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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED March 31, 2003
OR

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

FOR THE TRANSITION PERIOD FROM          TO          .



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TERAYON COMMUNICATION SYSTEMS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


|                                                                        |  |                                             
|----------------------------------------------------------------------- |  | --------------------------------------------
|DELAWARE
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION) |  | 77-0328533
(IRS EMPLOYER
IDENTIFICATION NO.)

4988 GREAT AMERICA PARKWAY
SANTA CLARA, CALIFORNIA 95054
(408) 235-5500
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
THE REGISTRANTS PRINCIPAL EXECUTIVE OFFICES)



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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.    Yes  [X]     No  [_]

Indication by check mark whether the registrant is an accelerated file (as
defined by Rule 12b-2 of the Exchange Act)    Yes  [X]    No  [_]

As of April 30, 2003, registrant had outstanding 73,719,116 shares of
Common Stock.



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TABLE OF CONTENTS



|                              |                                                                                               |  |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                              | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                              | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                              | ITEM 4.CONTROL AND PROCEDURES                                                                
|PART II. OTHER INFORMATION   
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5. OTHER INFORMATION                                                                    
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                   
|Certification:               
|Exhibit Index                
|EXHIBIT 99.1                 
|EXHIBIT 99.2                 



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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This Report on Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 which are subject to the safe harbor created
by those sections. These forward-looking statements include, but are not
limited to: statements related to industry trends and future growth in the
markets for cable modem systems; our strategies for reducing the cost of our
products; our product development efforts; the effect of GAAP accounting
pronouncements on our recognition of revenues; our future research and
development; the timing of our introduction of new products; the timing and
extent of deployment of our products by our customers; and future
profitability. We usually use words such as may, will, should, expect,
plan, anticipate, believe, estimate, predict, future, intend, or
certain or the negative of these terms or similar expressions to identify
forward-looking statements. Discussions containing such forward-looking
statements may be found throughout the document. These forward-looking
statements involve certain risks and uncertainties that could cause actual
results to differ materially from those in such forward-looking statements. We
disclaim any obligation to update these forward-looking statements as a result
of subsequent events. The business risks discussed in Part 1, Item 2 of this
Report on Form 10-Q, among other things, should be considered in evaluating our
prospects and future financial performance.




PART I. FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS

TERAYON COMMUNICATION SYSTEMS, INC.
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                               |  |      |   | 
|-------------------------------------------------------------------------------------------------------------- |  | ---- | - | 
|                                                                                                               |  | Page
|                                                                                                               |  |     
|Condensed Consolidated Balance Sheets as of March 31, 2003 (unaudited) and
December 31, 2002.                  |  |      | 3 | 
|Condensed Consolidated Statements of Operations for the three months ended
March 31, 2003 and 2002 (unaudited) |  |      | 4 | 
|Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2003 and 2002 (unaudited) |  |      | 5 | 
|Notes to Condensed Consolidated Financial Statements
(unaudited)                                               |  |      | 6 | 

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TERAYON COMMUNICATION SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

|                                         |                                      |                           |                                            |           |         |             |         |              |         |         |  | 
|---------------------------------------- | ------------------------------------ | ------------------------- | ------------------------------------------ | --------- | ------- | ----------- | ------- | ------------ | ------- | ------- |  | 
|                                         |                                      |                           |                                            |           |         | March 31,   |         | December 31,
|                                         |                                      |                           |                                            |           |         | 2003        |         | 2002        
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      |                           |                                            |           |         | (unaudited) |         |              |         |        
|                                         |                                      |                           |                                            | ASSETS    |         |             |         |              |         |         |  | 
|Current assets:                          |                                      |                           |                                            |           |         |             |         |             
|Cash and cash equivalents                |                                      | $                         | 97,254                                     |           |         | $           | 117,079 |             
|Short-term investments                   |                                      |                           | 82,116                                     |           |         |             | 89,424  |             
|Accounts receivable, net                 |                                      |                           | 15,872                                     |           |         |             | 16,355  |             
|Accounts receivable from related parties |                                      |                           | 1,811                                      |           |         |             | 842     |             
|Inventory                                |                                      |                           | 5,218                                      |           |         |             | 8,257   |             
|Other current assets                     |                                      |                           | 9,516                                      |           |         |             | 10,860  |             
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      | Total current assets      |                                            |           | 211,787 |             |         |              | 242,817 |        
|Property and equipment, net              |                                      |                           | 15,441                                     |           |         |             | 17,906  |             
|Intangibles and other assets, net        |                                      |                           | 13,120                                     |           |         |             | 14,987  |             
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      | Total assets              |                                            | $         | 240,348 |             |         | $            | 275,710 |        
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      |                           | LIABILITIES AND STOCKHOLDERS EQUITY       |           |         |             |         |              |         |         | 
|Current liabilities:                     |                                      |                           |                                            |           |         |             |         |             
|Accounts payable                         |                                      | $                         | 20,589                                     |           |         | $           | 23,920  |             
|Accrued payroll and related expenses     |                                      |                           | 5,150                                      |           |         |             | 6,227   |             
|Deferred revenues                        |                                      |                           | 489                                        |           |         |             | 497     |             
|Accrued warranty                         |                                      |                           | 7,687                                      |           |         |             | 8,607   |             
|Accrued restructuring                    |                                      |                           | 6,970                                      |           |         |             | 6,754   |             
|Accrued vendor cancellation charges      |                                      |                           | 9,247                                      |           |         |             | 13,865  |             
|Other accrued liabilities                |                                      |                           | 6,852                                      |           |         |             | 8,609   |             
|Other current obligations                |                                      |                           | 882                                        |           |         |             | 1,509   |             
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      | Total current liabilities |                                            |           | 57,866  |             |         |              | 69,988  |        
|Long-term obligations                    |                                      |                           | 3,815                                      |           |         |             | 3,499   |             
|Convertible subordinated notes           |                                      |                           | 65,081                                     |           |         |             | 65,081  |             
|Commitments and contingencies            |                                      |                           |                                            |           |         |             |         |             
|Stockholders equity:                    |                                      |                           |                                            |           |         |             |         |             
|                                         | Common stock                         |                           |                                            | 74        |         |             |         | 73           |        
|                                         | Additional paid in capital           |                           |                                            | 1,078,757 |         |             |         | 1,078,144    |        
|                                         | Accumulated deficit                  |                           |                                            | (961,196  | )       |             |         | (937,207     | )      
|                                         | Deferred compensation                |                           |                                            | (14       | )       |             |         | (25          | )      
|                                         | Treasury stock, at cost              |                           |                                            | (773      | )       |             |         | (773         | )      
|                                         | Accumulated other comprehensive loss |                           |                                            | (3,262    | )       |             |         | (3,070       | )      
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      |                           | Total stockholders equity                 |           |         | 113,586     |         |              |         | 137,142 | 
|                                         |                                      |                           |                                            |           |         |             |         |             
|                                         |                                      |                           | Total liabilities and stockholders equity |           | $       | 240,348     |         |              | $       | 275,710 | 
|                                         |                                      |                           |                                            |           |         |             |         |             

See accompanying notes.

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TERAYON COMMUNICATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

|                                                              |  |                                          |                          |   |                    |        |        |   |        |        | 
|------------------------------------------------------------- |  | ---------------------------------------- | ------------------------ | - | ------------------ | ------ | ------ | - | ------ | ------ | 
|                                                              |  |                                          |                          |   | Three Months Ended
|                                                              |  |                                          |                          |   | March 31,         
|                                                              |  |                                          |                          |   | 2003               |        | 2002  
|                                                              |  |                                          |                          |   |                    |        |       
|Revenues:                                                     |  |                                          |                          |   |                    |        |        |  
|Product
revenues                                              |  | $                                        | 20,608                   |   |                    | $      | 51,559 |  
|Related party product
revenues                                |  |                                          | 1,660                    |   |                    |        | 5,659  |  
|                                                              |  |                                          |                          |   |                    |        |        |  
|                                                              |  | Total
revenues                           |                          |   | 22,268             |        |        |   | 57,218 |       
|Cost of goods sold:                                           |  |                                          |                          |   |                    |        |        |  
|Cost of product
revenues                                      |  |                                          | 18,807                   |   |                    |        | 26,571 |  
|Cost
 of related party product
revenues                       |  |                                          | 786                      |   |                    |        | 5,156  |  
|                                                              |  |                                          |                          |   |                    |        |        |  
|                                                              |  | Total cost of goods
sold                 |                          |   | 19,593             |        |        |   | 31,727 |       
|                                                              |  |                                          |                          |   |                    |        |        |  
|Gross
profit                                                  |  |                                          | 2,675                    |   |                    |        | 25,491 |  
|Operating expenses:                                           |  |                                          |                          |   |                    |        |        |  
|                                                              |  | Research and
development                 |                          |   | 13,002             |        |        |   | 16,940 |       
|                                                              |  | Sales and
marketing                      |                          |   | 6,729              |        |        |   | 8,853  |       
|                                                              |  | General and
administrative               |                          |   | 3,727              |        |        |   | 3,634  |       
|                                                              |  | Restructuring costs and asset
write-offs |                          |   | 3,162              |        |        |   |       |       
|                                                              |  |                                          |                          |   |                    |        |        |  
|                                                              |  |                                          | Total operating
expenses |   |                    | 26,620 |        |   |        | 29,427 | 
|                                                              |  |                                          |                          |   |                    |        |        |  
|Loss from
operations                                          |  |                                          | (23,945                  | ) |                    |        | (3,936 | )
|                                                              |  | Interest
income                          |                          |   | 902                |        |        |   | 2,097  |       
|                                                              |  | Interest
expense                         |                          |   | (837               | )      |        |   | (2,180 | )     
|                                                              |  | Other
expense                            |                          |   | (40                | )      |        |   | (65    | )     
|                                                              |  |                                          |                          |   |                    |        |        |  
|Loss before tax expense                                       |  |                                          | (23,920                  | ) |                    |        | (4,084 | )
|                                                              |  | Income tax
expense                       |                          |   | (69                | )      |        |   | (6     | )     
|                                                              |  |                                          |                          |   |                    |        |        |  
|Net
loss                                                      |  | $                                        | (23,989                  | ) |                    | $      | (4,090 | )
|                                                              |  |                                          |                          |   |                    |        |        |  
|Basic and diluted net loss per
share                          |  | $                                        | (0.33                    | ) |                    | $      | (0.06  | )
|                                                              |  |                                          |                          |   |                    |        |        |  
|Shares used in computing basic and diluted net loss per
share |  |                                          | 73,710                   |   |                    |        | 72,453 |  
|                                                              |  |                                          |                          |   |                    |        |        |  

See accompanying notes.

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TERAYON COMMUNICATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

|                                                                            |                                             |   |                    |        |      |   |          |         |  
|--------------------------------------------------------------------------- | ------------------------------------------- | - | ------------------ | ------ | ---- | - | -------- | ------- | -
|                                                                            |                                             |   | Three Months Ended
|                                                                            |                                             |   | March 31,         
|                                                                            |                                             |   |                   
|                                                                            |                                             |   | 2003               |        | 2002
|                                                                            |                                             |   |                    |        |     
|Operating activities:                                                       |                                             |   |                    |        |      |   |          |        
|Net loss                                                                    |                                             | $ | (23,989            | )      |      | $ | (4,090   | )      
|Adjustments to reconcile net loss to net cash used in operating activities: |                                             |   |                    |        |      |   |          |        
|                                                                            | Depreciation                                |   |                    | 2,663  |      |   |          | 2,848   |  
|                                                                            | Amortization related to stock options       |   |                    | 4      |      |   |          | 195     |  
|                                                                            | Lower of cost or market inventory provision |   |                    | 19     |      |   |          |        |  
|                                                                            | Write-off and disposal of fixed assets      |   |                    | 468    |      |   |          |        |  
|Changes in operating assets and liabilities:                                |                                             |   |                    |        |      |   |          |        
|                                                                            | Accounts receivable                         |   |                    | 483    |      |   |          | (2,185  | )
|                                                                            | Accounts receivable from related parties    |   |                    | (969   | )    |   |          | (1,130  | )
|                                                                            | Inventory                                   |   |                    | 3,039  |      |   |          | 7,124   |  
|                                                                            | Other assets                                |   |                    | 3,212  |      |   |          | (12,212 | )
|                                                                            | Accounts payable                            |   |                    | (3,331 | )    |   |          | (4,861  | )
|                                                                            | Accrued payroll and related expenses        |   |                    | (1,077 | )    |   |          | (1,377  | )
|                                                                            | Deferred revenues                           |   |                    | (8     | )    |   |          | (2,075  | )
|                                                                            | Accrued warranty                            |   |                    | (920   | )    |   |          | (645    | )
|                                                                            | Accrued restructuring                       |   |                    | 216    |      |   |          | (1,141  | )
|                                                                            | Accrued vendor cancellation charges         |   |                    | (4,618 | )    |   |          | 3,360   |  
|                                                                            | Other accrued liabilities                   |   |                    | (1,413 | )    |   |          | (6,458  | )
|                                                                            | Interest payable                            |   |                    | (628   | )    |   |          | (1,820  | )
|                                                                            |                                             |   |                    |        |      |   |          |        
|Net cash used in operating activities                                       |                                             |   | (26,849            | )      |      |   | (24,467  | )      
|                                                                            |                                             |   |                    |        |      |   |          |        
|Investing activities:                                                       |                                             |   |                    |        |      |   |          |        
|Purchases of short-term investments                                         |                                             |   | (35,308            | )      |      |   | (132,595 | )      
|Proceeds from sales and maturities of short-term investments                |                                             |   | 42,393             |        |      |   | 129,153  |        
|Purchases of property and equipment                                         |                                             |   | (666               | )      |      |   | (1,344   | )      
|                                                                            |                                             |   |                    |        |      |   |          |        
|Net cash provided by (used in) investing activities                         |                                             |   | 6,419              |        |      |   | (4,786   | )      
|                                                                            |                                             |   |                    |        |      |   |          |        
|Financing activities:                                                       |                                             |   |                    |        |      |   |          |        
|Principal payments on capital leases                                        |                                             |   | (47                | )      |      |   | (36      | )      
|Proceeds from issuance of common stock                                      |                                             |   | 621                |        |      |   | 3,202    |        
|                                                                            |                                             |   |                    |        |      |   |          |        
|Net cash provided by financing activities                                   |                                             |   | 574                |        |      |   | 3,166    |        
|Effect of exchange rate changes                                             |                                             |   | 31                 |        |      |   | (235     | )      
|                                                                            |                                             |   |                    |        |      |   |          |        
|Net decrease in cash and cash equivalents                                   |                                             |   | (19,825            | )      |      |   | (26,322  | )      
|Cash and cash equivalents at beginning of period                            |                                             |   | 117,079            |        |      |   | 100,274  |        
|                                                                            |                                             |   |                    |        |      |   |          |        
|Cash and cash equivalents at end of period                                  |                                             | $ | 97,254             |        |      | $ | 73,952   |        
|                                                                            |                                             |   |                    |        |      |   |          |        

See accompanying notes.

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TERAYON COMMUNICATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



|1. |  | Organization and Summary of Significant Accounting Policies
|-- |  | -----------------------------------------------------------

Description of Business

Terayon Communication Systems, Inc. (Company) was incorporated under the
laws of the State of California on January 20, 1993. In July 1998, the Company
reincorporated in the State of Delaware.

The Company develops, markets and sells equipment to cable television
operators, telecom carriers and satellite network operators who use the
Companys products to deliver broadband voice, video and data services to
residential and business subscribers.

Basis of Presentation

The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States for interim financial information and in accordance with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation of the financial
statements at March 31, 2003 and for the three months ended March 31, 2003 and
2002 have been included.

Results for the three months ended March 31, 2003 are not necessarily
indicative of results for the entire fiscal year or future periods. These
financial statements should be read in conjunction with the consolidated
financial statements and the accompanying notes included in the Companys Form
10-K dated March 27, 2003, as filed with the U.S. Securities and Exchange
Commission. The accompanying balance sheet at December 31, 2002 is derived
from audited consolidated financial statements at that date.

Reclassifications

Certain amounts in the 2002 financial statements have been reclassified to
conform to the 2003 presentation.

Basis of Consolidation

The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated.

Use of Estimates

The preparation of the condensed consolidated financial statements in
conformity with generally accepted accounting principles in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates. Estimates are based on historical
experience, input from sources outside of the Company, and other relevant facts
and circumstances. Actual results could differ from those estimates. Areas that
are particularly significant include the Companys valuation of its accounts
receivable and inventory reserves, the assessment of recoverability and the
measurement of impairment of fixed assets, and the recognition of restructuring
reserves.

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Stock-based compensation

The Company accounts for stock-based compensation for its employees using
the intrinsic value method presented in Accounting Principles Board (APB)
Statement No. 25, Accounting for Stock Issued to Employees, (APB No. 25) and
related interpretations, and complies with the disclosure provisions of
Statement of Financial Accounting Standards (SFAS) Interpretation No. 123,
Accounting for Stock-Based Compensation, (SFAS No. 123) and with the disclosure
provisions of SFAS No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure Amendment of SFAS No. 123. Under APB No. 25,
compensation expense is based on the difference, as of the date of the grant,
between the fair value of the stock and the exercise price. The Company
accounts for stock options issued to non-employees in accordance with the
provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) 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.

The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation (in thousands, except per share
amounts):

|                                                                        |                                                                                                                                                                        |   |                    |        |      |   |         |         |  
|----------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | ------------------ | ------ | ---- | - | ------- | ------- | -
|                                                                        |                                                                                                                                                                        |   | Three months ended
|                                                                        |                                                                                                                                                                        |   | March 31,         
|                                                                        |                                                                                                                                                                        |   |                   
|                                                                        |                                                                                                                                                                        |   | 2003               |        | 2002
|                                                                        |                                                                                                                                                                        |   |                    |        |     
|Net loss                                                                |                                                                                                                                                                        | $ | (23,989            | )      |      | $ | (4,090  | )      
|Add:                                                                    | Stock-based compensation under
APB 25                                                                                                                                  |   |                    | 4      |      |   |         | 195     |  
|Deduct:                                                                 | Stock option compensation expense
determined under fair value-based
method  Employee stock purchase plan
compensation expense determined
under fair value-based method |   |                    | (6,173 | )    |   |         | (10,297 | )
|                                                                        |                                                                                                                                                                        |   |                    |        |      |   |         |        
|                                                                        |                                                                                                                                                                        |   |                    | (979   | )    |   |         | (770    | )
|Pro forma net loss                                                      |                                                                                                                                                                        | $ | (31,137            | )      |      | $ | (14,962 | )      
|                                                                        |                                                                                                                                                                        |   |                    |        |      |   |         |        
|Pro forma basic and diluted net loss per share                          |                                                                                                                                                                        | $ | (0.42              | )      |      | $ | (0.21   | )      
|                                                                        |                                                                                                                                                                        |   |                    |        |      |   |         |        
|Shares used in computing pro forma basic and
diluted net loss per share |                                                                                                                                                                        |   | 73,710             |        |      |   | 72,453  |        
|                                                                        |                                                                                                                                                                        |   |                    |        |      |   |         |        

Inventory

Inventory is stated at the lower of cost (first-in, first-out) or market.
The components of inventory are as follows (in thousands):

|                |  |           |       |              |  |   |       | 
|--------------- |  | --------- | ----- | ------------ |  | - | ----- | 
|                |  | March 31, |       | December 31,
|                |  | 2003      |       | 2002        
|                |  |           |       |             
|Finished goods  |  | $         | 1,672 |              |  | $ | 5,915 | 
|Work-in-process |  |           | 651   |              |  |   | 769   | 
|Raw materials   |  |           | 2,895 |              |  |   | 1,573 | 
|                |  |           |       |              |  |   |       | 
|                |  | $         | 5,218 |              |  | $ | 8,257 | 
|                |  |           |       |              |  |   |       | 

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Purchase Obligations

The Company has purchase obligations to certain of its suppliers that
support the Companys ability to manufacture its products. The obligations
require the Company to purchase minimum quantities of the suppliers products
at a specified price. Cost of goods sold for the three months ended March 31, 2003 included a reversal of $2.9 million in special charges taken for vendor
cancellation charges and inventory considered to be excess and obsolete. The
Company was able to reverse the provision, as it was able to sell inventory
originally considered to be excess and obsolete. In addition, the Company was
able to negotiate downward certain vendor cancellation claims to terms more
favorable to the Company. Cost of goods sold for the three months ended March
31, 2002, included a reversal of special charges of $11.4 million. The Company was able to reverse the provision, as it was able to sell inventory originally considered to be in excess and obsolete.

On February 26, 2003, the Company entered into an agreement with Solectron Corporation (Solectron) to
settle all outstanding obligations under two manufacturing agreements between the Company and Solectron. Under the terms of the settlement agreement, the Company paid Solectron approximately $3.9 million, and each party released
any and all claims that it may have had against the other party. Additionally, the Company received selected inventory from Solectron. The Company previously accrued $6.0 million toward the settlement of the Solectron matter as a vendor cancellation charge in the fourth quarter of 2000
and the second quarter of 2001. In the first quarter of 2003, in connection with the Solectron settlement, the Company reversed $2.1 million of accrued vendor cancellation charges.

As of March 31, 2003, the Company had $30.8 million of purchase
obligations, of which $9.2 million are included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times throughout 2003.

Net Loss Per Share

A reconciliation of the numerator and denominator of basic and diluted net
loss per share is provided as follows (in thousands, except per share amounts):

|                                                              |  |                    |         |      |  |   |        |  
|------------------------------------------------------------- |  | ------------------ | ------- | ---- |  | - | ------ | -
|                                                              |  | Three Months Ended
|                                                              |  | March 31,         
|                                                              |  | 2003               |         | 2002
|                                                              |  |                    |         |     
|Net loss                                                      |  | $                  | (23,989 | )    |  | $ | (4,090 | )
|                                                              |  |                    |         |      |  |   |        |  
|Shares used in computing basic and diluted
net loss per share |  |                    | 73,710  |      |  |   | 72,453 |  
|                                                              |  |                    |         |      |  |   |        |  
|Basic and diluted net loss per share                          |  | $                  | (0.33   | )    |  | $ | (0.06  | )
|                                                              |  |                    |         |      |  |   |        |  

Options to purchase 13,594,894 and 19,608,155 shares of common stock were
outstanding at March 31, 2003 and March 31, 2002, respectively, and warrants to
purchase 425,593 and 2,408,300 shares of common stock were outstanding at March
31, 2003 and March 31, 2002, respectively, but were not included in the
computation of diluted net loss per share, since the effect is antidilutive.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss presented in the accompanying
condensed consolidated balance sheets consists of net unrealized gains or
losses on short-term investments and accumulated net foreign currency
translation gains or losses.

The following are the components of comprehensive loss (in thousands):

|                             |                                                              |   |                    |      |      |   |        |      |  
|---------------------------- | ------------------------------------------------------------ | - | ------------------ | ---- | ---- | - | ------ | ---- | -
|                             |                                                              |   | Three Months Ended
|                             |                                                              |   | March 31,         
|                             |                                                              |   | 2003               |      | 2002
|                             |                                                              |   |                    |      |     
|Net loss                     |                                                              | $ | (23,989            | )    |      | $ | (4,090 | )   
|                             | Cumulative translation adjustments                           |   |                    | 30   |      |   |        | (235 | )
|                             | Change in unrealized loss on available- for-sale
investments |   |                    | (223 | )    |   |        | (875 | )
|                             |                                                              |   |                    |      |      |   |        |     
|Total comprehensive net loss |                                                              | $ | (24,182            | )    |      | $ | (5,200 | )   
|                             |                                                              |   |                    |      |      |   |        |     

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Impact of Recently Issued Accounting Standards

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for
Stock-Based CompensationTransition and Disclosurean amendment of SFAS 123
(SFAS No. 148). This statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
The Company adopted the annual disclosure provisions of SFAS No. 148 in its
quarterly financial reports in the first quarter of 2003. As the adoption of
this standard involves disclosures only, the Company did not and does not
expect a material impact on its results of operations, financial position or
liquidity.

2. Contingencies

Beginning in April 2000, several plaintiffs filed lawsuits against the
Company and certain of its officers and directors in federal court. The
plaintiff in the first of these lawsuits purported to represent a class whose
members purchased the Companys securities between February 2, 2000 and April
11, 2000. The complaint alleged that the defendants had violated the federal
securities laws by issuing materially false and misleading statements and
failing to disclose material information regarding the Companys technology.
The allegations in the other lawsuits were substantially the same and, on
August 24, 2000, all of these lawsuits were consolidated in the United States
District Court, Northern District of California. The court hearing the
consolidated action has appointed lead plaintiffs and lead plaintiffs counsel
pursuant to the Private Securities Litigation Reform Act.

On September 21, 2000, the lead plaintiffs filed a consolidated class
action complaint containing factual allegations nearly identical to those in
the original lawsuits. The consolidated class action complaint, however,
alleged claims on behalf of a class whose members purchased or otherwise
acquired the Companys securities between November 15, 1999 and April 11, 2000.
On October 30, 2000, defendants moved to dismiss the consolidated class action
complaint. On March 14, 2001, after defendants motion had been fully briefed
and argued, the court issued an order granting in part defendants motion and
giving plaintiffs leave to file an amended complaint. On April 13, 2001,
plaintiffs filed their first amended consolidated class action complaint. On
June 15, 2001, defendants moved to dismiss this new complaint and oral argument
on the motion occurred on December 17, 2001. On March 29, 2002, the court
denied the defendants motion to dismiss. The parties are now in the discovery
process. In addition, the court has certified the plaintiffs proposed class
and scheduled trial to begin on November 4, 2003.

The lawsuit seeks an unspecified amount of damages, in addition to other
forms of relief. The Company considers the lawsuits to be without merit and
intends to defend vigorously against these allegations. However, the litigation
could prove to be costly and time consuming to defend, and there can be no
assurances about the eventual outcome.

On October 16, 2000, a lawsuit was filed against the Company and the
individual defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the
California Superior Court, San Luis Obispo County. This lawsuit is titled
Bertram v. Terayon Communications Systems, Inc. (Bertram). The Bertram
complaint contains factual allegations similar to those alleged in the federal
securities class action lawsuit. The complaint asserts causes of action for
unlawful business practices, unfair and fraudulent business practices, and
false and misleading advertising. Plaintiffs purport to bring the action on
behalf of themselves and as representatives of all persons or entities in the
State of California and such other persons or entities outside California that
have been and are adversely affected by defendants activity, and as the Court
shall

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determine is not inconsistent with the exercise of the Courts
jurisdiction. Plaintiffs seek equitable and injunctive relief. Defendants
removed the Bertram case to the United States District Court, Central District
of California and, on January 19, 2001, filed a motion to dismiss the
complaint. A hearing on defendants motion was held March 26, 2001 and the
court granted Defendants motion to dismiss the action and denied Plaintiffs
motion requesting remand. On April 5, 2001, Defendants moved for an order
requiring further proceedings, if any to take place in the Northern District of
California. Plaintiffs did not oppose this motion and eventually entered into a
stipulation to go forward in the Northern District. On July 9, 2001, a status
conference was held in this case before Judge Patel. Plaintiffs did not appear
for the conference, and the court requested that defendants submit an order
dismissing the Bertram action with prejudice, which the defendants have
submitted to the court. On August 7, 2002, the court held another conference
at which it entered an order dismissing the Bertramcase. The courts order
permits the individual plaintiffs in the Bertramcase to pursue any claims that
they may have as members of the purported class in the related, consolidated
class action discussed above. Plaintiffs have appealed this order, and the
Court of Appeals has set a briefing schedule for the appeal.

The Company believes that the allegations in the Bertramcase, as with the
allegations in the federal securities case, are without merit and intends to
contest the matter vigorously.

On May 7, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of the Company against five of its current directors, two former
directors and two former officers. This lawsuit is titled Campbell vs. Rakib,
et al., and is pending in the California Superior Court, Santa Clara County.
The Company is a nominal defendant in this lawsuit, which alleges claims
relating to essentially the same purportedly misleading statements that are at
issue in the pending securities class action. In that litigation, the Company
disputes making any misleading statements. The derivative complaint also
alleges claims relating to stock sales by certain of the director and officer
defendants.

On July 12, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of the Company against three of its current directors, one former
officer and three former investors. This lawsuit is titled OBrien vs. Rakib,
et al., and is pending in the California Superior Court, San Francisco County.
The Company is a nominal defendant in this lawsuit, which alleges claims
relating to essentially the same purportedly misleading statements that are at
issue in the pending securities class action. In that litigation, the Company
disputes making any misleading statements. The derivative complaint also
alleges claims relating to stock sales by certain of the director and officer
defendants. The plaintiff in the OBriencase has dismissed the investor
defendants without prejudice.

Since the Campbelland OBriencases were filed, the parties have taken
steps to have these cases consolidated in the California Superior Court, County
of Santa Clara. On October 4, 2002, the California Superior Court, County of
San Francisco entered an order providing for the transfer of the OBriencase.
On October 29, 2002, plaintiff in the OBriencase submitted certain materials
to the California Superior Court, County of Santa Clara to effectuate that
transfer, which is now complete. The OBriencase is now consolidated with the
Campbellcase.

The Company believes that there are many defects in the Campbelland
OBrienderivative complaints.

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics (Israel) Ltd., an Israeli company, (Flextronics)
filed a claim with the Tel Aviv District Court in Israel against the Company
and Radwiz, the Companys subsidiary, alleging that damages of NIS 25,000,000
(approximately $5 million US dollars) were caused to them by the Companys
alleged failure to comply with its contractual obligations to accept and pay
for components manufactured by Flextronics in the first quarter of 2001
pursuant to projections it had received from Radwiz. The Company filed a
statement of defense denying the allegations, after which the parties accepted
the Courts recommendation to transfer the case to non-binding mediation.

On January 19, 2003, Omniband Group Limited, a Russian company, (Omniband)
filed a request for arbitration with the Zurich Chamber of Commerce, claiming
damages in an amount of $2,094,970

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allegedly caused by the Companys breach of an agreement to sell to
Omniband certain equipment pursuant to an agreement between Omniband and Radwiz
Ltd., the Companys subsidiary, dated February 22, 2000. The Company believes
that the allegations are baseless and intends to present a vigorous defense in
the arbitration proceedings.

The Company is currently a party to various other legal proceedings, in
addition to those noted above, and may become involved from time to time in
other legal proceedings in the future. While the Company currently believes
that the ultimate outcome of these other proceedings, individually and in the
aggregate, will not have a material adverse effect on the Companys financial
position or overall trends in results of operations, litigation is subject to
inherent uncertainties. Were an unfavorable ruling to occur in any of the
Companys legal proceedings, there exists the possibility of a material adverse
impact on the Companys results of operations for the period in which the
ruling occurs. The estimate of the potential impact on the Companys financial
position or overall results of operations for any of the above legal
proceedings could change in the future.



|3. |  | Operating Segment Information
|-- |  | -----------------------------

Since late 2000, the worldwide telecom and satellite industries have
experienced severe downturns that have resulted in significantly reduced
purchases of new broadband equipment. Because of this overall drop in demand,
the Company has refocused its efforts on the cable industry, and has
significantly reduced its investment in the telecom and satellite businesses.
Consequently, beginning in 2003, the Companys previously reported Telecom segment no longer meets the quantitative threshold for disclosure and the Company now operates as one business segment.
Therefore, segment disclosure for the three months ended March 31, 2003 is not
provided.

Prior to December 31, 2002, the Company operated primarily in two
principal operating segments: Cable Broadband Access Systems (Cable) and
Telecom Carrier Access Systems (Telecom). The Cable segment consisted primarily
of TeraComm System, TJ line of DOCSIS cable modems, Bluewave line of DOCSIS
Cable Modem Termination Systems (CMTS), and the CherryPicker family of Digital
Video Management Systems that are sold primarily to cable operators for the
deployment of data, video and voice services over the existing cable
infrastructure. The Telecom segment consisted primarily of MiniPlex DSL
Systems, IPTL Converged Voice and Data Service System and MainSail products,
which are sold to providers of broadband services for the deployment of voice
and data services over the existing copper wire infrastructure. The Company
determined these reportable operating segments based upon how the businesses
were managed and operated.

Information on reportable segments is as follows (in thousands):

|                                  |                        |  |   |              |   | 
|--------------------------------- | ---------------------- |  | - | ------------ | - | 
|                                  |                        |  |   | Three months
|                                  |                        |  |   | ended       
|                                  |                        |  |   | March 31,   
|                                  |                        |  |   | 2002        
|                                  |                        |  |   |             
|Cable Broadband Access Segment:   |                        |  |   |             
|                                  | Total Cable revenues   |  | $ | 54,625       |  
|                                  | Depreciation expense   |  | $ | 2,485        |  
|                                  | Operating loss         |  | $ | (657         | )
|Telecom Broadband Access Segment: |                        |  |   |             
|                                  | Total Telecom revenues |  | $ | 2,593        |  
|                                  | Depreciation expense   |  | $ | 363          |  
|                                  | Operating loss         |  | $ | (3,279       | )

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|                           |                                          |          |        |              |        |  
|-------------------------- | ---------------------------------------- | -------- | ------ | ------------ | ------ | -
|                           |                                          |          |        | Three months
|                           |                                          |          |        | ended       
|                           |                                          |          |        | March 31,   
|                           |                                          |          |        | 2002        
|                           |                                          |          |        |             
|Total revenues             |                                          | $        | 57,218 |             
|Total depreciation expense |                                          | $        | 2,848  |             
|Operating loss:            |                                          |          |        |             
|                           | Operating loss by reportable segments    |          | $      | (3,936       | )     
|                           | Unallocated amounts:                     |          |        |              |       
|                           | Interest and other income (expense), net |          |        | (148         | )     
|                           | Income tax expense                       |          |        | (6           | )     
|                           |                                          |          |        |              |       
|                           |                                          | Net loss |        | $            | (4,090 | )
|                           |                                          |          |        |              |       

|                              |                   |                       |        |        |        |                              |        |        |        |   |        | 
|----------------------------- | ----------------- | --------------------- | ------ | ------ | ------ | ---------------------------- | ------ | ------ | ------ | - | ------ | 
|                              |                   |                       |        |        |        | Three months ended March 31,
|                              |                   |                       |        |        |        | 2003                         |        | 2002  
|                              |                   |                       |        |        |        |                              |        |       
|Revenues by product:          |                   |                       |        |        |        |                              |        |        |       
|                              | Cable products    |                       | $      | 17,587 |        |                              | $      | 44,284 |       
|                              | Video products    |                       |        | 2,833  |        |                              |        | 6,482  |       
|                              | MiniPlex products |                       |        | 793    |        |                              |        | 1,559  |       
|                              | Other products    |                       |        | 1,055  |        |                              |        | 4,893  |       
|                              |                   |                       |        |        |        |                              |        |        |        |   |       
|Total revenues                |                   | $                     | 22,268 |        |        | $                            | 57,218 |       
|Revenues by geographic areas: |                   |                       |        |        |        |                              |        |       
|                              |                   | United States         |        | $      | 13,048 |                              |        | $      | 9,645  |  
|                              |                   | Canada                |        |        | 2,595  |                              |        |        | 7,112  |  
|                              |                   | Europe                |        |        | 2,522  |                              |        |        | 8,038  |  
|                              |                   | Israel                |        |        | 343    |                              |        |        |       |  
|                              |                   | Japan                 |        |        | 3,135  |                              |        |        | 21,081 |  
|                              |                   | Asia, excluding Japan |        |        | 625    |                              |        |        | 10,906 |  
|                              |                   | South America         |        |        |       |                              |        |        | 436    |  
|                              |                   |                       |        |        |        |                              |        |        |        |   |       
|                              |                   |                       |        | Total  |        | $                            | 22,268 |        |        | $ | 57,218 | 
|                              |                   |                       |        |        |        |                              |        |        |        |   |       

|                                 |              |   |              |         | 
|-------------------------------- | ------------ | - | ------------ | ------- | 
|                                 |              |   | December 31,
|                                 |              |   | 2002        
|                                 |              |   |             
|Assets:                          |              |   |              |        
|Cable Broadband Access Segment   |              | $ | 217,531      |        
|Telecom Broadband Access Segment |              |   | 58,179       |        
|                                 |              |   |              |        
|                                 | Total assets |   | $            | 275,710 | 
|                                 |              |   |              |        

|                     |                         |   |           |        |              |   |         |        | 
|-------------------- | ----------------------- | - | --------- | ------ | ------------ | - | ------- | ------ | 
|                     |                         |   | March 31, |        | December 31,
|                     |                         |   | 2003      |        | 2002        
|                     |                         |   |           |        |             
|Long-lived assets:   |                         |   |           |        |              |   |         |       
|                     | United States           |   | $         | 24,040 |              |   | $       | 28,169 | 
|                     | Canada                  |   |           | 791    |              |   |         | 787    | 
|                     | Europe                  |   |           | 166    |              |   |         | 170    | 
|                     | Israel                  |   |           | 3,384  |              |   |         | 3,442  | 
|                     | Asia                    |   |           | 180    |              |   |         | 207    | 
|                     | South America           |   |           |       |              |   |         | 118    | 
|                     |                         |   |           |        |              |   |         |        | 
|                     | Total long-lived assets |   |           | 28,561 |              |   |         | 32,893 | 
|Total current assets |                         |   | 211,787   |        |              |   | 242,817 |       
|                     |                         |   |           |        |              |   |         |        | 
|Total assets         |                         | $ | 240,348   |        |              | $ | 275,710 |       
|                     |                         |   |           |        |              |   |         |        | 

Three customers accounted for 10% or more of total revenues (26%, 14%,
and10%) for the three months ended March 31, 2003. Three customers accounted
for 10% or more of total revenues (36%, 10%

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and 10%) for the three months ended March 31, 2002. No other customer
accounted for more than 10% of revenues during these periods.

4. Restructuring Charges and Asset Write-offs

Restructuring

2003 Restructuring

During the first quarter of 2003, the Companys Board of Directors
approved a new restructuring plan to continue to conform the expense and
revenue levels and to better position the Company for future growth and
eventual profitability. The Company incurred restructuring charges in the
amount of $2.8 million related to employee termination costs. At March 31,
2003, restructuring charges of $0.9 million remain accrued. As of March 31,
2003, the employment of 77 employees has been terminated throughout the Company, and the Company
paid $1.9 million in termination costs. The Company anticipates that the
remaining employee termination costs related to employee benefits as well as
severance for an additional 4 employees will be substantially paid in the
second quarter of 2003.

A summary of the 2003 accrued restructuring charges is as follows (in
thousands):

|                          |  |              |        |  
|------------------------- |  | ------------ | ------ | -
|                          |  | Involuntary 
|                          |  | Terminations
|                          |  |             
|Total charge              |  | $            | 2,745  |  
|Cash payments             |  |              | (1,876 | )
|                          |  |              |        |  
|Balance at March 31, 2003 |  | $            | 869    |  
|                          |  |              |        |  

2002 Restructuring

During the third quarter of 2002, the Companys Board of Directors
approved a restructuring plan to conform the expense and revenue levels and to
better position the Company for future growth and eventual profitability. The
Company incurred restructuring charges in the amount of $3.6 million of which
$2.3 million related to employee termination costs and the remaining $1.3
million related to costs for excess leased facilities. At March 31, 2003,
restructuring charges of $1.3 million remain accrued. As of
March 31, 2003, the employment of all
153 employees has been terminated throughout the Company, and the Company paid
$2.2 million in termination costs and $0.1 million in excess facility costs.
The Company anticipates the remaining restructuring accrual, primarily relating
to excess leased facilities, will be utilized for servicing operating lease
payments or negotiated buyout of operating lease commitments, through 2005.

The following table summarizes the costs and activities during 2003,
related to the 2002 restructuring (in thousands):

|                             |  |              |     |           |  |                |       |   |  |   |       |  
|---------------------------- |  | ------------ | --- | --------- |  | -------------- | ----- | - |  | - | ----- | -
|                             |  |              |     |           |  | Excess Leased  |       |   |  |  
|                             |  |              |     |           |  | Facilities and |       |   |  |  
|                             |  | Involuntary  |     | Cancelled |  |                |       |  
|                             |  | Terminations |     | Contracts |  | Total         
|                             |  |              |     |           |  |               
|Balance at December 31, 2002 |  | $            | 88  |           |  | $              | 1,422 |   |  | $ | 1,510 |  
|Cash Payments                |  |              | (88 | )         |  |                | (171  | ) |  |   | (259  | )
|                             |  |              |     |           |  |                |       |   |  |   |       |  
|Balance at March 31, 2003    |  | $            |    |           |  | $              | 1,251 |   |  | $ | 1,251 |  
|                             |  |              |     |           |  |                |       |   |  |   |       |  

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2001 Restructuring

During 2001, the Companys Board of Directors approved a restructuring
plan to streamline the Companys organizational structure worldwide. The
Company incurred restructuring charges in the amount of $12.7 million in fiscal
year 2001 of which $4.9 million remained accrued at March 31, 2003. Of the
total restructuring charges recorded during fiscal year 2001, $3.2 million
related to employee termination costs throughout the Company, and the remaining
$9.5 million related primarily to costs for excess leased facilities. The
Company anticipates utilizing the remaining restructuring accrual, which
relates to servicing operating lease payments or negotiated buyout of operating
lease commitments, through 2005.

The following table summarizes the costs and activities during 2003,
related to the 2001 restructuring (in thousands):

|                             |  |  |                |       |       |  |   |       |  
|---------------------------- |  |  | -------------- | ----- | ----- |  | - | ----- | -
|                             |  |  | Excess Leased  |       |       |  |  
|                             |  |  | Facilities and |       |       |  |  
|                             |  |  | Cancelled      |       |       |  |  
|                             |  |  | Contracts      |       | Total
|                             |  |  |                |       |      
|Balance at December 31, 2002 |  |  | $              | 5,243 |       |  | $ | 5,243 |  
|Cash Payments                |  |  |                | (393  | )     |  |   | (393  | )
|                             |  |  |                |       |       |  |   |       |  
|Balance at March 31, 2003    |  |  | $              | 4,850 |       |  | $ | 4,850 |  
|                             |  |  |                |       |       |  |   |       |  

Asset Write-offs

For the three months ended March 31, 2003, the Company wrote off $0.4
million of fixed assets, which were determined to have no remaining useful
life. No assets were written-off during the three months ended March 31, 2002.

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|5. |  | Advertising
|-- |  | -----------

In December 2001, the Company entered into co-marketing arrangements with
Shaw Communications, Inc. (Shaw) and Rogers Communications, Inc. (Rogers), a
related party (see Note 6). The Company paid $7.5 million to Shaw and $0.9
million to Rogers, and recorded these amounts as other current assets. In July
2002, the Company began amortizing these prepaid assets and charging them
against Cable revenues in accordance with EITF 01-09, Accounting for
Consideration given by a Vendor to a Customer or Reseller in Connection with
the Purchase or Promotion of the Vendors Products. The Company will continue
to charge the amortization of these assets against revenues in each of the next
three quarters through December 31, 2003, the term of the related arrangements,
at the rate of $1.4 million per quarter. Amounts charged against revenues in
the first quarter of 2003 totaled approximately $1.4 million.



|6. |  | Related Party Transactions
|-- |  | --------------------------

Lewis Solomon, a member of the Companys Board of Directors and chairman
of the Companys Audit Committee is also a member of the Board of Directors of
Harmonic, Inc. (Harmonic). In April 2002, the Company entered into a reseller
agreement with Harmonic to sell certain of the Companys products. The
agreement appoints Harmonic as an authorized, non-exclusive reseller of certain
of the Companys video products. For the three months ended March 31, 2003,
related party revenue includes $0.4 million of revenue from Harmonic. The
Company recorded $50,000 of revenue related to Harmonic for the three months
ended March 31, 2002.

Alek Krstajic, a member of the Companys board of directors, was the
Senior Vice President of Interactive Services, Sales and Product Development
for Rogers until January 2003. For the three months ended March 31, 2003
the Company recognized $1.3 million of revenue related to Rogers, net of
amortization of co-marketing expense (See Note 5). For the three months
ended March 31 2002, the Company recognized revenue of $5.6 million in
connection with product shipments to Rogers. In May 2003, Rogers will no
longer be a related party to the Company.

Cost of related party product revenues consist of direct product costs in
cost of goods sold in the Companys consolidated statements of operations. No
indirect costs are applied to the cost of related party revenue. Accounts
receivable from Rogers and Harmonic totaled approximately $1.8 million at March
31, 2003. Accounts receivable from Rogers totaled approximately $5.1 million at
March 31, 2002. None of the related parties is a supplier to the Company.

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|7. |  | Product Warranties
|-- |  | ------------------

The Company provides for estimated product warranty expenses when it sells
the related products. Because warranty estimates are forecasts that are based
on the best available information  mostly historical claims experience -
claims costs may differ from amounts provided. An analysis of changes in the
liability for product warranties for the three months ended March 31, 2003, is
as follows (in thousands):

|                 |  |              |       |            |  |              |     |            |  |  |        |   |  |   |       | 
|---------------- |  | ------------ | ----- | ---------- |  | ------------ | --- | ---------- |  |  | ------ | - |  | - | ----- | 
|                 |  |              |       |            |  | Additions    |     | Charges    |  |  |        |   | 
|                 |  | Balance at   |       | Charged to |  | for
Warranty |     | Balance at
|                 |  | Beginning of |       | Costs and  |  | Services     |     | End of    
|                 |  | Period       |       | Expenses   |  | Provided     |     | Period    
|                 |  |              |       |            |  |              |     |           
|Warranty reserve |  | $            | 8,607 |            |  |              | 243 |            |  |  | (1,163 | ) |  | $ | 7,687 | 
|                 |  |              |       |            |  |              |     |            |  |  |        |   |  |   |       | 

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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
our condensed consolidated financial statements and notes thereto.

Overview

We are an experienced partner for broadband service providers, but are
primarily focused on cable operators. Our mission is to deliver innovative
broadband data, video and voice solutions for the deployment of
revenue-generating services today and tomorrow. We sell our products to cable
operators and other providers of broadband services through direct sales forces
in North America, Europe and Asia. We also distribute our products through
resellers and system integrators. Our products consist of Data Over
Cable Service Interface Specification (DOCSIS) standards
based products, our proprietary Synchronous Code Division Multiple
Access (S-CDMA) products, our CherryPicker digital video
management system and the Multigate telephony and data access system, which are
sold primarily to cable operators for the deployment of data, video and voice
services over the existing cable infrastructure.

Since late 2000, the worldwide telecom and satellite industries have
experienced severe downturns that have resulted in significantly reduced
purchases of new broadband equipment. Because of this overall drop in demand,
we have refocused our efforts on the cable industry, and have significantly
reduced our investment in the telecom and satellite businesses. Consequently,
beginning in 2003, we operate as one business segment.

Our customers, which primarily consist of U.S. and international cable
operators, are currently moving towards products which are standards-based
or, in other words, based on a set of generally accepted industry standards.
We have developed a new line of products that incorporate the
DOCSIS standard technologies and to establish ourselves through this new
product line as a supplier to the DOCSIS market. Currently, we are
the only vendor to the cable industry with a DOCSIS 2.0 qualified
Cable Modem Termination Systems (CMTS) and a complete, end-to-end DOCSIS 2.0 cable data system. Our revenues from proprietary
S-CDMA systems are declining as we are in a transitional period of launching
our DOCSIS-based systems. As a supplier of standards-based products, we face a
more competitive market. These standards are shared, at no cost, with us and
our competitors, which means that it will be increasingly difficult for us to
differentiate our products to compete with other companies who are producing
similar products. Consequently, we will need to find other ways (i.e. price,
quality, level of service) to differentiate ourselves from our competitors. In
the current marketplace, we have been affected by the move to standards-based
products through increased competition, which has driven down average selling
prices (ASPs) sharply. These ASP decreases, without a corresponding decrease
in the cost of good sold, could cause us to not be successful in transitioning
to a standards-based technology.

We had a net loss of $24.0 million and $4.1 million for the three months
ended March 31, 2003 and March 31, 2002, respectively. We had an accumulated
deficit of $961.2 million as of March 31, 2003. Our operating expenses are
based in part on our expectations of future sales, and we expect that a
significant portion of our expenses will be committed in advance of sales. We
anticipate that we will spend approximately $4 million to $6 million on capital
expenditures during the year ending December 31, 2003. Anticipated capital
expenditures consist of purchases of computer hardware, furniture and leasehold
improvements for our facilities, and software and equipment. We expect to
continue to incur losses for the foreseeable future.

Critical Accounting Policies

There have been no material changes to our critical accounting policies
and estimates as disclosed in our report on Form 10-K for the year ended
December 31, 2002.

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Results of Operations

Three Months Ended March 31, 2003 and 2002

Revenues

|                 |  |                            |        |          |  |           |        |  |  |  |     |   
|---------------- |  | -------------------------- | ------ | -------- |  | --------- | ------ |  |  |  | --- | --
|                 |  | For the three months ended |        |          |  |          
|                 |  | March 31,                  |        | % Change
|                 |  | 2003                       |        | 2002     |  | 2003/2002
|                 |  |                            |        |          |  |          
|Product revenues |  | $                          | 22,268 |          |  | $         | 57,218 |  |  |  | (61 | )%

We sell our products directly to broadband service providers, and to a
lesser extent, resellers and system integrators. Revenues related to product
sales are recognized when: (1) persuasive evidence of an arrangement exists,
(2) delivery has occurred or services rendered, (3) the selling price is fixed
or determinable, and (4) collectibility is reasonably assured. A provision is
made for estimated product returns as product shipments are made. Our existing
agreements typically do not grant return rights beyond those provided by the
warranty.

Revenues consist primarily of sales of products to new and existing
customers providing broadband services. Our revenues decreased 61% to $22.3
million for the three months ended March 31, 2003 from $57.2 million in the
same period in 2002. Revenues in North America, which includes the United
States and Canada, decreased to $15.6 million in the first quarter of 2003,
down from $16.8 million in the first quarter of 2002. Three customers accounted
for 50% and 56% of our total revenues for the three months ended March 31, 2003
and March 31, 2002, respectively. This decrease in total revenues and decrease in
North American revenues were primarily due to the slowdown in the general
economy, constraints on technology-related capital spending by cable
service providers and increased competition.
Additionally, our decrease in revenue continues to reflect the challenge of
transitioning from our proprietary products to standards-based products during
a period of difficult market conditions including significant declines in the
Average Selling Prices (ASPs) of our modems over the past two years.

During 2002, the cable industry moved to purchase more standards-based
DOCSIS products as opposed to our proprietary modems and head-ends, and we
faced increasingly strong competition from multiple vendors, which unfavorably
impacted revenues. Further, in 2002, we were unfavorably impacted by declines
in ASPs of our modems. The intensely competitive nature of the market for
broadband products resulted in significant price erosion in 2002. In recent
months, we have seen some stabilization of ASPs of our modems, but ASPs are
down significantly from the three months ended March 31, 2002 as compared to
March 31, 2003. A key component of our strategy is to decrease the cost of
manufacturing our products to offset the declines in ASPs. We intend to
continue to implement cost reduction efforts, including design changes and
manufacturing efficiencies.

|                             |                        |   |                            |       |          |   |           |       |  |  |     |     |   
|---------------------------- | ---------------------- | - | -------------------------- | ----- | -------- | - | --------- | ----- |  |  | --- | --- | --
|                             |                        |   | For the three months ended |       |          |   |          
|                             |                        |   | March 31,                  |       | % Change
|                             |                        |   | 2003                       |       | 2002     |   | 2003/2002
|                             |                        |   |                            |       |          |   |          
|Related party revenues:      |                        |   |                            |       |          |   |           |       |  |  |     |    
|                             | Rogers revenues        |   | $                          | 1,438 |          |   | $         | 5,609 |  |  |     | (74 | )%
|                             | Harmonic revenues      |   |                            | 375   |          |   |           | 50    |  |  |     | 650 | % 
|                             | Co-marketing
agreement |   |                            | (153  | )        |   |           |      |  |  |     |     |   
|                             |                        |   |                            |       |          |   |           |       |  |  |     |    
|Total related party revenues |                        | $ | 1,660                      |       |          | $ | 5,659     |       |  |  | (71 | )% 
|                             |                        |   |                            |       |          |   |           |       |  |  |     |    

Related party revenues decreased 71% to $1.7 million for the three months
ended March 31, 2003 from $5.7 million in the same period in 2002. Related
party revenues in 2003 and 2002 include revenues from Rogers Communications,
Inc. (Rogers) and Harmonic, Inc. (Harmonic). Alek Krstajic, a member of our
board of directors, was the Senior Vice President of Interactive Services,
Sales and Product Development for Rogers until January 2003. Effective in May
2003, Rogers will no longer be a related party to us. Lewis Solomon, another
member of our board of directors, is a member of the board of

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directors of Harmonic. The decline in related party revenues is primarily
due to the same economic and competitive pressures discussed above. None of our
related parties is a supplier to us.

In December 2001, we entered into co-marketing arrangements with Shaw
Communications, Inc. (Shaw) and Rogers Communications, Inc. (Rogers). We paid
$7.5 million to Shaw and $0.9 million to Rogers, and recorded these amounts as
other current assets. In July 2002, we began amortizing these prepaid assets
and charging them against revenues in accordance with EITF 01-09, Accounting
for Consideration given by a Vendor to a Customer or Reseller in Connection
with the Purchase or Promotion of the Vendors Products. We will continue to
charge the amortization of these assets against revenues in each of the next
four quarters through December 31, 2003 at the rate of $1.4 million per
quarter. Amounts charged against revenues in the first quarter of 2003 totaled
approximately $1.4 million of which $0.2 million was charged against related
party revenues.

Cost of Goods Sold

|                                       |  |                            |        |          |  |           |        |  |  |  |     |   
|-------------------------------------- |  | -------------------------- | ------ | -------- |  | --------- | ------ |  |  |  | --- | --
|                                       |  | For the three months ended |        |          |  |          
|                                       |  | March 31,                  |        | % Change
|                                       |  | 2003                       |        | 2002     |  | 2003/2002
|                                       |  |                            |        |          |  |          
|Cost of product revenues               |  | $                          | 18,807 |          |  | $         | 26,571 |  |  |  | (29 | )%
|Cost of related party product
revenues |  |                            | 786    |          |  |           | 5,156  |  |  |  | (85 | )%
|                                       |  |                            |        |          |  |           |        |  |  |  |     |   
|Total cost of goods sold               |  | $                          | 19,593 |          |  | $         | 31,727 |  |  |  | (38 | )%
|                                       |  |                            |        |          |  |           |        |  |  |  |     |   

Cost of goods sold consists of direct product costs as well as the cost of
our manufacturing operations. The cost of manufacturing includes contract
manufacturing, test and quality assurance for products, warranty costs and
associated costs of personnel and equipment. Cost of goods sold for the three
months ended March 31, 2003 included a reversal of approximately $2.9 million
in special charges taken in 2001 for vendor cancellation charges and inventory
previously considered to be in excess and obsolete. Additionally, we reserved
$1.8 million of inventory considered to be in excess and obsolete. Cost of goods sold
for the three months ended March 31, 2002 included a reversal
of special charges of $11.4
million for vendor cancellation charges and inventory previously
considered to be in excess and obsolete. We were able to negotiate downward certain
vendor cancellation charges to terms more favorable to us, and we
were able to sell inventory previously considered to be in excess and
obsolete.

Gross Profit

|             |  |                            |       |          |  |           |        |  |  |  |     |   
|------------ |  | -------------------------- | ----- | -------- |  | --------- | ------ |  |  |  | --- | --
|             |  | For the three months ended |       |          |  |          
|             |  | March 31,                  |       | % Change
|             |  | 2003                       |       | 2002     |  | 2003/2002
|             |  |                            |       |          |  |          
|Gross profit |  | $                          | 2,675 |          |  | $         | 25,491 |  |  |  | (90 | )%

We
achieved a gross profit of $2.7 million or 12% of revenues for the three
months ended March 31, 2003 compared to a gross profit of $25.5 million or 45%
of revenues for the three months ended March 31, 2002. The decrease in gross
profit was primarily attributable to a 61% decline in revenue for the three
months ended March 31, 2003 related to a decline in ASPs since
March 31, 2002.
Additionally, we were unable to decrease our cost of goods sold as quickly as
the decrease in ASPs. During 2003, we may continue to see further
decreases in our ASPs and continued pressure on our margins. We hope
to mitigate pressure on our margins by producing lower cost products
and increase revenues generated by our higher-margin head-end and video products. Any ASP
decreases, without a corresponding decrease in our product costs, will likely
have an adverse impact on our operating results through at least 2003. The
decrease in gross profit was also related to a $2.9 million reversal of special
charges compared to an $11.4 million reversal of special charges
in the first quarter of 2002. We were able to reverse these
provisions as we were able to negotiate downward certain vendor
cancellation claims to terms more favorable to us, and were able to
sell inventory originally considered to be in excess and obsolete.

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Operating Expenses

|                           |  |                            |        |          |  |           |        |  |  |  |     |   
|-------------------------- |  | -------------------------- | ------ | -------- |  | --------- | ------ |  |  |  | --- | --
|                           |  | For the three months ended |        |          |  |          
|                           |  | March 31,                  |        | % Change
|                           |  | 2003                       |        | 2002     |  | 2003/2002
|                           |  |                            |        |          |  |          
|Research and development   |  | $                          | 13,002 |          |  | $         | 16,940 |  |  |  | (23 | )%
|Sales and marketing        |  | $                          | 6,729  |          |  | $         | 8,853  |  |  |  | (24 | )%
|General and administrative |  | $                          | 3,727  |          |  | $         | 3,634  |  |  |  | 3   | % 

Research and Development. Research and development expenses consist
primarily of personnel costs, internally designed prototype material
expenditures, outside engineering consultants, equipment and supplies required
to develop and enhance our products. Research and development expenses
decreased 23% to $13.0 million or 58% of sales for the three months ended March
31, 2003, compared to $16.9 million or 30% of revenues for the three months ended
March 31, 2002. The decrease in research and development expenses was
attributable to $1.3 million of reductions in employee related expenses and a
reduction of $0.4 million of outside engineering consultants. The decrease in
research and development expense also included $1.3 million of reductions in
purchases of materials costs incurred to develop prototypes, and other
research and development expenses. Additionally,
we have reduced research and development efforts by $0.9 million due to market
conditions in the Telecom sector. We believe it is critical to continue to
make significant investments in research and development to create innovative
technologies and products that meet the current and future requirements of our
customers. Accordingly, we intend to continue our investment in research and
development primarily related to DOCSIS standards-based products. In connection
with our worldwide restructuring plan announced on March 14, 2003, we currently
expect research and development to decrease in 2003.

Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and commissions for sales personnel, marketing and support personnel,
and costs related to trade shows, consulting and travel. Sales and marketing
expenses decreased 24% to $6.7 million or 30% of revenues for the three months
ended March 31, 2003, compared to $8.9 million or 15% of
revenues for the three
months ended March 31, 2002. The decrease in sales and marketing expenses was
primarily due to $2.0 million in reduced employee expenses due to lower
headcount related to the restructuring, $0.3 million of decreased spending for
outside consultants, and $0.3 million of decreased travel costs. These spending
decreases were partially offset by $0.4 million of expenses
related to increased tradeshow and
other promotional activities. In connection with our worldwide restructuring
plan announced on March 14, 2003, we currently expect sales and marketing
expenses to continue to decrease in 2003.

General and Administrative. General and administrative expenses consist
primarily of salary and benefits for administrative officers and support
personnel, travel expenses and legal, accounting and consulting fees. General
and administrative expenses increased 3% to $3.7 million or 17%
of revenues for
the three months ended March 31, 2003, compared to
$3.6 million or 6% of revenues
for the first three months of 2002. The increase was primarily due to $0.3
million of severance expense related to the termination of an officer,
partially offset by lower headcount related to the restructuring in late March
2003. In connection with our worldwide restructuring plan announced on March
14, 2003, we currently expect general and administrative expenses to continue
to decrease in 2003.

Restructuring Costs and Asset Write-offs

|                                         |  |                            |       |          |  |           |   |  |  |  |   |  |  |  |  | 
|---------------------------------------- |  | -------------------------- | ----- | -------- |  | --------- | - |  |  |  | - |  |  |  |  | 
|                                         |  | For the three months ended |       |          |  |           |   |  |  | 
|                                         |  | March 31,                  |       | % Change |  |           |   | 
|                                         |  | 2003                       |       | 2002     |  | 2003/2002 |   |  |  | 
|                                         |  |                            |       |          |  |           |   |  |  | 
|Restructuring charges                    |  | $                          | 2,745 |          |  | $         |  |  |  |  |  | 
|Long-lived asset write-offs              |  |                            | 417   |          |  |           |  |  |  |  |  | 
|                                         |  |                            |       |          |  |           |   |  |  |  |   | 
|Restructuring costs and asset write-offs |  | $                          | 3,162 |          |  | $         |  |  |  |  |  | 
|                                         |  |                            |       |          |  |           |   |  |  |  |   | 

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Restructuring Costs

During the first quarter of 2003, our Board of Directors approved a
restructuring plan to conform our expense and revenue levels and to better
position us for future growth and eventual profitability. We incurred
restructuring charges in the amount of $2.8 million related to employee
termination costs. At March 31, 2003, restructuring charges of $0.9 million
remain accrued. As of March 31, 2003, 77 employees have been terminated and we
have paid $1.9 million in termination costs. We anticipate that the remaining
employee termination costs related to employee benefits as well as severance
for an additional 4 employees will be substantially paid in the second quarter
of 2003. We anticipate realizing annualized savings of approximately
$12 to $15 million from these actions combined with related
operational savings, including the curtailment of certain programs and
discretionary expenditures.

A summary of the 2003 accrued restructuring charges is as follows (in
millions):

|                          |  |              |        |  
|------------------------- |  | ------------ | ------ | -
|                          |  | Involuntary 
|                          |  | Terminations
|                          |  |             
|Total charge              |  | $            | 2,745  |  
|Cash payments             |  |              | (1,876 | )
|                          |  |              |        |  
|Balance at March 31, 2003 |  | $            | 869    |  
|                          |  |              |        |  

Asset Write-offs

In
connection with the restructuring, for the three months ended March
31, 2003, we wrote-off $0.4 million of fixed assets, which were determined to
have no remaining useful life. No assets were written-off for the three
months ended March 31, 2002.

Non-operating Expenses

|                 |  |                            |      |          |  |           |        |   |  |  |     |   
|---------------- |  | -------------------------- | ---- | -------- |  | --------- | ------ | - |  |  | --- | --
|                 |  | For the three months ended |      |          |  |          
|                 |  | March 31,                  |      | % Change
|                 |  | 2003                       |      | 2002     |  | 2003/2002
|                 |  |                            |      |          |  |          
|Interest income  |  | $                          | 902  |          |  | $         | 2,097  |   |  |  | (57 | )%
|Interest expense |  | $                          | (837 | )        |  | $         | (2,180 | ) |  |  | (62 | )%
|Other expense    |  | $                          | (40  | )        |  | $         | (65    | ) |  |  | (38 | )%

Interest Income. Interest income decreased 57% to $0.9 million for the
three months ended March 31, 2003 from $2.1 million in the same period in 2002.
The decrease in interest income was primarily due to lower invested average
cash balances due to the use of cash to repurchase Convertible Subordinated
Notes (Notes) in 2001 and 2002 and usage of cash for operations, as well as
lower interest rates.

Interest Expense.Interest expense, which relates primarily to interest
on our Notes due in 2007, decreased 62% to $0.8 million for the three months
ended March 31, 2003 from $2.2 million in the same period in 2002, primarily
due to the repurchase of a total of $434.9 million of the Notes in 2001 and 2002.

Other Expense.Other expense is comprised primarily of realization of
foreign currency translations and permanent gains or losses on investments.
Other expense decreased 38% in 2003 compared to the same period in 2002,
primarily due to favorable currency rates in Brazil.

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Income Taxes

|             |  |                            |     |      |  |   |    |  
|------------ |  | -------------------------- | --- | ---- |  | - | -- | -
|             |  | For the three months ended
|             |  | March 31,                 
|             |  | 2003                       |     | 2002
|             |  |                            |     |     
|Income Taxes |  | $                          | (69 | )    |  | $ | (6 | )

We have generated operating losses since our inception. In the first three
months of March 31, 2003 and March 31, 2002, we recorded an income tax expense
of $69,000 and $6,000, respectively, which was related to foreign
taxes.

Litigation

Beginning in April 2000, several plaintiffs filed lawsuits against us and
certain of our officers and directors in federal court. The plaintiff in the
first of these lawsuits purported to represent a class whose members purchased
our securities between February 2, 2000 and April 11, 2000. The complaint
alleged that the defendants had violated the federal securities laws by issuing
materially false and misleading statements and failing to disclose material
information regarding our technology. The allegations in the other lawsuits
were substantially the same and, on August 24, 2000, all of these lawsuits were
consolidated in the United States District Court, Northern District of
California. The court hearing the consolidated action has appointed lead
plaintiffs and lead plaintiffs counsel pursuant to the Private Securities
Litigation Reform Act.

On September 21, 2000, the lead plaintiffs filed a consolidated class
action complaint containing factual allegations nearly identical to those in
the original lawsuits. The consolidated class action complaint, however,
alleged claims on behalf of a class whose members purchased or otherwise
acquired our securities between November 15, 1999 and April 11, 2000. On
October 30, 2000, defendants moved to dismiss the consolidated class action
complaint. On March 14, 2001, after defendants motion had been fully briefed
and argued, the court issued an order granting in part defendants motion and
giving plaintiffs leave to file an amended complaint. On April 13, 2001,
plaintiffs filed their first amended consolidated class action complaint. On
June 15, 2001, defendants moved to dismiss this new complaint and oral argument
on the motion occurred on December 17, 2001. On March 29, 2002, the court
denied the defendants motion to dismiss. The parties are now in the discovery
process. In addition, the court has certified the plaintiffs proposed class and
scheduled trial to begin on November 4, 2003.

The lawsuit seeks an unspecified amount of damages, in addition to other
forms of relief. We consider the lawsuits to be without merit and intend to
defend vigorously against these allegations. However, the litigation could
prove to be costly and time consuming to defend, and there can be no assurances
about the eventual outcome.

On October 16, 2000, a lawsuit was filed against us and the individual
defendants (Zaki Rakib, Selim Rakib and Raymond Fritz) in the California
Superior Court, San Luis Obispo County. This lawsuit is titled Bertram v.
Terayon Communications Systems, Inc. (Bertram). The Bertram complaint contains
factual allegations similar to those alleged in the federal securities class
action lawsuit. The complaint asserts causes of action for unlawful business
practices, unfair and fraudulent business practices, and false and misleading
advertising. Plaintiffs purport to bring the action on behalf of themselves and
as representatives of all persons or entities in the State of California and
such other persons or entities outside California that have been and are
adversely affected by the defendants activity, and as the Court shall
determine is not inconsistent with the exercise of the Court s jurisdiction.
Plaintiffs seek equitable and injunctive relief. Defendants removed the Bertram
case to the United States District Court, Central District of California and,
on January 19, 2001, filed a motion to dismiss the complaint. A hearing on
defendants motion was held March 26, 2001 and the court granted Defendants
motion to dismiss the action and denied Plaintiffs motion requesting remand. On
April 5, 2001, Defendants moved for an order requiring further proceedings, if
any to take place in the Northern District of California. Plaintiffs did not
oppose this motion and eventually entered into a stipulation to go forward in
the Northern District. On July 9, 2001, a status conference was held in this
case before Judge Patel. Plaintiffs did not appear for the conference, and the

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court requested that defendants submit an order dismissing the Bertram
action with prejudice, which the defendants have submitted to the court. On
August 7, 2002, the court held another conference at which it entered an order
dismissing the Bertram case. The court s order permits the individual
plaintiffs in the Bertram case to pursue any claims that they may have as
members of the purported class in the related, consolidated class action
discussed above. Plaintiffs have appealed this order, and the Court of Appeals
has set a briefing schedule for the appeal.

We believe that the allegations in the Bertram case, as with the
allegations in the federal securities case, are without merit and intend to
contest the matter vigorously.

On May 7, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of us against five of its current directors, two former directors and
two former officers. This lawsuit is titled Campbell vs. Rakib, et al., and is
pending in the California Superior Court, Santa Clara County. We are a nominal
defendant in this lawsuit, which alleges claims relating to essentially the
same purportedly misleading statements that are at issue in the pending
securities class action. In that litigation, we dispute making any misleading
statements. The derivative complaint also alleges claims relating to stock
sales by certain of the director and officer defendants.

On July 12, 2002, a shareholder filed a derivative lawsuit purportedly on
behalf of us against three of our current directors, one former officer and
three former investors. This lawsuit is titled OBrien vs. Rakib, et al., and
is pending in the California Superior Court, San Francisco County. We are a
nominal defendant in this lawsuit, which alleges claims relating to essentially
the same purportedly misleading statements that are at issue in the pending
securities class action. In that litigation, we dispute making any misleading
statements. The derivative complaint also alleges claims relating to stock
sales by certain of the director and officer defendants. The plaintiff in the
OBrien case has dismissed the investor defendants without prejudice.

Since the Campbell and OBrien cases were filed, the parties have taken
steps to have these cases consolidated in the California Superior Court, County
of Santa Clara. On October 4, 2002, the California Superior Court, County of
San Francisco entered an order providing for the transfer of the OBrien case.
On October 29, 2002, plaintiff in the OBrien case submitted certain materials
to the California Superior Court, County of Santa Clara to effectuate that
transfer, which is now complete. The OBrien case is now consolidated with the
Campbell case.

We believe that there are many defects in the Campbell and OBrien
derivative complaints.

On September 3, 2002, Uniscor Ltd. (an Israeli company under voluntary
liquidation) and Flextronics (Israel) Ltd., an Israeli company (Flextronics)
filed a claim with the Tel Aviv District Court in Israel against us and Radwiz,
our subsidiary, alleging that damages of NIS 25,000,000 (approximately $5
million US dollars) were caused to them by our alleged failure to comply with
its contractual obligations to accept and pay for components manufactured by
Flextronics in the first quarter of 2001 pursuant to projections it had
received from Radwiz. We filed a statement of defense denying the allegations,
after which the parties accepted the Court s recommendation to transfer the
case to non-binding mediation.

On January 19, 2003, Omniband Group Limited, a Russian company, (Omniband)
filed a request for arbitration with the Zurich Chamber of Commerce, claiming
damages in an amount of $2.1 million allegedly caused by our breach of an
agreement to sell to Omniband certain equipment pursuant to an agreement
between Omniband and Radwiz Ltd., our subsidiary, dated February 22, 2000. We
believe that the allegations are without merit and intend to present a vigorous
defense in the arbitration proceedings.

We are currently a party to various other legal proceedings, in addition
to those noted above and may become involved from time to time in other legal
proceedings in the future. While we currently believe that the ultimate outcome
of these other proceedings, individually and in the aggregate, will not have a
material adverse effect on our financial position or overall trends in results
of operations, litigation is subject to inherent uncertainties. Were an
unfavorable ruling to occur in any of our legal proceedings, there exists the
possibility of a material adverse impact on our results of operations for the
period in which

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the ruling occurs. The estimate of the potential impact on our financial
position or overall results of operations for any of the above legal
proceedings could change in the future.

Liquidity and Capital Resources

At March 31, 2003, we had approximately $97.3 million in cash and cash
equivalents and $82.1 million in short-term investments. As of March 31, 2003, we had
approximately $68.9 million of long-term obligations.

In July 2000, we issued $500 million of 5% Convertible Subordinated Notes
due in August 2007 (Notes), resulting in net proceeds to us of approximately
$484.4 million. The Notes are our general unsecured obligation and are
subordinated in right of payment to all of our existing and future senior
indebtedness and to all of the liabilities of our subsidiaries. The Notes are
convertible into shares of our common stock at a conversion price of $84.01 per
share at any time on or after October 24, 2000 through maturity, unless
previously redeemed or repurchased. Interest is payable semi-annually. Debt
issuance costs related to the Notes were approximately $15.6 million.

Through March 31, 2003, we had repurchased approximately $434.9 million of
the Notes for $171.0 million in cash and $17.9 million in stock, resulting in a
gain on early retirement of debt of approximately $234.4 million net of related
unamortized issuance costs of $11.6 million. We did not repurchase any Notes
during the three months ended March 31, 2003.

Cash used in operating activities for the three months ended March 31,
2003 was $26.8 million compared to $24.5 million used in the same period in
2002. For the three months ended March 31, 2003, significant uses of cash by
operating activities included a $24.0 million net loss and a decrease of $5.8
million in accounts payable, accrued payroll and other accrued liabilities
partially offset by $3.0 million of cash provided by reductions in inventory.
For the three months ended March 31, 2002, cash used by operating activities
included a $4.1 million net loss, a decrease of $14.5 million in accounts
payable, interest paid on the Notes, accrued payroll, and other accrued
liabilities partially offset by $7.1 million of cash provided by reductions in
inventory .

Cash
provided by investing activities for the three months ended March
31, 2003 was $6.4 million, compared to cash used in investing activities of
$4.8 million in the same period in 2002. Investing activities consisted
primarily of the purchase and sale of short-term investments and fixed assets.

Cash
provided by financing activities was $0.6 million for the three
months ended March 31, 2003, compared to $3.2 million in the same period in
2002. Financing activities primarily consisted of cash received through the
exercise of stock options and shares issued through the stock purchase plan.

In 2002, we entered into an operating lease arrangement to lease a
corporate aircraft. This lease arrangement was originally secured by a $9.0
million letter of credit which has been classified as restricted cash
and is included as Other Assets on the Condensed Consolidated Balance
Sheets. The letter of credit was reduced to $7.5 million in
February 2003. This lease commitment is included in the table below. From
time to time, our Chief Executive Officer, Dr. Rakib, uses the aircraft for
personal use and reimburses us for this usage.

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The following summarizes our contractual obligations at March 31, 2003,
and the effect such obligations are expected to have on our liquidity and cash
flows in future periods (in millions):

|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 
|---------------------------------- |  | ----- | ----- | ------ |  | ---------------------- | ---- | ----- |  | ----- | ---- | ------- |  | - | ---- |  |  | - | --- | 
|                                   |  |       |       |        |  | Payments Due by Period
|                                   |  |       |       |        |  |                       
|                                   |  |       |       |        |  | Less than              |      | 1-3   |  | 4-5   |      | After 5
|                                   |  | Total |       | 1 year |  | years                  |      | years |  | years
|                                   |  |       |       |        |  |                        |      |       |  |      
|Capital Lease Obligations          |  | $     | 0.1   |        |  | $                      | 0.1  |       |  | $     |     |         |  | $ |     |  |  | $ |    | 
|Unconditional Purchase Obligations |  |       | 30.8  |        |  |                        | 30.8 |       |  |       |     |         |  |   |     |  |  |   |    | 
|Long Term Debt                     |  |       | 68.9  |        |  |                        |     |       |  |       | 2.1  |         |  |   | 65.1 |  |  |   | 1.7 | 
|Operating Lease Obligations        |  |       | 28.1  |        |  |                        | 5.1  |       |  |       | 11.4 |         |  |   | 6.0  |  |  |   | 5.6 | 
|Aircraft Lease                     |  |       | 5.7   |        |  |                        | 1.1  |       |  |       | 3.0  |         |  |   | 1.6  |  |  |   |    | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 
|Total Contractual Commitments      |  | $     | 133.6 |        |  | $                      | 37.1 |       |  | $     | 16.5 |         |  | $ | 72.7 |  |  | $ | 7.3 | 
|                                   |  |       |       |        |  |                        |      |       |  |       |      |         |  |   |      |  |  |   |     | 

We have unconditional purchase obligations to certain of our suppliers
that support our ability to manufacture our products. The obligations require
us to purchase minimum quantities of the suppliers products at a specified
price. As of March 31, 2003, we had approximately $30.8 million of purchase
obligations, of which $9.2 million are included on the balance sheet as accrued
vendor cancellation charges. The remaining obligations are expected to become
payable at various times through mid-2003.

Other commercial commitments, primarily required to support operating
leases, are as follows (in millions):

|                             |  |                                            |     |           |  |       |     |       |  |        |   |  |  |   |     |  |  |   |     | 
|---------------------------- |  | ------------------------------------------ | --- | --------- |  | ----- | --- | ----- |  | ------ | - |  |  | - | --- |  |  | - | --- | 
|                             |  | Amount of Commitment Expiration Per Period
|                             |  | Total                                      |     |           |  |       |     |       |  |        |   |  |  |   |     |  |  |  
|                             |  | Amounts                                    |     | Less than |  | 1-3   |     | 4-5   |  | Over 5
|                             |  | Committed                                  |     | 1 year    |  | years |     | years |  | years 
|Deposits                     |  | $                                          | 0.5 |           |  | $     | 0.5 |       |  | $      |  |  |  | $ |    |  |  | $ |    | 
|Standby Letters of Credit    |  |                                            | 8.4 |           |  |       | 0.7 |       |  |        |  |  |  |   | 7.5 |  |  |   | 0.2 | 
|                             |  |                                            |     |           |  |       |     |       |  |        |   |  |  |   |     |  |  |   |     | 
|Total Commercial Commitments |  | $                                          | 8.9 |           |  | $     | 1.2 |       |  | $      |  |  |  | $ | 7.5 |  |  | $ | 0.2 | 
|                             |  |                                            |     |           |  |       |     |       |  |        |   |  |  |   |     |  |  |   |     | 

We believe that our current cash balances will be sufficient to satisfy
our cash requirements for at least the next 12 months. This estimate is a
forward-looking statement that involves risks and uncertainties,

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and actual results may vary as a result of a number of factors, including
those discussed under the risk factor Our Operating Results May Fluctuate
below and elsewhere. We may need to raise additional funds in order to support
more rapid expansion, develop new or enhanced services, respond to competitive
pressures, acquire complementary businesses or technologies or respond to
unanticipated requirements. We may seek to raise additional funds through
private or public sales of securities, strategic relationships, bank debt,
financing under leasing arrangements or otherwise. If additional funds are
raised through the issuance of equity securities, the percentage ownership of
our existing stockholders will be reduced, stockholders may experience
additional dilution or such equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock. There can be no
assurance that additional financing will be available on acceptable terms, if
at all. If adequate funds are not available or are not available on acceptable
terms, we may be unable to continue operations, develop our products, take
advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, all of which could have a material adverse effect
on our business, financial condition and operating results.

Impact of Recently Issued Accounting Standards

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 148, Accounting for
Stock-Based CompensationTransition and Disclosurean amendment of SFAS
123"(SFAS No. 148). This statement amends SFAS No. 123, Accounting for
Stock-Based Compensation, to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results. We
adopted the annual disclosure provisions of SFAS No. 148 in our quarterly
financial reports in the first quarter of 2003. As the adoption of this
standard involves disclosures only, we did not and do not expect a material
impact on our results of operations, financial position or liquidity.

RISK FACTORS

You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing us. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial also may impair our business
operations. If any of the following risks actually occur, our business could be
harmed. In such case, the trading price of our common stock could decline, and
you may lose all or part of your investment.

We Have a History of Losses and May Continue to Incur Losses in the Future.

It is difficult to predict our future operating results. We began shipping
products commercially in June 1997, and we have been shipping products in
volume since the first quarter of 1998. As of March 31, 2003, we had an
accumulated deficit of $961.2 million. We believe that we will continue to
experience difficulties in selling our products at a profit and continue to
operate with net losses for the foreseeable future. Moreover, we have had
declining revenue since 2000. In the three-month period ended March 31, 2003,
our revenues decreased 61% from the same period in 2002. Additionally, we
generally are unable to reduce our expenses significantly in the short term to
compensate for any unexpected delay in generating or decrease in anticipated
revenues. For example, we have fixed commitments with some of our suppliers
that require us to purchase minimum quantities of their products at a specified
price irrespective of whether we can subsequently use such quantities in our
products. Because in the past, we have been unable to use all of the products
that we purchased from our suppliers, we have taken vendor cancellation charges
as a result of these fixed commitments, and we may have to take additional
charges in the future if we are unable to use

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all of the products that we purchase from our suppliers. Further, we have
been experiencing and will continue to experience declining ASPs of our
products. We record an inventory charge to reduce our inventory to the lower
of cost or market if average selling prices fall below the cost of these
products. In addition, we have significant operating lease commitments for
facilities and equipment that generally cannot be cancelled in the short-term
without substantial penalties.

Our business may be adversely affected by delays in, or our failure to,
commercialize new products, or reduce the cost of manufacturing our current
products. Moreover, given the conditions in the broadband equipment market, the
profit potential of our business remains unproven.

We May Experience Fluctuations in Our Operating Results and Face
Unpredictability in Our Future Revenues.

Our quarterly revenues have fluctuated and are likely to continue to
fluctuate significantly in the future due to a number of factors, many of which
are outside our control.

Factors that affect our revenues include, among others, the following:



| |  |  | variations in the timing of orders and shipments of our products;                                                                                                           
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | variations in the size of the orders by our customers and pricing concessions on volume sales;                                                                              
|
| |  |  | new product introductions by competitors;                                                                                                                                   
|
| |  |  | delays in our introduction of new products;                                                                                                                                 
|
| |  |  | delays in our introduction of added features to our products;                                                                                                               
|
| |  |  | delays in reducing the cost of our products;                                                                                                                                
|
| |  |  | delays in the commercialization of products that are competitive in the marketplace;                                                                                        
|
| |  |  | delays in our receipt of and cancellation of orders forecasted by customers;                                                                                                
|
| |  |  | variations in capital spending budgets of cable operators and
other broadband service providers;                                                                            
|
| |  |  | international conflicts, including the continuing conflict in
Iraq, and acts of terrorism and the impact of adverse economic,
market and political conditions worldwide; and
|
| |  |  | ability of our products to be qualified or certified as meeting industry standards.                                                                                         

A variety of factors affecting our gross margin include, among others, the following:



| |  |  | the sales mix of our products;                                      
| | - |  | --------------------------------------------------------------------
|
| |  |  | the volume of products manufactured;                                
|
| |  |  | the type of distribution channel through which we sell our products;
|
| |  |  | the ASPs of our products;                                           
|
| |  |  | the costs of manufacturing our products; and                        
|
| |  |  | the effectiveness of our cost reduction measures.                   

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The unit ASPs of our products have declined considerably in 2002, and we
anticipate that unit ASPs of our products will continue to decline in the
future. This has caused and will continue to cause a decrease in our gross
margins if we are unable to off-set the decline in ASPs with cost reduction
measures. In addition, the gross margins we realize from the sale of our
products are affected by the mix of product sales between higher margin, lower
volume head-end equipment, such as Cable Modem Termination Systems (CMTSs), and
lower margin, higher volume Customer Premise Equipment (CPE), such as modems.
In 2003 we expect that sales of our low-margin CPE will continue to make up a
significant portion of our revenues.

Our operating expenses generally vary from quarter to quarter depending on
the level of actual and anticipated business activities. However, a significant
percentage of these operating expenses are fixed due to operating leases for
our facilities and equipment. Also, we have fixed commitments with some of our
suppliers that require us to purchase minimum quantities of their products at a
specified price. As of March 31, 2003, $30.8 million of purchase obligations
are outstanding. Moreover, our research and development expenses fluctuate in
response to new product development, and changing industry requirements and
customer demands.

We Are Dependent on a Small Number of Customers and our Business Could be
Harmed by the Loss of Any of These Customers or Reductions in Their Purchasing
Volumes.

The markets we serve have undergone and are continuing to undergo
significant consolidation in both North America and internationally, as a
limited number of cable operators control an increasing number of systems. For
example, the top ten cable operators in the United States own and operate
systems that service approximately 81% of homes that receive cable services in
the United States, and the top ten cable operators in Europe own and operate
systems that service approximately 53% of homes that receive cable services in
Europe. As a result of the consolidation among cable operators, our revenue has
been and will continue to be dependent on sales to the few leading cable
operators worldwide and the continued consolidation may also reduce the number
of potential customers. For example, three customers accounted for 50% and 56%
of our total revenues for the three months ended March 31, 2003 and March 31,
2002, respectively. We may not succeed in attracting new customers as many of
our potential customers have pre-existing relationships with our current or
potential competitors and the continued consolidation of the cable industry
reduces the number of potential customers. To attract new customers, we may be
faced with intense price competition, which may affect our gross margins.
Moreover, we do not typically require our customers to purchase a minimum
quantity of our products, and our customers can generally cancel their orders
on short notice without significant penalties. The loss of any of our customers
can have a material adverse effect on our results of operations. Further, any
reduction in orders from a given customer can likewise have a material adverse
affect on our results of operations.

The Sales Cycle for Certain of Our Products Is Lengthy, Which Makes Forecasting
of Our Customer Orders and Revenue Difficult.

The sales cycle for certain of our products, such as our CMTS, is lengthy,
often lasting nine months to more than a year. Our customers generally conduct
significant technical evaluations, including customer trials, of our products
as well as competing products prior to making a purchasing decision. In
addition, purchasing decisions may also be delayed because of our customers
internal budget approval processes. Because of the lengthy sales cycle and the
size of customer orders, if orders forecasted for a specific customer for a
particular period do not occur in that period, our revenues and operating
results for that particular quarter could suffer. Moreover, a portion of our
expenses related to an anticipated order is fixed and difficult to reduce or
change, which may further impact our revenues and operating results for a
particular period.

There Are Many Risks Associated with Our Participation in Industry Standards.

In connection with the development of the DOCSIS 2.0 specification by
Cable Television Laboratories, Inc. a cable industry consortium that
establishes cable technology standards and administers compliance testing
(CableLabs), we entered into an agreement with CableLabs whereby we licensed to

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CableLabs on a royalty-free basis any of our intellectual property rights,
including rights to our proprietary S-CDMA technology, to the extent that such
rights may be asserted against a party desiring to design, manufacture or sell
DOCSIS based products, including DOCSIS 2.0 based products. This license
agreement grants to CableLabs the right to sublicense our intellectual
property, including our intellectual property rights in our S-CDMA patents, to
manufacturers that compete with us in the marketplace for DOCSIS based
products. As a result of this license to CableLabs, our competitors that
produce DOCSIS-based products have access to our technology without having to
pay us any royalties or other compensation for the use of our technology. As a
result of our contribution of technology to the DOCSIS intellectual property
pool, we may have foregone significant revenue from the potential licensing of
our proprietary technology, and we may be unable to recoup the investment in
the research and development efforts to develop the intellectual property
contributed to the DOCSIS technology pool.

Additionally, the agreement that we signed with CableLabs to participate
in the DOCSIS intellectual property pool may make it difficult for us to
enforce our intellectual property rights against other companies. Certain cable
equipment vendors manufacture and sell DOCSIS based and DOCSIS certified and
qualified product without sublicensing from CableLabs the technology in the
CableLabs intellectual property pool. Due to the interests of cable operators
in having as many equipment vendors as possible, we may feel constrained by
competitive pressures from pursuing the enforcement of our intellectual
property rights against our competitors that have not entered into sublicenses
with CableLabs. Moreover, if we seek to enforce our intellectual property
rights against other equipment manufacturers that access technology from the
CableLabs intellectual property pool, our license to the technology in the
pool may be jeopardized. Certain contributors of technology to the CableLabs
intellectual property pool are our competitors and may elect to revoke our
license to their technology if we attempt to enforce our intellectual property
rights against them.

We may have lost any competitive advantage that our proprietary S-CDMA
technology may have provided us in the marketplace by licensing it to
CableLabs, and we may face increased competition because our competitors have
the ability to incorporate our technology into their products. We believe that
this increased competition could come from existing competitors or from new
competitors who enter the market and that such competition is likely to result
in lower product ASPs, which could harm our revenues and gross margins.
Additionally, because our competitors will be able to incorporate our
technology into their products, our current customers may choose alternate
suppliers or choose to purchase DOCSIS-compliant products from multiple
suppliers. We may be unable to effectively compete with the other vendors if we
cannot produce DOCSIS compliant cable products more quickly or at lower cost
than our competitors.

DOCSIS specifications have not yet been accepted in Europe and Asia,
although an increasing number of Asian cable operators are requiring product to
be DOCSIS qualified or certified. An alternate specification for cable
products, called the Euro-DOCSIS specification, has been formalized by
tComLabs, a cable technology consortium of European cable operators, and some
European and Asian cable operators have embraced it. We intend to develop and
sell products that comply with the Euro-DOCSIS specification, which may require
the contribution of certain of our technologies, including our proprietary
S-CDMA technology, to the Euro-DOCSIS specification. We may be unsuccessful in
these efforts, and even if we are successful, we may face some of the same
risks associated with our contribution of intellectual property to CableLabs
DOCSIS intellectual property pool.

We Need to Certify and Qualify Our New and Existing Products to Meet Industry
Specifications in Order to Remain Competitive.

Major cable operators worldwide have endorsed the DOCSIS and PacketCable
specifications and rarely purchase equipment that is not certified or qualified
as compliant with these specifications. Cable operators have chosen to purchase
only products meeting industry specifications because the specifications enable
interoperability among products from multiple vendors, which leads to increased
competition among equipment manufacturers and consequently lowers product ASPs.
Consequently, our future success depends on our ability to compete effectively
in this marketplace by developing, marketing and selling

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products that are certified and qualified to industry standards in a
timely fashion and in a cost effective manner.

The DOCSIS and PacketCable specifications are promulgated by CableLabs.
Currently these specifications have been widely adopted by cable operators in
North America and by some cable operators in Asia, Latin America and Europe.
The Euro-DOCSIS specifications have been developed by tComLabs specifically to
meet the requirements of European operators, and have found some acceptance in
China as well. There is no guarantee that our products will be DOCSIS,
EuroDOCSIS or PacketCable certified or qualified. If we are unable to certify
or qualify our products as DOCSIS, EuroDOCSIS or PacketCable compliant in a
timely manner, we may be unable to sell our products and may lose some or all
of any advantage we might otherwise have had, and our future operating results
may be adversely affected.

Though we sell DOCSIS certified and qualified products, there have been
and may continue to be instances where our existing customers and potential new
customers elect to purchase DOCSIS products from one or more of our competitors
rather than from us. In response to this situation, we have reduced our prices
and continue to experience customer demand to further reduce our prices in
order to promote sales of our current products. This has had and may continue
to have an adverse impact on our revenues, operating results and gross margin.

Developing products to meet these various industry specifications has
several risks. The first is the cost and effort to engineer standards-based
products and to then prepare them for compliance testing. Not only do we have
to certify or qualify new products, but any of our currently certified or
qualified products must be re-certified or re-qualified should they be changed
in any way. Second, there is no guarantee that these products will be certified
or qualified as meeting these specifications in a timely fashion, if ever.
Because most cable operators purchase only those products that have been
certified or qualified as meeting these specifications, it is highly unlikely
that we will be able to sell our products until they achieve certification or
qualification, which can be a lengthy process. As a result, we may incur
significant research and development expenses to develop new products that may
not receive certification or qualification and we cannot recoup the costs of
these research and development expenses by marketing uncertified or unqualified
products. Moreover, a consequence of cable operators only purchasing products
certified or qualified as meeting industry specifications is the increased
competition between equipment vendors, which has resulted in a steady and
ongoing decline in equipment prices as vendors compete for cable operators
business. Third, there is no guarantee that we will be able to support all
future cable industry specifications, which will likely have an adverse impact
on our future revenues.

Average Selling Prices of Broadband Equipment Continue to Decline, Which is
Decreasing Our Gross Margins.

The broadband equipment market has been characterized by erosion of
product ASPs. We expect this erosion to continue. The ASPs for our products are
likely to continue to decline due to competitive pricing pressures, promotional
programs and customers possessing strong negotiating positions who require
price reductions as a condition of purchase. In addition, we believe that the
widespread adoption of industry specifications, such as the DOCSIS and
EuroDOCSIS specifications, is further eroding ASPs as cable modems and other
similar CPE become commodity products. Decreasing ASPs could result in
decreased revenues even if the number of units sold increases. Decreasing ASPs
may also require us to sell our products at much lower gross margin than in the
past, and in fact, we may sell products at a loss. The primary reason that our
gross profits have declined year-over year is the decline in product ASPs. As a
result, we may experience substantial period-to-period fluctuations in future
revenue, gross margin and operating results due to ASP erosion. Therefore, we
must continue to develop and introduce on a timely basis and a cost-effective
manner new products or next-generation products with enhanced functionalities
that can be sold at higher gross margins. Our failure to do this could cause
our revenues and gross margin to decline further.

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We Must Achieve Cost Reductions to Attain Profitability.

As product ASPs and revenue have declined in recent years, we have not
sufficiently decreased our costs, including operating expenses and the costs
associated with our products, to offset declining ASPs and revenue. This has
resulted in increased losses and thus making it difficult for us to attain
profitability. We have experienced a decrease in revenue, which was, in
large part, due to declining product ASPs. In order to achieve profitability,
we must significantly reduce our operating expenses and the cost of our
products.

We have made several attempts to lower our operating expenses. Although we
have implemented expense reduction and restructuring plans in the past,
including the latest restructuring in March 2003, that have focused on cost
reductions and operating efficiencies, we have not been successful in lowering
our operating expenses to keep pace with the decline in revenues, and we cannot
be certain that our future efforts to implement operating expense reduction
will be successful. A large portion of our expenses, including rent, and
operating lease expenditures, is fixed and difficult to reduce or change.
Accordingly, if our revenue does not meet our expectations, we may not be able
to adjust our expenses quickly enough to compensate for the shortfall in
revenue. In that event, our business, financial condition and results of
operations could be materially and adversely affected.

As product ASPs rapidly decline, we need to reduce the cost of our
products through design and engineering changes. We may not be successful in
redesigning our products, and, even if we are successful, our efforts may be
delayed or our redesigned products may contain significant errors and product
defects. In addition, any redesign may not result in sufficient cost reductions
to allow us to reduce significantly the list price of our products or improve
our gross margin. Reductions in our product costs will require us to use
lower-priced components that are highly integrated in future products and may
require us to enter into high volume or long-term purchase or manufacturing
agreements. Volume purchase or manufacturing agreements may not be available on
acceptable terms, if at all, and we could incur significant expenses without
related revenues if we cannot use the products or services offered by such
agreements. We have incurred significant cancellation charges related to volume
purchase and manufacturing agreements in the past and may incur such charges in
the future.

Broadband Services Delivered by Cable Operators Have Not Achieved Widespread
Market Penetration, and Other Competing Service Providers Exist.

Our success will depend upon the widespread penetration of broadband
services delivered by cable television operators. The markets for these
services are growing, but are not fully developed nor exploited. Additionally,
these markets may not grow as cable operators have a limited amount of
available bandwidth over which they can offer new services, such as high-speed
Internet access and telephony. Cable operators may elect not to provide any or
all of these new services to their customers or may not aggressively market
these services to their customers. If cable operators elect not to deploy such
new services or if customers elect not to subscribe to such services, it may
affect our ability to sell products to cable operators as their existing
equipment may meet their current infrastructure demands. We depend on cable
operators to provide new services and maintain their infrastructure in such a
manner that allows us to continue to sell products to them.

Cable operators must also compete with other service providers in the
delivery of services to their customers. CLECs, ILECs, satellite TV and
broadband service providers are aggressively competing with the cable industry
to deliver broadband services via DSL or satellite broadcast technologies. We
cannot accurately predict the future growth rate or the ultimate size of the
market for broadband services delivered via cable. The success of CLECs, ILECs,
satellite TV and other broadband service providers may slow or hamper the
continued acceptance of cable operators in delivering broadband services, which
in turn may impact demand for our products by cable operators.

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We Need to Develop Additional Distribution Channels to Market and Sell Our
Products.

We presently market our products primarily to cable operators worldwide.
To increase worldwide sales of our products, we need to establish new
distribution channels.

We face many challenges in establishing these new distribution channels.
These challenges include, among others, the following:



| |  |  | the ability to hire additional personnel necessary to
establish and enhance these new distribution channels;                                                                           
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the extent to which consumer electronics companies
enter the cable modem market, as their retail distribution
capabilities would provide them with a significant competitive
advantage;
|
| |  |  | the ability to find and train channels to effectively
market our more complex products, such CMTSs and CherryPickers;                                                                  
|
| |  |  | the ability to maintain acceptable margins for our
low margin products, such as cable modems, when sold through a
distributor; and                                                     
|
| |  |  | our potential distribution partners are likely to
prefer purchasing products from larger, more established
manufacturers.                                                              

The vast majority of our sales are to large cable operators. However, we
currently have limited access to smaller or geographically diverse cable
operators. Although we intend to establish strategic relationships with leading
distributors worldwide to access these customers, we may not succeed in
establishing these relationships. Even if we do establish these relationships,
the distributors may not succeed in marketing our products to their customers.
Some of our competitors have already established, long-standing relationships
with these cable operators that may limit our and our distributors ability to
sell our products to those customers. Even if we were to sell our products to
those customers, it would likely not be based on long-term commitments, and
those customers would be able to terminate their relationships with us at any
time without significant penalties.

In addition, we anticipate that the North American cable modem market may
at some point shift to a consumer purchase model. If this occurs, our success
will depend on our ability to effectively sell our products in the consumer
market. We may not have the capital required or the necessary personnel or
expertise to develop these distribution channels. Also, some of our
competitors, including Motorola and Thomson Consumer Electronics, have
well-established retail distribution capabilities and existing brands with
market acceptance that would provide them with a significant competitive
advantage.

Reduced Capital Spending by Cable Operators Could Impact Sales of Our Cable
Products.

Our success and future growth will be subject to economic and other
factors affecting cable operators, particularly their ability to finance
substantial capital expenditures. Capital spending levels in the cable industry
in the United States and internationally have fluctuated significantly in the
past, and we believe that such fluctuations will occur in the future. We are
currently experiencing reduced levels of spending by cable operators. The
capital spending patterns of cable operators are dependent on a variety of
factors, including the following:



| |  |  | the availability of financing;                                                                      
| | - |  | ----------------------------------------------------------------------------------------------------
|
| |  |  | annual budget cycles, as well as the typical
reduction in upgrade projects during the winter months;

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| |  |  | the status of federal, local and foreign government
regulation and deregulation of the telecommunications industry;
| | - |  | -------------------------------------------------------------------------------------------------------------------
|
| |  |  | overall demand for broadband services;                                                                             
|
| |  |  | competitive pressures (including the availability of
alternative data transmission and access technologies);       
|
| |  |  | discretionary consumer spending patterns; and                                                                      
|
| |  |  | general economic conditions.                                                                                       

In recent years, the cable market has been characterized by consolidation.
We cannot predict the effect, if any, that such consolidation will have on
overall capital spending patterns by cable operators. The effect on our
business of further industry consolidation also is uncertain.

We May Fail to Accurately Forecast Customer Demand For Our Products.

The nature of the cable industry makes it difficult for us to accurately
forecast demand for our products. Our inability to forecast accurately the
actual demand for our products may result in too much or too little supply of
products or an over/under capacity of manufacturing or testing resources at any
given point in time. The existence of any one or more of these situations could
have a negative impact on our business, operating results or financial
condition. We had purchase obligations of approximately $30.8 million as of
March 31, 2003, primarily to purchase minimum quantities of materials and
components used to manufacture our products. We must fulfill these obligations
even if demand for our products is lower than we anticipate.

We May Have Financial Exposure to Litigation Against Our Directors and
Officers.

We and/or our directors and officers are defendants in a number of
lawsuits, including securities litigation lawsuits. As a result, we may have
financial exposure to litigation as a defendant and because we are obligated to
indemnify our officers and members of our Board of Directors for certain
actions taken by our officers and directors on our behalf. In order to limit
financial exposure arising from litigation and/or our obligation to indemnify
our officers and directors, we have historically purchased directors and
officers insurance (D&O Insurance). However, the availability of D&O Insurance
is becoming more difficult for companies to attain as a number of insurance
underwriters no longer offer D&O Insurance and the remaining insurance
underwriters offering D&O Insurance have significantly increased the premiums
of such coverage. During 2002, we experienced a significant increase in the
cost of our D&O Insurance, and there can be no assurance that D&O Insurance
will be available to us in the future or, if D&O Insurance is available, it may
be prohibitively expensive.

Additionally, some insurance underwriters who offered D&O Insurance in the
past have been placed into liquidation or may be, at some future point, placed
into liquidation. In October 2001, one of the insurance underwriters from which
we purchased D&O Insurance, Reliance Insurance Co. (Reliance), was placed into
liquidation by the state of Pennsylvania. Reliance was the underwriter for one
excess layer of our D&O Insurance for the period covering the claims made
against us and our officers in the pending securities litigation. Because
Reliance is in liquidation, we will be responsible for the amount insured under
the Reliance policy, which is approximately $2.5 million.

We Are Dependent on Key Third-Party Suppliers and Any Failure by Them to
Deliver Components Could Limit Our Ability to Satisfy Customer Demand.

We manufacture all of our products using components or subassemblies
procured from third-party suppliers. Some of these components are available
from a sole source and others are available from limited sources. A majority of
our sales are from products containing one or more components that are
available only from sole source suppliers. Additionally, some of our components
are custom parts that are produced

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to our specifications, and it may be difficult to move the manufacturing
of such components from one vendor to another vendor.

Any interruption in the operations of our vendors of sole source or custom
product parts could adversely affect our ability to meet our scheduled product
deliveries to customers. If we are unable to obtain a sufficient supply of
components from our current sources, we could experience difficulties in
obtaining alternative sources or in altering product designs to use alternative
components. Resulting delays or reductions in product shipments could damage
customer relationships and expose us to potential damages that may arise from
our inability to supply our customers with products. Further, a significant
increase in the price of one or more of these components could harm our gross
margin or operating results.

We May Be Unable to Migrate to New Semiconductor Process Technologies
Successfully or on a Timely Basis.

Our future success will depend in part upon our ability to develop
products that utilize new semiconductor process technologies. These
technologies change rapidly and require us to spend significant amounts on
research and development. We continuously evaluate the benefits of redesigning
our integrated circuits using smaller geometry process technologies to improve
performance and reduce costs. The transition of our products to integrated
circuits with increasingly smaller geometries will be important to our
competitive position. Other companies have experienced difficulty in migrating
to new semiconductor processes and, consequently, have suffered reduced yields,
delays in product deliveries and increased expense levels. Moreover, we depend
on our relationship with our third-party manufacturers to migrate to smaller
geometry processes successfully.

Our Ability to Directly Control Product Delivery Schedules and Product Quality
Is Dependent on Third-Party Contract Manufacturers.

Most of our products are assembled and tested by contract manufacturers
using testing equipment that we provide. Currently, our modems are sole sourced
from our manufacturer in Thailand. As a result of our dependence on these
contract manufacturers for the assembly and testing of our products, we do not
directly control product delivery schedules or product quality. Any product
shortages or quality assurance problems could increase the costs of
manufacturing, assembling or testing our products. In addition, as
manufacturing volume increases, we will need to procure and assemble additional
testing equipment and provide it to our contract manufacturers. The production
and assembly of testing equipment typically requires significant lead times. We
could experience significant delays in the shipment of our products if we are
unable to provide this testing equipment to our contract manufacturers in a
timely manner.

There Are Many Risks Associated with International Operations.

We expect sales to customers outside of the United States to continue to
represent a significant percentage of our revenues for the foreseeable future.
For the three months ended March 31 2003 and March 31, 2002, approximately 41%,
and 86%, respectively, of our net revenues were from customers outside of the
U.S. International sales are subject to a number of risks, including the
following:



| |  |  | changes in foreign government regulations and communications standards;
| | - |  | -----------------------------------------------------------------------
|
| |  |  | export license requirements, tariffs and taxes;                        
|
| |  |  | trade barriers;                                                        
|
| |  |  | difficulty in protecting intellectual property;                        
|
| |  |  | difficulty in collecting accounts receivable;                          
|
| |  |  | currency fluctuations;                                                 

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| |  |  | difficulty in managing foreign operations; and
| | - |  | ----------------------------------------------
|
| |  |  | political and economic instability.           

If our customers are affected by currency devaluations or general economic
downturns, such as the economic downturns affecting many Asian, European and
Latin American economies, their ability to purchase our products could be
reduced significantly. Payment cycles for international customers typically are
longer than those for customers in North America. Foreign countries may decide
to prohibit, terminate or delay the construction of new cable infrastructures
for a variety of reasons. These reasons include environmental issues, economic
downturns and availability of favorable pricing for other communications
services or the availability and cost of related equipment. Any action like
this by foreign countries would reduce the market for our products.

While we generally invoice our foreign sales in U.S. dollars, we invoice
the majority of our sales in Europe in Euros. Since we have also elected to
take payment in Euros from our customers in Europe and may elect to take
payment in other foreign currencies, we are exposed to losses as the result of
foreign currency fluctuations. We currently do not engage in foreign currency
hedging transactions. We may in the future choose to limit our exposure by the
purchase of forward foreign exchange contracts or through similar hedging
strategies. No currency hedging strategy can fully protect against
exchange-related losses. In addition, if the relative value of the U.S. dollar
in comparison to the currency of our foreign customers should increase, the
resulting effective price increase of our products to those foreign customers
could result in decreased sales.

Our Business May Be Affected By Conditions In Israel.

We have significant operations in Israel. Our operations in Israel consist
primarily of research and development, and to a lesser extent sales and
manufacturing. Revenues generated by our business in Israel were $0.8 million
and $5.1 million for the three months ending March 31, 2003 and March 31, 2002,
respectively. Our research and development operations may be significantly
affected by conditions in Israel. Since the establishment of the State of
Israel in 1948, a number of armed conflicts have taken place between Israel and
its Arab neighbors and a state of hostility, varying in degree and intensity,
has led to security and economic problems for Israel. Hostilities within Israel
have continued to escalate over the past year, which could disrupt some of our
operations. We could be adversely affected by any major hostilities involving
Israel. As a result of the hostilities and unrest presently occurring within
Israel, the future of the peace efforts between Israel and its Arab neighbors
is uncertain. A number of our employees based in Israel are currently obligated
to perform annual military reserve duty and are subject to being called to
active duty at any time under emergency circumstances. We cannot assess the
full impact of these requirements and the hostilities on our workforce,
business or operations if conditions should change, and we cannot predict the
effect of any expansion or reduction of these obligations or the hostilities.

We May Be Unable to Provide Adequate Customer Support.

Our ability to achieve our planned sales growth and retain current and
future customers will depend in part upon the quality of our customer support
operations. Our customers generally require significant support and training
with respect to our products, particularly in the initial deployment and
implementation stages. Spikes in demand of our support services may cause us to
be unable to serve our customers. We may not have adequate personnel to provide
the levels of support that our customers may require during initial product
deployment or on an ongoing basis especially during peak periods. Our inability
to provide sufficient support to our customers could delay or prevent the
successful deployment of our products. In addition, our failure to provide
adequate support could harm our reputation and relationships with our customers
and could prevent us from selling product to existing customers or gaining new
customers.

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Our Industry Is Highly Competitive with Many Established Competitors.

The market for our products is extremely competitive and is characterized
by rapid technological change. Our direct competitors include Cisco Systems,
ADC, Arris, BigBand Networks, Juniper Networks, Com21, Motorola, Thomson
Consumer Electronics (which markets products under the brand name RCA),
Scientific-Atlanta and Toshiba. We also compete with companies that develop
integrated circuits for broadband products, such as Broadcom, Conexant and
Texas Instruments. The principal competitive factors in our market include the
following:



| |  |  | product performance, features and reliability;        
| | - |  | ------------------------------------------------------
|
| |  |  | price;                                                
|
| |  |  | size and stability of operations;                     
|
| |  |  | breadth of product line;                              
|
| |  |  | sales and distribution capabilities;                  
|
| |  |  | technical support and service;                        
|
| |  |  | relationships with providers of service providers; and
|
| |  |  | compliance with industry standards.                   

Some of these factors are outside of our control. Conditions in the market
could change rapidly and significantly as a result of technological
advancements. The development and market acceptance of alternative technologies
could decrease the demand for our products or render them obsolete. Our
competitors may introduce products that are less costly, provide superior
performance or achieve greater market acceptance than our products.

Many of our current and potential competitors have greater financial,
technical, marketing, distribution, customer support and other resources, as
well as better name recognition and access to customers than we do. The
widespread adoption of DOCSIS and other industry standards has and is likely to
continue to cause increased price competition. We believe that the adoption of
these standards have resulted in and are likely to continue to result in lower
ASPs for our products. Any increased price competition or reduction in sales of
our products, particularly our higher margin head-end products, has resulted
and will continue to result in decreased revenue and downward pressure on our
gross margin. These competitive pressures have and are likely to continue to
adversely impact our business.

We Are Dependent on Key Personnel.

Due to the specialized nature of our business, we are highly dependent on
the continued service of, and on the ability to attract and retain, qualified
engineering, sales, marketing and senior management personnel. The competition
for some of these personnel is intense. The loss of any of these individuals
may harm our business. In addition, if we are unable to hire qualified
personnel as needed, we may be unable to adequately manage and grow our
business.

Highly skilled employees with the education and training that we require,
especially employees with significant experience and expertise in both data
networking and radio frequency design, are in high demand. We may be unable to
continue to attract and retain qualified personnel necessary for the
development of our business. We do not have key person insurance coverage for
the loss of any of our employees. Any officer or employee can terminate his or
her relationship with us at any time. Our employees are not bound by
non-competition agreements with us.

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Our Business Is Subject to the Risks of Product Returns, Product Liability and
Product Defects.

Products like ours are very complex and can frequently contain undetected
errors or failures, especially when first introduced or when new versions are
released. Despite testing, errors may occur. The occurrence of errors could
result in product returns and other losses to us and/or our customers. This
occurrence could result in the loss of or delay in market acceptance of our
products. We have limitation of liability provisions in our standard terms and
conditions of sale. However, these terms and conditions may not be effective as
a result of federal, state or local laws or ordinances or unfavorable judicial
decisions in the United States or other countries. The sale and support of our
products entails the risk of product liability claims. In addition, any failure
by our products to properly perform could result in claims against us by our
customers. We maintain insurance to protect against certain claims associated
with the use of our products, but our insurance coverage may not adequately
cover any claim asserted against us. In addition, even claims that ultimately
are unsuccessful could result in our expenditure of funds in litigation and
divert managements time and other resources.

We May Be Unable to Adequately Protect or Enforce Our Intellectual Property
Rights.

We rely on a combination of patent, trade secret, copyright and trademark
laws and contractual restrictions to establish and protect proprietary rights
in our products. Even though we seek to establish and protect proprietary
rights in our products, there are risks. Our pending patent applications may
not be granted.

Even if they are granted, the claims covered by any patent may be reduced
from those included in our applications. Any patent might be subject to
challenge in court and, whether or not challenged, might not be broad enough to
prevent third parties from developing equivalent technologies or products
without a license from us.

We also believe that companies may be increasingly subject to infringement
claims as distressed companies and individuals attempt to generate cash by
enforcing their patent portfolio against a wide range of products. We have
received a letter from a company claiming that our technology and products
infringe on its patents. We have consulted with our patent counsel and are in
the process of reviewing the allegations made by such company. There can be no
assurance that, if the issue were to be submitted to a court, such court would
not find that our products infringe the patents, nor that the company will not
continue to allege infringement. If we are found to have infringed such
companys patents, we could be subject to substantial damages and/or an
injunction preventing us from conducting our business. Additionally, there can
be no assurance that other third parties will not assert infringement claims
against us in the future. Any such claim, whether meritorious or not, could be
time-consuming, result in costly litigation, cause product shipment delays or
require us to enter into royalty or licensing agreements. Such royalty or
licensing agreements may not be available on terms acceptable to us or at all,
which could have a material adverse effect upon our business, operating results
and financial condition.

We have entered into confidentiality and invention assignment agreements
with our employees, and we enter into non-disclosure agreements with many of
our suppliers, distributors and appropriate customers so as to limit access to
and disclosure of our proprietary information. These contractual arrangements,
as well as statutory protections, may not prove sufficient to prevent
misappropriation of our trade secrets or technology or deter independent
third-party development of similar technologies. In addition, the laws of some
foreign countries may not protect our intellectual property rights to the same
extent as do the laws of the United States.

CableLabs DOCSIS 2.0 specification includes two modulation techniques,
S-CDMA and A-TDMA. In connection with the development of the DOCSIS 2.0
specification by CableLabs, we entered into an agreement with CableLabs, on a
royalty-free basis, whereby we licensed to CableLabs many of our intellectual
property rights to the extent that such rights may be asserted against a party
desiring to design, manufacture or sell DOCSIS-based products, including DOCSIS
2.0-based products. This license agreement grants to CableLabs the right to
sublicense our intellectual property, including our intellectual

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property rights in our S-CDMA patents, to manufacturers that compete with
us in the marketplace for DOCSIS based products.

We pursue the registration of our trademarks in the United States and have
applications pending to register several of our trademarks throughout the
world. However, the laws of certain foreign countries might not protect our
products or intellectual property rights to the same extent as the laws of the
United States. Effective trademark, copyright, trade secret and patent
protection may not be available in every country in which our products may be
manufactured, marketed or sold.

Our Business and Our Customers Are Subject to Regulation.

Our business and customers are subject to varying degrees of regulation by
regulatory bodies in the United States and foreign countries. Although these
regulations have not materially restricted our operations to date or the
operations of our customers, future regulations applicable to our business or
customers could be adopted. The adoption of future regulations may adversely
affect our customers, our ability to sell our products and therefore our
operating results.

Our Products Are Subject to Safety Approvals and Certifications.

In the United States, our products are required to meet certain safety
requirements. For example, we are required to have our products certified by
Underwriters Laboratory in order to meet federal requirements relating to
electrical appliances to be used inside the home. Outside the United States,
our products are subject to the regulatory requirements of each country in
which the products are manufactured or sold. These requirements are likely to
vary widely. We may be unable to obtain on a timely basis or at all the
regulatory approvals that may be required for the manufacture, marketing and
sale of our products.

We Are Vulnerable to Earthquakes, Labor Issues and Other Unexpected Events.

Our corporate headquarters, as well as the majority of our research and
development activities and some manufacturing operations are located in
California, an area known for seismic activity. In addition, the operations of
some of our key suppliers are also located in this area and in other areas
known for seismic activity, such as Taiwan. An earthquake, or other significant
natural disaster, could result in an interruption in our business or the
operations of one or more of our key suppliers. Our business may also be
impacted by labor issues related to our operations and/or those of our
suppliers, service providers, or customers. Such an interruption could harm our
operating results. We may not carry sufficient business interruption insurance
to compensate for any losses that we may sustain as a result of any natural
disasters or other unexpected events.

Our Indebtedness Could Adversely Affect our Financial Condition; We May Incur
Substantially More Debt.

As of March 31, 2003, we had approximately $68.9 million of long-term
obligations. This level of indebtedness may adversely affect our stockholders
by:



| |  |  | making it more difficult for us to satisfy our obligations with respect to our indebtedness;                                                                                                                                                                                                                     
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increasing our vulnerability to general adverse economic and industry conditions;                                                                                                                                                                                                                                
|
| |  |  | limiting our ability to obtain additional financing;                                                                                                                                                                                                                                                             
|
| |  |  | requiring the dedication of a substantial portion of our cash
flow from operations to the payment of principal of, and interest
on, our indebtedness, thereby reducing the availability of our cash
flow to fund our growth strategy, working capital, capital
expenditures and other general corporate purposes;

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| |  |  | limiting our flexibility in planning for, or reacting to,
changes in our business and the industry; and
| | - |  | -------------------------------------------------------------------------------------------------------
|
| |  |  | placing us at a competitive disadvantage relative to our
competitors with less debt.                   

We may incur substantial additional debt in the future. The terms of our
outstanding debt do not fully prohibit us from doing so. If new debt is added
to our current levels, the related risks described above could intensify.

Our Stock Price Has Been and Is Likely to Continue To Be Highly Volatile.

The trading price of our common stock has been and is likely to continue
to be highly volatile. Our stock price could be subject to extreme fluctuations
in response to a variety of factors, including the following:



| |  |  | actual or anticipated variations in quarterly operating results;                                                         
| | - |  | -------------------------------------------------------------------------------------------------------------------------
|
| |  |  | announcements of technological innovations;                                                                              
|
| |  |  | new products or services offered by us or our competitors;                                                               
|
| |  |  | changes in financial estimates by securities analysts;                                                                   
|
| |  |  | conditions or trends in the broadband services industry;                                                                 
|
| |  |  | changes in the economic performance and/or market valuations of
Internet, online service or broadband service industries;
|
| |  |  | our announcement of significant acquisitions, strategic
partnerships, joint ventures or capital commitments;             
|
| |  |  | adoption of industry standards and the inclusion or
compatibility of our technology with such standards;                 
|
| |  |  | adverse or unfavorable publicity regarding us or our products;                                                           
|
| |  |  | additions or departures of key personnel;                                                                                
|
| |  |  | sales of common stock; and                                                                                               
|
| |  |  | other events or factors that may be beyond our control.                                                                  

In addition, the stock markets in general, and the NASDAQ National Market
and the stock price of broadband services and technology companies in
particular, have experienced extreme price and volume volatility and a
significant cumulative decline since the second quarter of 2000. This
volatility and decline has affected many companies irrespective of or
disproportionately to the operating performance of these companies.
Additionally, industry factors may materially adversely affect the market price
of our common stock, regardless of our actual operating performance.

Threatened Terrorist Attacks May Negatively
Impact All Aspects of Our Operations, Revenues, Costs and Stock Price.

The events of September 11, 2001, as
well as future events occurring in response to or in connection with them,
including, without limitation, future terrorist attacks against United States
targets, or military or trade disruptions impacting our domestic or foreign
suppliers of components required for the manufacturing of our products, may
cause delays or losses of customer orders.

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More generally, any of these events could cause consumer confidence and
spending to decrease or result in increased volatility in the United States and
worldwide financial markets and economic. They also could result in economic
recession in the United States or abroad. Any of these occurrences could have a
significant impact on our operating results, revenues and costs.

We May Not Be Able to Raise Additional Funds to Continue Operating Our
Business.

Our main source of liquidity continues to be our unrestricted cash on
hand. In addition and as a result of our history of operating losses, we expect
to continue to use our unrestricted cash to fund operating losses in the
future. We believe that our current unrestricted cash on hand should be
adequate to fund our working capital needs through at least the next twelve
months. However, if our operating losses are more severe than expected or
continue longer than expected, we may find it necessary or desirable to seek
other sources of financing to support our capital needs and provide available
funds for working capital. Given the current state of the telecommunications
industry (including equipment manufacturers that supply products to the
telecommunications industry) and the capital markets, there are few available
sources of financing. Commercial bank financing may not be available to us on
acceptable terms. Accordingly, any plan to raise additional capital, if
available to us, would likely involve an equity-based or equity-linked
financing, such as the issuance of convertible debt, common stock or preferred
stock, which would be dilutive to our stockholders. If we are unable to procure
additional working capital, as necessary, we may be unable to continue
operations.

Our Restructuring Efforts Could Result in the Erosion of Employee Morale, Legal
Actions Against Us and Management Distractions, and Could Impair Our Ability to
Respond Rapidly to Growth Opportunities in the Future.

As a result of the significant economic downturn and the related
uncertainties in the technology sector, we have implemented a number of
restructuring plans, including the most recent in March 2003, which has
resulted in personnel reduction. These reductions could result in an erosion of
morale, and affect the focus and productivity of our remaining employees,
including those directly responsible for revenue generation, which in turn may
affect our revenue in the future. Additionally, employees directly affected by
the reductions may seek future employment with our business partners, customers
or competitors. Although all employees are required to sign a proprietary
information agreement with us at the time of hire, there can be no assurances
that the confidential nature of our proprietary information will be maintained
in the course of such future employment. Additionally, we may face wrongful
termination, discrimination, or other claims from employees affected by the
reduction related to their employment and termination. We could incur
substantial costs in defending ourselves or our employees against such claims,
regardless of the merits of such actions. Furthermore, such matters could
divert the attention of our employees, including management, away from our
operations, harm productivity, harm our reputation and increase our expenses.
We cannot assure you that our restructuring efforts will be successful, and we
may need to take additional restructuring efforts, including additional
personnel reduction, in the future.

We May Dispose of Existing Product Lines, Which May Adversely Impact Our Future
Results.

On an ongoing basis, we evaluate our various product offerings in order to
determine whether any should be discontinued or, to the extent possible,
divested. Moreover, the worldwide downturn in the telecommunications industry
led us to reassess our business strategy, which in turn caused us to
discontinue investment in certain product lines. For example, we have reduced
our investment in the telecom and satellite spaces and discontinued our
Internet-over-Satellite product line. We cannot assure you that we correctly
forecasted the right product lines to discontinue or that our decision to
discontinue various investments and product lines is prudent if market
conditions change. In addition, we cannot assure you that the discontinuance of
various product lines will reduce our operating expenses. Furthermore, future
plans to discontinue existing product lines entail various risks, including the
risks that we will not be able to find a buyer for a product line or the
purchase price obtained will not be equal to the book value of the assets for
the product line.

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Products Currently Under Development May Fail to Realize Anticipated Benefits.

The markets in which we operate are characterized by rapidly changing
technologies, evolving industry standards, frequent new product introductions
and relatively short product life. The pursuit of necessary technological
advances and the development of new products require substantial time and
expense. For example, we made ten acquisitions during the period between 1999
and 2000. Due to various economic conditions, none of the products from our
acquired businesses have achieved the level of market acceptance that was
forecasted at the time of their acquisitions. Additionally, certain product
groups have not achieved the level of technological development needed to be
marketable or to expand the market. As a result, we recorded an aggregate of
approximately $576.8 million related to impairment charges and
write-down of in-process research and development related to the acquired
technologies, both of which negatively impacted our operating results. We
cannot assure you that technologies currently under development will achieve
feasibility or that even if we are successful, the developed product will be
accepted by the market. We may not be able to recover the costs of existing and
future product developments and our failure to do so may materially and
adversely impact our business, financial condition and results of operations.

We Are Exposed to the Credit Risk of Our Customers and to Credit Exposures in
Weakened Markets, Which Could Result in Material Losses.

Most of our sales are on an open credit basis, with payment terms of 30
days typically in the United States, and because of local customs or
conditions, longer in some markets outside the United States. We monitor
individual customer payment capability in granting such an open credit
arrangement, seek to limit such open credit to amounts we believe the customers
can pay and maintain reserves we believe are adequate to cover exposure for
doubtful accounts. Beyond our open credit arrangements, we have also
experienced a request for customer financing and facilitation of leasing
arrangements, which we have not provided to date and do not expect to provide
in the future. We expect demand for enhanced open credit terms, for example,
longer payment terms, customer financing and leasing arrangements to continue
and believe that such arrangements are a competitive factor in obtaining
business. Our decision not to provide these types of financing arrangements may
adversely affect our ability to sell product, and therefore, our revenue,
operations and business.

Because of the current slowdown in the global economy, our exposure to
credit risks relating to sales on an open-credit basis has increased. Although
we monitor and attempt to mitigate the associated risk, including monitoring
customers located in certain geographic areas, there can be no assurance that
our efforts will be effective in reducing credit risk. Additionally, there have
been significant insolvencies and bankruptcies among our customers, which have
and may continue to cause us to incur economic and financial losses. For
example, we recorded a loss of $0.9 million related to the settlement of all
outstanding accounts receivables due from Net Servicos, a customer. There can
be no assurance that additional losses would not be incurred and that such
losses would not be material. Although these losses have generally not been
material to date, future losses, if incurred, could harm our business and have
a material adverse effect on our operating results and financial condition.

We Have and We May Seek to Expand Our Business Through Acquisitions;
Acquisitions Could Disrupt Our Business Operations and Harm Our Operating
Results.

In order to expand our business, we may make strategic acquisitions of
other companies. We plan to continue to evaluate opportunities for strategic
acquisitions from time to time, and may make an acquisition at some future
point. However, the current volatility in the stock market and the current
price of our common stock may adversely affect our ability to make such
acquisitions.

Any acquisition that we make involves substantial risks, including the
following:



| |  |  | difficulties in integrating the operations,
technologies, products and personnel of an acquired company;
| | - |  | --------------------------------------------------------------------------------------------------------

41



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| |  |  | diversion of managements attention from normal daily
operations of the business;                                                                            
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | potential difficulties in completing projects
associated with in-process research and development;                                                           
|
| |  |  | difficulties in entering markets in which we have no
or limited direct prior experience and where competitors in such
markets have stronger market positions;
|
| |  |  | initial dependence on unfamiliar supply chains or relatively small supply partners;                                                                          
|
| |  |  | insufficient revenues to offset increased expenses associated with acquisitions; and                                                                         
|
| |  |  | the potential loss of key employees of the acquired companies.                                                                                               

Acquisitions may also cause us to:



| |  |  | issue common stock that would dilute our current stockholders percentage ownership;                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | assume liabilities;                                                                                                                        
|
| |  |  | 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; or                                                                                                   
|
| |  |  | become subject to litigation.                                                                                                              

Mergers and acquisitions of high-technology companies are inherently
risky, and no assurance can be given that our future acquisitions will be
successful and will not materially adversely affect our business, operating
results or financial condition. Failure to manage and successfully integrate
acquisitions we make could harm our business and operating results in a
material way. Even when an acquired company has already developed and marketed
products, there can be no assurance that product enhancements will be made in a
timely fashion or that all pre-acquisition due diligence will have identified
all possible issues that might arise with respect to such products.

We made ten acquisitions during the period between 1999 and 2000. Due to
various economic conditions, none of the products from our acquired businesses
have achieved the level of market acceptance that was forecasted at the time of
their acquisitions. Additionally, certain product groups have not achieved the
level of technological development needed to be marketable or to expand the
market. We recorded impairment losses of approximately $4.0 million and $572.8
million of intangible assets related to these acquisitions in December 31, 2002
and 2001. As of March 31, 2003, no intangible assets from these acquisitions
remain.

We Have Adopted a Stockholder Rights Plan, Which, Together With Provisions in
Our Charter Documents and Delaware Law, May Delay or Prevent an Acquisition of
Us, Which Could Decrease the Value of Our Stock.

We adopted a stockholder rights plan pursuant to which we distributed one
right for each outstanding share of common stock held by stockholders of record
as of February 20, 2001. Because the rights may substantially dilute the stock
ownership of a person or group attempting a take-over of us, even if such a
change in control is beneficial to our stockholders, without the approval of
our board of directors, the plan could make it more difficult for a third party
to acquire us, or a significant percentage of our

42



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##### Table of Contents



outstanding capital stock, without first negotiating with our board of
directors. Additionally, provisions of our Certificate of Incorporation and our
Bylaws could make it more difficult for a third party to acquire control of us
in a transaction not approved by our Board of Directors, and we have also opted
out of the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which could also have the effect of delaying or preventing our
acquisition by a third party.

Various Export Licensing Requirements Could Materially and Adversely Affect Our
Business or Require Us to Significantly Modify Our Current Business Practices.

Various government export regulations may apply to the encryption or other
features of our products. We may have to make certain filings with the
government in order to obtain permission to export certain of our products. In
the past, we may have inadvertently failed to file certain export applications
and notices, and we may have to make certain filings and request permission to
continue exportation of any affected products without interruption while these
applications are pending. If we do have to make such filings, we cannot assure
you that we will obtain permission to continue exporting the affected products
or that we will obtain any required export approvals now or in the future. If
we do not receive the required export approvals, we may be unable to ship those
products to certain customers located outside of the United States. In
addition, we may be subject to fines or other penalties due to the failure to
file certain export applications and notices.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk.

Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. The primary objective of our investment
activities is to preserve principal while maximizing yields without
significantly increasing risk. This is accomplished by investing in widely
diversified short-term investments, consisting primarily of investment grade
securities, substantially all of which mature within the next twenty-four
months. A hypothetical 50 basis point increase in interest rates would result
in an approximate $161,000 decline (less than 1%) in the fair value of our
available-for-sale securities.

Foreign Currency Risk.

A substantial majority of our revenue, expense and capital purchasing
activity are transacted in U.S. dollars. However, we do enter into transactions
from Belgium, United Kingdom, Hong Kong, Canada, and Israel
denominated in local currencies. A hypothetical
adverse change of 10% in exchange rates would result in a decline in income
before taxes of approximately $0.5 million.

All of the potential changes noted above are based on sensitivity analyses
performed on our financial positions at March 31, 2003. Actual results may
differ materially.




ITEM 4. CONTROL AND PROCEDURES

Within the 90 days prior to the date of filing this Quarterly Report on
Form 10-Q, we carried out an evaluation, under the supervision and with the
participation of management, including the Chief Executive Officer and the
Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14.
Based upon that evaluation, the Chief Executive Officer and the Chief Financial
Officer concluded that our disclosure controls and procedures are effective in
timely alerting them to material information relating to us (including its
consolidated subsidiaries) which is required to be included in our periodic SEC
filings. Subsequent to the date of that evaluation, there have been no
significant changes in our internal controls or in other factors that could
significantly affect internal controls, nor were any corrective actions
required with regard to significant deficiencies and material weaknesses.

43



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##### Table of Contents



It should be noted that the design of any system of controls is based in
part upon certain assumptions. There can be no assurance that any design will
succeed in achieving its stated goals under all potential conditions,
regardless of how remote.




PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

See Litigation under Part I, Item 2, Managements Discussion and Analysis of
Financial Condition and Results of Operations.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None




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

None




ITEM 5. OTHER INFORMATION

Due to a typographical error,
the Summary Compensation Table in the Company's Proxy Statement on Schedule 14A relating
to the 2003 Annual Stockholders Meeting incorrectly stated that Dr. Rakib and Mr. Rakib each
received a stock option to purchase 800,000 shares of the Company's common stock during the
fiscal year ended December 31, 2002. Dr. Rakib and Mr. Rakib actually received no stock option
grants in fiscal 2002. The following table shows the correct 2003 Summary Compensation Table
that should have been included in the Proxy Statement:

Compensation of Executive Officers

Summary of Compensation

The following table shows for the fiscal years ended
December 31, 2002, 2001 and 2000, compensation awarded or
paid to, or earned by, the Companys Chief Executive
Officer and its other two most highly compensated executive
officers at December 31, 2002 (Named Executive Officers).
There were no other Named Executive Officers of the Company
during 2002.

Summary Compensation Table

|                            |  |      |      |                     |  |        |         |              |  |                         |         |          |  |           |   |              |  |  |        |     |  |  |         |     |  |  |   |  |  |  |         |          
|--------------------------- |  | ---- | ---- | ------------------- |  | ------ | ------- | ------------ |  | ----------------------- | ------- | -------- |  | --------- | - | ------------ |  |  | ------ | --- |  |  | ------- | --- |  |  | - |  |  |  | ------- | ---------
|                            |  |      |      |                     |  |        |         |              |  |                         |         |         
|                            |  |      |      |                     |  |        |         |              |  | Long-Term Compensations |         |         
|                            |  |      |      |                     |  |        |         |             
|                            |  |      |      | Annual Compensation |  | Awards |         | Payouts     
|                            |  |      |      |                     |  | Other  |         | Restricted   |  | Securities              |         |          |  |          
|                            |  |      |      |                     |  | Annual |         | Stock        |  | Underlying              |         | LTIP     |  | All Other
|                            |  |      |      | Salary              |  | Bonus  |         | Compensation |  | Awards                  |         | Options/ |  | Payouts   |   | Compensation
|Name and Principal Position |  | Year |      | ($)                 |  | ($)    |         | ($)          |  | ($)                     |         | SARs (#) |  | ($)       |   | ($)         
|                           
|Dr. Zaki Rakib              |  |      | 2002 |                     |  |        | 450,000 |              |  |                         |        |          |  |           |  |              |  |  |       |     |  |  |        |     |  |  |  |  |  |  | 25,500  | (1)(3)   
|Chief Executive             |  |      | 2001 |                     |  |        | 450,000 |              |  |                         |        |          |  |           |  |              |  |  | 44,374 | (8) |  |  | 800,000 | (8) |  |  |  |  |  |  | 136,630 | (1)(2)(4)
|Officer and                 |  |      | 2000 |                     |  |        | 450,000 |              |  |                         | 105,000 |          |  |           |  |              |  |  |       |     |  |  | 800,000 | (8) |  |  |  |  |  |  |        |          
|Secretary                   |  |      |      |                     |  |        |         |              |  |                         |         |          |  |           |   |              |  |  |        |     |  |  |         |     |  |  |   |  |  |  |         |          
|                           
|Mr. Shlomo Rakib            |  |      | 2002 |                     |  |        | 450,000 |              |  |                         |        |          |  |           |  |              |  |  |       |     |  |  |        |     |  |  |  |  |  |  | 450     | (3)      
|Chairman of the             |  |      | 2001 |                     |  |        | 450,000 |              |  |                         |        |          |  |           |  |              |  |  | 44,374 | (8) |  |  | 800,000 | (8) |  |  |  |  |  |  | 95,324  | (2)(4)   
|Board and President         |  |      | 2000 |                     |  |        | 450,000 |              |  |                         | 105,000 |          |  |           |  |              |  |  |       |     |  |  | 800,000 | (8) |  |  |  |  |  |  |        |          
|                           
|Carol W. Lustenader         |  |      | 2002 |                     |  |        | 226,667 | (5)          |  |                         |        |          |  |           |  |              |  |  |       |     |  |  |        |     |  |  |  |  |  |  | 469     | (3)      
|Chief Financial             |  |      | 2001 |                     |  |        | 180,833 | (5)          |  |                         |        |          |  |           |  |              |  |  | 78,649 |     |  |  | 127,002 | (9) |  |  |  |  |  |  | 3,469   | (4)(6)   
|Officer(7)                  |  |      | 2000 |                     |  |        | 130,395 |              |  |                         | 26,918  |          |  |           |  |              |  |  |       |     |  |  |        |     |  |  |  |  |  |  |        |          
|                           



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes $25,200 and $24,700 of compensation paid by the Company
    on behalf of Dr. Rakib for an apartment in Israel in 2002
    and 2001, respectively. In 2002, Dr. Rakib paid $35,000 to
    reimburse the Company for his cost related to personal usage of
    a corporate aircraft calculated in accordance with Internal
    Revenue Service guidelines. This amount is not included in All
    Other Compensation above, and may not be sufficient to cover all
    of the costs associated with his personal usage of the corporate
    aircraft in 2002.                                                                                                                                                                                                                                                                                                                                                                              
|   
|(2) | Includes $111,630 of accrued and unused vacation paid to
    Dr. Rakib in 2001 and $95,024 for accrued and unused
    vacation paid out to Mr. Rakib in 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(3) | Includes $300, $450, and $469 contributed by the Company for
    premiums under a group term life insurance policy on behalf of
    Dr. Rakib, Mr. Rakib, and Ms. Lustenader,
    respectively, in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(4) | Includes $300, $300, and $469 contributed by the Company for
    premiums under a group term life insurance policy on behalf of
    Dr. Rakib, Mr. Rakib, and Ms. Lustenader,
    respectively, in 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(5) | On an annualized basis, Ms. Lustenaders salary was
    $220,000 in 2002 and $180,000 in 2001. She received compensation
    for retroactive salary increases of $6,667 in 2002 and $833 in
    2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   
|(6) | Includes $3,000 of compensation paid to Ms. Lustenader
    through the Companys Employee Referral Program.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(7) | Ms. Lustenader resigned as the Companys Chief
    Financial Officer as of February 23, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(8) | On February 14, 2001, Dr. Rakib and Mr. Rakib
    each received a stock option grant for 800,000 shares of
    common stock at a price per share of $6.81. In November 2001, the
    Companys Board of Directors approved a stock option
    exchange offer, which permitted employees and members of the
    Board of Directors to exchange all stock options with an
    exercise price per share equal to or greater than $9.00 for a
    common stock award. Both Dr. Rakib and Mr. Rakib
    participated in the Companys stock option exchange offer.
    On December 5, 2001, Dr. Rakib and Mr. Rakib each cancelled stock
options grants for 800,000 shares of common stock at a price per
share of $81.38. On December 6, 2001, Dr. Rakib and Mr. Rakib each
    received 3,136 shares of common stock in connection with the
    stock option exchange offer and those shares of common stock had
    a value of $44,374 on that date.
|   
|(9) | On February 14, 2001, Ms. Lustenader received a stock
    option grant for 83,002 shares of common stock at a price per
    share of $6.81. In November 2001, the Companys Board of
    Directors approved a stock option exchange offer, which
    permitted employees and members of the Board of Directors to
    exchange all stock options granted with an exercise price per
    share equal to or greater than $9.00 for a common stock award.
    Ms. Lustenader participated in the Companys stock
    option exchange offer. On December 5, 2001, Ms. Lustenader
cancelled stock option grants for 98,000 shares of common stock at
various prices per share between $19.25 and $33.44. On December 6, 2001,
    Ms. Lustenader received 2,431 shares of common stock in
    connection with the stock option exchange offer and those shares
    of common stock had a value of $78,649 on that date.                                




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  EXHIBITS

| |  |  |      |  |  |                                                                                                                       
| |  |  | ---- |  |  | ----------------------------------------------------------------------------------------------------------------------
| |  |  | 99.1 |  |  | Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| |  |  |      |  |  |                                                                                                                       
| |  |  | 99.2 |  |  | Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b)  REPORTS ON FORM 8-K

| |  |  |    |  |  |                                                                                                                                                         
| |  |  | -- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | 1. |  |  | On February 27, 2003, the Company filed a report on
Form 8-K announcing the appointment of Arthur Taylor as its
Chief Financial Officer.                
| |  |  |    |  |  |                                                                                                                                                         
| |  |  | 2. |  |  | On March 14, 2003, the Company filed a report on Form
8-K announcing that it had initiated a reduction in force in
order to decrease operating expenses.

Note: Terayon, TeraComm, MiniPlex are registered trademarks and CherryPicker
and MainSail are the trademarks of Terayon Communication Systems, Inc. All
other trademarks are property of their respective owners.

44



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                   |                                     |                                                                  
|------------------ | ----------------------------------- | -----------------------------------------------------------------
|Date: May 15, 2003 | TERAYON COMMUNICATION SYSTEMS, INC.
|                   |                                     |                                                                  
|                   |                                     | By /s/ Arthur T. Taylor

Arthur T. Taylor
Chief Financial Officer

45



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##### Table of Contents






Certification:I, Zaki Rakib, Chief Executive Officer, certify that:1.       I have reviewed this quarterly report on Form 10-Q of TerayonCommunication Systems, Inc.;2.       Based on my knowledge, this quarterly 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 quarterly
report;3.       Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly report;4.       The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)
designed such disclosure controls and procedures 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 quarterly report is being
prepared;
b)
evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and
c)
presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5.       The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and                                                                                                                                        

6.       The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                   |  |     |  |                                                  
|------------------ |  | --- |  | -------------------------------------------------
|Date: May 15, 2003 |  | By: |  | /s/ Zaki Rakib
Zaki Rakib
Chief Executive Officer

46



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Certification:
I, Arthur T. Taylor, Chief Financial Officer, certify that:
1.       I have reviewed this quarterly report on Form 10-Q of Terayon
Communication Systems, Inc.;
2.       Based on my knowledge, this quarterly 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 quarterly
report;
3.       Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly
report;
4.       The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)
designed such disclosure controls and procedures 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 quarterly report is being
prepared;
b)
evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and
c)
presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;

5.       The registrants other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent function):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrants ability to
record, process, summarize and report financial data and have
identified for the registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |  |                                                                                                                                                                                                                                                                                               
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrants internal
controls; and                                                                                                                                        

6.       The registrants other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|                   |  |     |  |                                                               
|------------------ |  | --- |  | --------------------------------------------------------------
|Date: May 15, 2003 |  | By: |  | /s/ Arthur T. Taylor

Arthur T. Taylor
Chief Financial Officer

47



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Exhibit Index

| |  |  |      |  |  |                                                                                                                       
| |  |  | ---- |  |  | ----------------------------------------------------------------------------------------------------------------------
| |  |  | 99.1 |  |  | Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| |  |  |      |  |  |                                                                                                                       
| |  |  | 99.2 |  |  | Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002