Zhone Technologies Annual Report 2004

By product family, revenue for our SLMS product family declined by $11.9 million or 36% in 2003 as
compared to 2002. Revenue for our legacy and service products declined by $17.7 million or 22% in 2003. The
percentage decline in SLMS product line revenue exceeded the overall percentage decline in revenue. Due to the
economic environment affecting service providers during 2003, our customers and potential customers limited
capital expenditures to sustain their current revenue generating activities while significantly reducing capital
expenditures for newer technologies. As a result, during 2003, network service providers continued to invest in
our legacy equipment and applications while spending more conservatively on newer technologies in the SLMS
product line.
In 2003, Motorola and Qwest accounted for approximately 17% and 11% of total revenue, respectively. In
2002, Motorola accounted for approximately 12% of total revenue. No other customer accounted for 10% or
more of total revenue in either period.
Cost of Revenue
Total cost of revenue decreased $18.6 million to $51.1 million for 2003 compared to $69.7 million for 2002,
driven primarily by the overall decrease in revenue. Total cost of revenue was 61% of revenue for 2003,
compared to 62% of revenue for 2002. Cost of revenue included excess inventory charges of $6.0 million in 2003
and $2.4 million in 2002, representing 7% and 2% of revenue, respectively. The higher excess inventory charges
recorded in 2003 were primarily due to the impact of our reduced sales forecasts.
Excluding the effect of excess inventory charges, total cost of revenue as a percentage of revenue would
have been 54% in 2003 compared to 60% in 2002. This improvement was primarily attributable to a shift in
product mix towards a higher percentage of revenue from certain high margin legacy products.
Research and Product Development Expenses
Research and product development expenses decreased 25% or $7.3 million to $22.5 million for 2003
compared to $29.8 million for 2002. The decrease was primarily due to lower depreciation expense and facilities
related costs, and a decrease in personnel-related expenses resulting from our restructuring activities in 2002,
which resulted in a consolidation of product offerings and more focused development programs. Depreciation
expense and facilities related costs decreased by approximately $4.1 million due to the effect of an impairment
charge for certain facilities and equipment in 2002 and a consolidation of research and product development
office locations. Personnel related expenses decreased by approximately $2.0 million for 2003 due primarily to
headcount reductions resulting from the consolidation of product offerings.
Sales and Marketing Expenses
Sales and marketing expenses decreased 19% or $3.8 million to $15.9 million for 2003 compared to $19.7
million for 2002. The decrease was primarily due to a credit to sales and marketing expense of $2.4 million
recorded in 2003, as a result of the termination of a customer financing agreement with a financial institution.
The amount represented the recovery of a reserve for projected credit losses which had originally been recorded
as sales and marketing expense in 2001.
General and Administrative Expenses
General and administrative expenses decreased 51% or $5.5 million to $5.3 million for 2003 compared to
$10.8 million for 2002. The decrease was primarily due to lower provisions for doubtful accounts of
approximately $7.1 million which occurred because there were no additional specifically reserved customer
accounts in 2003. This decrease was partially offset by higher legal and accounting expenses of approximately
$1.5 million, which was primarily attributable to increased costs associated with being an SEC registrant.
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