations incurred in the ordinary course of business (other than Liens imposed by ERISA);

(f) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (c), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase;

(g) leases or subleases of real property granted in the ordinary course of business, and leases, subleases, non-exclusive licenses or sublicenses of property (other than real property or intellectual property) granted in the ordinary course of Borrower’s business, if the leases, subleases, licenses and sublicenses do not prohibit granting Bank a security interest;

(h) non-exclusive license of intellectual property granted to third parties in the ordinary course of business;

(i) Liens arising from attachments or judgments, orders, or decrees in circumstances not constituting an Event of Default under Sections 8.4 and 8.7;

(j) Liens in favor of other financial institutions (not securing indebtedness for borrowed money owing to such financial institutions) arising in connection with Borrower’s deposit and/or securities accounts permitted hereunder held at such institutions, provided that Bank has a perfected security interest in the amounts held in such deposit and/or securities accounts;

(k) Liens in favor of customs and revenues authorities arising as a matter of law to secure payment of customs duties in connection with the importation of goods;

(l) inchoate statutory Liens of landlords that are not delinquent and as to which Borrower is in compliance with the applicable requirements of Section 5.2(c) with respect to such landlord;

(m) Liens in a total amount not to exceed $250,000 on earnest money deposits required under a letter of intent or purchase agreement which are in connection with transactions permitted by this Agreement and are consented to in writing by Bank in its good faith business judgment, provided such funds are at all times kept in a segregated escrow account;

(n) Liens on insurance proceeds in favor of insurance companies granted solely as security for financed premiums, provided such Liens are confined to such premiums and further, provided, the aggregate amount of such liens does not at any time exceed $250,000;

(o) Liens on escrowed cash in an aggregate amount not exceeding $250,000, representing a portion of the proceeds of sales or transactions permitted by this Agreement, established to satisfy contingent post closing obligations that Borrower owes (including earn-outs, indemnities and working capital adjustments) so long as such Liens are disclosed in writing to Bank at or prior to the date they arise; and

(p) governmental Liens in connection with progress payments made on government contracts which are limited to the Inventory being sold pursuant to such government contract.

34

“Permitted Location” are: (i) Collateral locations identified in the Perfection Certificate; (ii) locations where Collateral may be temporarily located for sales, testing or demonstration purposes, (iii) locations where movable goods, such as mobile phones, laptops and similar Equipment may be located with employees and consultants, (iv) locations where Collateral may be located with contract manufacturers in the ordinary course of business, (v) locations of deposit and securities accounts otherwise permitted hereunder, and (vi) other locations where Collateral with an aggregate book value of less than $500,000 may be stored or located in the ordinary course of business.

“Person” is any individual, sole proprietorship, partnership, limited liability company, joint venture, company, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

“Prime Rate” is Bank’s most recently announced “prime rate,” even if it is not Bank’s lowest rate.

“Registered Organization” is any “registered organization” as defined in the Code with such additions to such term as may hereafter be made.

“Requirement of Law” is as to any Person, the organizational or governing documents of such Person, and any law (statutory or common), treaty, rule or regulation or determination of an arbitrator or a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject.

“Reserves” means, as of any date of determination, such amounts as Bank may from time to time establish and revise in its good faith business judgment, reducing the amount of Advances and other financial accommodations which would otherwise be available to Borrower (a) to reflect events, conditions, contingencies or risks which, as determined by Bank in its good faith business judgment, do or may adversely affect (i) the Collateral or any other property which is security for the Obligations or its value (including without limitation any increase in delinquencies of Accounts), (ii) the assets, business or prospects of Borrower or any Guarantor, or (iii) the security interests and other rights of Bank in the Collateral (including the enforceability, perfection and priority thereof); or (b) to reflect Bank’s good faith belief that any collateral report or financial information furnished by or on behalf of Borrower or any Guarantor to Bank is or may have been incomplete, inaccurate or misleading in any material respect; or (c) in respect of any state of facts which Bank determines in good faith constitutes an Event of Default or is reasonably likely, with notice or passage of time or both, to constitute an Event of Default.

“Responsible Officer” is any of the Chief Executive Officer, President, Chief Financial Officer and Controller of Borrower.

“Revolving Line” is an Advance or Advances in an aggregate amount of up to the Maximum Revolver Amount outstanding at any time.

“Revolving Line Maturity Date” is 364 days following the Effective Date.

“Securities Account” is any “securities account” as defined in the Code with such additions to such term as may hereafter be made.

“Settlement Date” is defined in Section 2.1.3.

“Subordinated Debt” is indebtedness incurred by Borrower subordinated to all of the Obligations owing to Bank (pursuant to a subordination, intercreditor, or other similar agreement in form and substance satisfactory to Bank entered into between Bank and the other creditor), on terms acceptable to Bank in its good faith business judgment.

35

“Subsidiary” means, with respect to any Person, any Person of which more than 50.0% of the voting stock or other equity interests (in the case of Persons other than corporations) is owned or controlled directly or indirectly by such Person or one or more of Affiliates of such Person. Anything in the preceding sentence to the contrary notwithstanding, “Campus” shall not constitute a “Subsidiary” of Borrower (for purposes of the Loan Documents other than factual representations and warranties of Borrower in identifying its Subsidiaries) if and so long as Campus is a special purpose limited liability company whose sole asset is real property utilized by Borrower and is not permitted to guaranty the obligations of the Borrower under its agreement with its lender.

“Transaction Report” is that certain report of transactions and schedule of collections in the form attached hereto as Exhibit C.

“Transfer” is defined in Section 7.1.

“Unused Combined Revolving Line Facility Fee” is defined in Section 2.4(d).

[Remainder of page immediately left blank; signature page immediately follows.]

36

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the Effective Date. March 16, 2009

BORROWER:

ZTI MERGER SUBSIDIARY III, INC., a Delaware corporation
By	/s/ KIRK MISAKA

Name:	Kirk Misaka
Title:	Chief Financial Officer

ZHONE TECHNOLOGIES, INC., a Delaware corporation
By	/s/ KIRK MISAKA

Name:	Kirk Misaka
Title:	Chief Financial Officer

BANK:

SILICON VALLEY BANK
By	/s/ RICK FREEMAN

Name:	Rick Freeman
Title:	Relationship Manager

Signature Page

EXHIBIT A

The Collateral consists of all of Borrower’s right, title and interest in and to the following personal property:

All goods, Accounts (including health-care receivables), Equipment, Inventory, contract rights or rights to payment of money, leases, license agreements, franchise agreements, General Intangibles, commercial tort claims, documents, instruments (including any promissory notes), chattel paper (whether tangible or electronic), cash, deposit accounts, fixtures, letters of credit rights (whether or not the letter of credit is evidenced by a writing), securities, and all other investment property, supporting obligations, and financial assets, whether now owned or hereafter acquired, wherever located; and

all Borrower’s Books relating to the foregoing, and any and all claims, rights and interests in any of the above and all substitutions for, additions, attachments, accessories, accessions and improvements to and replacements, products, proceeds and insurance proceeds of any or all of the foregoing.

Notwithstanding the foregoing, the Collateral does not include: (A) any Voting Stock (as defined below) of any Foreign Subsidiary of Borrower in excess of 65% of the issued and outstanding shares (whether currently existing or hereafter arising or acquired) of Borrower’s capital stock of such Foreign Subsidiary which shares entitle the holder thereof to vote for directors or any other matter (“Voting Stock”); and (B) any license or rights under any contract or rights as lessee of any equipment or software, to the extent that (i) the grant of a security interest therein would be contrary to applicable law, or (ii) such license or contract or lease prohibits the grant of a security interest therein (but only to the extent such prohibition is enforceable under applicable law).

[END OF EXHIBIT A]

Exhibit A

EXHIBIT B

COMPLIANCE CERTIFICATE

TO:         SILICON VALLEY BANK	Date:
FROM:

The undersigned authorized officer of each of ZTI Merger Subsidiary III, Inc., a Delaware corporation formerly known as Zhone Technologies, Inc., and Zhone Technologies, Inc., a Delaware corporation formerly known as Tellium, Inc. (individually and collectively, and jointly and severally, “Borrower”) certifies that under the respective terms and conditions of the Second Amended and Restated Loan and Security Agreement between Borrower and Bank (the “Non-Exim Loan Agreement”) and the Loan and Security Agreement (Exim Facility) between Borrower and Bank (the “Exim Loan Agreement”) (individually and collectively, the “Agreement”), (1) Borrower is in complete compliance for the period ending                      with all required covenants except as noted below, (2) there are no Events of Default that have occurred and are continuing, (3) all representations and warranties in the Agreement are true and correct in all material respects on this date except as noted below; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date, (4) Borrower, and each of its Subsidiaries, has timely filed all required federal tax returns and reports, and all required state, local, and foreign, material tax returns and reports, and Borrower has timely paid all federal taxes, assessments, deposits and contributions owed by Borrower, and all state, local, and foreign, material taxes, assessments, deposits and contributions owed by Borrower, in each case except as otherwise permitted pursuant to the terms of Section 5.9 of the Agreement, and (5) no Liens have been levied or claims made against Borrower or any of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has not previously provided written notification to Bank. Attached are the required documents supporting the certification. The undersigned certifies that these are prepared in accordance with GAAP consistently applied from one period to the next except: (i) with respect to audited annual financial statements, as explained in an accompanying letter or footnotes; and (ii) interim financial statements may be subject to normal year-end audit adjustments (which will not be material in the aggregate) and need not contain footnote disclosures required by GAAP. The undersigned acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of Section 3 of the Agreement or a Default or Event of Default has occurred and is continuing, and that compliance is determined not just at the date this certificate is delivered. Capitalized terms used but not otherwise defined herein shall have the meanings given them in the Agreement.

Please indicate compliance status by circling Yes/No under “Complies” column.

Reporting Covenant	Required	Complies
Monthly financial statements with Compliance Certificate	Monthly within 30 days	Yes    No
Annual financial statement (CPA Audited) + CC	FYE within 120 days	Yes    No
10-Q, 10-K and 8-K	Within 5 days after filing with SEC	Yes    No
A/R & A/P Agings, Deferred revenue reports, and Sales reports	Monthly within 15 days	Yes    No
Concurrently with monthly A/R agings in respect of any month that is also the last month of a fiscal quarter, copies of actual invoices in respect of Eligible Accounts representing not less than 10% of the aggregate A/R agings balance as of the end of such last month of a fiscal quarter	Quarterly within 15 days	Yes    No
Transaction Reports	(i) at the time of each Advance, and (ii) so long as any Advance is outstanding, in addition not less frequently than weekly	Yes    No

Exhibit B

The following: (i) copyright (including any subsequent ownership right of Borrower in or to any copyright); or (ii) patent (including any subsequent ownership right of Borrower in or to any patent) constituting Material Intellectual Property; or (iii) trademark (including any subsequent ownership right of Borrower in or to any trademark) constituting Material Intellectual Property; was registered after the Effective Date (if no registrations, state “None”)

Financial Covenant	Required	Actual	Complies
Maintain on a Monthly Basis:
Minimum Liquidity Ratio	At least 2.00 : 1.00	_____ : 1.00	Yes    No
Minimum EBITDA for any Test Period of 2 Consecutive Fiscal Quarters (commencing with the Test Period ending on March 31, 2009)	See Section 6.9(b) of the Non-Exim Loan Agreement	EBITDA for Test Period most recently ended (“Last Quarter”): $_________	Yes    No

The following financial covenant analys[is][es] and information set forth in Schedule 1 attached hereto are true and accurate as of the date of this Certificate.

The following are the exceptions with respect to the certification above: (If no exceptions exist, state “No exceptions to note.”)

ZTI MERGER SUBSIDIARY III, INC., a Delaware corporation	BANK USE ONLY
By	Received by:
Name:		AUTHORIZED SIGNER
Title:	Date:
	Verified:
ZHONE TECHNOLOGIES, INC., a Delaware corporation		AUTHORIZED SIGNER
By	Date:
Name:
Title:	Compliance Status:             Yes     No

Exhibit B

Schedule 1 to Compliance Certificate

Financial Covenants of Borrower

In the event of a conflict between this Schedule and the Loan Agreement, the terms of the Loan Agreement shall govern.

Dated:                     

Liquidity Ratio [Section 6.9(a) of Non-Exim Loan Agreement]

Actual:

A.	Aggregate amount of Borrower’s unrestricted cash, as shown on Borrower’s consolidated balance sheet	$
B.	Aggregate net amount of Borrower’s Eligible Accounts under the Non-Exim Loan Agreement	$
C.	Aggregate net amount of Borrower’s “Eligible Accounts” under the Exim Loan Agreement	$
D.	Sum of line A plus line B plus line C	$
E.	Aggregate amount of all outstanding Obligations	$
F.	Liquidity Ratio (line D divided by line E)		____:1.00

Is line F equal to or greater than 2.00 : 1.00 ?

             No, not in compliance              Yes, in compliance

[continued on next page]

Exhibit B

Minimum EBITDA for any Test Period of 2 Consecutive Fiscal Quarters [Section 6.9(b) of Non-Exim Loan Agreement] (commencing with the Test Period ending on March 31, 2009)

Actual EBITDA for the fiscal quarter most recently ended (“Last Fiscal Quarter”), i.e., on                 , 200    :

A.	Net Income of Borrower		$
B.	To the extent included in the determination of Net Income
	1.	The provision for income taxes	$
	2.	Depreciation expense	$
	3.	Amortization expense	$
	4.	Interest Expense	$
	5.	non-cash stock compensation	$
	6.	foreign exchange gains and losses	$
	7.	other adjustments, if any, expressly agreed to by Bank [specify below]:	$
	8.	The sum of lines 1 through 7	$
C.	EBITDA (line A plus line B.8)		$

[continued on next page]

Exhibit B

Actual EBITDA for the fiscal quarter immediately preceding Last Fiscal Quarter, i.e., ending on                     , 200    :

D.	Net Income of Borrower		$
E.	To the extent included in the determination of Net Income
	1.	The provision for income taxes	$
	2.	Depreciation expense	$
	3.	Amortization expense	$
	4.	Interest Expense	$
	5.	non-cash stock compensation	$
	6.	foreign exchange gains and losses	$
	7.	other adjustments, if any, expressly agreed to by Bank [specify below]:	$
	8.	The sum of lines 1 through 7	$
F.	EBITDA (line D plus line E.8)		$

Is the sum of Line C plus Line F greater than or equal to the minimum amount of EBITDA for such Test Period as set forth in Section 6.9(b) of the Non-Exim Loan Agreement? If yes, check “Yes, in compliance” below. If no, then check “No, not in compliance” below.

             No, not in compliance              Yes, in compliance

Exhibit B

Exhibit C

Transaction Report

[EXCEL spreadsheet to be provided separately]

Exhibit C

EX-10.20

EXHIBIT 10.20

LOAN AND SECURITY AGREEMENT (EXIM FACILITY)

THIS LOAN AND SECURITY AGREEMENT (EXIM FACILITY) (this “Agreement”), dated as of March 16, 2009 (the “Effective Date”), between, on the one hand, SILICON VALLEY BANK, a California corporation (“Bank”), and, on the other hand, ZTI Merger Subsidiary III, Inc., a Delaware corporation formerly known as Zhone Technologies, Inc. (“ZMS-III”, and also a “Borrower”), and Zhone Technologies, Inc., a Delaware corporation formerly known as Tellium, Inc. (“Zhone”, and also a “Borrower”) (individually and collectively, and jointly and severally, “Borrower”), provides the terms on which Bank shall lend to Borrower and Borrower shall repay Bank.

The parties agree as follows:

A EXIM PROVISIONS

A.1 Exim Guaranty. Prior to the first Credit Extension hereunder, Borrower shall cause the Export Import Bank of the United States (the “Exim Bank”) to guarantee the Credit Extensions made under this Agreement, pursuant to a Master Guarantee Agreement, Loan Authorization Agreement and (to the extent applicable) Delegated Authority Letter Agreement or Fast Track Lender Agreement (collectively, the “Exim Guaranty”), and Borrower shall cause the Exim Guaranty to be in full force and effect throughout the term of this Agreement and so long as any Credit Extensions hereunder are outstanding. If, for any reason, the Exim Guaranty shall cease to be in full force and effect, or if the Exim Bank declares in writing the Exim Guaranty void or revokes in writing any obligations thereunder or denies in writing liability thereunder, or if Borrower takes or permits any action that could reasonably be expected to cause the Exim Guarantee to not be in full force and effect, any such event shall constitute an Event of Default under this Agreement. Nothing in any confidentiality agreement in this Agreement or in any other agreement shall restrict Bank’s right to make disclosures and provide information to the Exim Bank in connection with the Exim Guaranty. Bank shall have the right to take all actions required or authorized in the Exim Guaranty.

A.2 Exim Borrower Agreement; Costs. Borrower shall, promptly upon Bank’s request from time to time (including concurrently herewith), execute and deliver a Borrower Agreement, in the form specified by the Exim Bank, in favor of Bank and the Exim Bank, together with any amendments thereto which are required by the Exim Bank (as so amended, the “Exim Borrower Agreement”). This Agreement is subject to all of the terms and conditions of the Exim Borrower Agreement, all of which are hereby incorporated herein by this reference. Borrower expressly agrees to perform all of the obligations and comply with all of the affirmative and negative covenants and all other terms and conditions set forth in the Exim Borrower Agreement, as though the same were expressly set forth herein. In the event of any conflict between the terms of the Exim Borrower Agreement and the other terms of this Agreement or the Non-Exim Loan Agreement, whichever terms are more restrictive shall apply. Borrower acknowledges and agrees that it has received a copy of the Loan Authorization Agreement which is referred to in the Exim Borrower Agreement. Borrower agrees to be bound by the terms of the Loan Authorization Agreement, including, without limitation, by any additions or revisions made prior to its execution on behalf of Exim Bank. Upon the execution of the Loan Authorization Agreement by Exim Bank and Bank, it shall become an attachment to the Exim Borrower Agreement. Borrower shall reimburse Bank for all fees and all out of pocket costs and expenses incurred by Bank with respect to the Exim Guaranty and the Exim Borrower Agreement, including without limitation all facility fees and usage fees, and Bank is authorized to debit Borrower’s account with Bank for such fees, costs and expenses when paid by Bank.

A.3 Non-Exim Loan Agreement; Cross-Collateralization; Cross-Default. Concurrently herewith, Bank and the Borrower are entering into that certain other Second Amended and Restated Loan and Security Agreement, dated as of the Effective Date (as amended, restated, supplemented, or otherwise modified from time to time, the “Non-Exim Loan Agreement”). Both this Agreement and the Non-Exim Loan Agreement shall continue in full force and effect, and all rights and remedies under this Agreement and the Non-Exim Loan Agreement are cumulative. The term “Obligations” as used in this Agreement and in the Non-Exim Loan Agreement shall include without limitation the obligation to pay when due all Credit Extensions made pursuant to this Agreement (including all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit), the FX Reserve, and amounts

1

used for Cash Management Services, under this Agreement) (collectively, the “Exim Loans”) and all interest thereon and the obligation to pay when due all “Credit Extensions” under (and as such term is defined in) the Non-Exim Loan Agreement (including all outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”), the “FX Reserve”, and amounts used for “Cash Management Services”, under (and as such terms are defined in) the Non-Exim Loan Agreement) (collectively, the “Non-Exim Loans”) and all interest thereon. Without limiting the generality of the foregoing, all “Collateral” as defined in this Agreement and as defined in the Non-Exim Loan Agreement shall secure all Exim Loans and all Non-Exim Loans, and all other Obligations. Any Event of Default under this Agreement shall also constitute an Event of Default under the Non-Exim Loan Agreement, and any Event of Default under the Non-Exim Loan Agreement shall also constitute an Event of Default under this Agreement. In the event Bank assigns its rights under this Agreement and/or under any note evidencing Exim Loans and/or its rights under the Non-Exim Loan Agreement and/or under any note evidencing Non-Exim Loans, to any third party, including without limitation the Exim Bank, whether before or after the occurrence of any Event of Default, Bank shall have the right (but not any obligation), in its sole discretion, to allocate and apportion Collateral to this Agreement, the Non-Exim Loan Agreement, and/or any note(s) assigned and to specify the priorities of the respective security interests in such Collateral between itself and the assignee, all without consent of the Borrower.

A.4 Exim Insurance. If required by Bank, Borrower will obtain, and pay when due all premiums with respect to, and maintain, uninterrupted foreign credit insurance. In addition, Borrower will execute in favor of Bank an assignment of proceeds of any insurance policy obtained by Borrower and issued by Exim Bank insuring against comprehensive commercial and political risk (the “Exim Bank Insurance Policy”). The insurance proceeds from the Exim Bank Insurance Policy assigned or paid to Bank will be applied to the balance outstanding under this Agreement. Borrower will immediately notify Bank and Exim Bank in writing upon submission of any claim under the Exim Bank Insurance Policy, and thereafter Bank will not be obligated to make any further Credit Extensions hereunder to Borrower without prior approval from Exim Bank.

1 ACCOUNTING AND OTHER TERMS

Accounting terms not defined in this Agreement shall be construed following GAAP. Calculations and determinations must be made following GAAP. Capitalized terms not otherwise defined in this Agreement shall have the meanings set forth in Section 13. All other terms contained in this Agreement, unless otherwise indicated, shall have the meaning provided by the Code to the extent such terms are defined therein.

2 LOAN AND TERMS OF PAYMENT

2.1 Promise to Pay. Borrower hereby unconditionally promises to pay Bank the outstanding principal amount of all Credit Extensions, and all accrued and unpaid interest thereon, as and when due in accordance with this Agreement.

2.1.1 Revolving Advances.

(a) Availability. Subject to the terms and conditions of this Agreement and subject to deduction of Reserves, Bank shall make Advances not exceeding the Availability Amount; provided, however, that the sum of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) under this Agreement, plus all outstanding Non-Exim Loans under the Non-Exim Loan Agreement, shall not exceed at any time the Maximum Combined Amount.

Amounts borrowed pursuant to this Section may be repaid and, prior to the Revolving Line Maturity Date, reborrowed, subject to the applicable terms and conditions precedent herein. Advances and other Credit Extensions will be made to each Borrower based on the Eligible Accounts of such Borrower, subject to the Maximum Revolver Amount for all Advances and other Credit Extensions hereunder to all Borrowers combined, and subject to the Maximum Combined Amount for all Non-Exim Loans and Exim Loans to all Borrowers combined.

(b) Allocation of Credit Extensions and Reserves as Between this Agreement and the Non-Exim Loan Agreement. Subject at all times to Section 5.10 of this Agreement and Section 5.10 of the Non-Exim Loan Agreement (with respect to permitted purposes of Exim Loans and Non-Exim Loans), Bank and Borrower

2

hereby acknowledge and agree that, if and to the extent that there is both sufficient borrowing availability in accordance with the terms and conditions of this Agreement and sufficient borrowing availability in accordance with the terms and conditions of the Non-Exim Loan Agreement, Bank shall have the right (but not the obligation) to require that Advances and other Credit Extensions will be made, and deemed outstanding, first under this Agreement to the extent of borrowing availability under this Agreement, before being made, and deemed outstanding, under the Non-Exim Loan Agreement. Without limiting the generality of the foregoing, Bank shall have the right (but not the obligation) to allocate any Reserves (other than reserves in respect of specific Credit Extensions under this Agreement, specific “Credit Extensions” under the Non-Exim Loan Agreement, or specific Accounts) first against borrowing availability under this Agreement before being allocated against borrowing availability under the Non-Exim Loan Agreement.

(c) Termination of Revolving Line; Repayment. Bank’s obligation under this Agreement to provide Advances and other Credit Extensions in respect of the Revolving Line shall terminate on the Revolving Line Maturity Date. The principal amount of all Advances, the unpaid interest thereon, and all other Obligations relating to the Revolving Line shall be immediately due and payable on the Revolving Line Maturity Date.

2.1.2 Letters of Credit Sublimit.

(a) As part of the Revolving Line, Bank shall issue or have issued Letters of Credit for Borrower’s account, as requested by Borrower. The aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit), plus any Letter of Credit Reserves, under this Agreement may not exceed $7,000,000, subject to the Combined LC Sublimit set forth in Section 2.1.5(a). Such aggregate amounts utilized hereunder shall at all times reduce the amount otherwise available for Advances under the Revolving Line and the Combined Revolving Line. If, on the Revolving Line Maturity Date, there are any outstanding Letters of Credit, then on such date Borrower shall provide to Bank cash collateral in an amount equal to 105% of the face amount of all such Letters of Credit plus all interest, fees, and costs due or to become due in connection therewith (as estimated by Bank in its good faith business judgment), to secure all of the Obligations relating to said Letters of Credit. All Letters of Credit shall be in form and substance acceptable to Bank in its sole discretion and shall be subject to the terms and conditions of Bank’s standard Application and Letter of Credit Agreement (the “Letter of Credit Application”). Borrower agrees to execute any further documentation in connection with the Letters of Credit as Bank may reasonably request. Borrower further agrees to be bound by the regulations and interpretations of the issuer of any Letters of Credit guarantied by Bank and opened for Borrower’s account or by Bank’s interpretations of any Letter of Credit issued by Bank for Borrower’s account, and Borrower understands and agrees that Bank shall not be liable for any error, negligence, or mistake, whether of omission or commission, in following Borrower’s instructions or those contained in the Letters of Credit or any modifications, amendments, or supplements thereto.

(b) The obligation of Borrower to immediately reimburse Bank for drawings made under Letters of Credit shall be absolute, unconditional, and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement, such Letters of Credit, and the Letter of Credit Application. Without limiting the generality of the foregoing, any payment by Bank under or in connection with a Letter of Credit shall constitute an Advance hereunder on the date such payment is made.

(c) Borrower may request that Bank issue a Letter of Credit payable in a Foreign Currency. If a demand for payment is made under any such Letter of Credit, Bank shall treat such demand as an Advance to Borrower of the equivalent of the amount thereof (plus fees and charges in connection therewith such as wire, cable, SWIFT or similar charges) in Dollars at the then-prevailing rate of exchange in San Francisco, California, for sales of the Foreign Currency for transfer to the country issuing such Foreign Currency.

(d) To guard against fluctuations in currency exchange rates, upon the issuance pursuant to this Agreement of any Letter of Credit payable in a Foreign Currency, Bank shall create a reserve (the “Letter of Credit Reserve”) under the Revolving Line in an amount equal to ten percent (10%) of the face amount of such Letter of Credit. The amount of the Letter of Credit Reserve may be adjusted by Bank from time to time to account for fluctuations in the exchange rate. The availability of funds under the Revolving Line shall be reduced by the amount of such Letter of Credit Reserve for as long as such Letter of Credit remains outstanding and shall be subject to the Combined LC Sublimit set forth in Section 2.1.5.

3

2.1.3 Foreign Exchange Sublimit. As part of the Revolving Line, Borrower may enter into foreign exchange contracts with Bank under which Borrower commits to purchase from or sell to Bank a specific amount of Foreign Currency (each, a “FX Forward Contract”) on a specified date (the “Settlement Date”). FX Forward Contracts shall have a Settlement Date of at least one (1) FX Business Day after the contract date and shall be subject to a reserve of ten percent (10%) of each outstanding FX Forward Contract in a maximum aggregate amount equal to $5,000,000 for all such FX Forward Contracts pursuant to this Agreement (the “FX Reserve”) and further subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, the aggregate amount of FX Forward Contracts at any one time may not exceed ten (10) times the amount of the FX Reserve. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, the amount otherwise available for Credit Extensions under the Revolving Line hereunder shall be reduced by an amount equal to ten percent (10%) of each outstanding FX Forward Contract (the “FX Reduction Amount”). Any amounts needed to fully reimburse Bank in respect of FX Forward Contracts entered into pursuant to this Section 2.1.3 will be treated as Advances under the Revolving Line and will accrue interest at the interest rate applicable to Advances.

2.1.4 Cash Management Services Sublimit. Subject to the Combined FX/CMS Sublimit set forth in Section 2.1.5, Borrower may use up to $5,000,000 (the “Cash Management Services Sublimit”) of the Revolving Line for Bank’s cash management services which may include merchant services, direct deposit of payroll, business credit card, and check cashing services identified in Bank’s various cash management services agreements (collectively, the “Cash Management Services”). Any amounts Bank pays on behalf of Borrower, or any amounts that are not paid by Borrower, for any Cash Management Services provided pursuant to this Section 2.1.4 will be treated as Advances under the Revolving Line and will accrue interest at the interest rate applicable to Advances.

2.1.5 Combined LC Sublimit; Combined FX/CMS Sublimit.

(a) Anything herein to the contrary notwithstanding, the sum of (i) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, plus (ii) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Non-Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Non-Exim Loan Agreement, shall not exceed $7,000,000 (the “Combined LC Sublimit”).

(b) Anything herein to the contrary notwithstanding, the sum of (i) the FX Reserve under this Agreement, plus (ii) the “FX Reserve” under the Non-Exim Loan Agreement, plus (iii) the aggregate amount of Obligations in respect of Cash Management Services under this Agreement, plus (iv) the aggregate amount of Obligations in respect of “Cash Management Services” under the Non-Exim Loan Agreement, shall not exceed $5,000,000 (the “Combined FX/CMS Sublimit”).

2.2 Overadvances. If at any time or for any reason any one or more of the following occurs (in any such case, an “Overadvance”):

(a) the total of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) exceeds the lesser of (1) the Maximum Revolver Amount or (2) the Borrowing Base; or

(b) the sum of all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) under this Agreement, plus all outstanding Non-Exim Loans (and other monetary “Obligations”) under the Non-Exim Loan Agreement (including (iv) amounts used under the Non-Exim Loan Agreement for “Cash Management Services”, (v) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Non-Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Non-Exim Loan Agreement, and (vi) the “FX Reduction Amount” under the Non-Exim Loan Agreement), exceeds the Maximum Combined Amount; or

4

(c) the sum of (i) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, plus (ii) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Non-Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Non-Exim Loan Agreement, exceeds the Combined LC Sublimit; or

(d) the sum of (i) the FX Reduction Amount under this Agreement, plus (ii) the “FX Reduction Amount” under the Non-Exim Loan Agreement, plus (iii) the aggregate amount of Obligations in respect of Cash Management Services under this Agreement, plus (iv) the aggregate amount of Obligations in respect of “Cash Management Services” under the Non-Exim Loan Agreement, exceeds the Combined FX/CMS Sublimit;

then, Borrower shall promptly pay to Bank in cash such Overadvance within one Business Day following notice thereof from Bank to Borrower. Without limiting Borrower’s obligation to repay Bank any amount of the Overadvance, Borrower agrees to pay Bank interest on the outstanding amount of any Overadvance, on demand, at the Default Rate.

2.3 Payment of Interest on the Credit Extensions.

(a) Interest Rate. Subject to Section 2.3(b), the principal amount outstanding under the Revolving Line shall accrue interest at a per annum rate equal to the sum of the Loan Margin plus the Prime Rate, provided that the interest rate in effect on any day shall not be less than 6.50% per annum, which interest shall be payable monthly.

As used herein, the term “Loan Margin” means, as of any date of determination, 2.50 percentage points.

(b) Default Rate. Immediately upon the occurrence and during the continuance of an Event of Default, Obligations shall bear interest at a rate per annum which is four percentage points above the rate which is otherwise applicable to the Obligations (the “Default Rate”). Payment or acceptance of the increased interest rate provided in this Section 2.3(b) is not a permitted alternative to timely payment and shall not constitute a waiver of any Event of Default or otherwise prejudice or limit any rights or remedies of Bank.

(c) Adjustment to Interest Rate. Changes to the interest rate of any Credit Extension based on changes to the Prime Rate shall be effective on the effective date of any change to the Prime Rate and to the extent of any such change.

(d) 360-Day Year. Interest shall be computed on the basis of a 360-day year for the actual number of days elapsed.

(e) Debit of Accounts. Bank may debit any of Borrower’s deposit accounts, including the Designated Deposit Account, for (i) principal and interest payments, when due, or (ii) any other amounts Borrower owes Bank, when due. These debits shall not constitute a set-off.

(f) [reserved]

(g) Payment; Interest Computation; Float Charge. Interest is payable monthly on the last calendar day of each month. In computing interest on the Obligations, all Payments received after 12:00 p.m. Pacific time on any day shall be deemed received on the next Business Day. When the payment of an Obligation is due on a day that is not a Business Day, such payment shall be due the next Business Day and additional fees or interest, as applicable, shall continue to accrue until such Obligation is paid. In addition, Bank shall be entitled to charge Borrower a “float” charge in an amount equal to two (2) Business Days interest, at the interest rate applicable to the Advances, on all Payments received by Bank and applied to outstanding Advances. Said float charge is not included in interest for purposes of computing Minimum Monthly Interest (if any) under this Agreement. The float charge for each month shall be payable on the last day of such month. Bank shall not, however, be required to credit Borrower’s account for the amount of any item of payment which is unsatisfactory to Bank in its good faith business judgment, and Bank may charge Borrower’s Designated Deposit Account for the amount of any item of payment which is returned to Bank unpaid.

5

2.4 Fees. Borrower shall pay to Bank:

(a) Combined Commitment Fee. The combined commitment fee (fully earned on the Effective Date) set forth in Section 2.4(a) of the Non-Exim Loan Agreement.

(b) Letter of Credit Fee. Bank’s customary fees and expenses for the issuance or renewal of Letters of Credit, upon the issuance, each anniversary of the issuance, and the renewal, of any such Letter of Credit by Bank.

(c) [intentionally omitted]

(d) Unused Combined Revolving Line Facility Fee. The “Unused Combined Revolving Line Facility Fee” set forth in Section 2.4(d) of the Non-Exim Loan Agreement. Borrower shall not be entitled to any credit, rebate or repayment of any Unused Combined Revolving Line Facility Fee previously earned by Bank pursuant to this Section notwithstanding any termination of the Agreement, or suspension or termination of Bank’s obligation to make loans and advances hereunder or under the Non-Exim Loan Agreement.

(e) Combined Collateral Monitoring Fee. With respect to any “Qualified CMF Month” (as defined in the Non-Exim Loan Agreement), the monthly combined collateral monitoring fee set forth in Section 2.4(e) of the Non-Exim Loan Agreement.

(f) Bank Expenses. All Bank Expenses (including reasonable attorneys’ fees and expenses for documentation and negotiation of this Agreement and the other Loan Documents) incurred through and after the Effective Date, when due.

3 CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Credit Extension. Bank’s obligation to make the initial Credit Extension is subject to the condition precedent that Borrower shall consent to or have delivered, in form and substance satisfactory to Bank, such documents, and completion of such other matters, as Bank may reasonably deem necessary or appropriate, including, without limitation:

(a) Borrower and Guarantor shall have delivered duly executed original signatures to the Loan Documents to which it is a party, including this Agreement, the Non-Exim Loan Agreement, the Exim Borrower Agreement (including the Economic Impact Certification, attached both as Annex B to the Exim Borrower Agreement and as Annex E to the Master Guaranty Agreement comprising the Exim Guaranty), the IP Security Agreement, the Guaranty, the Guarantor Security Agreement, the Intercompany Subordination Agreement, and one or more Control Agreements relative to all Collateral Accounts maintained with any affiliate of Bank;

(b) certified copies, dated as of a recent date, of financing statement searches with respect to each of Borrower and Guarantor, as Bank shall request, accompanied by written evidence (including any UCC termination statements) that the Liens indicated in any such financing statements either constitute Permitted Liens or have been or will be terminated or released;

(c) Borrower and Guarantor shall have delivered duly executed original signatures to one or more Control Agreements relative to all Collateral Accounts maintained with any institution (other than Bank or any affiliate of Bank), except to the extent expressly not required under Section 6.8(b);

(d) Borrower and Guarantor shall have delivered: (i) its Operating Documents; and (ii) good standing certificates with respect to each Borrower and each Guarantor issued by the applicable Secretary of State (and, if separate, the state tax authority) of the jurisdiction of organization of each such Borrower or Guarantor and the applicable Secretary of State (and, if separate, the state tax authority) of the jurisdictions (other than the applicable jurisdiction of organization of such Borrower or such Guarantor) in which such Borrower’s or such Guarantor’s failure to be duly qualified or licensed would constitute a Material Adverse Change , in each case, as of a date no earlier than thirty (30) days prior to the Effective Date; provided, however, that with respect to Xybridge

6

Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date;

(e) Borrower shall have delivered duly executed original signatures to the completed Borrowing Resolutions for Borrower, and Guarantor shall have delivered executed original complete certified resolutions and incumbency certificate of Guarantor;

(f) With respect to each Borrower and each Guarantor, Bank shall have received certified copies, dated as of a recent date, of financing statement searches, as Bank shall request, reflecting Bank’s financing statements filed of record with respect to Bank’s Liens, and accompanied by written evidence (including any UCC termination statements) that the Liens (other than the Bank’s Liens) indicated in any financing statements either constitute Permitted Liens or have been or, in connection with the initial Credit Extension, will be terminated or released;

(g) Each Borrower shall have delivered a separate Perfection Certificate executed by such Borrower;

(h) [reserved]

(i) [reserved]

(j) Borrower shall have delivered evidence reasonably satisfactory to Bank that the insurance policies required by Section 6.7 hereof are in full force and effect, together with appropriate evidence showing loss payable and/or additional insured clauses or endorsements in favor of Bank;

(k) Borrower shall have paid the fees and Bank Expenses then due as specified in Section 2.4 hereof.

3.2 Conditions Precedent to all Credit Extensions. Bank’s obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following:

(a) except as otherwise provided in Section 3.4, timely receipt of an executed Transaction Report;

(b) the representations and warranties in Section 5 shall be true in all material respects on the date of the Transaction Report and on the Funding Date of each Credit Extension; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date, and no Event of Default shall have occurred and be continuing or result from the Credit Extension. Each Credit Extension is Borrower’s representation and warranty on that date that the representations and warranties in Section 5 remain true in all material respects; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date; and

(c) in Bank’s good faith business judgment, there has not been a Material Adverse Change.

3.3 Covenant to Deliver.

Borrower agrees to deliver to Bank each item required to be delivered to Bank under this Agreement as a condition to any Credit Extension. Borrower expressly agrees that a Credit Extension made prior to the receipt by Bank of any such item shall not constitute a waiver by Bank of Borrower’s obligation to deliver such item, and any Credit Extension in the absence of a required item shall be made in Bank’s sole discretion.

7

3.4 Procedures for Borrowing. Subject to the prior satisfaction of all other applicable conditions to the making of an Advance set forth in this Agreement, in order for any Borrower to obtain an Advance (other than Advances under Sections 2.1.2, 2.1.3, or 2.1.4), Zhone, as agent for all Borrowers, shall notify Bank (which notice shall be irrevocable) by electronic mail, facsimile, or telephone by 12:00 p.m. Pacific time on the Funding Date of the request for such Advance, which notice shall specify on behalf of which Borrower Zhone is requesting such Advance. Borrower must promptly deliver to Bank by electronic mail or facsimile a completed Transaction Report executed by a Responsible Officer or his or her designee. Bank shall credit Advances to the Designated Deposit Account. Bank may make Advances under this Agreement based on instructions from a Responsible Officer or his or her designee or without instructions if the Advances are necessary to meet Obligations which have become due. Bank may rely on any telephone notice given by a person whom Bank in its good faith business judgment believes is a Responsible Officer or designee.

4 CREATION OF SECURITY

4.1 Grant of Security Interest. Each Borrower hereby grants Bank, to secure the payment and performance in full of all of the Obligations, continuing security interests in, and pledges to Bank, all right, title, and interest of such Borrower in and to the Collateral, wherever located, whether now owned or hereafter acquired or arising, and all proceeds and products thereof. Borrower represents, warrants, and covenants that the security interests granted herein are and shall at all times continue to be first priority perfected security interests in the Collateral (subject in lien priority only to those Permitted Liens that are expressly entitled to such priority over the security interests of Bank by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens). If Borrower shall acquire one or more commercial tort claims involving amounts in excess of $250,000 (individually or in the aggregate with respect to all such acquired commercial tort claims), Borrower shall promptly notify Bank in a writing signed by Borrower of the general details thereof (unless and except to the extent such information would waive the attorney-client privilege). Such notification to Bank shall constitute an additional grant, hereunder, of a continuing security interest in the commercial tort claims and all proceeds thereof to Bank, and Borrower shall execute and deliver all such documents and take all such actions as Bank may reasonably request in connection therewith.

If both this Agreement and the Exim Loan Agreement are terminated, Bank’s Lien in the Collateral shall continue until the Obligations (other than inchoate indemnity obligations) are repaid in full in cash. Upon payment in full in cash of the Obligations (other than inchoate indemnity obligations) and at such time as Bank’s obligation to make Credit Extensions under this Agreement and the Exim Loan Agreement has terminated, Bank shall, at Borrower’s sole cost and expense, promptly release its Liens in the Collateral and all rights therein shall revert to Borrower.

4.2 Authorization to File Financing Statements. Borrower hereby authorizes Bank to file financing statements, without notice to Borrower, with all appropriate jurisdictions to perfect or protect Bank’s interest or rights hereunder, including a notice that any disposition of the Collateral prohibited under the Loan Documents, by either Borrower or any other Person, shall be deemed to violate the rights of Bank under the Code. Such financing statements may indicate the Collateral as “all assets of the Debtor” or words of similar effect, or as being of an equal or lesser scope, or with greater detail, all in Bank’s discretion.

5 REPRESENTATIONS AND WARRANTIES

Borrower represents, warrants, and agrees, as follows:

5.1 Due Organization, etc.; Authorization; Power and Authority; Material Domestic Subsidiaries.

(a) Borrower and each of its Subsidiaries are duly existing and in good standing in their respective jurisdictions of formation and are qualified and licensed to do business and are in good standing in any jurisdiction in which the conduct of their business or their ownership of property requires that they be qualified except where the failure to do so could not reasonably be expected to result in a Material Adverse Change; provided, however, that with respect to Xybridge Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days

8

following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date. In connection with this Agreement, Borrower has delivered to Bank, a separate completed certificate (for each of the Borrowers), dated on or about the Effective Date, signed by the applicable Borrower (individually and collectively, the “Perfection Certificate”). Borrower represents and warrants to Bank that: (i) Borrower’s exact legal name is that indicated on the Perfection Certificate and on the signature page hereof; (ii) Borrower is an organization of the type and is organized in the jurisdiction set forth in the Perfection Certificate; (iii) the Perfection Certificate accurately sets forth Borrower’s organizational identification number or accurately states that Borrower has none; (iv) the Perfection Certificate accurately sets forth Borrower’s place of business, or, if more than one, its chief executive office as well as Borrower’s mailing address (if different than its chief executive office); (v) Borrower (and each of its predecessors) has not, in the past five (5) years, changed its jurisdiction of formation, organizational structure or type, or any organizational number assigned by its jurisdiction, in each case, except as expressly identified in the Perfection Certificate; and (vi) all other information set forth on the Perfection Certificate pertaining to Borrower and each of its Subsidiaries is accurate and complete in all material respects (it being understood and agreed that Borrower may from time to time update certain information in the Perfection Certificate after the Effective Date to the extent permitted by one or more specific provisions in this Agreement). If Borrower is not now a Registered Organization but later becomes one, Borrower shall promptly notify Bank of such occurrence and provide Bank with Borrower’s organizational identification number.

(b) The execution, delivery and performance by Borrower of the Loan Documents to which it is a party have been duly authorized, and do not (i) conflict with any of Borrower’s organizational documents, (ii) contravene, conflict with, constitute a default under or violate any material Requirement of Law, (iii) contravene, conflict or violate, in any material respect, any applicable order, writ, judgment, injunction, decree, determination or award of any Governmental Authority by which Borrower or any its Subsidiaries or any of their property or assets (other than immaterial property and immaterial assets) may be bound or affected, (iv) require any action by, filing, registration, or qualification with, or Governmental Approval from, any Governmental Authority (except such Governmental Approvals which have already been obtained and are in full force and effect), or (v) constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which it is a party or by which it is bound in which the default could reasonably be expected to result in a Material Adverse Change.

(c) Concurrently herewith, Borrower has caused the following companies (the “Existing Guarantors”) to each execute and deliver to Bank the Guaranty and the Guarantor Security Agreement:

(1) Paradyne Corporation;

(2) Paradyne Networks, Inc.;

(3) Premisys Communications, Inc.;

(4) Xybridge Technologies, Inc.; and

(5) Zhone Technologies International, Inc.

Borrower represents and warrants that the Existing Guarantors are all of its domestic subsidiaries constituting Material Domestic Subsidiaries (as defined below) as of the Effective Date, except for Zhone Technologies Campus, LLC (“Campus”), which Borrower represents and warrants is a special purpose limited liability company whose sole asset is real property utilized by Borrower and which is not permitted to guaranty the obligations of the Borrower under its agreement with its lender. In the event that, in the future, any other Domestic Subsidiaries of Borrower become Material Domestic Subsidiaries, Borrower shall promptly cause any such additional Domestic Subsidiaries to execute and deliver to Bank a Guaranty and a Security Agreement, together with related documentation and certified resolutions or other evidence of authority with respect to the execution and delivery of such Loan Documents. Throughout the term of this Agreement Borrower shall cause the Guaranties and Security Agreements referred to in this Section to continue in full force and effect. It is acknowledged that the former California corporation domestic subsidiary of Borrower known as VPacket Communications, Inc. was merged with and into ZMS-III on or about 12/18/2006.

9

As used herein, the term “Material Domestic Subsidiary” means any domestic subsidiary of Borrower, other than a domestic subsidiary of Borrower that has less than $200,000 in tangible assets and less than $1,000,000 in fair market value of total assets.

5.2 Collateral.

(a) Borrower has good title to the Collateral, free of Liens except Permitted Liens. Borrower has no deposit account other than the deposit accounts with Bank and deposit accounts described in the Perfection Certificate delivered to Bank in connection herewith or as disclosed to Bank pursuant to Section 6.8(b), other than deposit accounts not required to be disclosed pursuant to Section 6.8(b). The Accounts are bona fide, existing obligations of the Account Debtors.

(b) The Collateral is not in the possession of any third party bailee (such as a warehouse), except for Permitted Locations. None of the components of the Collateral with an aggregate value in excess of $500,000 shall be maintained at locations other than Permitted Locations or as permitted pursuant to Section 7.2. In the event that Borrower, after the date hereof, intends to store or otherwise deliver any portion of the Collateral with an aggregate value in excess of $500,000 to any one or more bailees, then Borrower shall, promptly upon Bank’s request therefor, use commercially reasonable efforts to deliver to Bank a bailee agreement (in form and substance satisfactory to Bank in its good faith business judgment) duly executed by such bailee. In the event that Bank requests such a bailee agreement and Borrower uses such efforts but does not succeed in delivering such a bailee agreement, Bank may (in its good faith business judgment) maintain a Reserve with respect to the Collateral located with such bailee.

(c) With respect to any leased premises of Borrower at which Collateral with an aggregate value of more than $500,000 is located, Borrower shall, promptly upon Bank’s request therefor, use commercially reasonable efforts to deliver to Bank a landlord agreement (in form and substance satisfactory to Bank in its good faith business judgment) duly executed by the lessor of such leased premises. Without limiting the generality of the foregoing, Borrower shall use such efforts to obtain from the applicable landlord, no later than 60 days following the Effective Date, landlord agreements (in form and substance satisfactory to Bank) duly executed by such landlords in favor of Bank in respect of the following leased locations of Borrower: (1) 7001 Oakport Street, Oakland, CA 94621; (2) 8545 126th Avenue N. (G Building), Largo, FL 33773; and (3) 8625 126th Avenue N., Suite 100 (H Building), Largo, FL 33773. In the event that Bank requests such a landlord agreement and Borrower uses such efforts but does not succeed in delivering such a landlord agreement, Bank may (in its good faith business judgment) maintain a Reserve with respect to such leased premises.

(d) All Inventory is in all material respects of good and marketable quality, free from material defects, except for Inventory for which adequate reserves are maintained in accordance with GAAP.

(e) Borrower is the sole owner of its intellectual property, except for (i) non-exclusive licenses granted by Borrower as licensor to third-parties, and (ii) such intellectual property as is licensed by Borrower as a licensee. Each patent owned by Borrower that is material to Borrower’s business is valid and enforceable, and, to Borrower’s knowledge, no part of the intellectual property that is material to Borrower’s business has been judged invalid or unenforceable, in whole or in part, and to Borrower’s knowledge, no claim has been made that any part of the intellectual property that is material to Borrower’s business violates, in any material respect, the rights of any third party, except to the extent such claim could not reasonably be expected to result in a Material Adverse Change.

(f) Except as noted on the Perfection Certificate (or as disclosed to Bank in written updates of the Perfection Certificate with respect to the following), Borrower is not a party to, nor is bound by, any material license or other agreement with respect to which Borrower is the licensee (other than over-the-counter or shrink-wrap software licenses generally available to the public) relating to any material product lines of Borrower or Guarantor (i) that prohibits or otherwise restricts Borrower from granting a security interest in Borrower’s interest in such license or agreement or any other property (to the extent such prohibition is enforceable), or (ii) for which a default under or termination of could interfere in any material respect with Bank’s right to sell any Collateral. Borrower shall provide written notice to Bank within thirty (30) days of entering or becoming bound by any such license or agreement which is reasonably likely to have a material impact on Borrower’s business or financial condition (other than over-the-counter software that is commercially available to the public). Upon Bank’s request, Borrower shall use commercially reasonable efforts to promptly obtain the consent of, or waiver by, any person

10

whose consent or waiver is necessary for (x) all such licenses or agreements to be deemed “Collateral” and for Bank to have a security interest in the same that is otherwise restricted or prohibited by law or by the terms of any such license or agreement, whether now existing or entered into in the future, and (y) Bank to have the ability in the event of a liquidation of any Collateral to dispose of such Collateral in accordance with Bank’s rights and remedies under this Agreement and the other Loan Documents. If Borrower is unsuccessful in obtaining any such consent or waiver requested by Bank, then Borrower shall notify Bank in writing of same.

5.3 Accounts Receivable.

(a) For each Account with respect to which Advances are requested, on the date each Advance is requested and made, such Account shall be an Eligible Account.

(b) All statements made and all unpaid balances appearing in all invoices, instruments and other documents evidencing such Eligible Accounts are and shall be true and correct in all material respects as of the date such statement is made or such unpaid balance is disclosed to Bank, and all such invoices, instruments and other documents, and all of Borrower’s Books, are genuine and in all material respects what they purport to be. Whether or not an Event of Default has occurred and is continuing, Bank may notify any Account Debtor owing Borrower money of Bank’s security interest in such funds and verify the amount of such Eligible Account. All sales and other transactions underlying or giving rise to each Account shall comply in all material respects with all applicable laws and governmental rules and regulations. Borrower has no knowledge of any actual or imminent Insolvency Proceeding of any Account Debtor whose accounts are shown as Eligible Accounts in any Transaction Report. To the best of Borrower’s knowledge, all signatures and endorsements on all documents, instruments, and agreements relating to all Eligible Accounts are and will be genuine, and, to the best of Borrower’s knowledge, all such documents, instruments and agreements are and will be legally enforceable in accordance with their terms.

5.4 Litigation. Except as disclosed to the Bank in writing, there are no actions or proceedings pending or, to the knowledge of the Responsible Officers, threatened in writing by or against Borrower or any of its Subsidiaries involving more than $250,000 or more in the aggregate.

5.5 No Material Deviation in Financial Statements. All consolidated financial statements for Borrower and any of its Subsidiaries delivered to Bank fairly present in all material respects Borrower’s consolidated financial condition and Borrower’s consolidated results of operations as of the date of such financial statements, except that that interim financial statements may be subject to normal year-end audit adjustments (which will not be material in the aggregate) and need not contain footnote disclosures required by GAAP. There has not been any material deterioration in Borrower’s consolidated financial condition since the date of the most recent financial statements submitted to Bank.

5.6 Solvency. The fair salable value of Borrower’s assets (including goodwill minus disposition costs) exceeds the fair value of its liabilities; Borrower is not left with unreasonably small capital after the transactions in this Agreement; and Borrower is able to pay its debts (including trade debts) as they mature.

5.7 Regulatory Compliance. Borrower is not an “investment company” or a company “controlled” by an “investment company” under the Investment Company Act of 1940, as amended. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations X, T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Neither Borrower nor any of its Subsidiaries is a “holding company” or an “affiliate” of a “holding company” or a “subsidiary company” of a “holding company” as each term is defined and used in the Public Utility Holding Company Act of 2005. Borrower has not violated any laws, ordinances or rules, the violation of which could reasonably be expected to cause a Material Adverse Change. None of Borrower’s or any of its Subsidiaries’ properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower’s knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each of its Subsidiaries have obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all Government Authorities that are necessary to continue their respective businesses as currently conducted.

5.8 Subsidiaries; Investments. Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments.

11

5.9 Tax Returns and Payments; Pension Contributions. Borrower has timely filed (i) all required federal tax returns and reports, and (ii) all required state, local, and foreign, material tax returns and reports. Subject to Borrower’s right to contest taxes in accordance with the immediately following sentence, Borrower has timely paid all federal taxes, assessments, deposits and contributions owed by Borrower, and all state, local, and foreign, material taxes, assessments, deposits and contributions owed by Borrower. Borrower may defer payment of any contested taxes, provided that Borrower (a) in good faith contests its obligation to pay the taxes by appropriate proceedings promptly and diligently instituted and conducted, (b) notifies Bank in writing of the commencement of, and any material development in, such proceedings, and (c) posts bonds or takes any other steps required to prevent the governmental authority levying such contested taxes from obtaining a Lien upon any of the Collateral that is other than a “Permitted Lien”. Borrower is unaware of any claims or adjustments proposed for any of Borrower’s prior tax years which could result in additional taxes becoming due and payable by Borrower and which have not been timely discharged or contested in accordance with the immediately preceding sentence. Borrower has paid all amounts necessary to fund all present pension, profit sharing and deferred compensation plans in accordance with their terms, and Borrower has not withdrawn from participation in, and has not permitted partial or complete termination of, or permitted the occurrence of any other event with respect to, any such plan which could reasonably be expected to result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency.

5.10 Use of Proceeds. Borrower shall use the proceeds of the Credit Extensions solely for the purposes specified in the Exim Borrower Agreement, and Borrower will not use the proceeds of the Exim Loans for any purpose prohibited by the Exim Borrower Agreement. Without limiting the generality of the foregoing, any “Credit Accommodations” (as such term is defined in the Exim Borrower Agreement) made by Bank to Borrower for any of the purposes set forth in Section 2.01(a)(i)-(iv) of the Exim Borrower Agreement shall be deemed made under (and shall be subject to the terms and conditions of) the Non-Exim Loan Agreement as a Non-Exim Loan instead of under this Agreement as an Exim Loan.

5.11 Full Disclosure. No written representation, warranty or other statement of Borrower in any certificate or written statement given to Bank, as of the date such representation, warranty, or other statement was made, taken together with all such written certificates and written statements given to Bank, contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements not misleading (it being recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected or forecasted results).

6 AFFIRMATIVE COVENANTS

Borrower shall do all of the following:

6.1 Government Compliance. (a) Maintain its and all its Subsidiaries’ legal existence and good standing in their respective jurisdictions of formation and maintain qualification in each jurisdiction in which the failure to so qualify would reasonably be expected to cause a Material Adverse Change; provided, however, that with respect to Xybridge Technologies, Inc., a Texas corporation (which is not in good standing with the Texas Comptroller of Public Accounts as of February 20, 2009), Borrower shall deliver to Bank, no later than 60 days following the Effective Date, evidence of Xybridge Technologies, Inc.’s good standing with the Texas Comptroller of Public Accounts as of a date on or after the Effective Date. Borrower shall comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which it is subject, noncompliance with which could reasonably be expected to cause a Material Adverse Change.

(b) Obtain all of the Governmental Approvals necessary for the performance by Borrower of its obligations under the Loan Documents to which it is a party and the grant of a security interest to Bank in all of its property. Borrower shall promptly provide copies of any such obtained Governmental Approvals to Bank.

12

6.2 Financial Statements, Reports, Certificates.

(a) Borrower shall provide Bank with the following written reports, and such other written reports with respect to Borrower (including budgets, sales projections, operating plans and other financial documentation, and lists of stockholders of record), as Bank shall from time to time specify in its good faith business judgment:

(i)  a Transaction Report, (i) at the time of each Advance, and (ii) so long as any Advance is outstanding, in addition not less frequently than weekly;

(ii)  within fifteen (15) days after the end of each month:

(A)  (1) monthly accounts receivable agings, aged by invoice date; and (2) concurrently with such monthly accounts receivable agings in respect of any month that is also the last month of a fiscal quarter, copies of actual invoices in respect of Eligible Accounts representing not less than 10% of the aggregate accounts receivable agings balance as of the end of such last month of a fiscal quarter;

(B)  monthly accounts payable agings, aged by invoice date, and outstanding or held check registers, if any;

(C)  monthly reconciliations of accounts receivable agings (aged by invoice date), Transaction Reports, and general ledger;

(D)  [intentionally omitted]

(E)  monthly Deferred Revenue reports;

(iii)  as soon as available, and in any event within thirty (30) days after the end of each month, monthly unaudited financial statements;

(iv)  within thirty (30) days after the end of each month a monthly Compliance Certificate signed by a Responsible Officer, certifying that as of the end of such month, Borrower was in full compliance with all of the terms and conditions of this Agreement, and setting forth calculations showing compliance with the financial covenants set forth in this Agreement and such other information as Bank shall reasonably request, including, without limitation, a statement that at the end of such month there were no held checks;

(v)  within thirty (30) days after the end of each fiscal quarter, a written status update with respect to Borrower’s ongoing discussions with the New Jersey tax authority regarding the New Jersey sales & use tax obligation of Zhone (for the period covering 10/01/2001 – 09/30/2003) described in the Perfection Certificate; provided, however, that in addition, Borrower shall also deliver such a status update (irrespective of whether such quarterly report is then due) of, and promptly upon, the occurrence of a material adverse development (if any) in such discussions with the New Jersey tax authority regarding such tax obligation;

(vi)  as soon as available, and in any event within thirty (30) days prior to the end of each fiscal year of Borrower, (A) annual financial projections and operating budgets (including income statements, balance sheets and cash flow statements, by month) for the upcoming fiscal year (on a monthly basis) of Borrower, as approved by Borrower’s board of directors; and

(vii)  as soon as available, and in any event within 120 days following the end of Borrower’s fiscal year, annual financial statements certified by, and with an unqualified opinion of, independent certified public accountants reasonably acceptable to Bank.

(b) At all times that Borrower is subject to the reporting requirements under the Securities Exchange Act of 1934, as amended, within five (5) days after filing, all reports on Form 10-K, 10-Q and 8-K filed with the Securities and Exchange Commission or a link thereto on Borrower’s or another website on the Internet.

(c) Prompt written notice of (i) any material change in the composition of the intellectual property, (ii) the registration (or filed application for registration) of any copyright (including any subsequent ownership right of Borrower in or to any copyright), any patent (including any subsequent ownership right of Borrower in or to any patent) constituting Material Intellectual Property, or any trademark (including any subsequent ownership right of Borrower in or to any trademark) constituting Material Intellectual Property, in each case, that is not previously disclosed in writing to Bank, or (iii) Borrower’s knowledge of an event that materially adversely affects the value of the intellectual property.

13

6.3 Accounts Receivable.

(a) Schedules and Documents Relating to Accounts. Borrower shall deliver to Bank transaction reports and schedules of collections, as provided in Section 6.2, on Bank’s standard forms; provided, however, that Borrower’s failure to execute and deliver the same shall not affect or limit Bank’s Lien and other rights in all of Borrower’s Accounts, nor shall Bank’s failure to advance or lend against a specific Account affect or limit Bank’s Lien and other rights therein. If requested by Bank, Borrower shall furnish Bank with copies (or, at Bank’s request, originals) of all contracts, orders, invoices, and other similar documents, and all shipping instructions, delivery receipts, bills of lading, and other evidence of delivery, for any goods the sale or disposition of which gave rise to such Accounts. Without limiting the generality of the foregoing, Borrower shall deliver to Bank the copies of the invoices required under Section 6.2(a)(ii)(A)(2) above. In addition, Borrower shall deliver to Bank, on its request, the originals of all instruments, chattel paper, security agreements, guarantees and other documents and property evidencing or securing any Accounts, in the same form as received, with all necessary endorsements, and copies of all credit memos.

(b) Disputes. Borrower shall promptly notify Bank of all disputes or claims relating to Accounts, in excess of $250,000 individually or in the aggregate at any one time, on the Transaction Reports. Borrower may forgive (completely or partially), compromise, or settle any Account for less than payment in full, or agree to do any of the foregoing so long as (i) Borrower does so in good faith, in a commercially reasonable manner, in the ordinary course of business, in arm’s-length transactions, and reports the same to Bank in the regular reports provided to Bank; (ii) no Event of Default has occurred and is continuing; and (iii) after taking into account all such discounts, settlements and forgiveness, no Overadvance exists.

(c) Collection of Accounts. Borrower shall have the right to collect all Accounts, unless and until a Default or an Event of Default has occurred and is continuing. Whether or not an Event of Default has occurred and is continuing, Borrower shall hold all payments on, and proceeds of, Accounts in trust for Bank, and Borrower shall immediately deliver all such payments and proceeds to Bank in their original form, duly endorsed, which payments and proceeds shall be applied to the Obligations pursuant to the terms of Section 9.4 hereof. Bank may, in its good faith business judgment, require that all proceeds of Accounts be deposited by Borrower into a lockbox account, or such other “blocked account” as Bank may specify, pursuant to a blocked account agreement in such form as Bank may specify in its good faith business judgment.

(d) Returns. Provided no Event of Default has occurred and is continuing, if any Account Debtor returns any Inventory to Borrower, Borrower shall promptly (i) determine the reason for such return, (ii) issue a credit memorandum to the Account Debtor in the appropriate amount, and (iii) in the event that the amount of such credit memorandum, individually or in the aggregate, exceeds $250,000, provide a copy of each such credit memorandum to Bank. In the event any attempted return occurs after the occurrence and during the continuance of any Event of Default, Borrower shall hold the returned Inventory in trust for Bank, and immediately notify Bank of the return of the Inventory.

(e) Verification. Bank may, from time to time, verify directly with the respective Account Debtors the validity, amount and other matters relating to the Accounts, either in the name of Borrower or Bank or such other name as Bank may choose.

(f) No Liability. Bank shall not be responsible or liable for any shortage or discrepancy in, damage to, or loss or destruction of, any goods, the sale or other disposition of which gives rise to an Account, or for any error, act, omission, or delay of any kind occurring in the settlement, failure to settle, collection or failure to collect any Account, or for settling any Account in good faith for less than the full amount thereof, nor shall Bank be deemed to be responsible for any of Borrower’s obligations under any contract or agreement giving rise to an Account. Nothing herein shall, however, relieve Bank from liability for its own gross negligence or willful misconduct.

6.4 Remittance of Proceeds. Except as otherwise provided in Section 6.3(c), deliver, in kind, all proceeds arising from the disposition of any Collateral to Bank in the original form in which received by Borrower not later than the following Business Day after receipt by Borrower, which, shall be dealt with as provided in Section 6.3(c); provided that, if no Default or Event of Default has occurred and is continuing, Borrower shall not be

14

obligated to remit to Bank the proceeds of the sale of worn out, surplus, or obsolete Equipment disposed of by Borrower in good faith in an arm’s length transaction for an aggregate purchase price of $250,000 or less (for all such transactions in any fiscal year). Borrower agrees that it will not commingle proceeds of Collateral with any of Borrower’s other funds or property, but will hold such proceeds separate and apart from such other funds and property and in an express trust for Bank. Nothing in this Section limits the restrictions on disposition of Collateral set forth elsewhere in this Agreement.

6.5 Taxes; Pensions. Timely file, and require each of its Subsidiaries to timely file, all required federal tax returns and reports (and all required state, local, and foreign, material tax returns and reports), and timely pay, and require each of its Subsidiaries to timely file, all federal taxes, assessments, deposits and contributions (and all state, local, and foreign, material taxes, assessments, deposits and contributions) owed by Borrower and each of its Subsidiaries, except for deferred payment of any taxes contested pursuant to the terms of Section 5.9 hereof, and shall deliver to Bank, on demand, appropriate certificates attesting to such payments, and pay all amounts necessary to fund all present pension, profit sharing and deferred compensation plans in accordance with their terms.

6.6 Access to Collateral; Books and Records. At reasonable times, on at least one (1) Business Day’s notice (provided no notice is required if an Event of Default has occurred and is continuing), Bank, or its agents, shall have the right to inspect the Collateral and the right to audit and copy Borrower’s Books; provided, however, that, so long as no Event of Default has occurred and is continuing, any audits shall be conducted no more often than once every 6 months (it being understood that audits taking place at one or more locations of Borrower during substantially the same overall examination period shall constitute but a single audit for purposes of the foregoing proviso). The foregoing inspections and audits shall be at Borrower’s expense, and the charge therefor shall be $750 per person per day (or such higher amount as shall represent Bank’s then-current standard charge for the same), plus reasonable out-of-pocket expenses. In the event Borrower and Bank schedule an audit more than ten (10) days in advance, and Borrower cancels or seeks to reschedules the audit with less than ten (10) days written notice to Bank, then (without limiting any of Bank’s rights or remedies), Borrower shall pay Bank a fee of $1,000 plus any out-of-pocket expenses incurred by Bank to compensate Bank for the anticipated costs and expenses of the cancellation or rescheduling.

6.7 Insurance. Keep its business and the Collateral insured for risks and in amounts standard for companies in Borrower’s industry and location and as Bank may reasonably request. Insurance policies shall be in a form, with companies, and in amounts that are satisfactory to Bank. All property policies shall have a lender’s loss payable endorsement showing Bank as lender loss payee and waive subrogation against Bank, and all liability policies shall show, or have endorsements showing, Bank as an additional insured. All policies (or the lender loss payable and additional insured endorsements) shall provide that the insurer must give Bank at least twenty (20) days notice before canceling, amending, or declining to renew its policy. At Bank’s request, Borrower shall deliver certified copies of policies and evidence of all premium payments. Proceeds payable under any policy shall (subject only to the applicable senior claims of those holders of Permitted Liens that are expressly entitled to lien priority over the security interests of Bank in the applicable insured Collateral by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens), at Bank’s option, be payable to Bank on account of the Obligations. Notwithstanding the foregoing, (a) so long as no Event of Default has occurred and is continuing, Borrower shall have the option of applying the proceeds of any casualty policy up to $250,000, in the aggregate, toward the replacement or repair of destroyed or damaged property; provided that any such replaced or repaired property shall be deemed Collateral in which Bank has been granted a first priority security interest (subject in lien priority only to those Permitted Liens described in clause (c) of the definition of “Permitted Liens”, if any, that are applicable to such replaced or repaired property), and (b) after the occurrence and during the continuance of an Event of Default, all proceeds payable under such casualty policy shall, at the option of Bank, be payable to Bank on account of the Obligations. If Borrower fails to obtain insurance as required under this Section 6.7 or to pay any amount or furnish any required proof of payment to third persons and Bank, Bank may make all or part of such payment or obtain such insurance policies required in this Section 6.7, and take any action under the policies Bank deems prudent.

6.8 Operating Accounts.

(a) Maintain all of its and its Subsidiaries’ primary depository and operating accounts and securities accounts with Bank and Bank’s Affiliates, which accounts shall represent at least 85% of the dollar value of Borrower’s and such Subsidiaries accounts at all financial institutions.

15

(b) Provide Bank five (5) days prior written notice before Borrower or any of its Subsidiaries establishes or has any Collateral Account at or with any bank or financial institution other than Bank or Bank’s Affiliates, if such Collateral Account is not expressly identified on the Perfection Certificate and if Borrower holds a balance of more than $20,000 in such Collateral Account (except that the total of amounts in all Collateral Accounts with a balance of $20,000 or less and as to which written notice of the same is not given to Bank shall not exceed $250,000 in the aggregate). In addition, for each Collateral Account that Borrower or any Guarantor at any time maintains, Borrower shall, upon Bank’s request, cause the applicable bank or financial institution (other than Bank) at or with which any such Collateral Account is maintained to execute and deliver a Control Agreement or other appropriate instrument with respect to such Collateral Account to perfect Bank’s Lien in such Collateral Account in accordance with the terms hereunder. The provisions of the previous sentence shall not apply to (i) deposit accounts exclusively used for payroll, payroll taxes and other employee wage and benefit payments to or for the benefit of Borrower’s or Guarantor’s employees and identified to Bank by Borrower or Guarantor as such, and (ii) deposit accounts located outside the United States used to facilitate payment of local operating expenses provided that the amount on deposit in any such account described in this clause (ii) shall not exceed, at any time, the amount necessary to fund operating expenses for such jurisdiction for the then current fiscal quarter. Without limiting the generality of the foregoing, Borrower and Bank hereby agree that: (1) no later than 60 days following the Effective Date, Borrower and Guarantor shall cause Wachovia Bank to execute and deliver such a Control Agreement in favor of Bank with respect to the Collateral Accounts of Borrower and Guarantor maintained with Wachovia Bank; and (2) no Control Agreement by Wells Fargo in favor of Bank shall be required under this Section 6.8(b) so long as the total amount of funds of all Borrowers and all Guarantors on deposit in any and all Collateral Accounts of Borrower and Guarantor maintained with Wells Fargo does not exceed $250,000 in the aggregate.

6.9 Financial Covenants. Borrower shall maintain at all times, to be tested as of the last day of each month, unless otherwise noted, on a consolidated basis with respect to Borrower and its Subsidiaries:

(a) Minimum Liquidity Ratio. As of the end of each month, commencing March 31, 2009, and continuing as of the end of each month thereafter, Borrower shall maintain a Liquidity Ratio of at least 2.00 to 1.00.

As used herein, the term “Liquidity Ratio” means, as of any date of determination, the ratio of:

(A) the total of Borrower’s unrestricted cash, as shown on Borrower’s consolidated balance sheet, plus the sum of the net amount of Eligible Accounts under this Agreement and the net amount of “Eligible Accounts” under the Exim Loan Agreement;

to

(B) the aggregate amount of all outstanding Obligations (including the following (without duplication): all outstanding Advances (including (i) amounts used hereunder for Cash Management Services, (ii) the aggregate face amount of outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) under this Agreement, plus any Letter of Credit Reserve under this Agreement, and (iii) the FX Reduction Amount hereunder) and all other monetary Obligations under this Agreement, plus all outstanding Exim Loans (and other monetary “Obligations”) under the Exim Loan Agreement (including (iv) amounts used under the Exim Loan Agreement for “Cash Management Services”, (v) the aggregate face amount of outstanding “Letters of Credit” (including drawn but unreimbursed “Letters of Credit”) under the Exim Loan Agreement, plus any “Letter of Credit Reserve” under the Exim Loan Agreement, and (vi) the “FX Reduction Amount” under the Exim Loan Agreement)).

16

(b) Required EBITDA for any 2 Consecutive Fiscal Quarters. For each EBITDA Test Period (as defined below), Borrower shall achieve EBITDA of not less than the required amount set forth below [note: amounts shown below within pointed brackets ( < $ > ) are negative amounts]:

EBITDA Test Period ending on:	Minimum EBITDA Amount
March 31, 2009	<$9,000,000.00>
June 30, 2009	<$6,400,000.00>
September 30, 2009	<$1,400,000.00>
December 31, 2009	$1,400,000.00
March 31, 2010	$2,000,000.00

As used herein, the term “EBITDA Test Period” means the 2 consecutive fiscal quarter period then or most recently ended.

6.10 Protection and Registration of Intellectual Property Rights. Borrower shall: (a) protect, defend and maintain the validity and enforceability of any and all of its intellectual property that (individually or in the aggregate) is material to Borrower’s business (individually and collectively, “Material Intellectual Property”); (b) promptly advise Bank in writing of known material infringements of its Material Intellectual Property; and (c) not allow any Material Intellectual Property to be abandoned, forfeited or dedicated to the public without Bank’s written consent. Borrower hereby represents and warrants that, as of the Effective Date, Borrower does not own any maskworks, computer software, or other copyrights of Borrower that are registered (or the subject of an application for registration) with the United States Copyright Office (collectively, the “Registered Copyrights”). Borrower will NOT register with the United States Copyright Office (or apply for such registration of) any of Borrower’s maskworks, computer software, or other copyrights, unless Borrower: (x) provides Bank with at least fifteen (15) days prior written notice of its intent to register such copyrights or mask works together with a copy of the application it intends to file with the United States Copyright Office (excluding exhibits thereto); (y) executes and delivers a security agreement or such other documents as Bank may reasonably request to maintain the perfection and priority of Bank’s security interest in the copyrights or mask works intended to be registered with the United States Copyright Office; and (z) records such security agreement with the United States Copyright Office contemporaneously with or promptly (but in no event more than 10 days) after filing the copyright or mask work application(s) with the United States Copyright Office. Borrower shall promptly provide to Bank a copy of the application(s) actually filed with the United States Copyright Office together with evidence of the recording of the security agreement necessary for Bank to maintain the perfection and priority of its security interest in the copyrights or mask works intended to be registered with the United States Copyright Office. Borrower hereby represents and warrants that, as of the Effective Date, the IP Security Agreement identifies all patents (constituting Material Intellectual Property) and trademarks (constituting Material Intellectual Property) of Borrower that are registered (or the subject of an application for registration) with the United States Patent and Trademark Office. From and after the Effective Date, Borrower shall provide written notice to Bank of any application filed by Borrower in the United States Patent and Trademark Office for a patent (constituting Material Intellectual Property) or to register a trademark (constituting Material Intellectual Property) or service mark (constituting Material Intellectual Property) within 30 days after any such filing, and, upon the request of Bank, Borrower shall promptly execute and deliver a security agreement or such other documents as Bank may reasonably request with respect to such additional patents (constituting Material Intellectual Property) and/or trademarks (constituting Material Intellectual Property) of Borrower that are registered (or the subject of an application for registration) with the United States Patent and Trademark Office. The foregoing notwithstanding, Bank shall not acquire any interest in any intent to use a federal trademark application for a trademark, servicemark, or other mark filed on Borrower’s behalf prior to the filing under applicable law of a verified statement of use (or equivalent) for such mark that is the subject of such application.

6.11 Litigation Cooperation. From the date hereof and continuing through the termination of this Agreement, make available to Bank, without expense to Bank, Borrower and its officers, employees and agents and Borrower’s books and records, to the extent that Bank may deem them reasonably necessary to prosecute or defend any third-party suit or proceeding instituted by or against Bank with respect to any Collateral or relating to Borrower.

17

6.12 Intercompany Debt. All present and future indebtedness of Borrower and any Guarantor owed or owing to any one or more of Borrower, any Guarantor, or any other Affiliate of Borrower or any other Affiliate of any Guarantor shall, at all times, be subordinated to the Obligations pursuant to a subordination agreement on Bank’s standard form (the “Intercompany Subordination Agreement”).

6.13 [intentionally omitted]

6.14 Further Assurances. Borrower shall execute any further instruments and take further action as Bank reasonably requests to perfect or continue Bank’s Lien in the Collateral or to effect the purposes of this Agreement.

7 NEGATIVE COVENANTS

Borrower shall not do any of the following without Bank’s prior written consent:

7.1 Dispositions. Convey, sell, lease, transfer or otherwise dispose of (collectively, “Transfer”), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, except for (A) the sale of Inventory in the ordinary course of Borrower’s business, (B) the sale or other disposition of obsolete or unneeded Equipment in the ordinary course of business; (C) non-exclusive licenses and similar non-exclusive arrangements for the use of the property of Borrower; (D) Transfers consisting of the granting of Permitted Liens or the making of Permitted Investments or the liquidation of Permitted Investments; (E) Transfers consisting of the payment of operating expenses in the ordinary course of business; and (F) Transfers of Inventory and Equipment to Borrower’s contract manufacturers in the ordinary course of Borrower’s business.

7.2 Changes in Business, Management, Ownership, or Business Locations.

(a) Engage in or permit any of its Subsidiaries to engage in any business other than the businesses currently engaged in by Borrower and such Subsidiary, as applicable, or reasonably related thereto;

(b) liquidate or dissolve; or

(c) cause, permit or suffer any Change in Control; or

(d) without at least ten (10) days prior written notice to Bank, add any new offices or business locations, including warehouses (unless such new offices or business locations contain assets and property of Borrower with an aggregate value of less than $100,000 or are Permitted Locations); or

(e) without at least thirty (30) days prior written notice to Bank: (1) change its jurisdiction of organization; (2) change its organizational structure or type; (3) change its legal name set forth in its articles/certificate of incorporation/formation; or (4) change its organizational number (if any) assigned by its jurisdiction of organization.

7.3 Mergers or Acquisitions.

(a) Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person without Bank’s prior written consent (which shall be a matter of its good faith business judgment); or

(b) acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person;

in each case (of (a) or (b) above), provided however that (i) prior or concurrent written notice by Borrower to Bank (rather than such written consent of Bank) is required with respect to any such transaction as to which Borrower (or, as to any such transaction to which Borrower is not a party, such Subsidiary) is the surviving or successor person and no Default or Event of Default has occurred and is continuing or would result therefrom, and (ii) a Subsidiary of Borrower may merge or consolidate into another Subsidiary of Borrower.

18

In connection with any such acquisition, Borrower may create a subsidiary that has nominal assets (and would not constitute a Material Domestic Subsidiary prior to giving effect to the acquisition) solely for the purpose of and in preparation for such acquisition prior to obtaining Bank’s consent.

7.4 Indebtedness. Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary of Borrower to do so, other than Permitted Indebtedness.

7.5 Encumbrance. Create, incur, allow, or suffer any Lien on any of the Collateral, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, permit any Collateral not to be subject to the first priority security interests of Bank therein (subject in lien priority only to those Permitted Liens that are expressly entitled to such priority over the security interests of Bank by operation of law or by written subordination agreement duly executed and delivered by Bank in favor of the holders of such Permitted Liens), or enter into any agreement, document, instrument or other arrangement (except with or in favor of Bank) with any Person which directly or indirectly prohibits or has the effect of prohibiting Borrower or any Subsidiary from assigning, mortgaging, pledging, granting a security interest in or upon, or encumbering any of Borrower’s or any Subsidiary’s owned (as opposed to licensed) Material Intellectual Property, except as is otherwise permitted in Section 7.1 hereof and the definition of “Permitted Lien” herein.

7.6 Maintenance of Collateral Accounts. Maintain any Collateral Account except pursuant to the terms of Section 6.8.(b) hereof.

7.7 Investments; Distributions; Special Investment re Campus Real Estate Loan. (a) Directly or indirectly make any Investment other than Permitted Investments, or permit any of its Subsidiaries to do so; or (b) pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock, provided that (i) Zhone may convert any of its convertible securities into other securities pursuant to the terms of such convertible securities or otherwise in exchange thereof, (ii) Borrower may pay dividends solely in equity securities; (iii) Zhone may repurchase the stock of former employees, directors, or consultants pursuant to stock repurchase agreements so long as no Default or Event of Default has occurred at the time of such repurchase and would not exist after giving effect to such repurchase, provided such repurchase does not exceed in the aggregate of $250,000 per fiscal year; and (iv) payments of dividends or distributions made by (x) any Borrower to any other Borrower, or (y) any Subsidiary of Borrower to Borrower, or (z) any Subsidiary of Borrower to any other Subsidiary of Borrower, are expressly permitted. With respect to the real estate loan of Campus secured by the real property used by Borrower, Borrower may make Investments in Campus solely for the purpose of funding, when due, regularly scheduled principal and interest payments in respect of such real estate loan, provided that (i) no Event of Default has occurred and is continuing or would result therefrom, and (ii) after giving pro forma effect to such Investment, Borrower would be in compliance with the financial covenant(s) in Section 6.9.

7.8 Transactions with Affiliates. Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower, except for transactions that are upon fair and reasonable terms and no less favorable to Borrower than would be obtained in an arm’s length transaction with a non-Affiliated Person, other than bona fide sales of Borrower’s equity securities.

7.9 Subordinated Debt. Without Bank’s prior written consent, (a) make or permit any payment on any Subordinated Debt, except under the terms of the subordination, intercreditor, or other similar agreement to which such Subordinated Debt is subject, or (b) amend any provision in any document relating to the Subordinated Debt which would increase the amount thereof or the amount of any permitted payments thereunder or adversely affect the subordination thereof to Obligations owed to Bank.

7.10 Compliance. Become an “investment company” or a company controlled by an “investment company”, under the Investment Company Act of 1940, as amended, or undertake as one of its important activities extending credit to purchase or carry margin stock (as defined in Regulation U of the Board of Governors of the Federal Reserve System), or use the proceeds of any Credit Extension for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation could reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so; withdraw or permit any Subsidiary to withdraw from participation in, permit partial or complete termination of, or permit the occurrence of any other event with respect to, any present pension, profit sharing and deferred compensation plan which could reasonably be expected to result in any liability of Borrower, including any liability to the Pension Benefit Guaranty Corporation or its successors or any other governmental agency.

19

8 EVENTS OF DEFAULT

Any one of the following shall constitute an event of default (an “Event of Default”) under this Agreement:

8.1 Payment Default. Borrower fails to (a) make any payment of principal or interest on any Credit Extension on its due date, or (b) pay any other Obligations within three (3) Business Days after such Obligations are due and payable (which three (3) day grace period shall not apply to payments due on the Revolving Line Maturity Date). During the cure period, the failure to cure the payment default is not an Event of Default (but no Credit Extension will be made during the cure period);

8.2 Covenant Default.

(a) Borrower fails or neglects to perform any obligation in Sections 6.2, 6.3, 6.4, 6.6, 6.8, or 6.9, or violates any covenant in Section 7; or

(b) Borrower fails or neglects to perform, keep, or observe, in any material respect, any other term, provision, condition, covenant or agreement contained in this Agreement or any Loan Documents, and as to any default (other than those specified in this Section 8) under such other term, provision, condition, covenant or agreement that can be cured, has failed to cure the default within ten (10) days after the occurrence thereof; provided, however, that if the default cannot by its nature be cured within the ten (10) day period or cannot after diligent attempts by Borrower be cured within such ten (10) day period, and such default is likely to be cured within a reasonable time, then Borrower shall have an additional period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to cure the default shall not be deemed an Event of Default (but no Credit Extensions shall be made during such cure period). Grace periods provided under this section shall not apply, among other things, to financial covenants or any other covenants set forth in subsection (a) above;

8.3 Material Adverse Change. A Material Adverse Change occurs;

8.4 Attachment; Levy; Restraint on Business. (a) (i) The service of process seeking to attach, by trustee or similar process, any funds of Borrower or of any Material Domestic Subsidiary on deposit with Bank or any Bank Affiliate, or (ii) a notice of lien, levy, or assessment is filed against any of Borrower’s assets by any government agency, and the same under subclauses (i) and (ii) hereof are not, within ten (10) days after the occurrence thereof, discharged or stayed (whether through the posting of a bond or otherwise); provided, however, no Credit Extensions shall be made during any ten (10) day cure period; and (b) (i) any material portion of Borrower’s assets is attached, seized, levied on, or comes into possession of a trustee or receiver, or (ii) any court order enjoins, restrains, or prevents Borrower from conducting any part of its business;

8.5 Insolvency. (a) Borrower is unable to pay its debts (including trade debts) as they become due or otherwise becomes insolvent; (b) Borrower commences an Insolvency Proceeding in respect of Borrower as debtor or debtor-in-possession; or (c) an Insolvency Proceeding is commenced against Borrower as debtor or debtor-in-possession and not dismissed or stayed within forty-five (45) days (but no Credit Extensions shall be made while of any of the conditions described in clause (a) exist and/or until any Insolvency Proceeding is dismissed);

8.6 Other Agreements. There is a default in any agreement to which Borrower or any Material Guarantor is a party with a third party or parties resulting in a right by such third party or parties, whether or not exercised, to accelerate the maturity of any Indebtedness in an amount in excess of $250,000 or that could result in a Material Adverse Change with respect to Borrower or any Material Guarantor; provided, however, that the Event of Default under this Section 8.6 caused by the occurrence of a default under such other agreement shall be cured or waived for purposes of this Agreement upon Bank receiving written notice from the party asserting such default of such cure or waiver of the default under such other agreement, if at the time of such cure or waiver under such other agreement (a) Bank has not declared an Event of Default under this Agreement and/or exercised any rights with respect thereto; (b) any such cure or waiver does not result in an Event of Default under any other provision of this Agreement or any Loan Document; and (c) in connection with any such cure or waiver under such other agreement, the terms of any agreement with such third party are not modified or amended in any manner which could in the good faith judgment of Bank be materially less advantageous to Borrower or any Material Guarantor;

20

8.7 Judgments. One or more judgments, orders, or decrees for the payment of money in an amount, individually or in the aggregate, of $250,000 or more (not covered by independent third-party insurance as to which liability has been accepted by such insurance carrier) shall be rendered against Borrower and shall remain unsatisfied, unvacated, or unstayed for a period of ten (10) days after the entry thereof (provided that no Credit Extensions will be made prior to the satisfaction, vacation, or stay of such judgment, order, or decree);

8.8 Misrepresentations. Borrower or any Person acting for Borrower makes any representation, warranty, or other statement now or later in this Agreement, any Loan Document or in any writing delivered to Bank or to induce Bank to enter this Agreement or any Loan Document, and such representation, warranty, or other statement is incorrect in any material respect when made;

8.9 Subordinated Debt. A default or breach occurs under any agreement between Borrower and any creditor of Borrower that signed a subordination, intercreditor, or other similar agreement with Bank, or any creditor that has signed such an agreement with Bank breaches any terms of such agreement; or

8.10 Guaranty. (a) Any guaranty of any Obligations terminates or ceases for any reason to be in full force and effect; (b) any Material Guarantor does not perform any obligation or covenant under any guaranty of the Obligations; (c) any circumstance described in Sections 8.3, 8.4, 8.5, 8.7, or 8.8. occurs with respect to any Material Guarantor, or (d) the death, liquidation, winding up, or termination of existence of any Guarantor.

9 BANK’S RIGHTS AND REMEDIES

9.1 Rights and Remedies. If an Event of Default has occurred and is continuing, Bank may, without notice or demand, do any one or more or all of the following:

(a) declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank);

(b) stop advancing money or extending credit for Borrower’s benefit under this Agreement or under any other agreement between Borrower and Bank;

(c) demand that Borrower (i) deposit cash with Bank in an amount equal to the aggregate amount of any Letters of Credit remaining undrawn, as collateral security for the repayment of any future drawings under such Letters of Credit, and Borrower shall forthwith deposit and pay such amounts, and (ii) pay in advance all Letter of Credit fees scheduled to be paid or payable over the remaining term of any Letters of Credit;

(d) terminate any FX Forward Contracts;

(e) demand payment of, and collect any Accounts and General Intangibles comprising Collateral, settle or adjust disputes and claims directly with Account Debtors for amounts, on terms, and in any order that Bank considers advisable, notify any Account Debtor or other Person owing Borrower money of Bank’s security interest in such funds, verify the amount of the same and collect the same;

(f) make any payments and do any acts it considers necessary or reasonable to protect the Collateral and/or its security interest in the Collateral. Borrower shall assemble the Collateral if Bank requests and make it available as Bank designates. Bank may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Bank a license to enter and occupy any of its premises, without charge, to exercise any of Bank’s rights or remedies;

(g) apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower;

21

(h) ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral. Bank is hereby granted a non-exclusive, royalty-free license or other right to use, without charge, Borrower’s premises, vehicles, hoists, lifts, cranes, and other Equipment and all other property, including Borrower’s labels, patents, copyrights, mask works, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any similar property as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and, in connection with Bank’s exercise of its rights under this Section, Borrower’s rights under all licenses and all franchise agreements inure to Bank’s benefit;

(i) place a “hold” on any account maintained with Bank and/or deliver a notice of exclusive control, any entitlement order, or other directions or instructions pursuant to any Control Agreement or similar agreements providing control of any Collateral;

(j) demand and receive possession of Borrower’s Books; and

(k) exercise all rights and remedies available to Bank under the Loan Documents or at law or equity, including all remedies provided under the Code (including disposal of the Collateral pursuant to the terms thereof).

9.2 Power of Attorney. Borrower hereby irrevocably appoints Bank as its lawful attorney-in-fact, exercisable upon the occurrence and during the continuance of an Event of Default, to: (a) endorse Borrower’s name on any checks or other forms of payment or security; (b) sign Borrower’s name on any invoice or bill of lading for any Account or drafts against Account Debtors; (c) settle and adjust disputes and claims about the Accounts directly with Account Debtors, for amounts and on terms Bank determines reasonable; (d) make, settle, and adjust all claims under Borrower’s insurance policies; (e) pay, contest or settle any Lien, charge, encumbrance, security interest, and adverse claim in or to the Collateral, or any judgment based thereon, or otherwise take any action to terminate or discharge the same; and (f) transfer the Collateral into the name of Bank or a third party as the Code permits. Borrower hereby appoints Bank as its lawful attorney-in-fact to sign Borrower’s name on any documents necessary to perfect or continue the perfection of Bank’s security interest in the Collateral regardless of whether an Event of Default has occurred until all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been satisfied in full and Bank is under no further obligation to make Credit Extensions hereunder. Bank’s foregoing appointment as Borrower’s attorney in fact, and all of Bank’s rights and powers, coupled with an interest, are irrevocable until all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been fully repaid and performed and Bank’s obligation to provide Credit Extensions terminates.

9.3 Protective Payments. If Borrower fails to obtain the insurance called for by Section 6.7 or fails to pay any premium thereon or fails to pay any other amount which Borrower is obligated to pay under this Agreement or any other Loan Document, Bank may obtain such insurance or make such payment, and all amounts so paid by Bank are Bank Expenses and immediately due and payable, bearing interest at the then highest applicable rate, and secured by the Collateral. Bank will make reasonable efforts to provide Borrower with notice of Bank obtaining such insurance at the time it is obtained or within a reasonable time thereafter. No payments by Bank are deemed an agreement to make similar payments in the future or Bank’s waiver of any Event of Default.

9.4 Application of Payments and Proceeds. Borrower shall have no right to specify the order or the accounts to which Bank shall allocate or apply any payments required to be made by Borrower to Bank or otherwise received by Bank under this Agreement when any such allocation or application is not specified elsewhere in this Agreement. If an Event of Default has occurred and is continuing, Bank may apply any funds in its possession, whether from Borrower account balances, payments, proceeds realized as the result of any collection of Accounts or other disposition of the Collateral, or otherwise, to the Obligations in such order as Bank shall determine in its sole discretion. Any surplus shall be paid to Borrower by credit to the Designated Deposit Account or to other Persons legally entitled thereto; Borrower shall remain liable to Bank for any deficiency. If Bank, in its good faith business judgment, directly or indirectly enters into a deferred payment or other credit transaction with any purchaser at any sale of Collateral, Bank shall have the option, exercisable at any time, of either reducing the Obligations by the principal amount of the purchase price or deferring the reduction of the Obligations until the actual receipt by Bank of cash therefor.

22

9.5 Bank’s Liability for Collateral. So long as Bank complies with Bank’s obligations (as a secured party), if any, under the Code, and reasonable banking practices, regarding the safekeeping of the Collateral in the possession or under the control of Bank, Bank shall not be liable or responsible for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other Person. Borrower bears all risk of loss, damage or destruction of the Collateral.

9.6 No Waiver; Remedies Cumulative. Bank’s failure, at any time or times, to require strict performance by Borrower of any provision of this Agreement or any other Loan Document shall not waive, affect, or diminish any right of Bank thereafter to demand strict performance and compliance herewith or therewith. No waiver hereunder shall be effective unless signed by Bank and then is only effective for the specific instance and purpose for which it is given. Bank’s rights and remedies under this Agreement and the other Loan Documents are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank’s exercise of one right or remedy is not an election, and Bank’s waiver of any Event of Default is not a continuing waiver. Bank’s delay in exercising any remedy is not a waiver, election, or acquiescence.

9.7 Demand Waiver. Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Bank on which Borrower is liable.

10 NOTICES

All notices, consents, requests, approvals, demands, or other communication by any party to this Agreement or any other Loan Document must be in writing and shall be deemed to have been validly served, given, or delivered: (a) upon the earlier of actual receipt and three (3) Business Days after deposit in the U.S. mail, first class, registered or certified mail return receipt requested, with proper postage prepaid; (b) upon transmission, when sent by electronic mail or facsimile transmission; (c) one (1) Business Day after deposit with a reputable overnight courier with all charges prepaid; or (d) when delivered, if hand-delivered by messenger, all of which shall be addressed to the party to be notified and sent to the address, facsimile number, or email address indicated below. Bank or Borrower may change its mailing or electronic mail address or facsimile number by giving the other party written notice thereof in accordance with the terms of this Section 10. All notices to Borrower shall be sent, as provided herein, in care of Zhone with respect to any and all Borrowers.

If to Borrower:	c/o ZHONE TECHNOLOGIES, INC. 7001 Oakport Street Oakland, CA 94621
	Attn: Chief Financial Officer Fax: 510.777.7593 Email: kmisaka@zhone.com
If to Bank:	SILICON VALLEY BANK
	185 Berry Street, Suite 3000
	San Francisco, CA 94107 Attn: CFD Relationship Manager Fax: 415.856.0810
	Email: rfreeman@svb.com

11 CHOICE OF LAW, VENUE, JURY TRIAL WAIVER AND JUDICIAL REFERENCE.

California law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Santa Clara County, California; provided, however, that nothing in this Agreement shall be deemed to operate to preclude Bank from bringing suit or taking other legal action in any other jurisdiction to realize on the Collateral or any other security for the Obligations, or to enforce a judgment or other court order in favor of Bank. Borrower expressly submits and consents in advance to such jurisdiction in any action or suit commenced in any such court, and Borrower hereby waives any objection that it may have based upon lack of personal jurisdiction, improper venue, or forum non conveniens and hereby consents to the granting of such legal or equitable relief as is deemed appropriate by such court. Borrower hereby waives personal service of the summons, complaints, and other process issued in such

23

action or suit and agrees that service of such summons, complaints, and other process may be made by registered or certified mail addressed to Borrower at the address set forth in Section 10 of this Agreement and that service so made shall be deemed completed upon the earlier to occur of Borrower’s actual receipt thereof or three (3) days after deposit in the U.S. mails, proper postage prepaid.

TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS AGREEMENT, THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.

WITHOUT INTENDING IN ANY WAY TO LIMIT THE PARTIES’ AGREEMENT TO WAIVE THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY, if the above waiver of the right to a trial by jury is not enforceable, the parties hereto agree that any and all disputes or controversies of any nature between them arising at any time shall be decided by a reference to a private judge, mutually selected by the parties (or, if they cannot agree, by the Presiding Judge of the Santa Clara County, California Superior Court) appointed in accordance with California Code of Civil Procedure Section 638 (or pursuant to comparable provisions of federal law if the dispute falls within the exclusive jurisdiction of the federal courts), sitting without a jury, in Santa Clara County, California; and the parties hereby submit to the jurisdiction of such court. The reference proceedings shall be conducted pursuant to and in accordance with the provisions of California Code of Civil Procedure §§ 638 through 645.1, inclusive. The private judge shall have the power, among others, to grant provisional relief, including without limitation, entering temporary restraining orders, issuing preliminary and permanent injunctions and appointing receivers. All such proceedings shall be closed to the public and confidential and all records relating thereto shall be permanently sealed. If during the course of any dispute, a party desires to seek provisional relief, but a judge has not been appointed at that point pursuant to the judicial reference procedures, then such party may apply to the Santa Clara County, California Superior Court for such relief. The proceeding before the private judge shall be conducted in the same manner as it would be before a court under the rules of evidence applicable to judicial proceedings. The parties shall be entitled to discovery which shall be conducted in the same manner as it would be before a court under the rules of discovery applicable to judicial proceedings. The private judge shall oversee discovery and may enforce all discovery rules and order applicable to judicial proceedings in the same manner as a trial court judge. The parties agree that the selected or appointed private judge shall have the power to decide all issues in the action or proceeding, whether of fact or of law, and shall report a statement of decision thereon pursuant to the California Code of Civil Procedure § 644(a). Nothing in this paragraph shall limit the right of any party at any time to exercise self-help remedies, foreclose against collateral, or obtain provisional remedies. The private judge shall also determine all issues relating to the applicability, interpretation, and enforceability of this paragraph.

12 GENERAL PROVISIONS

12.1 Maturity Date; Early Termination of this Agreement.

(a) On the Revolving Line Maturity Date or on any earlier effective date of termination, Borrower shall pay and perform in full all Obligations, whether evidenced by installment notes or otherwise, and whether or not all or any part of such Obligations are otherwise then due and payable.

(b) This Agreement (together with, but not separately from, the Non-Exim Loan Agreement) may be terminated prior to the Revolving Line Maturity Date by Borrower, effective three (3) Business Days after written notice of termination is given to Bank, or by Bank upon the occurrence and during the continuation of an Event of Default. Notwithstanding any termination of this Agreement, Bank’s liens and security interests in the Collateral shall continue until Borrower pays in full in cash, and otherwise performs in full, its Obligations (other than inchoate indemnity obligations).

12.2 Successors and Assigns. This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights or obligations under it without Bank’s prior written consent (which may be granted or withheld in Bank’s discretion). Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank’s obligations, rights, and benefits under this Agreement and the other Loan Documents.

24

12.3 Indemnification. Borrower agrees to indemnify, defend and hold Bank and its directors, officers, employees, agents, attorneys, or any other Person affiliated with or representing Bank (each, an “Indemnified Person”) harmless against: (a) all obligations, demands, claims, and liabilities (collectively, “Claims”) asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses incurred, or paid by such Indemnified Person from, following, or arising from transactions between Bank and Borrower (including reasonable attorneys’ fees and expenses), except for Claims and/or losses directly caused by such Indemnified Person’s gross negligence or willful misconduct. This Section 12.2 shall survive any termination of this Agreement or any other Loan Document.

12.4 Time of Essence. Time is of the essence for the performance of all Obligations in this Agreement.

12.5 Severability of Provisions. Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

12.6 Correction of Loan Documents. Bank may correct patent errors and fill in any blanks in this Agreement and the other Loan Documents consistent with the agreement of the parties.

12.7 Amendments in Writing; Integration. All amendments to this Agreement must be in writing and signed by both Bank and Borrower. This Agreement and the Loan Documents represent the entire agreement about this subject matter and supersede prior negotiations or agreements. All prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement and the Loan Documents merge into this Agreement and the Loan Documents.

12.8 Counterparts. This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.9 Survival. All covenants, representations and warranties made in this Agreement continue in full force until this Agreement has terminated pursuant to its terms and all Obligations (other than inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) have been satisfied. The obligation of Borrower in Section 12.2 to indemnify Bank shall survive until the statute of limitations with respect to all claims and causes of action with respect to which indemnity is given to Bank shall have run.

12.10 Confidentiality. In handling any confidential information, Bank shall exercise the same degree of care that it exercises for its own proprietary information, but disclosure of information may be made: (a) to Bank’s Subsidiaries or Affiliates; (b) to prospective transferees or purchasers of any interest in the Credit Extensions (provided, however, Bank shall use commercially reasonable efforts to obtain such prospective transferee’s or purchaser’s agreement to the terms of this provision); (c) as required by law, regulation, subpoena, or other order; (d) to Bank’s regulators or as otherwise required in connection with Bank’s examination or audit; (e) as Bank considers appropriate in exercising remedies under the Loan Documents; and (f) to third-party service providers of Bank so long as such service providers have executed a confidentiality agreement with Bank with terms no less restrictive than those contained herein. Confidential information does not include information that either: (i) is in the public domain or in Bank’s possession when disclosed to Bank, or becomes part of the public domain after disclosure to Bank; or (ii) is disclosed to Bank by a third party, if Bank does not know that the third party is prohibited from disclosing the information.

Subject to the foregoing, Bank may use confidential information for any bona fide Bank purpose, including, without limitation, for the development of client databases, reporting purposes, and market analysis, so long as Bank does not disclose Borrower’s identity or the identity of any person associated with Borrower unless otherwise expressly permitted by this Agreement. The provisions of this Section 12.10 shall survive the termination of this Agreement.

25

12.11 Attorneys’ Fees, Costs and Expenses. In any action or proceeding between Borrower and Bank arising out of or relating to the Loan Documents, the prevailing party shall be entitled to recover its reasonable attorneys’ fees and other costs and expenses incurred, in addition to any other relief to which it may be entitled.

13 DEFINITIONS

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

“Account” is any “account” as defined in the Code with such additions to such term as may hereafter be made, and includes, without limitation, all accounts receivable and other sums owing to Borrower.

“Account Debtor” is any “account debtor” as defined in the Code with such additions to such term as may hereafter be made.

“Advance” or “Advances” means an advance (or advances) under Section 2.1.1(a) hereof.

“Affiliate” of any Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person’s senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person’s managers and members.

“Agreement” is defined in the preamble hereof.

“Availability Amount” is the result of (a) the lesser of (i) the Maximum Revolver Amount or (ii) the amount available under the Borrowing Base, minus (b) the sum of the amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit) and an amount equal to the Letter of Credit Reserve, minus (c) the FX Reserve, minus (d) any amounts used for Cash Management Services, and minus (e) the outstanding principal balance of any Advances and (without duplication) any Reserves.

“Bank” is defined in the preamble hereof.

“Bank Expenses” are all audit fees and expenses, and all other costs and expenses (including reasonable attorneys’ fees and expenses) for preparing, amending, negotiating, administering, defending and enforcing the Loan Documents (including, without limitation, those incurred in connection with appeals or Insolvency Proceedings) or otherwise incurred with respect to Borrower.

“Borrower” is defined in the preamble hereof.

“Borrower’s Books” are all Borrower’s books and records including ledgers, federal and state tax returns, records regarding Borrower’s assets or liabilities, the Collateral, business operations or financial condition, and all computer programs or storage or any equipment containing such information.

“Borrowing Base” is, as of any date of determination, 90% (the “Eligible Accounts Advance Rate” and also an “Advance Rate”) of the net amount of Borrower’s Eligible Accounts (as determined by Bank from Borrower’s most recent Transaction Report). The foregoing notwithstanding, Bank may decrease any one or more Advance Rates in its good faith business judgment based on events, conditions, contingencies, or risks which, as determined by Bank, may adversely affect Collateral.

“Borrowing Resolutions” are, with respect to any Person, those resolutions adopted by such Person’s Board of Directors and delivered by such Person to Bank approving the Loan Documents to which such Person is a party and the transactions contemplated thereby, together with a certificate executed by its secretary on behalf of such Person certifying that (a) such Person has the authority to execute, deliver, and perform its obligations under each of the Loan Documents to which it is a party, (b) sets forth the resolutions then in full force and effect authorizing and ratifying the execution, delivery, and performance by such Person of the Loan Documents to which it is a party, (c) the names of the Persons authorized to execute the Loan Documents on behalf of such Person, together with a sample of the true signatures of such Persons, and (d) that Bank may conclusively rely on such certificate unless and until such Person shall have delivered to Bank a further certificate canceling or amending such prior certificate.

26

“Business Day” is any day that is not a Saturday, Sunday or a day on which Bank is closed.

“Campus” is defined in Section 5.1(c).

“Cash Equivalents” means (a) marketable direct obligations issued or unconditionally guaranteed by the United States or any agency or any State thereof having maturities of not more than one (1) year from the date of acquisition; (b) commercial paper maturing no more than one (1) year after its creation and having the highest rating from either Standard & Poor’s Ratings Group or Moody’s Investors Service, Inc., (c) Bank’s certificates of deposit issued maturing no more than one (1) year after issue; and (d) money market funds at least ninety-five percent (95%) of the assets of which constitute Cash Equivalents of the kinds described in clauses (a) through (c) of this definition.

“Cash Management Services” is defined in Section 2.1.4.

“Change in Control” means any event, transaction, or occurrence as a result of which (a) any “person” (as such term is defined in Sections 3(a)(9) and 13(d)(3) of the Securities Exchange Act of 1934, as an amended (the “Exchange Act”)), other than a trustee or other fiduciary holding securities under an employee benefit plan of Zhone, is or becomes a beneficial owner (within the meaning Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of securities of Zhone, representing thirty-five percent (35%) or more of the combined voting power of Zhone’s then outstanding securities; or (b) Zhone shall cease to own and control 100% of the issued and outstanding capital stock of each other Borrower.

“Code” is the Uniform Commercial Code, as the same may, from time to time, be enacted and in effect in the State of California; provided, that, to the extent that the Code is used to define any term herein or in any Loan Document and such term is defined differently in different Articles or Divisions of the Code, the definition of such term contained in Article or Division 9 shall govern; provided further, that in the event that, by reason of mandatory provisions of law, any or all of the attachment, perfection, or priority of, or remedies with respect to, Bank’s Lien on any Collateral is governed by the Uniform Commercial Code in effect in a jurisdiction other than the State of California, the term “Code” shall mean the Uniform Commercial Code as enacted and in effect in such other jurisdiction solely for purposes on the provisions thereof relating to such attachment, perfection, priority, or remedies and for purposes of definitions relating to such provisions.

“Collateral” is any and all properties, rights and assets of Borrower described on Exhibit A.

“Collateral Account” is any Deposit Account, Securities Account, or Commodity Account.

“Combined FX/CMS Sublimit” has the meaning set forth in Section 2.1.5.

“Combined LC Sublimit” has the meaning set forth in Section 2.1.5.

“Combined Revolving Line” is one or more Advances and Non-Exim Loans in an aggregate amount of up to the Maximum Combined Amount outstanding at any time.

“Commodity Account” is any “commodity account” as defined in the Code with such additions to such term as may hereafter be made.

“Compliance Certificate” is that certain certificate in the form attached hereto as Exhibit B.

“Contingent Obligation” is, for any Person, any direct or indirect liability, contingent or not, of that Person for (a) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (b) any obligations for undrawn letters of credit for the account of that Person; and (c) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but “Contingent Obligation” does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under any guarantee or other support arrangement.

27

“Control Agreement” is any control agreement entered into among the depository institution at which Borrower maintains a Deposit Account or the securities intermediary or commodity intermediary at which Borrower maintains a Securities Account or a Commodity Account, Borrower, and Bank pursuant to which Bank obtains control (within the meaning of the Code) over such Deposit Account, Securities Account, or Commodity Account.

“Credit Extension” is any Advance, Letter of Credit, FX Forward Contract, amount utilized for Cash Management Services, or any other extension of credit by Bank for Borrower’s benefit.

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

“Default Rate” is defined in Section 2.3(b).

“Deferred Revenue” is all amounts received or invoiced in advance of performance under contracts and not yet recognized as revenue.

“Deposit Account” is any “deposit account” as defined in the Code with such additions to such term as may hereafter be made.

“Designated Deposit Account” is Borrower’s deposit account, account number _____________, maintained with Bank.

“Dollars,” “dollars” and “$” each mean lawful money of the United States.

“Domestic Subsidiary” means a Subsidiary organized under the laws of the United States or any state or territory thereof or the District of Columbia.

“EBITDA” shall mean, for any period, (a) Net Income, plus (b) Interest Expense, plus (c) to the extent deducted in the calculation of Net Income, (i) depreciation expense, (ii) amortization expense, and (iii) the sum of non-cash stock compensation and foreign exchange gains and losses, plus (d) income tax expense, plus (e) other adjustments, if any, expressly agreed to by Bank (which shall be a matter of Bank’s good faith business judgment) in writing from time to time.

“Effective Date” has the meaning ascribed to such term in the preamble of this Agreement.

“Eligible Accounts” are Accounts which arise in the ordinary course of Borrower’s business that are subject to Bank’s first-priority perfected security interests therein and meet all Borrower’s representations and warranties in Section 5.3. Bank reserves the right at any time and from time to time after the Effective Date, with notice to Borrower, to adjust any of the criteria set forth below and to establish new criteria in its good faith business judgment. Unless Bank agrees otherwise in writing, Eligible Accounts shall exclude:

(a)(1) Accounts that the Account Debtor has not paid within sixty (60) days of due date regardless of invoice payment period terms; and (2) Accounts with selling terms of more than 180 days from date of invoice;

(b) all Accounts owing from an Account Debtor, fifty percent (50%) or more of whose Accounts are excluded under clause (a) above;

(c) Accounts owing from an Account Debtor which has its principal place of business in the United States;

(d) Accounts not invoiced and collected by Borrower from the United States;

(e) Accounts owing from an Account Debtor to the extent that Borrower is indebted or obligated in any manner to the Account Debtor (as creditor, lessor, supplier or otherwise - sometimes called “contra” accounts, accounts payable, customer deposits or credit accounts), with the exception of customary credits, adjustments and/or discounts given to an Account Debtor by Borrower in the ordinary course of its business;

(f) Accounts for which the Account Debtor is Borrower’s Affiliate, officer, employee, or agent;

28

(g) Accounts with credit balances over ninety (90) days from invoice date;

(h) Accounts owing from an Account Debtor, including Affiliates, whose total obligations to Borrower exceed twenty-five percent (25%) of all Accounts, for the amounts that exceed that percentage, unless Bank approves in writing;

(i) Accounts owing from an Account Debtor which is a United States government entity or any department, agency, or instrumentality thereof unless Borrower has assigned its payment rights to Bank and the assignment has been acknowledged under the Federal Assignment of Claims Act of 1940, as amended;

(j) Accounts for demonstration or promotional equipment, or in which goods are consigned, or sold on a “sale guaranteed”, “sale or return”, “sale on approval”, or other terms if Account Debtor’s payment may be conditional;

(k) Accounts owing from an Account Debtor that has not been invoiced or where goods or services have not yet been rendered to the Account Debtor (sometimes called memo billings or pre-billings);

(l) Accounts subject to contractual arrangements between Borrower and an Account Debtor where payments shall be scheduled or due according to completion or fulfillment requirements where the Account Debtor has a right of offset for damages suffered as a result of Borrower’s failure to perform in accordance with the contract (sometimes called contracts accounts receivable, progress billings, milestone billings, or fulfillment contracts);

(m) Accounts owing from an Account Debtor the amount of which may be subject to withholding based on the Account Debtor’s satisfaction of Borrower’s complete performance (but only to the extent of the amount withheld; sometimes called retainage billings);

(n) Accounts subject to trust provisions, subrogation rights of a bonding company, or a statutory trust;

(o) Accounts owing from an Account Debtor that has been invoiced for goods that have not been shipped to the Account Debtor unless Bank, Borrower, and the Account Debtor have entered into an agreement acceptable to Bank in its sole discretion wherein the Account Debtor acknowledges that (i) it has title to and has ownership of the goods wherever located, (ii) a bona fide sale of the goods has occurred, and (iii) it owes payment for such goods in accordance with invoices from Borrower (sometimes called “bill and hold” accounts);

(p) Accounts owing from an Account Debtor with respect to which Borrower has received Deferred Revenue (but only to the extent of such Deferred Revenue);

(q) Accounts for which the Account Debtor has not been invoiced;

(r) Accounts that represent non-trade receivables or that are derived by means other than in the ordinary course of Borrower’s business;

(s) Accounts for which Borrower has permitted Account Debtor’s payment to extend beyond 90 days;

(t) Accounts subject to chargebacks or others payment deductions taken by an Account Debtor (but only to the extent the chargeback is determined invalid and subsequently collected by Borrower);

(u) Accounts in which the Account Debtor disputes liability or makes any claim (but only up to the disputed or claimed amount), or if the Account Debtor is subject to an Insolvency Proceeding, or becomes insolvent, or goes out of business;

(v) Accounts for which Bank in its good faith business judgment determines collection to be doubtful;

(w) Accounts which are not “Eligible Export-Related Accounts Receivable” (as defined in the Exim Borrower Agreement) or do not meet all applicable standards for lending as set forth in the Exim Borrower Agreement;

29

(x) Accounts owing from an Account Debtor affiliated with any military organization or that arise from the sale or licensing of goods or provision of services related to the defense industry;

(y) Accounts owing from an Account Debtor located in countries where the Exim Bank is legally prohibited from doing business or in which Exim Bank coverage is not available (as designated by the Exim Bank’s most recent “Country Limitation Schedule” (as such term is defined in the Exim Borrower Agreement)); and

(z) other Accounts that Bank, or the Exim Bank, deems ineligible in the exercise of its good faith business judgment.

“Equipment” is all “equipment” as defined in the Code with such additions to such term as may hereafter be made, and includes without limitation all machinery, fixtures, goods, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing.

“ERISA” is the Employee Retirement Income Security Act of 1974, and its regulations.

“Event of Default” is defined in Section 8.

“Exim Bank” is defined in Section A.

“Exim Bank Insurance Policy” is defined in Section A.

“Exim Borrower Agreement” is defined in Section A.

“Exim Guaranty” is defined in Section A.

“Exim Loan” is defined in Section A.

“Existing Guarantors” is defined in Section 5.1(c).

“Foreign Currency” means lawful money of a country other than the United States.

“Foreign Subsidiary” means any Subsidiary which is not a Domestic Subsidiary.

“Funding Date” is any date on which a Credit Extension is made to or on account of Borrower which shall be a Business Day.

“FX Business Day” is any day when (a) Bank’s Foreign Exchange Department is conducting its normal business and (b) the Foreign Currency being purchased or sold by Borrower is available to Bank from the entity from which Bank shall buy or sell such Foreign Currency.

“FX Forward Contract” is defined in Section 2.1.3.

“FX Reduction Amount” is defined in Section 2.1.3.

“FX Reserve” is defined in Section 2.1.3.

“GAAP” is generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other Person as may be approved by a significant segment of the accounting profession, which are applicable to the circumstances as of the date of determination.

“General Intangibles” is all “general intangibles” as defined in the Code in effect on the date hereof with such additions to such term as may hereafter be made, and includes without limitation, all copyright rights, copyright applications, copyright registrations and like protections in each work of authorship and derivative work, whether published or unpublished, any patents, trademarks, service marks and, to the extent permitted under applicable law, any applications therefor, whether registered or not, any trade secret rights, including any rights to

30

unpatented inventions, payment intangibles, royalties, contract rights, goodwill, franchise agreements, purchase orders, customer lists, route lists, telephone numbers, domain names, claims, income and other tax refunds, security and other deposits, options to purchase or sell real or personal property, rights in all litigation presently or hereafter pending (whether in contract, tort or otherwise), insurance policies (including without limitation key man, property damage, and business interruption insurance), payments of insurance and rights to payment of any kind.

“Governmental Approval” is any consent, authorization, approval, order, license, franchise, permit, certificate, accreditation, registration, filing or notice, of, issued by, from or to, or other act by or in respect of, any Governmental Authority.

“Governmental Authority” is any nation or government, any state or other political subdivision thereof, any agency, authority, instrumentality, regulatory body, court, central bank or other entity exercising executive, legislative, judicial, taxing, regulatory or administrative functions of or pertaining to government, any securities exchange and any self-regulatory organization.

“Guarantor” is any present or future guarantor of any of the Obligations, including without limitation the Existing Guarantors identified in Section 5.1(c).

“Guarantor Security Agreement” is, with respect to each Guarantor, a security agreement (in form and substance satisfactory to Bank in its good faith business judgment) by such Guarantor in favor of Bank.

“Guaranty” is, with respect to each Guarantor, a continuing guaranty (in form and substance satisfactory to Bank in its good faith business judgment) by such Guarantor in favor of Bank, relative to Borrower.

“Indebtedness” is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations, and (d) Contingent Obligations.

“Indemnified Person” is defined in Section 12.3.

“Insolvency Proceeding” is any proceeding by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

“Intercompany Subordination Agreement” is defined in Section 6.12.

“Interest Expense” means for any fiscal period, interest expense (whether cash or non-cash) determined in accordance with GAAP for the relevant period ending on such date, including, in any event, interest expense with respect to any Credit Extension and other Indebtedness of Borrower and its Subsidiaries, including, without limitation or duplication, all commissions, discounts, or related amortization and other fees and charges with respect to letters of credit and bankers’ acceptance financing and the net costs associated with interest rate swap, cap, and similar arrangements, and the interest portion of any deferred payment obligation (including leases of all types).

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

“Investment” is any beneficial ownership interest in any Person (including stock, partnership interest or other securities), and any loan, advance or capital contribution to any Person.

“IP Security Agreement” is that certain Intellectual Property Security Agreement executed and delivered by Borrower and Guarantor to Bank dated as of the Effective Date (as the same may be amended, restated, supplemented or otherwise modified from time to time).

“Letter of Credit” means a standby letter of credit issued by Bank or another institution based upon an application, guarantee, indemnity or similar agreement on the part of Bank as set forth in Section 2.1.2.

31

“Letter of Credit Application” is defined in Section 2.1.2(a).

“Letter of Credit Reserve” has the meaning set forth in Section 2.1.2(d).

“Lien” is a claim, mortgage, deed of trust, levy, charge, pledge, security interest or other encumbrance of any kind, whether voluntarily incurred or arising by operation of law or otherwise against any property.

“Loan Documents” are, collectively, this Agreement, the Non-Exim Loan Agreement, the Exim Borrower Agreement, the Exim Guaranty, the Perfection Certificate, the IP Security Agreement, the Guaranty, the Guarantor Security Agreement, any note, or notes or guaranties executed by Borrower or any Guarantor, and any other present or future agreement between Borrower or any Guarantor and/or for the benefit of Bank in connection with this Agreement (or the Non-Exim Loan Agreement), all as amended, restated, or otherwise modified.

“Loan Margin” is defined in Section 2.3(a)(i).

“Material Adverse Change” is: (a) a material impairment in the perfection or priority of Bank’s Lien in the Collateral or in the value of such Collateral; or (b) a material adverse change in the business, operations, or condition (financial or otherwise) of Borrower or any Guarantor taken as a whole; or (c) a material impairment of the prospect of repayment of any portion of the Obligations; or (d) Bank determines, based upon information available to it and in its reasonable judgment, that there is a reasonable likelihood that Borrower shall fail to comply with one or more of the financial covenants in Section 6 during the next succeeding financial reporting period.

“Material Guarantor” is a Guarantor, that as of any date of determination has greater than $200,000 in tangible assets and greater than $500,000 in fair market value of total assets.

“Maximum Combined Amount” is $20,000,000.

“Maximum Revolver Amount” is $10,000,000.

“Net Income” means, as calculated on a consolidated basis for Borrower and its Subsidiaries for any period as at any date of determination, the net profit (or loss), after provision for taxes, of Borrower and its Subsidiaries for such period taken as a single accounting period.

“Non-Exim Loan” is defined in Section A.

“Non-Exim Loan Agreement” is defined in Section A.

“Obligations” are Borrower’s obligation to pay when due any debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, whether under this Agreement, the other Loan Documents, or otherwise, including, without limitation, all obligations relating to letters of credit (including reimbursement obligations for drawn and undrawn letters of credit), cash management services, and foreign exchange contracts, if any, and including interest, and other amounts, accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank, and the performance of Borrower’s duties under the Loan Documents. It is expressly acknowledged and agreed that each and all of the Borrowers are, and at all times shall be, jointly and severally liable for all Obligations, regardless of which Borrower or Borrowers requested, received, used, or directly enjoyed the benefit of, the Obligations.

“Operating Documents” are, for any Person, such Person’s formation documents, as certified with the Secretary of State of such Person’s state of formation on a date that is no earlier than 30 days prior to the Effective Date, and, (a) if such Person is a corporation, its bylaws in current form, (b) if such Person is a limited liability company, its limited liability company agreement (or similar agreement), and (c) if such Person is a partnership, its partnership agreement (or similar agreement), each of the foregoing with all current amendments or modifications thereto.

“Overadvance” is defined in Section 2.2.

32

“Payment” means all checks, wire transfers and other items of payment received by Bank (including proceeds of Accounts and payment of the Obligations in full) for credit to Borrower’s outstanding Advances or, if the balance of the Advances have been reduced to zero, for credit to the Designated Deposit Account.

“Perfection Certificate” is defined in Section 5.1.

“Permitted Indebtedness” is:

(a) Borrower’s Indebtedness to Bank under this Agreement and the other Loan Documents;

(b) Indebtedness existing on the Effective Date and shown on the Perfection Certificate;

(c) Subordinated Debt;

(d) unsecured Indebtedness to trade creditors incurred in the ordinary course of business;

(e) Indebtedness incurred as a result of endorsing negotiable instruments received in the ordinary course of business;

(f) Indebtedness, in an aggregate principal amount not to exceed $100,000, secured by Permitted Liens described in clause (c) of the definition of “Permitted Liens”;

(g) unsecured Indebtedness under any performance, surety, statutory, or appeal bonds or similar obligations incurred in the ordinary course of business;

(h) other Indebtedness not otherwise permitted by Section 7.4 not exceeding $250,000 in the aggregate outstanding at any time; and

(i) extensions, refinancings, modifications, amendments and restatements of any items of Permitted Indebtedness (a) through (h) above, provided that the principal amount thereof is not increased or the terms thereof are not modified to impose more burdensome terms upon Borrower or its Subsidiary, as the case may be.

“Permitted Investments” are:

(a) Investments shown on the Perfection Certificate and existing on the Effective Date;

(b)(i) Cash Equivalents; and (ii) any Investments permitted by Borrower’s investment policy, as amended from time to time, provided that such investment policy (and any such amendment) has been approved by Bank in Bank’s good faith business judgment;

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

(d) Investments consisting of deposit and securities accounts, in which Bank has a perfected security interest;

(e) Investments accepted in connection with Transfers permitted by Section 7.1;

(f) Investments consisting of (i) travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business, and (ii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower or its Subsidiaries pursuant to employee stock purchase plans or agreements approved by Borrower’s Board of Directors;

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

33

(h) Investments consisting of notes receivable of, or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates, in the ordinary course of business; provided that this paragraph shall not apply to Investments of Borrower in any Subsidiary;

(i) Investments by Borrower in Subsidiaries from time to time in amounts sufficient to fund operating expenses of such Subsidiaries in the ordinary course of business;

(j) Investments consisting of joint ventures entered into by Borrower or any Subsidiary in the ordinary course of Borrower’s or such Subsidiary’s (as the case may be) business consisting of the non-exclusive licensing of technology from Borrower or such Subsidiary, the development of technology or the providing of technical support, provided that any cash investments by Borrower and all such Subsidiaries do not exceed $250,000 in the aggregate in any fiscal year;

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

(l) the special real estate loan payment Investments by Borrower to Campus described in the last sentence of Section 7.7; and

(m) other Investments not otherwise permitted by Section 7.7 not exceeding $100,000 in the aggregate outstanding at any time.

“Permitted Liens” are:

(a)(i) Liens existing on the Effective Date and shown on the Perfection Certificate; and (ii) Liens arising under this Agreement and the other Loan Documents;

(b) inchoate Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, provided that no notice of any such Lien has been filed or recorded under the Internal Revenue Code of 1986, as amended, and the Treasury Regulations adopted thereunder;

(c) purchase money Liens (including the interests of lessors under capitalized leases): (i) on Equipment (and related software) acquired or held by Borrower incurred for financing the acquisition of the Equipment (and related software) securing no more than $100,000 in the aggregate amount outstanding; or (ii) existing on Equipment (and related software) when acquired; in each case, only if such Lien is confined to such Equipment (and related software) and related improvements, related accessions, related replacements, and the proceeds thereof;

(d) inchoate Liens of carriers, warehousemen, suppliers, or other Persons that are possessory in nature arising in the ordinary course of business so long as such Liens attach only to Inventory, and which are (i) not delinquent or (ii) remain payable without penalty or (iii) are being contested in good faith and by appropriate proceedings which proceedings have the effect of preventing the forfeiture or sale of the property subject thereto;

(e) inchoate Liens to secure payment of workers’ compensation, employment insurance, old-age pensions, social security and other like obligations incurred in the ordinary course of business (other than Liens imposed by ERISA);

(f) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (c), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase;

(g) leases or subleases of real property granted in the ordinary course of business, and leases, subleases, non-exclusive licenses or sublicenses of property (other than real property or intellectual property) granted in the ordinary course of Borrower’s business, if the leases, subleases, licenses and sublicenses do not prohibit granting Bank a security interest;

34

(h) non-exclusive license of intellectual property granted to third parties in the ordinary course of business;

(i) Liens arising from attachments or judgments, orders, or decrees in circumstances not constituting an Event of Default under Sections 8.4 and 8.7;

(j) Liens in favor of other financial institutions (not securing indebtedness for borrowed money owing to such financial institutions) arising in connection with Borrower’s deposit and/or securities accounts permitted hereunder held at such institutions, provided that Bank has a perfected security interest in the amounts held in such deposit and/or securities accounts;

(k) Liens in favor of customs and revenues authorities arising as a matter of law to secure payment of customs duties in connection with the importation of goods;

(l) inchoate statutory Liens of landlords that are not delinquent and as to which Borrower is in compliance with the applicable requirements of Section 5.2(c) with respect to such landlord;

(m) Liens in a total amount not to exceed $250,000 on earnest money deposits required under a letter of intent or purchase agreement which are in connection with transactions permitted by this Agreement and are consented to in writing by Bank in its good faith business judgment, provided such funds are at all times kept in a segregated escrow account;

(n) Liens on insurance proceeds in favor of insurance companies granted solely as security for financed premiums, provided such Liens are confined to such premiums and further, provided, the aggregate amount of such liens does not at any time exceed $250,000;

(o) Liens on escrowed cash in an aggregate amount not exceeding $250,000, representing a portion of the proceeds of sales or transactions permitted by this Agreement, established to satisfy contingent post closing obligations that Borrower owes (including earn-outs, indemnities and working capital adjustments) so long as such Liens are disclosed in writing to Bank at or prior to the date they arise; and

(p) governmental Liens in connection with progress payments made on government contracts which are limited to the Inventory being sold pursuant to such government contract.

“Permitted Location” are: (i) Collateral locations identified in the Perfection Certificate; (ii) locations where Collateral may be temporarily located for sales, testing or demonstration purposes, (iii) locations where movable goods, such as mobile phones, laptops and similar Equipment may be located with employees and consultants, (iv) locations where Collateral may be located with contract manufacturers in the ordinary course of business, (v) locations of deposit and securities accounts otherwise permitted hereunder, and (vi) other locations where Collateral with an aggregate book value of less than $500,000 may be stored or located in the ordinary course of business.

“Person” is any individual, sole proprietorship, partnership, limited liability company, joint venture, company, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

“Prime Rate” is Bank’s most recently announced “prime rate,” even if it is not Bank’s lowest rate.

“Registered Organization” is any “registered organization” as defined in the Code with such additions to such term as may hereafter be made.

“Requirement of Law” is as to any Person, the organizational or governing documents of such Person, and any law (statutory or common), treaty, rule or regulation or determination of an arbitrator or a court or other Governmental Authority, in each case applicable to or binding upon such Person or any of its property or to which such Person or any of its property is subject.

35

“Reserves” means, as of any date of determination, such amounts as Bank may from time to time establish and revise in its good faith business judgment, reducing the amount of Advances and other financial accommodations which would otherwise be available to Borrower (a) to reflect events, conditions, contingencies or risks which, as determined by Bank in its good faith business judgment, do or may adversely affect (i) the Collateral or any other property which is security for the Obligations or its value (including without limitation any increase in delinquencies of Accounts), (ii) the assets, business or prospects of Borrower or any Guarantor, or (iii) the security interests and other rights of Bank in the Collateral (including the enforceability, perfection and priority thereof); or (b) to reflect Bank’s good faith belief that any collateral report or financial information furnished by or on behalf of Borrower or any Guarantor to Bank is or may have been incomplete, inaccurate or misleading in any material respect; or (c) in respect of any state of facts which Bank determines in good faith constitutes an Event of Default or is reasonably likely, with notice or passage of time or both, to constitute an Event of Default.

“Responsible Officer” is any of the Chief Executive Officer, President, Chief Financial Officer and Controller of Borrower.

“Revolving Line” is an Advance or Advances in an aggregate amount of up to the Maximum Revolver Amount outstanding at any time.

“Revolving Line Maturity Date” is 364 days following the Effective Date.

“Securities Account” is any “securities account” as defined in the Code with such additions to such term as may hereafter be made.

“Settlement Date” is defined in Section 2.1.3.

“Subordinated Debt” is indebtedness incurred by Borrower subordinated to all of the Obligations owing to Bank (pursuant to a subordination, intercreditor, or other similar agreement in form and substance satisfactory to Bank entered into between Bank and the other creditor), on terms acceptable to Bank in its good faith business judgment.

“Subsidiary” means, with respect to any Person, any Person of which more than 50.0% of the voting stock or other equity interests (in the case of Persons other than corporations) is owned or controlled directly or indirectly by such Person or one or more of Affiliates of such Person. Anything in the preceding sentence to the contrary notwithstanding, “Campus” shall not constitute a “Subsidiary” of Borrower (for purposes of the Loan Documents other than factual representations and warranties of Borrower in identifying its Subsidiaries) if and so long as Campus is a special purpose limited liability company whose sole asset is real property utilized by Borrower and is not permitted to guaranty the obligations of the Borrower under its agreement with its lender.

“Transaction Report” is that certain report of transactions and schedule of collections in the form attached hereto as Exhibit C.

“Transfer” is defined in Section 7.1.

“Unused Combined Revolving Line Facility Fee” is defined in Section 2.4(d).

[Remainder of page immediately left blank; signature page immediately follows.]

36

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the Effective Date: March 16, 2009

BORROWER:
ZTI MERGER SUBSIDIARY III, INC., a Delaware corporation
By	/s/ KIRK MISAKA
Name:	Kirk Misaka
Title:	Chief Financial Officer

ZHONE TECHNOLOGIES, INC., a Delaware corporation
By	/s/ KIRK MISAKA
Name:	Kirk Misaka
Title:	Chief Financial Officer

BANK:
SILICON VALLEY BANK
By	/s/ RICK FREEMAN
Name:	Rick Freeman
Title:	Relationship Manager

Signature Page

EXHIBIT A

The Collateral consists of all of Borrower’s right, title and interest in and to the following personal property:

All goods, Accounts (including health-care receivables), Equipment, Inventory, contract rights or rights to payment of money, leases, license agreements, franchise agreements, General Intangibles, commercial tort claims, documents, instruments (including any promissory notes), chattel paper (whether tangible or electronic), cash, deposit accounts, fixtures, letters of credit rights (whether or not the letter of credit is evidenced by a writing), securities, and all other investment property, supporting obligations, and financial assets, whether now owned or hereafter acquired, wherever located; and

all Borrower’s Books relating to the foregoing, and any and all claims, rights and interests in any of the above and all substitutions for, additions, attachments, accessories, accessions and improvements to and replacements, products, proceeds and insurance proceeds of any or all of the foregoing.

Notwithstanding the foregoing, the Collateral does not include: (A) any Voting Stock (as defined below) of any Foreign Subsidiary of Borrower in excess of 65% of the issued and outstanding shares (whether currently existing or hereafter arising or acquired) of Borrower’s capital stock of such Foreign Subsidiary which shares entitle the holder thereof to vote for directors or any other matter (“Voting Stock”); and (B) any license or rights under any contract or rights as lessee of any equipment or software, to the extent that (i) the grant of a security interest therein would be contrary to applicable law, or (ii) such license or contract or lease prohibits the grant of a security interest therein (but only to the extent such prohibition is enforceable under applicable law).

[END OF EXHIBIT A]

Exhibit A

EXHIBIT B

COMPLIANCE CERTIFICATE

TO:	SILICON VALLEY BANK	Date:
FROM:	___________________________

The undersigned authorized officer of each of ZTI Merger Subsidiary III, Inc., a Delaware corporation formerly known as Zhone Technologies, Inc., and Zhone Technologies, Inc., a Delaware corporation formerly known as Tellium, Inc. (individually and collectively, and jointly and severally, “Borrower”) certifies that under the respective terms and conditions of the Second Amended and Restated Loan and Security Agreement between Borrower and Bank (the “Non-Exim Loan Agreement”) and the Loan and Security Agreement (Exim Facility) between Borrower and Bank (the “Exim Loan Agreement”) (individually and collectively, the “Agreement”), (1) Borrower is in complete compliance for the period ending _______________ with all required covenants except as noted below, (2) there are no Events of Default that have occurred and are continuing, (3) all representations and warranties in the Agreement are true and correct in all material respects on this date except as noted below; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects as of such date, (4) Borrower, and each of its Subsidiaries, has timely filed all required federal tax returns and reports, and all required state, local, and foreign, material tax returns and reports, and Borrower has timely paid all federal taxes, assessments, deposits and contributions owed by Borrower, and all state, local, and foreign, material taxes, assessments, deposits and contributions owed by Borrower, in each case except as otherwise permitted pursuant to the terms of Section 5.9 of the Agreement, and (5) no Liens have been levied or claims made against Borrower or any of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has not previously provided written notification to Bank. Attached are the required documents supporting the certification. The undersigned certifies that these are prepared in accordance with GAAP consistently applied from one period to the next except: (i) with respect to audited annual financial statements, as explained in an accompanying letter or footnotes; and (ii) interim financial statements may be subject to normal year-end audit adjustments (which will not be material in the aggregate) and need not contain footnote disclosures required by GAAP. The undersigned acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of Section 3 of the Agreement or a Default or Event of Default has occurred and is continuing, and that compliance is determined not just at the date this certificate is delivered. Capitalized terms used but not otherwise defined herein shall have the meanings given them in the Agreement.

Please indicate compliance status by circling Yes/No under “Complies” column.

Reporting Covenant	Required	Complies
Monthly financial statements with Compliance Certificate	Monthly within 30 days	Yes     No
Annual financial statement (CPA Audited) + CC	FYE within 120 days	Yes     No
10-Q, 10-K and 8-K	Within 5 days after filing with SEC	Yes     No
A/R & A/P Agings, Deferred revenue reports, and Sales reports	Monthly within 15 days	Yes     No
Concurrently with monthly A/R agings in respect of any month that is also the last month of a fiscal quarter, copies of actual invoices in respect of Eligible Accounts representing not less than 10% of the aggregate A/R agings balance as of the end of such last month of a fiscal quarter	Quarterly within 15 days	Yes     No
Transaction Reports	(i) at the time of each Advance, and (ii) so long as any Advance is outstanding, in addition not less frequently than weekly	Yes     No

Exhibit B

The following: (i) copyright (including any subsequent ownership right of Borrower in or to any copyright); or (ii) patent (including any subsequent ownership right of Borrower in or to any patent) constituting Material Intellectual Property; or (iii) trademark (including any subsequent ownership right of Borrower in or to any trademark) constituting Material Intellectual Property; was registered after the Effective Date (if no registrations, state “None”)

_________________________________________________________________

Financial Covenant	Required	Actual	Complies
Maintain on a Monthly Basis:
Minimum Liquidity Ratio	At least 2.00 : 1.00	_____ : 1.00	Yes No
Minimum EBITDA for any Test Period of 2 Consecutive Fiscal Quarters (commencing with the Test Period ending on March 31, 2009)	See Section 6.9(b) of the Non-Exim Loan Agreement	EBITDA for Test Period most recently ended (“Last Quarter”): $_________	Yes No

The following financial covenant analys[is][es] and information set forth in Schedule 1 attached hereto are true and accurate as of the date of this Certificate.

The following are the exceptions with respect to the certification above: (If no exceptions exist, state “No exceptions to note.”)

ZTI MERGER SUBSIDIARY III, INC., a Delaware	BANK USE ONLY
corporation
	Received by: _____________________
By		AUTHORIZED SIGNER
Name:	Date:
Title:
	Verified: ________________________
ZHONE TECHNOLOGIES, INC., a Delaware	AUTHORIZED SIGNER
corporation	Date:
By	Compliance Status:         Yes    No
Name:
Title:

Exhibit B

Schedule 1 to Compliance Certificate

Financial Covenants of Borrower

In the event of a conflict between this Schedule and the Loan Agreement, the terms of the Loan Agreement shall govern.

Dated: ____________________

Liquidity Ratio [Section 6.9(a) of Non-Exim Loan Agreement]

Actual:

A.	Aggregate amount of Borrower’s unrestricted cash, as shown on Borrower’s consolidated balance sheet	$_____
B.	Aggregate net amount of Borrower’s Eligible Accounts under the Non-Exim Loan Agreement	$_____
C.	Aggregate net amount of Borrower’s “Eligible Accounts” under the Exim Loan Agreement	$_____
D.	Sum of line A plus line B plus line C	$_____
E.	Aggregate amount of all outstanding Obligations	$_____
F.	Liquidity Ratio (line D divided by line E)	____:1.00

Is line F equal to or greater than 2.00 : 1.00 ?

             No, not in compliance              Yes, in compliance

[continued on next page]

Exhibit B

Minimum EBITDA for any Test Period of 2 Consecutive Fiscal Quarters [Section 6.9(b) of Non-Exim Loan Agreement] (commencing with the Test Period ending on March 31, 2009)

Actual EBITDA for the fiscal quarter most recently ended (“Last Fiscal Quarter”), i.e., on ___________, 200__:

A.	Net Income of Borrower	$_____
B.	To the extent included in the determination of Net Income
	1.      The provision for income taxes	$_____
	2.      Depreciation expense	$_____
	3.      Amortization expense	$_____
	4.      Interest Expense	$_____
	5.      non-cash stock compensation	$_____
	6.      foreign exchange gains and losses	$_____
	7.      other adjustments, if any, expressly agreed to by Bank [specify below]:	$_____
	_______________________________________
	8.      The sum of lines 1 through 7	$_____
C.	EBITDA (line A plus line B.8)	$_____

[continued on next page]

Exhibit B

Actual EBITDA for the fiscal quarter immediately preceding Last Fiscal Quarter, i.e., ending on ___________, 200__:

D.	Net Income of Borrower	$_____
E.	To the extent included in the determination of Net Income
	1.      The provision for income taxes	$_____
	2.      Depreciation expense	$_____
	3.      Amortization expense	$_____
	4.      Interest Expense	$_____
	5.      non-cash stock compensation	$_____
	6.      foreign exchange gains and losses	$_____
	7.      other adjustments, if any, expressly agreed to by Bank [specify below]:	$_____
	_______________________________________
	8.      The sum of lines 1 through 7	$_____
F.	EBITDA (line D plus line E.8)	$_____

Is the sum of Line C plus Line F greater than or equal to the minimum amount of EBITDA for such Test Period as set forth in Section 6.9(b) of the Non-Exim Loan Agreement? If yes, check “Yes, in compliance” below. If no, then check “No, not in compliance” below.

             No, not in compliance              Yes, in compliance

Exhibit B

Exhibit C

Transaction Report

[EXCEL spreadsheet to be provided separately]

Exhibit C

EX-23.1

EXHIBIT 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

Zhone Technologies, Inc.:

We consent to the incorporation by reference in the registration statements on Form S-3 (Nos. 333-115306 and 333-113320) and in the registration statements on Form S-8 (Nos. 333-155321, 333-149598, 333-141153, 333-134217, 333-132336, 333-128092, 333-123369, 333-117142, 333-110713, 333-98855, 333-88732, 333-83422, 333-73352 and 333-61956) of Zhone Technologies, Inc. of our reports dated March 16, 2009, with respect to the consolidated balance sheets of Zhone Technologies, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008, and the effectiveness of internal control over financial reporting as of December 31, 2008, which reports appear in the December 31, 2008 annual report on Form 10-K of Zhone Technologies, Inc.

/s/ KPMG LLP

Mountain View, California

March 16, 2009

EX-31.1

EXHIBIT 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO

RULE 13a-14(a)/15d-14(a)

I, Morteza Ejabat, certify that:

1. I have reviewed this Annual Report on Form 10-K of Zhone Technologies, Inc.;

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

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

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

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

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

Date: March 16, 2009

/s/ MORTEZA EJABAT

Morteza Ejabat

Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO

RULE 13a-14(a)/15d-14(a)

I, Kirk Misaka, certify that:

1. I have reviewed this Annual Report on Form 10-K of Zhone Technologies, Inc.;

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

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

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

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

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

Date: March 16, 2009

/s/ KIRK MISAKA

Kirk Misaka

Chief Financial Officer

EX-32.1

EXHIBIT 32.1

SECTION 1350 CERTIFICATION

Pursuant to 18 U.S.C. Section 1350, Morteza Ejabat, Chief Executive Officer of Zhone Technologies, Inc. (the “Company”), and Kirk Misaka, Chief Financial Officer of the Company, each hereby certify that, to their knowledge:

1. The Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

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

Date: March 16, 2009

/s/ MORTEZA EJABAT	/s/ KIRK MISAKA
Morteza Ejabat Chief Executive Officer	Kirk Misaka Chief Financial Officer